The Dangers of an All-Stock Portfolio
Retirement isn’t a finish line for investors—it’s the beginning of a new phase in managing their investments. After spending decades trying to accumulate wealth, you must now begin to think about how you will manage your savings to protect your income, so that your money will last throughout your lifetime.
Many people assume that investing in the S&P 500 Index will provide the best overall growth for their portfolios over time. That’s not always the case, however—especially if you withdraw money from your savings on a regular basis, as most retired investors do.
Regular withdrawals can exacerbate the negative effects of portfolio volatility, making it harder for your investments to make up ground they lose during downturns. So if you intend to draw upon your savings during retirement, an investment approach that trades a bit of growth potential for greater stability is likely to make your funds last significantly longer. This fact has crucial implications on how you should invest your retirement savings.
The danger of investing too conservatively
Some retirees respond to their new investment goal by shifting their savings wholesale out of volatile investments, such as stock funds, into bonds, bank CDs and Treasury bills. Such a conservative investment approach can be a huge mistake, because it exposes you to the risk that your savings won’t grow enough to outpace inflation.
A 65-year-old man can expect to live another 17 years. The life expectancy of a woman aged 65 is even longer, almost 20 years. But these are only averages, meaning you have a chance of living even longer—and if you and a spouse are both in good health at retirement age, there’s an excellent chance that at least one of you will live well into your 90s.
You’ll need to withdraw more from your savings each year during that time in order to keep up with inflation. Say you’re 65 now, you’re in your first year of retirement and you need to withdraw $40,000 to meet your expenses. Assuming inflation averages 3.5% per year and your spending patterns don’t change, your withdrawals will grow to $67,000 by age 80 and $94,500 by age 90.
The danger of investing too aggressively
Clearly, your retirement portfolio needs some growth investments—but how many? A retirement portfolio that consists entirely of stocks also can be dangerous, for the obvious reason that the stock market is volatile.
Few retirees want to ride out big fluctuations in the value of their investments. But let’s say you are willing to do so. After all, you might easily have 15, 20 or even 30 years ahead of you—plenty long enough to ride out some market moves.
Trouble is (and this might come as a surprise to many readers) an all-stock portfolio might not provide the biggest long-term returns. The reason: Your retirement withdrawals compound the ill effects of a bear market.
When your investments lose money and you withdraw funds, your future investment returns come off a significantly lower base. A reduction in your savings therefore makes it harder for your investment gains to make up for the amount you withdraw. For example, say stock market declines and withdrawals decrease your savings by 20% in a given year. You’d have to gain 25% the following year just to get back to where you started—significantly more if you make another withdrawal that year. What’s more, you’ll have to withdraw increasing amounts each year to compensate for inflation. The combined effect of weaker growth and larger withdrawals can throw your savings into an accelerating downward spiral.
On the other hand, if you can manage volatility while pursuing growth—for example, by investing in a balance of stocks and bonds—your savings will have a much better chance of lasting for the long term. Your investments won’t have to make up for losses as frequently as they would in an all-stock portfolio. And they aren’t likely to decline as much when they do lose value—which means they won’t have as much ground to make up. Ultimately, avoiding some of the market’s downside volatility can mean the difference between outliving your assets and your assets outliving you.
A balanced portfolio—60 percent stocks and 40 percent bonds, for instance—is almost always the better choice for retirement investors. The actual returns you’ll earn from a diversified portfolio depend on more than the average long-term results for an asset class such as stocks. You must also take into account the timing of market fluctuations, which can have a significant impact on the growth of your portfolio over time. Thus, an all-stock or all-bond portfolio might pose serious risks for retirees not only in the short term, but in the long term as well.
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