Stocks vs. Bonds and Retirement Spending

For retirees in globally diversified stock and bond portfolios, the ratio of stocks and bonds they choose to hold will determine the vast majority of their return as investors. Stock returns are less certain and thus provide higher returns over time. Bond returns are less variable and therefore offer a lower return.

It makes sense that how much you put in one of these buckets versus the other would have a big impact on the return you receive as an investor. But what is less obvious is how it impacts a financial plan and how much people can plan to spend in retirement.

When we build financial plans, we can’t just assume average returns. We have to account for the unpredictability of returns and the chance we could have bad luck. Stock returns are much more variable than bond returns, which means a much wider range of potential investment outcomes.

Though over time you expect to be rewarded for this in the form of higher returns, it isn’t a lock. This can really anchor retirement spending plans, which must account for the possibility of bad portfolio returns.

When building financial plans, it is often the case that increasing the stock allocation of a portfolio from 50% to 60% or even 70% doesn’t increase planned ongoing spending as much as people would expect. You simply can’t bank on good or even average stock returns showing up until they do, at which point you can make an adjustment.

Though a higher stock allocation may not result in much higher planned spending on the front-end of retirement, there is a much higher likelihood that spending is able to be increased if the extremely bad returns we anticipate in our planning process don’t show up. Because of this greater potential for spending increases, a plan funded by a higher stock allocation will likely end up spending more if stock returns aren’t downright terrible; we just can’t plan on that in advance.

Though this is often the way the mix of stocks and bonds impacts retirement spending, this is by no means the case for all retirees. Depending on the specific plan and the timing of spending goals, the tradeoffs between owning more stocks and owning more bonds may be entirely different. If you don’t know the impact your specific mix of stocks and bonds will have on your financial plans, you may want to talk to a financial planner.

Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.