How to Think About Risky Stocks When You’re Approaching Retirement

Pulling back into a potential recession isn’t what anyone would want, but there are ways to maintain some control over your portfolio during times of economic downturn. Making some big adjustments to your investments in the years leading up to retirement can pay big dividends across the board while adding extra security to your spending plan.

Let’s think further about how to protect yourself if you experience anxiety into old age.

The danger of sequence risk

The goal of most people in their careers is to accumulate wealth. In the years leading up to retirement, the focus is on preserving assets.

As we can reasonably anticipate that the economy may face some difficult years ahead, it is all the more necessary to change your strategy for entering retirement. Given the large number of variables that go into retirement planning (such as how long you expect to live, how much you expect to spend, etc.), it’s important to be as secure about money as possible.

One of the less frequently discussed topics in retirement planning is sequence risk (sometimes referred to as “return sequence risk”). Simply put, sequence risk is the potential to encounter poor returns in the years after you’ve finished your job, which can then lead to long-term portfolio failure.

In other words, if you experience a sharp decline in portfolio in the early years of retirement — when you’ve already started using the money to cover living expenses — you run a higher risk of running out of money than if you were in would retire in a bull market.

Addressing sequence risk

The easiest way to deal with sequence risk is to increase the proportion of lower-risk assets (like bonds and cash) versus stocks. As 2022 has shown us so far, bonds aren’t entirely risk-free, but they generally come with a lower risk of extreme drawdown — especially when compared to stock investments. While you may not get great returns from bonds, they are a valuable risk control measure that offers at least some diversification benefit.

Suppose you’ve maintained an asset allocation of 80% stocks/20% bonds throughout your career. Given the rapid bull market of the 2010s, this allocation has performed particularly well.

However, as retirement looms, you might briefly consider switching to a 20% stocks/80% bonds asset allocation. Rethinking your asset allocation can help protect against the threat of poor returns in the early years of retirement, which pose a significant threat to retirement success.

A numerical example

Let’s say you started your 2022 retirement with a $500,000 portfolio and an asset allocation of 80% stocks/20% bonds. After the stock market is down 20% and the bond market is down 10%, you are left with $410,000. From there, you would have to withdraw money for expenses, which could be detrimental to the long-term viability of your portfolio.

In an alternate world, imagine you started with the same $500,000 portfolio but with a more conservative asset allocation of 20% equities/80% bonds. In this example, after the stock market has lost another 20% and the bond market has lost 10%, you are left with $440,000. This is still a loss, but an improvement over the riskier portfolio used in the first scenario.

While this is by no means a way to completely insulate your portfolio, it does provide some cushion should stocks continue to slide over the next few years.

Retirement isn’t easy, but it’s possible

The reality remains that retirement is a financially challenging milestone for the vast majority of workers. But between Social Security, personal savings, and (increasingly) active income, retirement is totally doable.

As you approach retirement, you should consider the risks involved and the extent of the stock market loss you would be willing to tolerate. From there, adjust your overall asset allocation as needed, but also make sure to keep a healthy cash reserve on hand.