This Is What You Need to Know about Investment Risk in Retirement
When investing for retirement, risk tolerance generally changes over time. Individuals who are decades away from retirement typically accept a larger amount of risk for the chance to achieve significant growth, which is one of the benefits of saving for retirement earlier rather than later.
As individuals get closer to retirement, they tend to get more conservative to protect their nest egg from market fluctuations. With decades to spare, individuals can wait out lows, but this is not always possible in retirement when people may need immediate access to money.
Prior to retiring, individuals should take the time to look at their investment risk and make sure they are not jeopardizing their ability to make ends meet in retirement.
The Issue of Investment Risk during Retirement
Because of this issue, some people minimize their risk in the years before and after retirement. Then, these individuals slowly increase investment risk to get the best of both worlds.
At the same time, getting more aggressive with risk later in retirement comes with its own complications. This situation is most frequently encountered by people who have not saved enough money to retire comfortably and need to play catch-up.
Individuals in this situation are likely to take losses much harder than gains, according to recent research. When people are unable to deal with losses in an acceptable manner, they may end up panicking if the market has a downturn and selling their stocks.
This is a losing strategy since it does not allow for normal recovery. Realistically, people should only accept retirement risk in retirement if they have the mental capacity to handle losses strategically instead of panicking.
The Decision of How Much Investment Risk to Accept
The decision of how much risk to accept in retirement is ultimately a personal one. Individuals need to consider how much they have saved and their projected budget for retirement. These two data points can help people figure out how much wiggle room they have financially.
People should view the amount they need from their investment accounts to meet annual spending projections the minimum level of productivity for those accounts. The amount of their nest egg needed to produce this amount should be protected from risk as much as possible. Any money in retirement accounts beyond that could theoretically be invested aggressively provided that people can deal with market fluctuations since individuals would still have the minimum amount that they need to make ends meet.
The general rule of thumb is that people should never take on more risk than they need to meet their financial goals during retirement. However, there are situations in which increasing risk could make sense provided that the minimum monthly income is still met.
For example, some individuals want to build wealth to leave a legacy for heirs. In this case, goals will change over time. At the beginning of retirement, people in this situation want to have enough to maintain their lifestyle, but later they will want to build their wealth as much as possible.
These individuals often take more risks as they get older since they have enough to maintain their lifestyle and want to get as much as possible out of their investments. In this situation, it is still important not to invest so much that a market downturn could hinder the ability to cover monthly expenses.
The Other Option to Consider with Retirement Investing
Adjusting allocations during retirement is risky, whether that means increasing or decreasing the percentage of a portfolio inequities. People may find themselves forced to buy stocks when they are high or sell when they are low. For this reason, many financial advisors recommend keeping allocations fairly constant throughout retirement, but the decision ultimately depends on someone’s unique situation.
A safer way to invest in retirement involves adjusting spending rather than allocations. With this strategy, individuals change their spending based on market performance. If the market goes down, individuals can dial back their discretionary spending as a means of protecting their nest egg rather than changing their portfolio allocations.
Bear markets are temporary, but the losses incurred with selling off stocks during them are permanent. Adjusting spending is a way to avoid the panic impulse of selling off stocks and helps bridge the gap until market recovery occurs, at which point the losses will no longer matter. The other thing to keep in mind is that recessions tend to follow a bear market, so people may actually save money by postponing discretionary spending, such as vacations, and taking them later when it is actually cheaper to do so.