As you get closer to retirement, you will need to check certain things off your list, which usually includes lowering your risk exposure on investments. However, according to new research, some retirement investors may need to do that sooner rather than later.
Earning a good return on your retirement investment is important, so putting some funds in the stock market is virtually unavoidable. However, it is important not to invest too much in the stock market and put your nest egg at risk. According to a recent survey conducted by Fidelity, more than 23 percent of respondents invest a higher percentage of their 401(k) in equities than what is recommended for their age. In fact, about 7 percent of responders said their entire 401(k) is tied up in the stock market.
The survey showed that overinvestment in the stock market affected retirement investors of all ages, but it was especially prominent among baby boomers, who are getting quite close to retirement age. In this specific demographic, 37.6 percent had more money invested in equities than was recommended. Of this number, nearly 8 percent had all their money invested in stocks.
This is especially dangerous so close to retirement since individuals could lose a considerable amount of money right as they stop making a regular income. Older investors have very little time to recover, and the panic caused by losses could lead to additional poor investment decisions.
How Investors Should Think about Dividing Their Nest Eggs
In general, retirees should have much less money invested in equities than people who are in their 20s or 30s. Young investors can withstand boom-and-bust cycles in the market since they will not touch the money for decades; short-term losses can prove hard for their morale, but these losses will not hurt their portfolio as much as it will someone who needs the money within a handful of years. When you need the money for living expenses, you cannot simply leave it invested and hope that the market recovers quickly.
However, finding a balance can prove difficult. Investing too little in the market can result in reduced returns and a struggle to meet savings goals. Investors need to figure out the balance that protects them from undue risk while allowing their nest egg to grow.
Ideally, you will make a conscious choice about how much money gets invested in stocks and how much goes in investments with lower risk, such as bonds. You may want to accept the added risk if you do so conscientiously and understanding the possible consequences, but it is important to weigh the pros and cons.
As a general rule, you can subtract your age from 110 to figure out the proper percentage to invest in equities. People in their early 20s will invest the majority of their savings in equities. For each subsequent decade, the percentage of savings in equities should decrease by about 10 percent. Once you are in your 70s, you should have only about 40 percent of your money or less in equities.
The Need for a More Proactive Approach to Investment Decisions
The problem with this model is that it requires active management of a retirement account. You must readjust your savings ratios each year to keep current. In the end, checking in with retirement allocations once a year is not a bad idea anyway, even if you are making changes less frequently than that.
Some people may have a higher percentage of their nest egg invested in equities simply because they have forgotten to make adjustments to their accounts. However, this is an unlikely explanation for the high percentage of people in the survey who had so much of their savings invested in stocks, considering that these people knew their ratios. At the same time, it’s possible they do not fully understand the risks of investing heavily in stocks as they get closer to full retirement age.
Overall, some investors may decide that they want to put all of their retirement savings in riskier investments. These individuals may willingly choose to put all of their nest egg in the stock market, which is an acceptable decision provided that they completely understand the risk. On the other end of the spectrum are people who choose to invest significantly less in the stock market than recommended because they are averse to risk. These people may need to save more money in the long run to meet the same financial goals, but sometimes the extra savings can be worth the peace of mind that they gain by choosing not to gamble with their retirement savings.
The important factor in each of these decisions is the conscientiousness of the action. You should avoid putting your money in a 401(k) and then forgetting it altogether.