Saving just got a lot more complicated

Investment adviser Brett Danko has a warning for a New Jersey couple in their early 50s who've sought his help about how to plan for retirement: Either allocate more savings to stocks than fixed income, or risk having to scrimp in old age. The couple, ages 51 and 53, have about 80% of their $1 million retirement savings stashed in government bonds yielding just 1% to 2%; the rest is in stocks. They'll need to double their nest egg if they want to retire at 67 and have the $80,000 a year they're hoping to draw from their investments, says Mr. Danko, an adviser at Main Street Financial Solutions in Pennington, N.J. “Their risk tolerance is very low, and I don't want them staring at the ceiling at night and worrying,” he says. “But if they don't change how they're allocating savings, they'll be worrying in their 80s, when they may start running out of money.” There used to be a simple rule for retirement savers: The percentage of bonds in your portfolio should match your age. So a 60-year-old would have 60% of her retirement stake in bonds. The idea was that, as you aged, you should use bonds — which offer dependable payouts and rarely default — to shield more of your money from the wild swings of the stock market, even if that meant sacrificing potential investment gains. But today, in an era of ultralow interest rates and longer life spans, that one-size-fits-all approach won't work for many people nearing retirement. NO CONSENSUS No one really knows what to replace it with. There's no consensus among professionals about how baby boomers should allocate their savings. That's apparent in the surprisingly wide variations in the allocations in target-date mutual funds, which automatically reset the mix of stocks, bonds and cash, depending on what year investors plan to stop working. At the end of 2014, equity allocations in 54 target funds aimed at people retiring in 2015 ranged from 8% to 68%, Morningstar Inc. found. VARIABLES If you're devising your own allocation, you've got to consider a lot of variables — including life expectancy, health and other sources of income — and do a lot of guessing. People who keep working into their 70s, or retire at 62 but have a pension that provides guaranteed lifetime income, can afford to keep more money in stocks. A 65-year-old in bad health won't need to increase her savings as much as someone who's 65 and might live to 105, says Ann Kaplan, founder of Circle Wealth Management, a New York investment advisory firm. “There's no cookie-cutter solution,” she says. Julie Jason, head of the investment management practice Jackson, Grant Investment Advisers in Stamford, Conn., tells clients to spend a lot of time calculating their current annual expenses and what they expect to need in the future to cover housing, food, travel, medical and other costs. She calls this “demand-based” retirement planning. “The people most at risk are those who don't know how much they're spending each month and don't know their needs vs. wants,” she says. Once people have a clear idea of their expenses, they can better understand whether they'll be able to ride out down years in the equity markets. “One person's flexibility is another's fixed cost,” says Anthony Webb, senior research economist at the Center for Retirement Research at Boston College. “Is a trip to Paris every year a luxury you can cut out? It depends on who you are.” DICEY TIME Now is a particularly dicey time to be loading up on bonds. If interest rates rise by just 1 or 2 percentage points over the next few years, there will be big losses in the value of some bond portfolios, Main Street's Mr. Danko says. An investor who recently bought a 10-year Treasury note yielding 2% would see its value decline almost 9% if interest rates rise to 4% in the next five years. “I look at the risk-return and don't find it in long-term bonds right now,” says Mr. Danko, who's telling clients to stick to short-term, which take less of a hit than longer-term bonds when rates rise. John Sweeney, executive vice president for retirement planning and strategy at Fidelity Investments, advises those in their 50s and 60s to take more risks than they might if interest rates were higher. “We're asking folks to make sure they aren't too conservative at a time when interest rates are so low,” he says. “They need some portion of their savings growing, because they don't know if they're going to be running a sprint or a marathon as they age — and have to plan for the marathon.” Many advisers caution against trying to boost income by investing in riskier issues, such as junk bonds. Arden Rodgers, who heads investment adviser Arbus Capital Management in New York, has been counseling a retired couple in their mid-50s who have about $5 million in savings. When he first began working with them a few years ago, about 75% of their savings was in government bonds, and they worried about the low interest these bonds were yielding. “Like a lot of retirees, they wanted to live entirely off their interest and dividends and not touch their principal,” Mr. Rodgers says. “It's a psychological issue for a lot of folks who've been savers all their lives.” To get more income, the couple considered buying riskier, high-yield bonds, but Mr. Rodgers advised that if they wanted to add risk to their portfolio in hopes of higher returns, they should allocate more to stocks. “Don't make your bond portfolio more risky, because that's where you want stability,” Mr. Rodgers told them. They've gradually reallocated their savings so they now hold only 40% in fixed income and 60% in stocks. LADDERING Wade Pfau, a professor of retirement income at the American College in Bryn Mawr, Pa., recommends building a portfolio of bonds that come due at different times and holding them to maturity. That gives you cash coming in at regular intervals, which lowers the chance that you'd have to sell investments during a market slump to cover unexpected expenses. It also allows you to reinvest money at higher yields if rates are rising. “They don't know if they're going to be running a sprint or a marathon as they age — and have to plan for the marathon” High-quality dividend-paying stocks can also be an alternative to low-yielding bonds. Eleven of the 30 stocks in the Dow Jones industrial average yielded more than 3% as of March 12. Annuities offer the security of guaranteed lifetime income, letting people take more risks with the rest of their portfolio. Annuities are priced based on prevailing interest rates, though, and low rates make them more expensive. Olivia Mitchell, a professor at the Wharton School at the University of Pennsylvania, says products such as longevity annuities, which defer income down the road — typically to when an investor turns 85 — can still be worth it, because they provide peace of mind for people scared of running out of money. New York Life Insurance says a 65-year-old couple could spend $100,000 on an immediate annuity and get $437 a month for the rest of both of their lives, but if they deferred taking the payments for 20 years until turning 85 they could get $2,682 a month for the rest of both of their lives. DELAY SOCIAL SECURITY About a quarter of people currently in their 60s receive pension income, says the Employee Benefit Research Institute, though that number will decline with future generations, because companies have largely abandoned pensions. One of the best ways to increase a dependable income stream is to delay taking Social Security, says Michael Finke, a professor in the department of personal financial planning at Texas Tech University. He says it's like buying “a supercheap annuity from the federal government.” Monthly benefits can be 76% higher for people who wait until age 70 instead of starting at 62, the earliest allowable age. Fewer than 15% of people currently receiving Social Security waited until age 70. People who need to save more, says Judith Ward, senior financial planner at T. Rowe Price, should consider trying to work longer, which lets them accumulate more savings and delay drawing down their nest egg. “That is not always the answer they want,” she says. People can get creative: Her mother took in a tenant, a family friend who needed a place to stay during college. “It was a nice little income stream for a few years,” Ms. Ward says. More broadly, she says, investors can put too much emphasis on their asset mix rather than looking at the bigger-picture questions of how much they're saving before retirement and how much they'll spend once they stop working. “The allocation can help on the margin,” she says, “but primarily it is the behavior that is really, really important.”