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Why Taking Risk In Retirement Just Makes Sense


Did you use the terms "risk," "retirement," and "just makes sense" all in the same sentence?

I think you might have lost your mind. 

Well as it turns out, neither I, nor many others have lost their mind on the notion that you may actually fare better by increasing your commitment to stocks gradually through your retirement years.  

Confused yet?  We thought so, let me explain:

As it turns out, the most problematic "time zone"  for retired investors tends to come in the early years immediately after retirement. In the parlance of investment decision making, this problem is grounded in what's known as sequence risk, the potential for the early years of your retirement to be the worst years in the market. (Think, "what if I had retired in 2007-2008?")  Obviously, the decline in market values would not have been a good way to kick off the retirement party now would it. 

No, it would not have. 

What research shows is that there are more or less, three core strategies that one can consider when looking at retirement as it relates to the "how much money should I invest/keep invested in stocks?"

  • Own more stocks now and less as time goes on
  • Own the same amount of stocks now and tomorrow (this works better than the first one)
  • Own less stocks now and more over time (this actually works the best)

So this takes us back to the fact that if you had 70% of your portfolio in stocks just prior to and at retirement, cutting that back to let's say 40% for five or six years might not be a bad idea. With the understanding of course that at some point shortly after that fifth or sixth year, we're going to move that 40% to 45%, then 47% then 50% and so on.  Can you "cap out" at some point?  The research doesn't really say, but I'd suppose that you could, you might get back to your original 70% and stand pat.

So Why Does This Work?

I'd guess that there's a substantive number of mathematical reasons why it works (and there are) but we're not writing our own research paper on the matter. 

I think that viewing the issue at a distance there are some simple conclusions that most anyone could draw; 

1. the decreased allocation to stocks early on, protects against the stock market declines extracting too much value of your total assets just after retirement when you'd be the most vulnerable to steep declines; 

2. the de-emphasis of "bonds and cash" over time allows you to have more money at risk, which means more money poised for growth rather than income

3. the allocation to equities over the long term enabled your assets to better keep pace with inflation

4. good years typically happen more than bad years when taken over an extended time horizon, so your profits build as you moved through time, taking advantage of compounding

5. you were able to pursue more of a "total return" strategy; which meant that you removed your focus from "income" per se, to "cash flow"

This will mean that we'll have to reframe retirement investing from "growth assets today, but less growth assets tomorrow.." to "less growth assets today and more growth assets tomorrow!"

Counterintuitive to be sure and hence, it will escape use by but a few. 

And, for the record, the less counterintuitive bet, "less risk today and less risk over time"; isn't working and there's already "real people" math to substantiate that. It's one of the reasons that retirement in America winds up so poorly funded. 

Sometimes, things just aren't what they seem.  

Better you adjust and choose a new course of action.