The breathtaking coronavirus-induced plunge of the stock market has unnerved retirement investors of all ages, but it poses special risks for people close to, or already retired. Unlike younger workers with many years ahead of earning and saving, older investors are less able to fall back on income from work and may have less ability to wait out their losses.
How should older investors think about their portfolios now? In one sense, this is the wrong question. A much bigger concern is uncertainty about the resilience of the economy as major sectors grind to a halt as we fight the virus. Still, here are some big-picture thoughts about portfolios from the experts, and some tactical moves to consider.
First, think of the big picture, said Allan Roth, a CFP and head of Wealth Logic in Colorado Springs, Colorado.
“Markets going down for the last three and a half weeks is statistically rare, but 11 years of a bull market? This is the first time that has happened, so it’s the larger perspective that matters.”
“People are working toward financial independence, and suddenly, the market goes way down in a very fast, shocking manner,” Roth added. “So the natural instinct is not acting out of fear, but to protect what’s left - ‘I would love to get out of the market now, it would make me feel so much better.’ And my logic tells me it’s the absolute wrong thing to do.”
And in this moment, it is critical to understand the difference between volatility and risk.
Volatility is what you will always experience from time to time in the stock market. Risk, on the other hand, is about uncertainty, and the fact that we cannot predict the future. And there is risk in any investment.
For example, selling off your portfolio and stuffing your mattress with cash carries the risk that inflation will erode the value of your savings - sharply - over time. If inflation continues at a 2% annual pace, cash will lose half its value over a 25-year period.
Roth is a big fan of rebalancing your portfolio periodically. This keeps you on track with whatever equity-fixed income allocation you have determined is right for you. But it also can improve returns over time, because it lets you run against the market herd without even thinking about it - when stocks surge, you are selling a bit toward the top of the market; when they drop, you are buying the dip.
Roth calculates that an all-stock portfolio so far this century (through the end of February, using total market index funds, two-thirds U.S. and one-third international) has enjoyed a 4.98% annualized return, while a balanced portfolio (60% stocks, 40% bonds) earned 5.36%.
For retirees, how much of that allocation should go to equities? If you are looking for a proxy on how professional money managers think about that question, look no further than target date funds, which automatically reduce participants’ exposure to stocks as retirement approaches. Target date funds have become dominant favorites in 401(k) plans in recent years, and a growing number of participants are keeping them in retirement, either by staying in their workplace plans or using them in rollover IRAs.
Fidelity Investments’ target date series hold 51% equity at the point of retirement - an allocation that the firm decreased by 3.5% two years ago. And last year, it boosted global diversification within the equity portion of its portfolio.
Along with stocks, the funds hold 41% in bonds and 8% in cash equivalents.
The balance between equities, bonds and cash differs somewhat among the three largest target date fund providers, depending very much on their view of the primary goals for retirees. That reflects a Fidelity view that diversification - including cash - is critical.
“We think investors at the point of retirement are thinking mainly about the balance of risks that they’re likely to experience in the future,” said Andrew Dierdorf, one of Fidelity’s target date fund portfolio managers. “Our goal is to help them maintain their standard of living in retirement.”
That means retired investors will need to achieve returns from equities over the long run, especially since they may well live an additional 20 or 30 years, he notes. But the diminished ability to earn income from work - an income stream that generally behaves like income from bonds would - points to the need for diversification, he adds.
T. Rowe Price has a more aggressive approach. In February, it adjusted the glide path of its retirement funds target date series, with the equities allocation gradually falling to 30% at the end point (30 years after retirement), up from 20% earlier. Investors in this series hold 55% in equities at the initial point of retirement.
The higher equity allocation reflects the saving shortfalls of most investors and rising longevity, notes Wyatt Lee, head of target date strategies for the firm. “We can’t fully invest our way out of a savings problem,” he said. “But by maintaining a reasonable level of growth over the long term, we can continue to help support that income stream - even if it means more short-term volatility.”
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