The Challenge of Extending Retirement Portfolios
The growing population of retirees who may spend a third or more of their lifespan in their retirement years is creating new challenges for retirement plan sponsors. Plan sponsors today must select investments that deliver a consistently high level of
income to meet the current needs of the expanding crop of baby boom generation retirees, but also generate portfolio
growth to ensure that the needs of retirees are met three decades in the future, and to offset the effects of
inflation in the process.
Many plans are turning to increased allocations to real estate, including REITs, for solutions to these problems. The requirement that REITs pass at least 90 percent of their taxable income through to shareholders in the form of dividends makes them a strong income generating investment. However, as stocks, also provide the opportunity for capital appreciation. This combination of investment characteristics makes them effective in extending the lives of retirement portfolios, as the following chart illustrates.
Source: © 2007 Morningstar
The chart shows how long three different retirement portfolios with different allocation strategies may last for a 65-year-old retiree who withdraws a given inflation-adjusted percentage of the portfolio each year.
For example, at a 5 percent annual withdrawal level, a portfolio consisting of 45 percent stocks (represented by the S&P 500), 45 percent bonds (represented by the 20-year U.S. government bond) and 10 percent cash (represented by the 30-day U.S. Treasury bill) could last until the investor is 86 years old.
Reducing the stock and bond allocations to 40 percent each and adding a 10 percent allocation to REITs (represented by the FTSE NAREIT Equity REIT Index), however, could extend the life of the portfolio another two years. Reducing the stock and bond allocations to 35 percent each and adding a 20 percent allocation to REITs could extend the portfolio another three years, until the retiree is 91 years old.