Why an Overly Conservative Retirement Portfolio Can Increase the Odds of Running Out of Money

A study published in the Journal of Financial Planning found that the strategy many retirees view as safest — piling into bonds and cash — is often the one most likely to leave them short of money.

That calculation changes when retirement savings must last 25 to 30 years while also absorbing higher health care costs and yearly inflation.

Bond-heavy portfolios can struggle over three decades of withdrawals

The well-known 4% withdrawal rule, based on William Bengen’s 1994 research for the Journal of Financial Planning, assumes a portfolio split roughly evenly between stocks and fixed income over a 30-year period.

According to Fidelity, retirees who lean too far toward bonds give up the growth potential that helps make that withdrawal rate workable.

Morningstar’s State of Retirement Income report places the safe initial withdrawal rate for retirees at 3.9% of total assets, already below the traditional 4% rule and still based on a portfolio with a meaningful stock allocation.

The Motley Fool warned that retirees whose portfolios are weighted more heavily toward bonds than a balanced 50/50 mix may not be able to sustain a 4% starting withdrawal rate.

Financial advisors who once urged clients to sharply reduce stock exposure at retirement now often recommend keeping a much larger equity stake, with many planners suggesting 40% to 80% in stocks to help provide income while reducing the impact of inflation and longevity risk, CNBC reported.

Retirees whose basic living expenses are already covered by Social Security or a pension have more flexibility to keep equities working inside the portfolio.

Why planners have moved away from the old conservative formula

The traditional guidance for new retirees was to cut stock exposure to about 30% of a portfolio once work ended. That approach was designed for a time when retirement was expected to last only 12 to 15 years.

Cheri Belski, head of investment management solutions at LPL Financial, told CNBC that holding more equities in retirement marks a major shift from older planning assumptions.

Belski said there is no universal allocation that works for everyone, since the right mix depends on account age, risk tolerance, income, assets, spending needs and taxes.

Target-date retirement funds show how practice has changed. Vanguard’s funds, for example, continue lowering equity exposure for 10 to 20 years after the target retirement date, but they never eliminate stocks completely, Belski noted.

Matt Gentzkow, managing director and wealth advisor at Coastal Bridge Advisors, told CNBC that retirees who plan to leave money to heirs effectively extend their investing timeline and may justify a more growth-focused allocation.

Belski added that the issue becomes especially important for retirees whose savings must last 30 years or more.

Inflation and medical costs make the challenge worse

Conservative portfolios are more vulnerable over long retirements because two forces steadily work against fixed-income returns every year: inflation and rising health care costs.

Inflation doesn't destroy a portfolio overnight; it erodes it slowly.

Chandler Riggs, a financial consultant and vice president at Fidelity Investments, told Kiplinger that inflation gradually chips away at retirement purchasing power over time.

Even when savings look stable on paper, each dollar buys less if the portfolio fails to keep up with inflation.

Riggs also noted in the same Kiplinger interview that sequence-of-returns risk can magnify the danger. When retirees withdraw money from a declining portfolio, they permanently lock in losses, reducing the balance to a level that may never fully recover.

National health spending is projected to rise 5.4% annually through 2034, outpacing expected GDP growth of 4.1%, according to the Centers for Medicare and Medicaid Services (CMS).

Fidelity says the average retired couple will need about $371,000 after tax to cover lifetime medical expenses, not including long-term care.

The comparison retirees should make before settling on an allocation

Belski advised retirees to compare their portfolios with the income they will need across decades of withdrawals, because that exercise shows how conservative allocations stack up against the drag of inflation and medical costs over time.

Delaying that comparison too long can mean discovering a shortfall only after modest returns have already fallen behind rising expenses.

Christine Benz, Morningstar’s director of personal finance and retirement planning, told CNBC that pairing stock exposure with a cash reserve covering one to two years of expenses can help retirees handle market declines without being forced to sell at low prices.

Fidelity found that the most important figure for retirees is the gap between their current allocation and the return needed to stay ahead of inflation.