GMO’s Inker: Don’t Outlive Your Retirement Money

And many people think they can do their own their investing.

Yes. Investing isn't brain surgery—you don't need 17 years of professional training to do it. However, when people make their own investment decisions, an awful lot of them make really, really bad ones. Schools don't teach this stuff; they don't teach it in the workplace. So people aren't equipped with the tools for it. And the emotional aspect [of investing] absolutely enters into it too.

Do advisors do a much better job?

The problem we see in a lot of the conversations advisors have with clients is that they want to make saving for retirement a psychological issue. They talk about how their psychological profile differs from that of other people, and therefore their willingness to take risk differs from the next guy.

What's the matter with that?

It's not a particularly useful way of thinking about the problem. The reality is that if your client is risk-averse, the response that leads to better outcomes in retirement is not: "Put more money in bonds and less in stocks." It's: "Save more." The question is: "How likely is that portfolio going to give you the wealth you need to retire on to support the consumption you want?" That has nothing to do with psychological risk-aversion. But it's got a ton to do with: "How long do I have before drawdowns really matter?"

Are you advocating just rebalancing during retirement?

We go a step further. Take this, for example: "Wow! Stocks just fell 10%. That probably means they're 9% or l0% cheaper. A 50:50 allocation was the right place to be before; but now maybe it should be 53:47 or 55:45." Dynamic allocation is: Sell what's been doing well; buy what's been doing badly. Move your portfolio not just back to a static allocation, but move it beyond that so you're tilting it toward the better opportunities at any given point.

When is the best time to employ dynamic allocation?

Even if you've got only a couple of years to retirement, having the right asset allocation is a big deal. We would argue that today your allocation should probably be less stock-heavy than normal—certainly less heavy in U.S. stocks because they're not priced to give anything like a normal return, and they're risky and volatile. They can still do nasty things to your portfolio. Therefore, you need to get paid for taking that risk and for the ugliness that equities embody. The less you're getting paid for that ugliness, the less [equities] you should own. This is true for a 63-year-old or a 43-year-old.

What, then, are the opportunities in today's market?

If you're going to buy equities, we think the ones to buy, generally, are outside the U.S. European value stocks and emerging [markets] stocks look significantly better than U.S. stocks. But if you're going to own U.S. stocks, the ones to own are the big, stable, high-quality blue chips rather than small cap, which to us look dangerously overpriced. There's nothing cheap enough, though, to pound the table and say, "Wow! This is going to be a wonderful return!"

What about bonds?

On the fixed-income side, there isn't a lot you can do. But Treasury Inflation-Protected Securities—TIPS—make a fair bit of sense because in retirement, what you care about is real purchase income, and bonds don't protect against inflation.

What good or ill has the Federal Reserve's policy of quantitative easing brought to pre-retirees and retirees?

The biggest problem for investors is that, by pushing down the yields so much, it pushed down the yields on bonds, which retirees need. And it pushed up the prices of stocks, which is the other way retirees can generate returns.

Anything upbeat about that?

The good news about bond yields going down and bond prices going up is that you got better returns over the last five years. So you're in better shape if you'd done all your savings before five years ago. If you're five years into retirement, your portfolio has probably gone up more than you were expecting. The bad news is that the prospective returns are worse.

Any other thoughts about equities?

Historically, whenever valuations have been as high as they are now, the return on stocks has been pretty low. We have no reason to believe that this time will be any different. The Federal Reserve has said that a goal of quantitative easing was to cause asset prices to go up—and they did. So if they're going to take credit for that, they've got to take the blame that this means prospective returns are worse.

What else should be kept in mind when allocating retirement portfolios?

At the margin, you probably want to own fewer stocks than normal and really make sure that your stock allocation is biased toward those few areas where you're getting paid for taking stock risk. My advice is to try to up your savings a little. But just because you've retired, that doesn't mean you should be putting all your money in bonds. Again, a 75-year-old needs to protect against inflation. And very low-risk [products], like bonds and CDs, don't do that very well.

Are you next in line to succeed Jeremy Grantham? I imagine that he has a succession plan in place.

Jeremy Grantham is an utterly unique kind of talent in the investment world, and I'm not attempting to be him. As a firm, we're not attempting to recreate him. We're attempting to make use of him for as long as he's willing to come to work. We're attempting to make sure that we're doing whatever we can to manage our clients' money well while he's here and the day he can no longer come to work.