A restaurant can be packed every night and still struggle financially. Knowing how much revenue comes through the door tells you something, but not nearly enough. You also need to know what it costs to operate and what obligations must be paid. Retirement portfolios deserve the same treatment. An account balance, or the age of the person who owns it, provides useful information, but neither tells us whether the resources are sufficient for the job ahead.
Age has traditionally played a large role in asset allocation. The logic is reasonable enough: as retirement approaches and then progresses, there is less time to recover from market losses, employment income has usually disappeared, and withdrawals make poor returns more consequential. These considerations help explain why conventional investment approaches often reduce stock exposure with age.
The difficulty comes when age moves from being one consideration to being the organizing principle for the entire portfolio. Retirement planning is ultimately concerned with financing a set of goals, and two households of the same age can be in remarkably different positions relative to those goals. A better starting point is to ask how well your financial resources cover the goals you are asking them to support. That comparison can be captured by using a funded ratio, and the How Much Do I Need to Retire workshop in the Retirement Researcher Academy walks through how to build one for your own numbers.
What Your Portfolio Has to Pay For
The funded ratio compares the present value of your retirement resources with the present value of your future financial goals. Those resources can include investment accounts, Social Security, pensions, annuities, and other assets available to support retirement. On the other side are your expected liabilities, which include future spending needs and other goals, including reserves for unexpected expenses and any legacy you intend to fund.
Because income and expenses occur at different points in the future, a proper funded-ratio calculation brings those future cash flows back to present values. This allows a pension received years from now and spending required years from now to be compared in today’s terms. The calculation depends on assumptions, particularly a conservative discount rate used to value future liabilities, so the result should be viewed as a planning measure rather than a guarantee that a retirement plan won’t fail. Changes in spending, inflation, interest rates, or other assumptions can change the result.
A funded ratio of 1.0, or 100%, indicates that assets equal the estimated value of liabilities under the assumptions being used. A ratio above 1.0 indicates a surplus, while a ratio below 1.0 identifies a shortfall.
The Same Age and Portfolio Can Hide Very Different Risks
The real value of the calculation isn’t the decimal point. It is the shift in perspective from asking how much money you have to asking how well that money finances what you hope to do.
Consider a 70-year-old with $2 million of investments, substantial Social Security benefits, a pension, and relatively modest spending. Now compare that household with another 70-year-old who also has $2 million but no pension, higher spending, and a greater dependence on portfolio withdrawals. Looking only at age and portfolio size makes them appear similar. Once future income and spending enter the calculation, the resemblance largely disappears. That difference has direct implications for investment risk.
This is also why the percentage of an investment account held in stocks can be misleading when viewed by itself. Social Security, pensions, annuities, reserves, and other resources are part of the household balance sheet even though they do not appear inside the brokerage account. Asset allocation makes more sense when those resources are considered alongside the spending obligations they are meant to finance.
More Funding Creates More Room for Risk
When resources comfortably exceed the amount needed to finance retirement goals, the portfolio has more room to absorb disappointing outcomes. A market decline could reduce future discretionary spending or the amount ultimately left to heirs without requiring a change in essential spending. An overfunded household may therefore have greater capacity to take investment risk while simultaneously having less need to take it. The portfolio can afford more volatility, but it does not need higher returns simply to make the retirement plan work.
That does not necessarily mean the retiree should invest aggressively. Risk tolerance still matters, and someone who is uncomfortable with market volatility has little reason to take more risk simply because the balance sheet permits it. The takeaway is that an overfunded household has more financial flexibility when deciding how much risk to accept.
Fully Funded Is Not the Same as Having a Cushion
A funded ratio around 100% presents a particularly important situation. The plan has enough resources to finance its projected goals under the assumptions being used, but there is little or no surplus available to absorb a disappointing investment outcome.
In that sense, a fully funded household may have the least capacity to take market risk because nearly every dollar of available resources is already committed to financing future goals. A significant market decline can therefore threaten spending that the portfolio was expected to support. This becomes particularly important around retirement, when withdrawals can magnify the damage caused by poor early returns through sequence-of-returns risk.
That does not necessarily mean eliminating stocks. Growth assets may still play a role in the broader plan, but without substantial surplus wealth, there is less capacity to expose the resources needed to finance retirement goals to market losses. This is why having “enough” and having substantial financial flexibility are not necessarily the same thing.
Underfunding Creates a Different Problem
When the funded ratio falls below 100%, planned goals exceed the resources available to finance them. At that point, there is no single investment response. A household focused on protecting essential income may seek to secure more of its required spending with reliable income while reconsidering spending or other goals. A household following a total-return approach may accept greater investment risk in an effort to improve the probability of closing the shortfall, recognizing that doing so also increases the possibility of an even worse outcome. The appropriate response depends partly on how the retiree weighs the consequences of reducing goals today against the possibility of worse outcomes later.
The funded ratio helps make that tradeoff visible. An investment portfolio cannot always solve a funding problem, and asking it to do so can create more risk precisely when there is less capacity to absorb a disappointing outcome. The funded ratio broadens the conversation beyond investment returns to include spending, reliable income, retirement timing, and the goals themselves.
Funded status is not the only measure of risk capacity. Two households with the same funded ratio may still differ because one has more reliable income, greater flexibility to reduce discretionary spending, or larger reserves for unexpected expenses. Each of those characteristics reduces the degree to which a market loss would threaten the household’s standard of living. The funded ratio therefore belongs within a broader assessment of how vulnerable retirement goals would be to investment losses.
Put Age in Its Proper Place
Age still matters. It influences longevity, the length of the withdrawal period, healthcare considerations, and the ability to recover from financial setbacks. It simply does not tell us enough on its own to determine an appropriate portfolio.
Funded status adds the missing context by showing how much financial margin exists between available resources and future goals. An overfunded household has greater capacity to absorb investment losses, even if it has little need to pursue additional risk. A fully funded household has less surplus available to absorb disappointing outcomes, while an underfunded household must weigh investment risk against other adjustments such as spending, retirement timing, or reliable income.
The funded ratio is not an asset-allocation formula, and it will not produce a single correct percentage to hold in stocks or bonds. Instead, it provides context for deciding how much investment risk the plan can reasonably bear. Two people who are both 70 years old may therefore arrive at very different portfolios for perfectly sensible reasons. Their age tells us where they are on the calendar. Their funded status tells us much more about the financial problem their portfolios need to solve.
Want to learn more? Listen to Episode 239 of the Retire With Style Podcast.
