Does the stock market’s nose dive make you want to shift into full retreat — no stocks, no bonds at all?
It’s an understandable reaction for young investors living through their first major market decline, triggered by the coronavirus — or even for more experienced investors who find themselves worrying that the market plunge will wreck their retirement plans.
But understand this: While getting out of stocks and bonds may shelter you from market volatility, the alternatives carry risk, too.
For example, putting all your savings into cash would leave you exposed to erosion in its value from inflation. “Cash isn’t riskless,” said Mike Hennessy, chief executive of Harbor Crest Wealth Advisors in South Florida. “If inflation averages 2 or 3 percent, cash today will be worth half its value in 25 years.”
Other risks of bailing out completely depend on your age. Working people would find it nearly impossible to accumulate meaningful savings. And retirees still need exposure to stocks and bonds to meet expenses over lengthening life spans.
How should retirement investors think about risk? Many financial planners use tools like Riskalyze with new clients to gauge their risk tolerance, although this approach has its dissenters.
“The way we feel about risk is very unstable,” said Allan Roth, a certified financial planner and the head of Wealth Logic in Colorado Springs. “I can ask what you would feel if stocks went down 50 percent, but I’d have to kick you in the gut three times to simulate the pain you would actually feel.”
If you’re younger and working
If you won’t be tapping retirement savings for many years to come, time — to paraphrase the Rolling Stones — is on your side.
Sticking to an investment allocation of both equities and income makes sense, and the market’s drop offers a good opportunity to rebalance, Mr. Roth said.
“The key purpose of rebalancing is to keep risk relatively constant, but I do think it boosts return in the long run by going against the herd,” he said.
But younger investors have another factor working in their favor: Their most important asset is their future earnings, not their current savings.
Economists refer to this ability to generate income from work as “human capital.” Your future earnings have “bondlike qualities,” said Jay Abolofia, a certified financial planner and the founder of Lyon Financial Planning near Boston.
“If your job is secure, that income is going to be steady, tossing off income much as a bond would,” he added. “That means you can afford to hold more of your savings in stocks.”
If you’re closing in on retirement
If you plan to retire within 10 years and are on track to meet your goals, shifting your portfolio to include more bonds and less stock can be a good move.
“The purpose of money is choices in life and financial independence,” Mr. Roth said. “You don’t want to get out of the market entirely, but the closer you are to winning the game, take more risk off the table.”
But too much de-risking at this stage of life poses its own risks, cautioned Christine Benz, director of personal finance at Morningstar.
“With 10-year Treasuries yielding less than 1 percent, you’d effectively be saying, ‘This is what I’m settling for,’ and most people need a higher rate of return,” she said. “At this stage of life, volatility is still your friend. You can buy more when the market is down.”
Also examine ways to rework your retirement plan in your favor.
Working longer so you can delay claiming Social Security benefits offers a meaningful way to improve retirement income — you’ll get roughly 8 percent more annual income for every 12 months of delay.
There is risk here, too: 37 percent of workers retire earlier than they intended to, according to research by the Center for Retirement Research at Boston College. But the risk of falling short of working as long as you planned diminishes as you get closer to retirement, Mr. Abolofia argued.
“Planning to work longer is a riskier assumption at younger ages, but if you’re already 65 and still working, pushing out your retirement date by a few years probably is realistic,” he said.
Another safe way to recalibrate your retirement plan is to revisit spending goals. Start by looking at what you are spending annually now, and look for possible cuts you could make in retirement if necessary.
“A lot of people just don’t really have a good sense of how much they’re spending,” said Wade Pfau, professor of retirement income at the American College of Financial Services. He recommends using personal financial management software (examples include Mint, Personal Capital and You Need a Budget) to get a handle on categories of spending, and how they might change in retirement.
If you’re retired
Back in the days when retirees could earn a substantial return only in bonds and certificates of deposit, traditional wisdom held that equity allocations could fall to very low levels. But these days, most professional allocations call for at least some exposure to stocks in retirement.
Retirees seeking to reduce volatility also could consider buying an immediate annuity, using no more than 30 percent of their assets, Mr. Pfau said.
“The best approach is to start by looking at your spending goal,” he said. “If there is an income gap after your Social Security or a pension is factored in, you could use the annuity to meet expenses that you don’t want exposed to market volatility.”
How rattled are retirees about the market? Financial planners contacted this past week reported that they had talked a few clients off the cliff, but that most were keeping their cool — especially those who already have age-appropriate equity-bond allocations.
“We had one retired client ask about getting out of the market completely and moving his entire 401(k) to cash,” said Eric Simonson, a certified financial planner and the owner of Abundo Wealth in Minneapolis. “We reminded him that his portfolio was only 40 percent invested in equities, so he is not down nearly as much as he had thought.”