Retirees need equities

For those soon to retire or already retired, market volatility and emotions are their two worst enemies when combined.

They are fearful of their retirement portfolios taking a “big hit” if markets drop and then running out of money.

In their minds, the logical solution is to seek the “safe haven” of bonds and other fixed income. 

But there is something else they should be more fearful of — guaranteeing they will run out of money by being too conservative. 

For years, investors have been warned about “sequential risk," that is the risk of retiring just before a bear market begins. With that risk so regularly discussed, many are drastically reducing the amount of equities they hold in favour of “safer” fixed income investments. 

The problem with fixed income though, is that it doesn’t produce any meaningful returns. And once you put inflation and taxes on top, the net purchasing power of money invested in fixed income is guaranteed to go down each year. 

Yes, equities are more volatile but if your goal is to maintain your ability to pay expenses over three decades with ever-increasing costs of living, equities are really your only option. Why do I say that maintaining a high stock allocation is necessary, even if it increases volatility? 

Risk rewards

Volatility is the entire reason that stocks provide higher returns than bonds.

Investors are rewarded for taking part in this volatility, but it doesn’t have to be a bad thing. Proper investment management can take advantage of it by deploying additional cash during downturns to boost returns further. Income needs can be managed by keeping a healthy emergency fund or cash reserve. 

No crystal ball

There are many products and service providers out there that claim they can get equity like returns without the volatility but unless they have a crystal ball, this is not possible. Suppressing volatility means suppressing returns. Instead you need to embrace it for what it – there is no free lunch out there. 

Sequence of returns

The sequence of returns risk does not apply to your entire retirement account, unless you plan to spend all your money in the next few years. If your retirement plan spans three decades, the money you will spend in years five to 30 can easily absorb a short term drop as they’ll fully recover well before you need it.

Yet many feel they need to invest their entire account as if it will be spent soon. 

Volatility vs risk

Many people mistake volatility for risk, but they are two different things. Volatility in itself doesn’t make your personal financial plan riskier as long as it is managed right. But you know what does?

The fear of volatility creating a permanent reduction to one’s standard of living for the rest of your life.

Every time the markets drop, plenty of people come out of the woodworks to say why this time is different and they will never rebound. Yet every time they drop, markets not only rebound but grow to new highs. 

Equities will no doubt see drops and even crashes again, but those will be temporary and investors willing to hold on through them will be rewarded on the other end.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.