What do you do when your retirement portfolio comes up short of your retirement needs?

This is the question that Sanjiv Das, Seoyoung Kim and Meir Statman attempt to answer in their 2014 paper Coming Up Short: Managing Underfunded Portfolios in a LDI-ES Framework.  With the Baby Boomers entering retirement after two major bear markets in the span of 15 years—and with bond yields still near historic lows—many investors find themselves with portfolios that cannot be realistically expected to fund their retirement needs.  The same goes for pension plans.

The authors found that individual investors had four basic options:

  1. Make a new cash infusion (i.e. save and invest more)
  2. Reduce your targeted retirement wealth (i.e. accept a lower standard of living in retirement)
  3. Increase your shortfall tolerance (i.e. take more risk in the hope of catching up with higher returns)
  4. Postpone your retirement date

Of all of these options, the first—saving and investing more—is a lot more feasible earlier in the planning process.  If you find that you’re running behind in your retirement planning goals at age 30, you have three or four decades to remedy the situation.  But if you’re already near retirement, it’s probably not realistic to plug the gap with new cash infusions.  The dollars needed to plug the gap simply get too big to be feasible.  And this becomes more true the more risk averse you are, particularly in today’s environment of low bond yields.  The lower your expected return (due to the allocation of low-yielding bonds), the larger the cash infusion you need to meet your retirement goals.

Not surprisingly, the authors found cash infusions to be the least effective of the four remediation options.

What are the practical takeaways here?  To start, it’s far easier to correct funding shortfalls earlier in the planning process.  When time is on your side, saving more and altering your asset allocation are credible ways to get your retirement planning back on track.  But the longer you wait to correct the problem—or the later in the planning time horizon you suffer a major setback due to excessive risk taking—the more unpalatable your options become.  Your choices are essentially to work longer or accept a more modest retirement.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.