Should I take less risk now that I am close to (or already in) retirement? An old rule of thumb tells us that you should have as much of your money invested in safe investments as your age. So if you are 65, the theory goes, you should have 65% of your money in safe places and only 35% of your money invested in stocks. This may appear to be attractive in that you don’t feel you have the time to make up for market losses and less risk just feels better. But what about the “invisible” risk factor of inflation? Remember that this “rule of thumb” was established long ago when life expectancies were lower and the average retiree only lived a few years in retirement. What about today?
Statistically, a married couple at age 65 now has a 58% chance that one of them will live to age 90; a 50% chance one will live to 92; and a 25% chance one of them will live to reach 100. This means most retirees will need to plan for a 30 year retirement. Add the good news that life expectancy continues to go up with advances in medicine, and pretty soon, 90 will be the new 60! The bad news is that many people are not planning for inflation over this time frame. If you do not take the right amount of risk when you retire, you are likely to encounter financial trouble down the road.
Inflation eats away at our earning power in a slow and deliberate way that is similar to watching your kids grow. Day by day they look the same, but over time, the changes are dramatic. It’s the same with inflation. We don’t really feel the pain on a week by week basis, but just think about what a cart full of groceries costs today compared with 20 years ago. Not taking enough risk with investments that have a track record of outpacing inflation will slowly eat away your portfolio. To illustrate, if you are age 65 now and inflation averages around 3.5% (the long term historical average), it will cost you almost double to live by the time you reach age 85.
The answer is that each individual needs to create a plan that meets their unique spending needs both for now and the future. Even though it feels counterintuitive, you need to have enough of your assets invested in equities to generate your required income. There is a difference between risk and volatility, and it is vital that you understand it if you are to be successful in managing your retirement. The basic steps to create this plan are:
- Understand your income needs.
- Develop a portfolio ratio of stocks to fixed investments that produces a return that is double the withdrawal rate (based on long term historical averages) needed to fund your spending to help counteract inflation.
- Make sure the ratios stay the same over time by rebalancing as the market moves both up and down.
- Test how your plan is working at least once a year.
If you find this to be too much of an undertaking, find a qualified fee-only professional adviser who is not selling investments to help you.