Retirement investing can be risky, but it does not need to be a gamble.
Ask Real Deal Retirement: I have roughly $1 million saved and hope to retire in about 10 years. I’m nervous about the market, but also worried that moving out of stocks could leave me with lower returns and a less secure retirement. Any suggestions for how I should invest my savings? —Denise, Seattle, Washington
Investing is always a balancing act between risk and return, but it’s an especially delicate one as you near and enter retirement. You have to invest aggressively enough to generate the returns you’ll need to build a nest egg that can support you comfortably the rest of your life. But you also want to insulate yourself somewhat from market setbacks that could force you to delay or even abandon your post-career plans.
So the real question is how do you arrive at an acceptable trade-off, mix of stocks and bonds that can deliver adequate returns while offering adequate downside protection? There’s no single answer; what one investor considers an acceptable tradeoff may be quite different from what another deems appropriate. But following the three steps below should help you arrive at an investing strategy that works for you.
1. Determine your true tolerance for risk
Given the stock market’s recent wild gyrations, it’s understandable that you and other investors have gotten jittery. But to set a viable retirement investing strategy, you need to go beyond simply feeling anxious about a possible loss and get a realistic handle on how much you could watch the value of your retirement nest egg drop before you start jettisoning stocks and seeking refuge in less volatile investments.
One way to do that is to see how portfolios with different concentrations of stock would have fared in a past severe downturn. From the market’s 2007 high to its 2009 low, for example, stocks lost roughly 60% of their value while bonds gained about 8%. So if we were to see a decline of similar magnitude sometime in the future—a not-unreasonable expectation given the history of market meltdowns—a 70% stocks-30% bonds portfolio would lose about 40% (assuming norebalancing). If that sort of setback would totally freak you out, then perhaps a less stock-intensive 50% stocks-50% bonds portfolio (which lost 26%) or even a 40% stocks-60% bonds mix (which fell 19%) would be more suitable for you, even though both could be considered a bit conservative for someone still 10 years from retirement.
You can get a more accurate gauge of your appetite for risk by completing a risk tolerance questionnaire. Vanguard has a good 11-question risk tolerance-asset allocation tool online that’s free, while Australian firm FinaMetrica offers a more comprehensive 25-question version used by many financial advisers for $40 (although given recent market turbulence FinaMetrica is offering the test and the nine-page report that comes with it for $4 until the end of September). Both tests recommend an investment portfolio based on your answers.
2. Settle on a reasonable asset allocation
You could simply go with the portfolio recommended by the risk-tolerance test or with a stocks-bonds mix you feel you would be comfortable with based on how that blend has performed in past market downturns. But remember: protecting yourself from market setbacks isn’t your only goal. You also want a stocks-bonds blend that has a reasonable shot at delivering the returns you’ll need to build a nest egg that can allow you to keep your pre-retirement standard of living throughout your post-career life.
You can get a decent sense of how likely different portfolios are to support you during a long retirement by plugging various mixes of stocks and bonds into a good retirement income calculator, along with such information as the value of your retirement savings, how many years you expect to live in retirement and how much annual income you expect you’ll need once you retire. What you may find is that the portfolio mix that you would feel most comfortable with in a market downturn doesn’t provide the growth necessary to fund the lifestyle you envision and maintain your purchasing power in the face of inflation. If that’s the case, then you may need to give up a bit of short-term comfort to gain more retirement security in the long run.
Ideally, once you’ve decided on a stocks-bonds mix you’ll want to stick with it, except for periodic rebalancing. But it can be hard to resist the urge to tinker when stock prices are jumping around like crazy and every time you turn on the TV or visit a financial website some sage or pundit is touting an ETF or other investment that’s supposed to generate high returns with low risk.
If you can tune out this investment noise, great. If that’s not feasible, resist acting on it. Emotional decisions rarely work out well for your finances. One way to avoid making moves in the heat of the moment is to set a “cooling off” period in advance—that is, resolve that no matter how tempted you may be to overhaul your strategy because of some development in the market or add some promising some new investing vehicle may seem you’ll hold off at least a week before making any changes. In many cases the mere fact of waiting will help you realize you’re probably better off not making the move at all. But even if you do decide to make a change, the extra time a waiting period provides will allow you to better evaluate your options and come to a more rational decision.
As you get closer to retirement, you’ll have other issues to consider (such as whether to throw some guaranteed lifetime income into the mix). For now, though, the single most important thing you can do is get the trade-off between short-term security and long-term growth right.