Is Holding Too Many Stocks a Bad Idea?
Are you a retiree with most of your retirement investments in stocks? Good idea? No. Even as the markets near or notch records every day, stay conscious of risks of not diversifying between classes of assets.
A recent Wall Street Journal article discussed how retirement savers are putting more money into stocks. Two excerpts:
“Stocks accounted for 67 percent of employees’ new contributions into retirement portfolios in March, according to the most-recent data … ”
“What cash I have, I’m going to use to buy more if the market dips,” said Roy Chastain, a 68-year-old retiree in Sacramento, Calif., who put an extra 10 percent of his retirement account into stocks in September, bringing his total stock allocation to 80 percent.”
If I understand Chastain’s situation, he sold out about half way through the market decline, likely missed a good part of the ensuing market run-up and now bulks up on stocks five-plus years into the market rally.
Part of the likely rationale: Stocks seem to be the only game in town. Bonds appear exhausted; with interest rates at record low levels there is seemingly nowhere for bond prices to go but down. Alternatives beyond stocks, bonds and cash, the new darlings of the mutual fund industry, have merit but separating alternatives’ wheat from the chaff is hard for most individual investors (and for many advisors).
With the stock market flirting with all-time highs and in year six of a torrid bull market, returns are even a bit more at risk than on March 9, 2009, when the Standard & Poor’s 500 bottomed out. Let’s say an investor’s $500,000 portfolio has 80 percent in stocks and the rest in cash. If stocks drop 57 percent, like the S&P 500 did from Oct. 9, 2007, through March 2009, the portfolio shrinks to $272,000.
Not devastating if this investor is 45 with 15 to 20 years until retirement. If this investor is 68 and counting on this money to fund retirement, this drop can change the game.
Let’s further assume this occurs just as this investor starts retirement. Using the classic 4 percent annual rule for retirement withdrawals, this investor might reasonably withdraw $20,000 annually from his nest egg prior to this market decline. After the 57 percent loss on the equity portion, this withdrawal amount declines to $10,880, a drop of 45.6 percent.
This retiree having other sources of income, such as Social Security and perhaps a pension, mitigates the damage. Still, diversification can partially protect against this type of disastrous loss in a retiree’s portfolio.
Will the stock market suffer another 57 percent decline? I’m guessing (hoping) this isn’t in the cards – but after the S&P 500 suffered a 49 percent drop from May 24, 2000, through Oct. 9, 2002, many folks including me felt like another market decline of this magnitude wasn’t going to happen anytime soon.
I agree that investing in bonds will likely not result in gains over the next few years. But given a low correlation to stocks and relatively lower volatility, bonds (or bond mutual funds) can still be a key diversifying tool.
Investors are historically notorious for bad market timing. Are you willing to bet your retirement that the markets will keep going up? Or perhaps you think that you might be able to get out before the big market correction?
Nothing goes up forever; resurgences take time after a market plunge. Consider some financial planning to include an appropriate investment allocation for your stage of life and your real risk tolerance.
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Written by Roger Wohlner, CFP, a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides financial planning and investment advice to individual clients, 401(k) plan sponsors and participants, foundations, and endowments. Please feel free to contact him with your investing and financial planning questions. Check out his Financial Planning and Investment Advice for Individuals page to learn more about his firm’s services. Roger is active on both Twitter and LinkedIn. Check out Roger’s popular blog The Chicago Financial Planner where he writes about issues concerning financial planning, investments, and retirement plans. He is also a regular contributor to the US News Smarter Investor Blog and has been quoted extensively in the financial press including The Wall Street Journal, Forbes and Smart Money. Roger is a member of NAPFA, the largest professional organization for fee-only financial advisors in the country. All NAPFA Registered Advisors sign a fiduciary oath promising to act in the best interests of their clients.
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