As you approach retirement, you might think it’s time to sell your stocks to avoid market risks. However, it’s crucial to understand that retirement investing is different from wealth-building during your working years. When you’re young, the exact timing of your investments is less critical. Over a long period, whether you experience good returns early and bad returns later, or vice versa, the outcome can be similar. But this changes once you retire.

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Retirement Investing: The Impact of Sequence of Returns Risk

In retirement, when you start drawing an income from your investments, the sequence of returns becomes crucial. For example, consider three hypothetical portfolios: A, B, and C, each with an average annual return of 7%. If you start retirement with $1,000,000 and need $60,000 annually, Portfolio C, with negative returns early in retirement, can run out of money before age 90. In contrast, Portfolio A, with positive early returns, might end up with more money than you started with.

This phenomenon is known as the Sequence of Returns risk. It highlights that early returns are critical in retirement. Since market directions are unpredictable, this risk must be considered whether you are approaching retirement or already retired.

The Pitfall of Avoiding Stocks

One might think that avoiding the volatility of stocks by switching to fixed-income investments like CDs is a safer option. However, this approach doesn’t account for the long-term growth potential of stocks, which can significantly outperform bonds and cash over time. Historical data shows that while cash and bonds barely outpace inflation, stocks offer substantial growth even over a typical retirement period.

Retirement Investing for the Long Term

The stock market can experience wide fluctuations in any given year. Yet, over longer periods, the risk decreases. For instance, while there have been years with significant declines, over 20-year periods, the stock market has consistently delivered positive returns. Over 30 years, even starting from periods of severe downturns like the Great Depression, the cumulative returns have been substantial.

Creating a Balanced Investment Plan

To manage the risks while benefiting from the growth potential of stocks, a balanced investment plan is essential. Here’s a simple system to maintain stability and growth:

  1. Cash Bucket: Allocate 1-3 years’ worth of income in cash or equivalents like money markets or CDs. This provides liquidity for current income needs.
  2. Bond Bucket: Invest in short to intermediate-term bonds for needs over the next 2-10 years. This reduces the need to sell stocks during market downturns.
  3. Stock Bucket: Use this for long-term growth. Stocks will fluctuate in the short term, but over the long term, they tend to provide significant returns. Depending on your risk tolerance, this bucket could be used 3-20 years down the line.

Rebalancing Your Portfolio

Regularly rebalancing your portfolio ensures it stays aligned with your risk tolerance and financial goals. This involves adjusting your investments back to their target allocations. For instance, if your stock investments grow and exceed their target percentage, you can sell some stocks and reinvest in bonds or cash. This strategy helps maintain a balanced risk profile and ensures you have the necessary liquidity.

Conclusion

A well-structured investment plan that includes a mix of cash, bonds, and stocks can help manage the Sequence of Returns risk while allowing you to benefit from the growth potential of stocks. Regular rebalancing is key to maintaining this balance and ensuring your portfolio continues to meet your retirement income needs.

For personalized help with your retirement portfolio, consider consulting with a Certified Financial Planner to create a strategy tailored to your specific situation.

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This does not constitute an investment recommendation. Investing involves risk. Past performance is no guarantee of future results. Consult your financial advisor for what is appropriate for you. Disclosures: https://onedegreeadvisors.com/solutions/#disclosures

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