3 investment risk-management moves every retiree should make
Author: Diane Mtetwa
Source: The Motley Fool
You've finally reached retirement. You've spent the majority of your working years accumulating money. But now as you're nearing the time when you'll be using it, you're wondering how you can manage your investment risk.
In retirement, your accounts will be declining because of withdrawals and you don't want this exaggerated by declines in market value. These three risk management tips will help.
1. Understand the risk
When you invest, it's important that you understand there is always some risk. If the idea of losing money scares you, you shouldn't steer clear of investing; rather, you should get a better understanding of the risk you're taking.
The stock market has good, bad, and flat years, but over long periods of time, it has always grown. In 2000, 2001, and 2002, large-cap stocks lost a total of 43% of their value. Despite this huge loss, the S&P 500 traded at a higher level within seven years after the dot-com crash began. Understanding this dynamic will make it more likely that you'll endure bear markets when they happen.
History won't necessarily repeat itself but knowing that even in this worst-case scenario the stock market came back, you can manage your expectations around how your accounts will perform. You'll find yourself less tempted to sell out of your investments in a panic and more mindful of time horizons. The stock market has always rebounded but it may take years to do so. Keeping this in mind, you should avoid investing money too aggressively that you will need in the short term.
2. Diversify your risk
Asset classes react to events in different ways and have various levels of risk, which is why you can benefit from holding a lot of different types of them. Stocks are the riskiest asset class and because of this, you should earn the most for owning them in the long term. But you could also lose the most when the stock market declines.
2008 experienced the worst year of losses for the stock market since the Great Depression. If you held only large-cap stocks in that year, your account would have lost 37% of its value. In that same year, corporate bonds returned 5%. If you owned 60% stocks and 40% bonds, your accounts would've only lost 20%.
You can diversify and reduce your risk by adding other types of investments with less or non-correlated risk to your portfolios like bonds, cash, or commodities. Sure, this may limit your upside, but it also limits your downside and gives you peace of mind in the process.
3. Rebalance your risk
As your investments grow (or shrink), your allocations become skewed. As a result, you become either too aggressively or too conservatively invested.
If the stock market performs well, your 60% stock and 40% bond allocation can grow to 70% stocks and 30% bonds. In a good market cycle, this won't be that big of a deal, but if the next year a bear market happens, your account, which is more aggressive than your initial allocation, may lose more money than you feel comfortable with.
There is also the scenario where that same portfolio had a year where stocks underperformed, leaving your allocation at 50% stocks and 50% bonds. If in the following year, the stock market does really well, your accounts probably won't perform as well as you expect them to. The result is that you might feel disappointed with your lackluster performance and find yourself short of meeting your goals in the long run.
Rebalancing your accounts back to their original allocations will fix this problem. Rebalancing your accounts means you sell the investments that have done well and buy more of the investments that didn't do well. At a minimum, you should rebalance your accounts once a year but they may need it more often during a year where the markets are volatile and have gained or lost a lot.
Once you've reached your retirement savings goal, your main concern is protecting your wealth. Managing risks is always important, but it's even more important during a time where you will be withdrawing money. While you can't prevent losses completely, you can manage them and enjoy your retirement years instead of worrying about running out of money.
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