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By Kevin McDevitt, CFA | 06-19-2014 02:00 PM

Inker: Rethink the Retirement Glide Path

GMO's Ben Inker says retirement portfolios should broaden the scope beyond solely age-based stock and bond allocations and evaluate the risk/return profile of equities as well as how much money is needed for retirement.

Kevin McDevitt: Hi, I'm Kevin McDevitt. I'm here at the Morningstar Investment Conference with Ben Inker from GMO.

Ben, thanks for joining us.

Ben Inker: Thanks for having me.

McDevitt: I want to ask you about the research you've done on saving for retirement, and in particular, the evaluation you did of the traditional fixed asset-allocation approach or the traditional glide-path approach. What are the potential drawbacks of those two asset-allocation methodologies?

Inker: I think the biggest concern we have about the traditional way putting together a glide path is it's assuming that you're always getting paid the same amount for taking risk. It's assuming that stocks are always at fair value and bonds are always at fair value.

And one thing that's pretty clear is valuations matter, and we think it's not reasonable to say, "I'm 25 years old; I can afford to take a lot of risk." That's fine. But if you're not getting paid for taking a risk, don't take it. And by the same token, even if you're a 75-year-old well into retirement, if bond yields are really low, and stocks are cheap, you should own some stocks.

I think the most important problem is that they don't respect the fact that valuations change, and as valuations change your portfolio should change, as well.

McDevitt: As an alternative, you've proposed the expected shortfall minimization framework. Why do you think this is a better option? And again, you kind of alluded to that with your last answer, but what are some of the advantages of that approach?

Inker: I think that's actually a slightly broader issue than the question of whether to be dynamic or not. The nice thing about expected shortfall is it's asking what is the question I'm trying to solve, and it's saying the problem I'm trying to solve is how do I avoid running out of money in retirement. And if you're putting together your portfolio with that in mind, we think you can get better outcomes. And among other things, what that says is there is no magic amount of equities you should own given your age. It's a combination of your age, how much money you have, how much money you need, and how much money you're getting paid for taking equity risk.

And so, we think with taking all of that into consideration, you can put together a better portfolio than simply assuming that your age is the only thing that should cause your weighting in equities to change.

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