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Why Every Retirement Portfolio Needs Growth Stocks

I’m going to start by sharing a dirty little secret of the financial planning profession: Most financial planning rules are dumbed down to the point of being unusable. In fact, I would argue that they’re downright harmful, as they potentially deprive investors of desperately-needed growth in retirement.

Financial GrowthLet’s start with perhaps the biggest offender of all: The rule that says your allocation to stocks should equal 100 minus your age. So, if you’re 70 years old, you should have 30% allocated to stocks and 70% allocated to cash and bonds.

Allowing for longer lifespans, I’ve seen variations on this theme that suggest using 120 minus your age as opposed to 100.

But it doesn’t matter. It’s still a terrible rule that completely ignores market valuations. The relative expensiveness or cheapness of stocks and bonds is not considered at all, which is ludicrous and flies in the face basic common sense.

The Problem With Retirement “Rules”

If stocks were cheap and bond expensive, you could make a case for massively overweighting your allocation to stocks, whether you’re 18 years old or 80. And the flipside would be equally true; if bonds were cheap relative to stocks (as they were in the late 1990s), investors of all ages should overweight bonds and underweight stocks.

But that said, as incomplete as this rule is, there is a small but important nugget of truth to it. No matter you age, you should always have some portion of your portfolio allocated to growth investments. By relying exclusively on income investments, you run the risk of falling behind due to inflation. And if you have portfolio goals that exceed your own lifespan — such as leaving a nest egg for a younger spouse or children — investing for growth becomes all the more important.

This relates to another often misused rule: the 4% Rule. The idea here is that 4% is the highest “safe” withdrawal rate that will survive a 30-year retirement without depleting your portfolio. Under the rule, which became standard planning practice in the 1990s, you take a 4% withdrawal in the year of retirement and adjust the figure up by the rate of inflation.

There’s one big problem here. The model assumed a 50/50 mix of stocks and bonds, and bond yields were a lot higher in the 1990s. At current prices, bonds cannot be expected to generate 4% annual returns over the next 30 years. So, withdrawals of 4% are going to eat into your principle pretty quickly and leave you at risk of depleting your portfolio in retirement.

So, what is an investor to do?

How to Secure Your Retirement

To start, it pays to maintain a flexible attitude concerning income. When it comes to paying your bills in retirement, it doesn’t really matter if you use an “income” dollar paid via dividends or interest or whether you use a “capital gains” dollar from the sale of stock. At the end of the day, a dollar is a dollar.

Your decision here will have a lot to do with what the market is offering. If you can’t realistically pay your bills given the yields on offer, then creating “synthetic dividends” by selling stock might be your only option.

As a general rule, I prefer to use income dollars for personal expenses to avoid selling shares. In a prolonged bear market, selling your shares can be akin to a farmer eating his seed capital. Shares sold at depressed prices are shares that won’t grow in value when the market turns around.

But this doesn’t mean I buy overpriced income securities just for the income. In the end, I invest where I see the most value, and if that means a larger allocation that usual to growth stocks, then so be it.

Today, you can make a strong case for eliminating bonds from a portfolio altogether. With yields as low as they are, they offer virtually nothing in the way of return. A diversified portfolio of dividend-paying stocks, REITs or even MLPs introduces more portfolio volatility, but it also gives you a better probability for generating returns high enough to meet your retirement goals.

But even here, income stocks are expensive relative to growth stocks due to investors reaching for yield. For a typical investor nearing retirement, a portfolio along the lines of 50% income stocks, 40% growth stocks and 10% cash might give the best odds of meeting most of your retirement expenses via current income, but still allowing you the luxury to take synthetic dividends via sales as need arises.

Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.

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