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Retirement Planning Mistake: Investing Too Conservatively

The stock market crash of 2008 still lingers in the rearview mirror of many of today’s retirees whose retirement plans were decimated by 40 to 50 percent declines. Although many have seen their retirement portfolios recover, they enter retirement intent on avoiding a similar calamity by reducing their exposure to equities. Conventional planning models tell us that is precisely what retirees should do – to gradually reduce equity exposure as a way to avoid market risk. While that is considered a prudent approach to retirement investing, going too far can put retirees at risk of outliving their income.

The challenge for retirees in today’s economic and market environment is that the alternative to equities – bonds or cash equivalents – aren’t performing the way they did when those conventional planning models were created. Who could argue with that approach when bonds were yielding 7 to 10 percent, or CDs were yielding 5 to 6 percent? It was with those yields that the 60/40 asset allocation between stocks and bonds was established as the default model for long-term investing. The problem is the yields on these instruments today are just a fraction of what they were a decade or two ago. Investment grade bond yields are still hovering around low single digits and CD rates are more than half that.

The Bigger Retirement Risk

While no one likes to lose money, market risk should be the least of retirees’ concern as they face the prospect of living 30 years or more in retirement. Retirees have more to fear than a temporary stock market decline. With life spans expanding by the day, the worst fear of many retirees is the possibility of outliving their income. The greater risk for retirees is their own longevity compounded by inflation, which has a 100 percent certainty of reducing their purchasing power over 25 or 30 years. Reduced purchasing power increases the need to draw down more assets which can lead to its early depletion.  

What is Longevity Risk?

Your longevity, which is a measure of the average number of years of life expectancy, is not a static measure; rather it is an ever-expanding measure of life expectancy based on your attained age. For example, a male who reaches the age of 60 can expect to live another 21 years until age 81 (24 years for a female). For males who reach the age of 70, they could be expected to live until age 84, and so on. Prior to the advances in medical technology and the emphasis on healthy lifestyles that marked the last couple of decades, longevity risk was not as big a consideration as it is today.

While inflation has always had implications for retirement planning, when it’s combined with longevity risk, their implications are not only compounded, they can have a devastating impact on the actual lifetime income value of one’s assets.

The Real Risk of Investing Too Conservatively

The following chart represents how inflation has worked to erode the purchasing power on income generated from a 10-year Treasury bond. Although the most recent decade had one of the lowest inflation rates in the last several decades, purchasing power was reduced by 25 percent. It’s important to note that the inflation rate typically measured by the Consumer Price Index (CPI) doesn’t include food and energy prices, which have increased at a faster rate over the last several years.

National Association of Realtors,

Source: National Association of Realtors,

While investments in safe, fixed yield investments offers greater peace of mind for the moment, they do very little to preserve your purchasing power when it is needed – 25 years into the future.

Instead of fearing the stock market, retirees should learn to embrace the market risk that generates the type of returns that can extend their income while maintaining their purchasing power. Only through a well-conceived, long-term investment plan that employs an optimal diversification strategy can retirees harness the risk in a way that captures the returns of the market while limiting the amount of portfolio volatility to a tolerable level.

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