Many financial experts seem to agree that as you get older you want to begin shifting away from high risk investments and begin to transition to more conservative less risk investments. The primary reason is the cure to the volatility of the stock market is time. The more time you have on your side, then the more risk you can afford to take because you have plenty of time to recover from a severe market sell off. As you approach and transition through retirement, you may not have enough time on your side to recover from a significant market downturn.
The other risk you face is inflation. Inflation tends to be a slow moving train, but a very real risk if you just bury your money in a can in the back yard because your dollars just wont buy as much in the future. So it’s really a balancing act to keep enough money in an at risk position to help you ward off inflation while not having so much at risk that a severe market correction could cause you to have to change your lifestyle in retirement.
How much risk should you be taking with your investments now that you are retired? One common rule of thumb is called the one hundred minus age (100-age) rule. This rule says if you are 60 years old, then you would subtract 60 from 100 and get 40. So 40% of your portfolio should be invested with risk, and 60% should be allocated toward more safety. Whatever your age, this is how much of your money should be invested in safer, less risky portfolios. So if you are 70 you would have 70% allocated toward safety and 30% allocated toward risk. Some people who are more comfortable with taking more risk will use the formula of 110 – age. If you are 60 years old, then using this more aggressive formula you might have 50% of your money at risk.
The problem with this rule of thumb is everyone has different size thumbs. While this rule may provide some guidance on how much risk you should be taking in your portfolio, a much better solution would be to create a comprehensive retirement plan and allocate your resources between safe and risk investments based on what you really need to accomplish instead of generic rules.
I remember meeting with a gentleman several years ago who had a couple of million dollars set aside for retirement. After completing a comprehensive retirement plan, we found if he just earned a 4% return every year, then he would be in great financial shape for the rest of his life. Knowing that he could accomplish all of his goals with just a 4% return gave him the freedom and peace of mind of knowing that he could have all of his money allocated toward safety without having to worry about the whims of the stock market.
Remember a general rule of thumb like one hundred minus your age may be a good starting point for having a discussion about risk vs safety in your diversification strategy but it should be just that – a starting point.
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