If you're retiring, think long-term

The stock market's recent volatility has put new focus on a key question older investors have been asking themselves since the 2008 crash: What is the correct retirement portfolio equity exposure for investors close to retirement, or who already are retired?

The percentage of U.S. households willing to take "above-average or substantial risk" to meet their financial goals has plunged, according to survey data from the Investment Company Institute. The decline has been sharp across all age groups, but is especially dramatic among older baby boomers.

The instinct to protect assets from market risk is understandable. Still, it's just as important to protect yourself from longevity risk. A retirement date is the starting point for a period that might last 30 years or more, and equities must be part of the mix to produce the growth necessary to meet your long-term needs.

"Your framework for thinking about this should be long-term," says Stuart Ritter, a financial planner at T. Rowe Price. "You need to balance two risks -- short-term volatility against long-term risk that inflation will erode your assets."

T. Rowe Price advises retirees at age 65 to keep 55 percent of their money in equities, 35 percent in bonds and 10 percent in cash. But expert opinion on this is all over the map. For example, target date funds -- which aim to reduce equity exposure as retirement approaches -- take widely varying approaches to stocks near retirement. A survey of target date funds by the Putnam Institute found that retirement date equity allocations ranged from 65 percent to just 35 percent. Meanwhile, Putnam's own experts reached a much more conservative conclusion -- that retirees should have no more than 25 percent of their money in stocks.

So, what's the correct equity allocation for older investors? My answer: As little as possible, while maintaining high confidence that you can meet your retirement goals. Trouble is, the only way to maintain that confidence is by taking a step too many of us avoid: creating a serious retirement plan.

In most cases, I advocate doing this with the help of a fee-only planner. A good plan starts with a credible estimate of spending needs. This should be balanced against income you can count on from Social Security, pensions or perhaps the future purchase of an income annuity. Finally, you back into an equity allocation for your portfolio that provides enough growth to fill in the gaps but exposes you to as little risk as possible.

A good planner can help not only with the spending and income needs, but also by running "what-if" scenarios for you that take into account varying market performance and outcomes over time. The result should be a plan that gives you high confidence of reaching your goals.

Investors who've done this are far less likely to react emotionally to market volatility. "Our clients who just made the jump into retirement are somewhat uneasy and disappointed, but no one is running for the hills yet," says Chip Workman, a registered investment adviser based in Cincinnati.

Workman says most of his clients near retirement have anywhere from 40 to 60 percent of their portfolios in equities.

"We always try to focus on their specific tolerance for risk and their goals, and find the magic area in between how much risk they can tolerate to meet their goals," he says. We also try to get them to refocus on the idea that it's not about decisions you make today at retirement, but what might be a 30-year retirement. We get them to reflect on everything that has happened in the world and the markets over their lifetimes, and see that they're likely to experience these things again."

Mark Miller's Retire Smart column is carried on Tribune Media Services.