Stocks Are Risky – But Avoiding Them Can Be, Too
Without stocks, your retirement portfolio may not grow as fast as prices rise. With inflation at 3%, the $100,000 you have available to spend today could be worth less than $48,000 25 years down the road.
Anyone who’s ever invested in the stock market — or even thought about it — should know there’s risk involved.
While you potentially can make a lot of money, you also potentially can lose a lot.
Stocks are just inherently more volatile than other investments such as bonds or cash instruments. Even a portfolio with only half its assets in stocks potentially could lose more than 22% of its overall value in at least one year.
So as you enter or near retirement, a time when many people worry about keeping whatever they’ve accumulated over the years, you might think to yourself: Why not simply minimize the possibility of loss by getting out of the market and sticking with more conservative products from here on out?
Can you be too safe?
It’s a natural thought and a good question. But there’s a problem with taking that approach because, while there’s definitely risk when it comes to investing in the stock market, there’s also a different type of risk when it comes to playing it safe.
One simple truth is that we’re facing inflation, and inflation can erode your purchasing power over time. For example, if you assume a 3% inflation rate, the $100,000 you have available to spend today could be worth the equivalent of just $74,409 in 10 years and $47,761 in 25 years.
Another way to look at it is that to maintain the same purchasing power of that $100,000, assuming the 3% inflation rate, you would need $134,392 in 10 years and $209,378 in 25 years.
Plan for a LONG retirement
It’s important to keep in mind that life expectancy is at an all-time high. With that increasing longevity, the average retirement may last 25 years or longer, so inflation is a real concern for retirees.
Income sources such as Social Security and pensions are not likely to increase at 3% annually. According to the Social Security Administration, the 2016 cost of living adjustment, or COLA, was 0.3%. What that means is, assuming the inflation rate used in the above example, you will still need an increase of 2.7 percentage points to cover that cost.
Yes, stocks are risky, there’s no denying it. But without them, your portfolio may not grow as fast as prices rise, and if that’s the case, you’d be losing purchasing power over time.
While it’s dependent on each person’s unique situation, for investors with longer time horizons, it may be more important to address inflation risks over market risks, as they have more time to bounce back from any market losses.
A delicate balancing act
So it becomes a little tricky. In retirement, you probably don’t want to go all in with the stock market because you don’t have time to recover from a big loss, especially at a time when you’re spending some of that money to cover day-to-day living.
But wander too far down the “safe” route, and the money might not be adding up as quickly as you’d hoped. Many retirees often report that their No. 1 concern is running out of money.
So how do you find a healthy balance? There’s no right answer for everyone, so to find that healthy balance it’s important to work with a financial adviser who knows the ins and outs of financial strategies and who specializes in retirement income.
For my clients, I often suggest a portion of their portfolio be in value stocks that pay a good dividend; a portion in the balanced ETF portfolio with some stocks and bonds; and, last but not least, replacing some of the bonds with the appropriate fixed-index annuities that have no fees. I am currently using annuities as an alternative to bonds, given interest-rate sensitivity.
Even though we know stocks come with an inherent amount of risk, it is important to remember that avoiding them can open you up to the potential of a whole different kind of risk — the long-term impact of inflation. Having a balanced portfolio that is positioned to at least outperform the inflation rate is one key to a more confident retirement.
The information presented here does not construe an Investment Advice; please consult with a qualified professional prior to making any decisions.
About the Author
Founder, OCTO Capital and Shub and Company
Daniel Shub is the founder of OCTO Capital and Shub & Company. Since 1997, he has worked in the financial services industry, specifically focusing on clients' goals and wealth protection for retirement. He also authored the book, Retirement IQ. Shub holds the Registered Financial Consultant® designation, has passed the Series 65 securities exam and is insurance licensed.