Many things change during the transition into retirement, from insurance needs to investment strategies. As people approach retirement, they generally become more averse to investment risks, and for good reason. There’s less time to recover any losses and allow your portfolio to rebound.
Holding stocks closer to retirement means that a significant portion of your nest egg could be lost. For that reason, most retirees have a portfolio that is overwhelmingly composed of bonds and other investments traditionally considered lower-risk. While this is a solid strategy, it also limits the growth potential for your nest egg during retirement. Some people may want to consider having a significant portion of their retirement portfolio dedicated to stocks even after retiring.
At the same time, not everyone should keep a significant number of stocks in their portfolio once retired. People with large nest eggs who will not be significantly impacted by losses are the best candidates for this strategy. In addition, people who are willing to accept the risk and have a strategic plan for dealing with any potential losses can consider this strategy. Financial experts sometimes also suggest taking calculated risks as part of a broader retirement income plan, depending on your particular situation and ultimate goals. Ultimately, the decision shouldn’t be taken lightly—it needs to be made with a full understanding of the possible ramifications.
Making the Decision to Invest in Stocks While Retired
The first step in deciding whether it’s feasible to hold stocks in retirement is to calculate the minimum return on investment you need to meet your estimated budget. You should have a general idea of the monthly income you’ll need during retirement and what you expect to earn from other sources. The difference is the minimum return.
Often, it is possible to achieve this return using annuities and similar tools that account for only a portion of the nest egg. In this situation, the remainder of the portfolio can be kept in stocks since any losses would not have an immediate impact on your lifestyle.
In general, if you would need to count on returns from stocks to meet your minimum return, then you cannot afford to have those stocks. It’s best to use stocks to boost your monthly income when the market does well. Your minimum monthly income should come from other sources outside the stock market.
Sometimes, stocks can be part of a holistic plan for income during retirement. This sort of strategy is best undertaken with the guidance of a professional, because it requires looking at risk in a different way. This strategy involves using a technique to ensure consistent income over a set period of time—like a bond ladder. The money not used in the bond ladder is then invested in stocks and allowed to grow to repeat the ladder strategy down the line.
For example, if you put $200,000 into bond ladders for 20 years and invested an additional $100,000 in stocks, that investment would need to double in value over those two decades. This is a calculated risk, because the return needed would be only 2.36 percent on average. Such a return is well below average returns over the past 20 years, even when the market is down.
Preparing for the Possibility of Losses During Retirement
The scenarios above reduce the risks involved in investing in stocks during retirement by eliminating the need for strong performance. Nevertheless, both scenarios still carry some risk; you may also decide to keep stocks in your portfolio as part of some other strategy beyond the two mentioned. In any case, it’s important to have a clear plan of what to do should that risk materialize.
If you panic, you may end up making poor decisions, so it is critical to consider the best paths before that happens. Making a plan first involves understanding the potential repercussions. For example, stocks could underperform, which means that you’ll have less monthly income than expected. You should be in a position where you can lower your spending if this happens. Ideally, you should be able to reduce your spending enough to account for zero return on the stocks.
Some retirees accept the possibility of reduced spending in the future to boost their ability to spend early in retirement. As long as you have an action plan and understand the sacrifices you may need to make, this is an acceptable amount of risk. However, you also need to account for the illiquidity of stocks in a bear market. Retirees should avoid putting any more into stocks than they will need in the coming five years since that reduces flexibility in the ability to sell them.
If you need to sell during a down market, you will lock into the losses and could end up getting into a tricky financial situation. Your action plan should ensure enough liquidity so that market downturns can be waited out for at least five years.