8 Ways to Navigate Investment Risk During Retirement
7 Min Read
As you transition from workforce to retirement, a lot of things change. A major alteration that happens is the variation in investments. Once you are closer to retirement, it is good to keep most of your asset allocation in secure instruments such as bonds and fewer investments in stocks. But the strategy considerably shifts after you retire. Even though the main aim of post-retirement investments is to secure a stable income, the methodology transforms eventually. Moreover, since the market is unstable, retirement investments are not always straightforward. Hence, it is critical to manage your risk to live your golden days in full spirit.
Here are Eight Ways to Navigate Investment Risk During Retirement:
- Reanalyze your risk
The basic strategy of retirement investment is to be safe and reduce risk. However, once you retire, the approach changes but the aptitude of risk remains the same. Hence, to safeguard your investments during retirement, you can revisit your risk tolerance. The goal is to manage risk to maximize yields over an extended life expectancy. In that aspect, retirees can divide a significant part of investments into safe market instruments and the rest in stocks for higher returns. The conservative part can support expenses, and the risker ones can support growth. However, while distributing your assets, it is best to take a holistic view. In most cases, retirees take this decision in isolation by only considering the potential risk and reward of sources like a 401(k) account and an IRA (Individual Retirement Account). Whereas, it is advisable to account for your whole retirement income, including Social Security benefits and pension. Thus, for better asset allocation, it is helpful to consider the total retirement income portfolio.
For instance, your total retirement income portfolio comprises Social Security benefits, a 401(k) account, an IRA, and a pension plan. As projected, earnings from Social Security and pension are enough to support your existing lifestyle. This would imply that you can direct a greater portion of other income sources – a 401(k) account and an IRA – into riskier assets such as stocks. Yet this would not compromise the overall risk appetite. - Accommodate inflation
A major investment risk in retirement is that your assets will not be able to provide adequate income to last for a lifetime. Outliving your retirement savings is one of the worst retirement situations. Hence, to navigate the investment risk and ensure that you have considerable savings for life, it is good to structure your portfolio by accounting for inflation. Your portfolio should ideally include investments that are likely to offset the impact of rising future prices. These could include inflation-linked municipal bonds, annuities, real estate investment trust (REIT), commodities, and a responsible share of equities. While most retirees might act solely on the impulse to seek safe investments, not accounting for inflation in the long-run can be detrimental for retirement. Inflation will gradually push the prices of goods and services, leaving non-inflation adapted retirement funds at a complete loss. For example, if inflation occurs at the same rate as of 2019 and 2020, the cost of goods and services will rise by 6% in 2021 as compared to now. - Invest rationally
A good method to navigate undue risk during retirement is by treading carefully. It is beneficial to make investments in the ratio as required and not as you desire. This implies that supposedly you conduct a comprehensive investment analysis and deduce that you need a 5% average return on your investments to support a suitable retirement lifestyle. Then, in this case, your investments should only target a safer return of 5-6% and not more. This will enable you to keep your risk in perspective. However, while evaluating your average return requirements, you can exclude all assets that you wish to accumulate or pass on to your heirs as a legacy. This method will ensure that you do not risk your future security, while still allowing assets to grow significantly. - Frame five-year segments
A good strategy to mitigate investment risk is to break down your lifelong retirement plan into shorter segments, ideally of 5 years. The reason for structuring the investment plan is that no single investment style can suffice for all of the retirement years. Each of the five-year frameworks will have different lifestyle requirements and correspondingly varied investment needs. That way, you would be able to have a more targeted investment approach and modify the approach to best accommodate your needs. For example, consider a scenario where you retire at 65 while your kids are in college. It is highly likely that in the next seven years they will plan to marry, and you would want to contribute. In such a case, your investment plan of a 65-70-year framework can be more growth-oriented to have higher returns. - Invest in a home
Owning a house is a coveted American dream because it provides security not just mentally but also financially. The rate of homeownership in the U.S. increased to 65.30% in the first quarter of 2020. Even though it is a huge investment, owning a house has its unique monetary benefits, which are unparalleled and uncorrelated with other investments. Hence, it can help to navigate the risk during retirement. Investing in a home offers benefits like increasing equity, tax exemptions, capital gain exclusions, enhanced creditworthiness, etc. Moreover, it also helps to offset the impact of inflation in retirement income. - Keep hybrid securities
To mitigate investment risk in retirement, you can keep a good share of hybrid securities in your portfolio. Hybrid securities combine the best features of equities and bonds. These often provide higher returns than fixed income instruments such as bonds but lower returns than variable income securities like equities. However, hybrid securities have a higher risk as compared to bonds and lower than that of equities. Some good choices in hybrid securities include convertible bonds and preferred shares. - Make a drawdown strategy
Having a well-planned drawdown strategy can also reduce risk in retirement. The ultimate objective is to make the most of retirement savings and incomes. For this purpose, you can leverage tax-efficient strategies and optimize Social Security benefits. For example, not withdrawing your 401(k) account before 59.5 years, as it will attract a 10% penalty and income tax on withdrawals. Furthermore, you can delay your Social Security benefits to maximize your share. Legally, you can withdraw Social Security benefits from the age of 62. But keeping money in this account for longer will improve returns. For example, if you withdraw one year later than your official retirement age, you will get 108% of the monthly benefit. Overall, you can add more than 50% to the cheque if you delay the withdrawals until the age of 70. - Improve liquidity
It is good for you to keep a part of your investments in cash and cash equivalents. These can include short-term bonds, treasury bills, certificates of deposits (CDs), etc. This will safeguard your retirement income when all other methods fail. Ideally, it is advisable to keep 5 years’ worth of expenses in cash and equivalents.
To sum it up
You might get complacent upon retirement, but this is the phase where your lifelong planning will come to test. Therefore, it is important to strategize and make comprehensive plans to navigate investment risk during retirement. You can also consult professional Financial Advisors to secure your golden years.
