As you approach retirement, you’ll likely be inundated with advice about how you should alter your retirement planning strategy. To the team at Fisher Investments, the key is in understanding that any decision you make will have a tradeoff. Any adviser who pitches you a “perfectly safe” retirement investment is selling you a myth.
Many brokers tell their clients who are approaching retirement to dial back on the percentage of stocks they invest in; ratcheting up bonds, cash and other securities that are allegedly “safer.” By safer, we figure they mean “less volatile.” But that presumes volatility is the biggest risk you face—and that bonds don’t experience volatility along the way too.
Every investment ever bought, sold or held in the world has risk. It just shifts and changes! This is because all categories of securities have expected risk and return characteristics—those characteristics just aren’t the same.
Yes, the stocks you own are and will be volatile. However, historically, stocks compensate investors for this with the highest returns of any liquid (easy to convert to cash) investment1.
True, bonds are less volatile overall, but they also tend to have lower long-term returns. And, bonds are not risk free! After all, if you buy a bond, you are lending money to a government or corporation. Bonds are subject to interest rate risk, the risk the issuer defaults, and reinvestment risk. The first two cause lost money. The third; causes lost opportunity.
As for cash, it has no volatility but also very low, if any, return.
Three Risks for Bond Investors
|1. Interest Rate Risk
|Bond yields and prices sit at opposite ends of a seesaw. When rates rise, prices fall. (To varying degrees based on the type of bond)
|2. Reinvestment Risk
|Bonds have maturities, and some can be redeemed early by the issuer. When that happens, can you match the yield you received before?
|3. Credit Risk
|The risk the bond issuer can't pay you back with interest and defaults.
Return on Investment
The simple truth is most retirees need some kind of return. The person who has saved enough so that he or she doesn’t have to take any volatility risk to fund retirement is a rare breed. For one, life expectancies are growing. An American man who retires today at 62 has 20 years to fund through retirement planning, based on the Centers for Disease Control’s life expectancy tables. Women have a bit longer; over 24 years. So if funding your retirement is one of your savings goals, keep in mind that 20-24 years is quite a long time.
An additional and related risk is inflation. Over time, the purchasing power of a dollar declines. The US Bureau of Labor Statistics’ Consumer Price Index has increased at around 3% per year since 1990. In dollar terms, that means an expense costing $100 in August 1990 and rising at the average rate of inflation costs over $180 today.
Inflation’s Impact on a $100 Expense, August 1990 – August 2015
Source: US Bureau of Labor Statistics, Headline Consumer Price Index Inflation.
To maintain the purchasing power of your portfolio, it must match inflation. And that’s just the average rate! As you age, many of the products and services you consume appreciate at rates exceeding the average (e.g., medical care, pharmaceuticals, college tuition for the grandkids, etc.).
Tradeoffs You Must Make in Retirement Planning
So, here is the tradeoff:
- If you want less volatility risk, you will get more longevity risk and inflation risk.
- If you want less longevity and inflation risk, you will get more volatility.
There is no way around this tradeoff. It is part and parcel of investing. Anyone telling you they have the safe solution that renders this null and void is someone you should probably think twice about entrusting with your retirement.
Like what you read? 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.
1Source: Global Financial Data, Inc., as of 1/7/2015. Since 1926, Stocks have posted annualized returns of 10.0%, outperforming corporate bonds, gold, US Treasurys and municipal bonds.