# How to Invest Conservatively for Retirement

If you are retiring soon, you might wonder **how conservative to invest.** That is, what asset allocation should you have given sequence of return risk?

Current stock market valuations are high, which indicates future returns for the midterm are expected to be lower than average.

If you are retiring in the next 5-10 years, you need to mitigate Sequence of Return Risk by de-risking.

Let’s look at how you might invest given known risks for soon-to-be-retired folks face.

## Define Asset Allocation

This is for moderately advanced investors. If you need a definition for Sequence of Return Risk or for Asset Allocation please click the links.

In brief, if you are drawing down on a portfolio while it has negative equity returns, there is a good chance of running out of assets in your retirement. One way to prevent Sequence of Return Risk is by making your asset allocation more conservative.

## Historical 50/50 Asset Allocation

Let’s look at recent history and see how a 50/50 asset allocation performs. If you are going conservative—de-risking—then a 50/50 portfolio is *a good place to start*. We can compare this to 0% and 100% equities, as well as 30/70 and 70/30 portfolios.

Figure 1 is busy but really informative.

See on the top of the figure with returns since 2000. In addition, see the annualized returns, standard deviations, the worst 3-, 6-, and 12-month returns, and the worst draw downs.

We start with 0% equities (100% treasury bills) on the left and end with 100% equities (S&P 500) all the way on the right. In the middle, asset allocations are **30/70, 50/50, and 70/30.**

**This is a great way to study expected future comparative returns of a 50/50 portfolio, and less and more aggressive asset allocations.** Also, most of us can remember this time period well, so **recency bias** is strong given the two large recessions in this short time period.

### Years with Negative Returns since 2000

Note that there are 5 of 18 years when equities had negative returns.

A 100% treasury portfolio avoided all of those negative years, but did have a year (2013) where it had negative returns.

Our least aggressive asset allocation (30/70) avoided 2 of the 5 negative years, but both the 50/50 and the 70/30 suffered from all 5 of the years with negative returns.

### Annualized Return

The annualized return (since 1970) for a 50/50 portfolio is 9.1%. This compares to 9.7% for a 70/30 portfolio and 8.5% for a 30/70 portfolio. Are you surprised that the difference isn’t greater?

### Worst 3-, 6-, and 12-Month Return

You can look at these numbers yourself to compare the different asset allocations. What is interesting to note here is how similar the worth 6- and 12-month returns are. That is, after a really bad 6 months, on average, it doesn’t get much worse from there.

In fact, look now at the bottom of the figure next. The worst drawdown is the percentage decrease from the top of the market to the bottom. Again, after a really bad 6 months, the market does not go down much more thereafter. Maybe that is a consideration as to when to be greedy (when others are fearful) during corrections?

### Worst 36- and 60-Month Annualized Returns

Finally, note the worst 3- and 5- year periods.

Since 1970, a 50/50 portfolio had a 3-year return of -6.8% and a 5-year return of -2.1%. Note how these returns compare to the other listed portfolios.

## Modern Portfolio and 50/50 Asset Allocation

The historical numbers above are based upon the S&P 500 and treasury bonds. History is nice to understand, lest we repeat it.

Today’s 50/50 asset allocation likely includes the **modern portfolio theory**. There are many ways to skin a cat, and many ways to allocate your assets. Let’s look at one version of the modern portfolio and see what a conservative 50/50 asset allocation looks like.

Figure 2 (A Modern Portfolio with a conservative 50/50 Asset Allocation)

First off, note the annual return of** 6.9%** and standard deviation of 8.8% in the bottom right corner of figure 1. This compares to **9.1%** and **9.3%**, respectively, from our historical results above.

Future expected returns are lower for a modern 50/50 portfolio compared to historical returns. Note, however, that when you take the standard deviation into account—that is, when you *risk-adjust the returns*—the annual returns are not as disparate.

Instead of just being S&P 500 and treasure bonds, this version of a modern portfolio includes:

- 50% Equities (US, International, Emerging, Real Estate)
- 50% Fixed Income (US bonds, International bonds, Cash)

We can further break down the modern portfolio.

## Modern Portfolio for a Conservative Asset Allocation

In figure 3, US equities are further broken down into Large Growth and Large Value, will a small addition of Mid Cap and Small Cap.

Bonds in this conservative 50/50 asset allocation include 20% Corporate, 10% Government, 4% High Yield, and 1% Municipal. This is not an example of what I would do, but it is one way to skin the asset allocation cat. Some might consider Bond Alternatives.

Let’s take one final quick look at the equity portion before we summarize.

## The Equity Portion of a Conservative 50/50 Asset Allocation

Above, you can see the breakdown of the equity-only portion of a conservative 50/50 asset allocation. These number sum to 100%.

On the top, the large caps are divided into Value, Bend, and Growth valuations. In this model, mid-caps and small-caps make up a much smaller proportion of the equities than large-cap, and the valuation distribution is equal.

The circle in the middle is the weighted average of the model.

## Summary: A Conservative Asset Allocation

If you are going to be drawing down on your portfolio in the next 5-10 years, you need to pay attention to known Risks.

Above, we see the historical returns of a 50/50 asset allocation and compare them to slightly more or less aggressive asset allocations. You can see the worst-case scenarios.

In addition, I also demonstrate a version of a modern portfolio to show how you can portion asset allocation. There are many different ways to allocate your portfolio, and you can be as simple (Bogleheads 3-Fund Portfolio) or as complicated (Merriman’s Ultimate Buy and Hold Portfolio) as you wish.

Sequence of Return Risk is inevitable when withdrawing from retirement accounts. Plan your pre-retirement glidepath and “go conservative.” With a conservative asset allocation, you can be in the game for the long haul.

Excellent analysis. I am retired +3yrs currently living strictly on rental income. We are allowing my stock/bond portfolio to continue to grow until 59.5, since I am now entering the 5yr lead up. I shifted to a 50/50 balance last summer. (Boy, am I glad that I did!) Like a “bad timing” investor, I confess to doing three small rebalances during this COVID period, so I am actually up for the year. Our plan is to ride out the 50/50 until our initial draw downs in four more years, and gradually shift back to 60/40 during our post-ten-years. Eventually shifting back towards a 70/30 Smile glide path as we age. While this is likely way too conservative in conjunction with our high rental income (which we actually live comfortably on and could allow us greater risk taking on the stock/bond side), I do sleep very well at night with the conservative approach! Well done (again) on the article.

Given that having a mortgage is akin to holding bonds–and could even be considered to represent two rungs of the bond portion of an asset allocation–would a new mortgage (after years of renting) be considered “de-risking” and help to prevent SORR? I ask this because we’re a military family and have been unable to own a home for the past 10 years due to frequent moves every 1-2 years. I plan to purchase a home when I retire from the military in 5 years. Should I look at this purchase as something similar to shifting to bonds, and would it suffice for meeting the intent of a more conservative AA as described in this post? (We’re currently 20% in bonds on a roughly $1.2M portfolio.)

No specific advice, of course, but is a mortgage compared to renting considered “de-risking?” I’ve thought about that and even wrote a blog that says it is ( https://www.fiphysician.com/mortgage-and-sequence-of-return-risk/ ).

In a way, mortgage vs renting in retirement is more like an inflation hedge, as rent will go up over time but a mortgage won’t. Since they are both necessary costs, and likely you will be able to pay yours out of a pension, I think a mortgage will prevent SORR as long as it doesn’t increase your withdrawal rate.

Thanks, doc. Copy and appreciate the info.