Photo credit: www.cnbc.com
Many retirees believe that shifting all their investments into cash and bonds, while avoiding stocks altogether, is a surefire way to protect their financial security. However, this may not be the best strategy, according to financial experts.
Experts emphasize the importance of retaining exposure to stocks, which are considered the growth engines of an investment portfolio. This is crucial for ensuring that retirees do not outlive their savings during what could be an extended retirement period lasting several decades. David Blanchett, head of retirement research for PGIM, notes, “It’s important for retirees to have some equities in their portfolio to increase long-term returns.”
Longevity: A Major Financial Risk
One of the primary financial risks retirees face is longevity risk, or the possibility of outliving their savings. The average life expectancy has significantly increased, rising from approximately 68 years in 1950 to around 78.4 years in 2023, as reported by the Centers for Disease Control and Prevention. In fact, projections from the Pew Research Center suggest that the number of centenarians in the U.S. could quadruple over the next thirty years.
While some retirees might think that shifting out of stocks during periods of market volatility—like those caused by tariffs or other economic pressures—might shield them from risk, they fail to consider the long-term implications. Cash and bonds tend to be more stable, providing a buffer against short-term fluctuations in the stock market. However, experts recommend a balanced approach that gradually reduces stock exposure while increasing allocations to cash and bonds. This helps protect investments during periods when immediate access to funds is necessary.
Nonetheless, drastically reducing stock investments may also lead to challenges, such as difficulties in keeping pace with inflation and the increased likelihood of exhausting one’s savings, warns Blanchett. Historically, stocks have delivered returns of about 10% per year—outperforming bonds significantly. “Retirement can last up to three decades or more, meaning your portfolio will still need to grow in order to support you,” remark Judith Ward and Roger Young, certified financial planners at T. Rowe Price.
Determining an Appropriate Stock Allocation
This raises the question: what constitutes a suitable allocation of stocks for retirees? A common guideline suggests that retirees subtract their age from 110 or 120 to find the right percentage of their portfolio to invest in stocks. For instance, a 65-year-old might target a 50% allocation in stocks, resulting in a balanced portfolio alongside bonds and cash.
For those in their 60s, a stock allocation might range from 45% to 65%, with bonds making up 30% to 50% and cash between 0% to 10%. Similarly, investors over 70 could adopt a more conservative stance, with 30% to 50% in stocks, 40% to 60% in bonds, and 0% to 20% in cash.
Tailoring Your Investment Strategy
However, investment strategies should not be one-size-fits-all. Individual circumstances significantly influence risk tolerance and the need for growth. For example, retirees who have substantial savings or guaranteed income streams, such as pensions or Social Security, may have the flexibility to adopt less aggressive investment strategies.
Risk appetite—how much volatility an individual is comfortable with—also comes into play. Blanchett advises that retirees who may panic during market downturns should limit their stock exposure to around 50% to 60%, while those with a greater tolerance for risk might opt for a more aggressive position.
Additional Considerations for Retirees
Beyond stock allocation, there are several other critical factors retirees should consider:
Diversification: It’s essential to diversify within stock investments. Rather than investing heavily in a single stock or a small group of companies, retirees should consider total market index funds that provide broad market exposure.
Bucketing: Withdrawals from investments during down markets can diminish a portfolio’s longevity. This risk is particularly pronounced in the early years of retirement. To mitigate this, retirees are encouraged to establish separate “buckets” of cash and bonds to draw from during market downturns, allowing their stock investments time to recover.
Source
www.cnbc.com