6 Signs of Risky Retirement Planning Strategies

During your annual retirement planning review, make sure to look at these 6 signs that you’re taking risks with your portfolio.

When undertaking a portfolio review, many people fixate on returns. We humbly suggest you take a step further and pay attention to risk factors.

Here are six things to consider and discuss with your retirement-planning strategist with regard to the amount of risk you’re taking with your nest egg.

Retirement Planning & Stocks

1. Have all of your stocks gone up a lot?

Many folks would think this is an ideal scenario, but it is actually a warning sign—all your stocks moving in the same direction is a potential sign you aren’t sufficiently diversified.

Diversification is not just about having more than one stock—it is about having multiple stocks, across multiple sectors and industries and, ideally, even multiple countries. If all your stocks rise simultaneously, this movement suggests they are all responding to the same key factors and drivers. A properly diversified portfolio will spread out investments across categories that respond uniquely to different factors and drivers.

Many investors think owning more than one stock is diversification and, to some extent, that’s true. But this scenario diversifies only one type of uncertainty: company-specific risk. While it could help protect you from the risk of having all your money concentrated in an Enron-like house of cards, it won’t protect you from higher-level concerns and considerations.

If, for example, you own a slew of energy-firm stocks, you’ve diversified company-specific risk. But you are still exposed to the risk when the sector falls prey to sinking oil prices—as it has since June 2014. If you own all US-based firms, you could obtain significant diversification on a company- or industry-specific level. But you likely haven’t mitigated the risk of the US government passing laws detrimental to domestic firms.

Post-Retirement Withdrawals

2. How much do you withdraw annually, and could you cut it if you had to?

This might seem like an off-topic question, because few folks think of withdrawals as a risk. However, they are a crucial consideration in retirement planning—particularly for investors early in retirement. The primary point of a retirement portfolio is to fund the years when you aren’t working. The very biggest risk you face during that time is depleting your assets while you still need them. And, annual withdrawals typically put the greatest strain on your portfolio during retirement.

You can calculate your annual withdrawal rate by using your account’s online-access tools. It usually isn’t too hard to sort the transactions page to view your withdrawals for the year (if you can’t figure it out, your grandkids can probably help). Total the past year’s withdrawals, and then divide that sum by the value of your portfolio at the beginning of the year. The resulting number is your withdrawal rate for the year.

How high is it? If it is lofty—8%, 9%, 10%—you could very well have a major, acute and immediate problem in need of rectifying. Even if it is a more manageable level—4%, 5%, 6%—you should consider the worst-case scenario and assess how you would live if you had to slash this amount by a quarter or half. Write down your plan.

Having flexibility in your withdrawal rate is a big depletion-risk mitigator. Even if you presume you will perfectly foresee every market downturn from here until you leave this earth, it is wise to humbly prepare as though you won’t.

Diversification in Retirement

3. How many individual companies do you own?

You no doubt noticed this item isn’t titled, “How many stocks do you own?” That is intentional, as many folks only consider the number of stocks owned, while overlooking the number of companies owned. If you only invest in individual securities—stocks, bonds, etc.—then determining how many individual companies you own is pretty simple. Just ensure there isn’t any overlap (e.g., Apple stock and an Apple bond), and then count. But, also, look at the percentages of assets you have in each company. Do you have more than 5% in any one issuer? If so, you may want to reconsider how diverse you actually are.

However, if you are a mutual-fund investor, the consideration is a little different:

  • How many funds do you own?
  • What do they buy?
  • Are they diversified?
  • Does Fund A overlap with Fund B?
  • Do you own many funds, with holdings numbering into the thousands?
    • If so, do you have a strategy for determining your ideal mix of holdings, or do you just “own everything”?

Diversification is a balancing act—you don’t want to tip too far in any one direction.

4. Are your bonds diversified?

We touched on bond diversification in our recent series of posts regarding special considerations for retirement investors on a fixed income; but in our experience, many investors do not use the same level of care and caution when considering bonds as they do for stocks. They presume bonds are safe and, if they own them, they’ll own very few issues in very large positions.

Look at your statements. If you have a million-dollar portfolio invested in individual bonds (not funds or ETFs), getting diversification could be hard. After all, a $50,000 bond position is about as big as you would really want to take in a single issue. Owning 20 different positions at that level—not a very large number!—would mean you are 100% in bonds. Own less than that? Own fewer, bigger positions? You could easily be insufficiently diversified.

Expect the Unexpected in Retirement

 5. Does your retirement-planning strategy include an emergency fund?

Here we go again with something you probably don’t think of as a typical investment risk, but most of you should have an emergency fund of cash. You don’t need it to be anything extreme, like years’ worth of withdrawals, but having a cushion you can easily access and turn to in times of market turmoil is key. And it may easily help you navigate those tough times, too, to know that you have a cushion to fall back on. Your emergency fund should be off-limits to investment in other assets with volatility risk. Violating this principle defeats the purpose.

MORE: Interested in retirement advice that you can use right now? If you have a $500,000 portfolio, download our retirement guide called "The 15-Minute Retirement Plan." Even if you have something else in place, this must-read guide includes research and analysis you can use today. 

Cash: Not Always King

6. Do you have too much cash?

Some folks, though, take item #5 to the extreme, keeping huge swaths of cash idle “just in case” some very unlikely need arises. You have to assess the positive aspects of having a sound emergency fund against the possible negative of carrying too much cash, weighing on your longer-term return.

Always remember: Cash is not risk free. It risks losing purchasing power to inflation, and it costs you the opportunity to earn bigger returns in other asset classes. In the longer run, it is arguably as risky—if not riskier—to have too much cash as it is not enough. Always ask yourself: Is my total asset allocation—cash, stocks, bonds and other securities—aligned with my longer-term goals? If you don’t know the answer, you have a big problem and should talk to your financial professional immediately.

Obviously, there are other factors worth including when assessing your retirement-planning strategy and portfolio. But these points are a good place to start, and considering them could help you prosper in 2016 and beyond.

i The same logic would also apply if all your stocks went down, but we figure most people would be quite aware of that.

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