Have you ever hit your retirement savings objective forward of schedule? If that’s the case, it may be time to shield that nest egg by unloading some stocks.
The concept is to cut back funding threat and protect savings.
Stocks are an essential constructing block in a retirement portfolio: They yield increased returns, on common, than “safer” varieties of investments. However these returns include extra threat — particularly, the potential of an enormous loss. Younger buyers have ample time to claw again losses, however near-retirees do not.
For older buyers, stocks are “Three Mile Island and Chernobyl-level risky, and you do want to cut back on them,” William Bernstein, an funding advisor and creator of “Rational Expectations: Asset Allocation for Investing Adults, has said.
It should be stated up front: Most retirees need at least some stock exposure to guard against other risks like inflation (rising consumer costs) and longevity (living longer than expected).
But if you have enough money to live comfortably in old age, why not take some chips off the table? This involves shifting some money from stocks to bonds and cash, which are generally less volatile.
Otherwise, a market crash might mean a huge loss and the need to sacrifice important retirement goals like putting a kid through college or traveling the world, according to Allan Roth, a certified financial planner at Wealth Logic, based in Colorado Springs, Colorado.
Those risks outweigh the benefits of having a bit more money — which, if you’ve hit your savings goal, you theoretically don’t need.
“Dying the richest particular person within the graveyard shouldn’t be a great objective, for my part,” Roth said.
“Taking an excessive amount of threat will increase the likelihood you may run out of cash,” he said of retirement. “And the implications of operating out of cash can be dire.”
(The reverse logic isn’t true: It’s generally a bad idea to try investing your way out of a savings shortfall by taking outsized investment risk.)
This framework begs two questions: How do I know if I’ve hit my retirement goal? And, how do I “de-risk” my investment portfolio?
Retirement goal
Figuring out how much you might need for retirement can be tough.
There are several future unknowns: investment returns, life span, inflation, and costs for health care or long-term care, for example.
“There’s at all times going to be uncertainty about how a lot cash you are going to have,” said David Blanchett, head of retirement research at PGIM, the investment management arm of Prudential Financial.
Retirees can use the logic of the “4% rule” as a rough guide for determining when they’ve hit their savings goal, according to financial planners.
Basically, retirees determine how much they’d need to withdraw from their investments in their first year of retirement to live comfortably.
Someone who needs $40,000 or less per year from their nest egg (after accounting for guaranteed income like Social Security and pensions) would have a high degree of certainty that a $1 million portfolio would suffice for a 30-year retirement, for example. ($40,000 is 4% of $1 million.)
(A recent Morningstar analysis cautioned that retirees should use 3.3% instead of 4% as a rule of thumb to reflect likely future conditions. This would yield a $33,000 first-year withdrawal in the above example.)
Reducing risk
Reducing your stock exposure might be a behavioral challenge.
For one, stock returns have been strong, and “recency bias” may lead investors to think that upward trajectory will continue. Savers have also been in an “accumulation” mindset for decades leading up to retirement.
Near-retirees also often update their goals once they’ve hit their initial savings target, Blanchett said. They may wish to maximize their legacy for children and grandchildren, which might mean keeping a higher relative allocation to stocks, for example.
And perhaps counterintuitively, those who are “overfunded” (meaning they’ve saved more than they need) have an ability to take more risk with their extra savings if they’d like, Blanchett added. That’s because it doesn’t matter if they lose that money.
But those who want to throttle back and get more conservative will generally be shifting money from stocks to fixed income and cash, according to financial planners.
Cash generally equates to a high-yield savings account, and perhaps a money-market mutual fund if interest rates rise a bit, according to Jude Boudreaux, CFP, shareholder and senior financial planner at The Planning Center.
Relative to fixed income, retirees will generally want short-term bonds (with a maturity of five years or less) with a high credit quality, said Boudreaux, who’s based in New Orleans. (For simplicity, investors can buy bond mutual funds with these specifications.)
However, holding too much cash can be just as risky for near-retirees as having too high an allocation to stocks. Lower average relative returns from cash holdings mean a higher risk of inflation eroding your future purchasing power.
Retirees who hold between 30% and 60% of their nest egg in stocks have a higher probability of making their money last over a three- to four-decade retirement, when compared to other allocations, according to Morningstar.
Boudreaux agrees there does not seem to be a monetary good thing about lowering stocks under 30%.
“There is not any actual risk-free portfolio if you consider a long-term retirement,” Boudreaux said. “It’s extra, what is the threat we’re selecting?”