How conservative should my portfolio be as I approach retirement?
I am 66 years old and I am still working. However, I will be retiring within the next year or two. I also have a simple IRA. Do I take less risk or high risk in my portfolio? Do I look for high returns?
Just because you are nearing retirement doesn’t necessarily mean you should be more conservative with your investment portfolio. This decision should be based on what you are spending, what income sources you will have in retirement (i.e. social security, pensions, rental income, etc.), and how long you think you will realistically live. The key here is to do more in-depth planning (hopefully with a qualified advisor) to find out how much you will need to pull from your investments each year, accounting for inflation, to meet your retiment goals. If you only need 1%-3% from your portfolio, then yes, your portfolio can be invested conservatively. If you need 4%, 5%, or more, then a conservative portfolio is likely a guaranteed failure (i.e. you will run out of money before you run out of life). So, instead of thinking about risk tolerance based on your age or your proximity to retirement, think of it based on your needs and the chances of reaching your goals. After all, what is really more risky---guaranteed failure, or possible failure with a good chance of success?
Without knowing your details, I couldn't begin to give you solid advice. Anyone who tells you they can are wrong in my opinion. So without knowing your net worth, investment knowledge, spending plans, genetics/likely longevity, and whether you have a sell discipline etc... I cannot say. That said, "conventional wisdom" says the older you are the more conservative you should become because you don't have the time to recoup a major downturn.
I don't necessarily prescribe to conventional wisdom so will give you a different perspective. The problem with the above view is that when you have a major correction, 80% of all stocks go down whether stable large cap or growth. The S&P 500 declined approx 40% in 2008 with the NASDAQ growth even worse. So it is really about how much risk is in the overall market, not the "style." And there will be times to get defensive. Now we are currently fully invested but that could change if the environment changes.
If you are a multi-millionaire and could withstand a 2000 or 2008 like event with a buy-and-hold strategy (not recommending), then you wouldn't have to be more conservative. This brings me to bonds. An old rule of thumb is the older you are the more you should have in bonds. Never mind that we are at or near the end of the dropping interest rate supercycle in bonds that began around 1981. So bonds have become more risky than even just a year ago and are probably as fully as stocks. Did you know that treasury bonds lost -32% of their value in just 16 months between 77-79? Inflation is like kryptonite to bonds, even worse than rising rates. Thus far, inflation according to the Fed has been tame and so there isn't too much concern yet.
I am not trying to scare you, rather, to think outside the box. You need to measure the broader trends and make adjustments accordingly. So your allocation should change fairly often, a couple of times per year. You would adjust the percentage of bonds, stocks, and even commodities up and down depending upon the economic data & inflation numbers.
So while you should have some bonds, you should currently be looking for "stable" dividend paying stocks in lieu of a portion of your bond portfolio. I believe these may actually be less risky than many bond sectors in this current environment. And you should have a sell discipline for both of these and everything in your portfolio.
Now in full disclosure, I am an active manager and do not prescribe to the buy-and-hold "pie chart" mentality especially in this later stage bull market - both stocks and bonds. But since the Central Bankers have engineered interest rates to artificially low levels, there is no "safe" investment, like a CD, that will keep up with your inflation (medical costs etc..). Therefore the low paying, fixed interest safe investments will almost guarantee you a loss in terms of purchasing power. And indexed annuities will only pay you between 3% to 4% no matter what the insurance agent tells you.
This will continue until rates normalize and the Central Bankers actually raise rates to even near normal levels. What I am telling you is that the conventional risk versus returns is not nearly as important as the market risks. So while we have an ETF Porfolio customized for the individual, we also have sell metrics for every "slice" of the pie chart within the portfolio. So any sector could default to cash, and if things begin to get really ugly, a huge portion of the portfolio could be in cash. You adjust risks in the portfolio by dialing up & down your cash levels. You also manage risks by position sizing.
You have always been told that to make more you have to take more risks. But you can make a solid return without taking more risks. If you miss a decent portion of the downturn by being heavy in cash and then be more fully invested during solid uptrends, you should be fine. This is what I call risk-adjusted returns. Dialing up and down risks by taking more risk (more fully invested) when things are stable, and taking less risk when the markets are choppy or in a downtrend. Thus participating in the markets when they are good and not trying to outperform, but getting out of much of the way when they are bad. This is contrary to a static pie chart.
But if you are going to do a buy-and-hold strategy, then yes, you need to dial down your risks. You need to have a decent portion in bonds and most of your equities should large cap stocks. You should also have a small portion in precious metals as a hedge against inflation and your bond portfolio.
Again, all of this was meant to stimulate your thought processes and to give you a different perspective to research.
Hope this helps and best of luck, Dan Stewart CFA®
This is always an interesting question and as I've done on a number of occasions, I believe the answer lies in your personal cash flow. As an example, if you enter retirement with a 70% equity position and 30% bond position, and the market were to fall by 20%, your entire portfolio would be down 14% (20% of 70%). Now the question is, could you withstand such a hit? More importantly, how uncomfortable would this fall be, even if you could afford it. Common sense says that unless you have a significantly large portfolio, retirement is a point in time were conservation of principal is much more important capital appreciation. For some people who've not save properly, they may have to take some additional risk and although this is discussed quite often, it may not be the approach to take it all. But again, sit down and put together your personal cash flow requirementas and try to determine how your family will be affected by a market fall off. Would you be okay if the market really did fall 20%? How about 40% or 50%. Keep in mind this would only affect your equity portion of the portfolio but if you're going to lose sleep over these possibilities, then lighten up on the risk as you move into retirement. Keep in mind that many of us believe the markets are getting grossly overpriced and if we are right, a recession is ahead and the markets may take a significant hit. Each individual case is different as I'm sure you're aware. We should only be concerned about your own and start with an analysis of your cash flow and try to determine if it would remain comfortable under any market conditions. I know this is a little broad & general, but I hope it helps and good luck.
High returns are generally not the key to success in retirement planning. Growing your money during your working years a higher return has a bigger impact, however, when retired and withdrawing your money the preservation of what you have already saved is more important. Avoiding a large loss is generally far more important than having a high return. For example, if there are two investors and one of them earns 4% and the other earns 8%, you may only extend your retirement dollars (when you will run out of money) by 4 to 6 years. The risk you must take in increase your return from 4% to 8% could be substantial. In addition, a large loss could shave off as much as 15 years from your retirement income needs. The key to success is managing risk, and having a well laid out written plan covering all aspects of your retirement such as taxes, social security, estate planning and insurance to make sure you have the highest probability of success as possible.
There are many factors to consider when trying to determine the "right" asset allocation for you which will determine the "right" amount of risk in your portfolio. These factors can be net worth, income, time horizon, comfort with risk, knowledge of markets, liquidity, spending plan/budget, etc. There is not a one-size-fits-all portfolio that is "right" for a 66 year old person. I suggest you use a tool to help determine your risk capacity. There is a good one available at https://www.ifa.com/survey/ that can give you some direction. But also, you should consider having a conversation with an unbiased, fee-only advisor to help you determine how much risk you should and can take in your portfolio. Good luck!