There are three types of people who should consider owning stocks in retirement.
- Those who can afford to take on risk
- Those who are taking on risk as part of a holistic retirement income plan
- Those who understand the actions they need to take if the risks materialize
This article explains how you determine if you meet any or all of these criteria.
Determining If You Should Own Stocks in Retirement
As you near retirement, you’ll want to calculate the minimum return your investments need to earn for you to meet your lifestyle goals.
For example, suppose you have $200,000 saved. You decide it is ok to die with $1 in the bank. In the meantime, you need $10,000 a year for the next 30 years. Your $200k would have a required minimum return of 2.85% to accomplish your lifestyle goal of $10,000 a year.
If you can accomplish this goal with something safe and guaranteed, like an immediate annuity, then why take on risk? On the other hand, if you had $300,000 saved, then perhaps the first $200k could be used to secure your lifestyle goal and the remainder could be used to invest in stocks—because at that point you can afford to take a risk with the extra $100k.
If you require your stock portfolio to earn average returns for your plan to work then you cannot afford to take the risk. Average means that half the time your stocks will earn more and half the time they will earn less. Your retirement plan should use stocks as an “extra” boost if the market does well—but if you require the stock portion of your portfolio to perform then you don’t have a solid plan.
Are You Using Risk as Part of a Holistic Plan?
Another way of using stocks as part of a plan would be to take $200,000 and ladder out CDs or bonds so that $10,000 matures each year for the next 20 years. With cash flow needs secured for 20 years, the remaining $100k could be invested in stocks, with an incredibly high probability that it would double in value over those 20 years. During that 20 year period, if the stocks did well, a reasonable portion of gains could be taken to secure additional years of cash flow, or to fund extras along the way.
This strategy means you are using stocks as part of a plan – they need to earn about a 2.36% average return over 20 years—which is well below the market’s historical 20 year returns metrics even in a bad 20 years. You are not requiring stocks to deliver something that only happens 50% of the time.
Do You Have an Action Plan to Follow If the Risk Materializes?
What if you keep a portion of your savings invested in stocks in retirement and stocks don’t do well at all? You must understand the repercussions.
First, you shouldn’t have money in stocks if you’ll need to sell and use that portion of your savings in the next five years. You don’t ever want to own stocks unless you have the flexibility to NOT sell them when the market is down.
Second, if stocks do poorly for a prolonged period of time, you may have to reduce your spending. If you had planned on spending $10,000 a year from your portfolio and stocks deliver zero returns maybe you’ll need to reduce spending to $9,500 or $9,000 a year.
For some retirees, the ability to spend more early on is sufficient compensation for taking on risk – but they know if they get prolonged poor stock market returns, they may need to reduce spending later. They are using stocks in retirement – but with an action plan in place. They understand the possible consequences if stock markets don’t deliver positive returns.
How Do You Own Stocks in Retirement?
If you meet the criteria above, the next thing to understand is how to own stocks. When I say “stocks” I don’t mean putting a large portion of your funds in a single stock and I don’t mean sprinkling your money across a handful of stocks that you researched or read about—unless it is a small part of your total retirement funds and you don’t require that portion to help you meet your retirement income needs.
What I do mean is putting an appropriate portion of your money into a diversified portfolio of stock index funds. By doing this you get exposure to nearly 15,000 publicly traded companies across the globe and significantly reduce the amount of investment risk you are taking.
Pros of Owning Stocks in Retirement
Here is a short summary of the pros and cons of stocks as part of your retirement portfolio.
- Based on past returns stocks are more likely than other investments to help your portfolio and keep up with inflation.
- Stocks give you the possibility of higher returns and thus the possibility of higher future income and the ability to leave a larger legacy.
Cons of Owning Stocks in Retirement
- Stocks are volatile and that volatility means if you retire into a time period with below-average stock market returns this could force you into a situation where you must spend less than you thought in retirement.
- It can be stressful to weather the downturns in the stock market. If you aren’t using stocks as part of a plan, the emotional stress may cause you to sell at the wrong time and thus permanently lock in a loss and force you to live on less in retirement.
Some articles throw around rules of thumb like using your age to decide your allocation. If you're 60, for example, you should have 60% bonds and 40% stocks. This might be appropriate for certain people but for most, advice like this is overly simple and generalized. Many retirees have higher stock allocations than some might see as safe because other parts of their financial picture make them able to shoulder the risk.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.