We are well taught that the more you want to preserve your capital, the more conservative your investments should be. When it comes to saving for retirement, and especially when you are in retirement, it does pay to be conservative to be sure.
Our view of what’s conservative is where the problem often lies though. We usually think of buying and holding stocks as being conservative for instance, when this approach is one of the riskiest you can take in the market.
Whenever you are in an investment and do not have an exit strategy, that’s actually one of the worst things you can do, surpassed perhaps only by having exit strategies that are based upon emotions.
When you don’t have an exit strategy, and one based upon sound judgement, you are exposing your entire portfolio to risk. Even if people stay the course as so many advise us to, that’s still going to expose us to the full brunt of any market risk that comes our way, and some pretty big ones are known to come.
As people are looking to accrue enough funds to comfortably retire on, they may have a long time horizon, and thus may not be concerned with things like your portfolio losing half its value or so, the sort of things that drive people to panic and do the wrong thing,
Doing the wrong thing and selling at the bottom is certainly not a good idea, but to think of either holding or bailing at the bottom as the only alternatives is a mistaken view. It’s a tale that mutual funds and investment advisors want us to believe though, since they benefit the most by us doing nothing and keeping our funds under their management come hell or high water.
This is not a conservative approach to investing though in any sense of the word. Instead, it involves taking a lot more risk on than necessary, and it actually doesn’t get much riskier than having your whole portfolio on the line and having no plans at all to manage any of this risk.
Growth Investments and Retirement Goals
The difference between the person who starts his or her first job right out of school and those in their 90’s who are looking to stretch out their retirement savings in the final stretch of their lives is time horizon.
The idea behind the buy and hold strategy of growth investments is that it is assumed that any drawdowns in one’s portfolio will be overcome with enough time. For the most part, given enough time, this has been the case.
This does not mean that this trend will continue, and we may indeed see a significant bear market that may last several decades, and we’ve seen such things in the past. If we look at the inflation adjusted numbers from the Dow, it steadily lost 75% of its value between 1966-1982. It wasn’t until 1995 that it regained its 1966 levels.
That covers a period of 30 years, about the same amount of time it took the Dow to recover from the 1929 crash. So while markets have recovered in the past from bear markets, it can take quite a while at times, periods that may well exceed people’s particular time horizons.
At a minimum, if we’re going to want to be reasonably confident in this model, this is going to require that we have enough of a time horizon to at least offset this risk, even though that may mean that we may not even get a positive return on our investments.
So that may mean we may want to have a time horizon in excess of 30 years to use the buy and hold approach to stocks, if we’re concerned about managing this risk properly that is. The trouble is, we do’s tend to be terribly concerned with managing risk when it comes to stock investing.
No other longer term investment has performed anywhere near as well as stocks have over the last 100 years, but at the same time we aren’t investing for that long. So, we need to make sure that our strategy matches up with our time frame, and as we approach retirement and especially when we’re in retirement, we simply do not have this much time, and there is a lot on the line if things go awry.
There Are Other Approaches To Stock Investing
This all does not mean that people should not invest in stocks when their time frame is too short to properly manage the risk involved, it just means that buying and holding may not be the best approach in a lot of cases. It’s really never the best approach anyway, since it manages risk so poorly, it doesn’t manage it at all actually.
Professional traders would never consider entering a trade without proper risk management, and risk management is the most important element of successful trading or investing. Very few individual investors don’t even have a plan to manage it though, and when they do look to intervene, their responses tend to be unplanned and based upon fear rather than sound analysis, which usually just makes the problem worse.
The number one way people lose money in the market though is to stay in positions where they should have exited some time ago, for a number of reasons. With longer term investing, it’s mostly because we are told that either you cannot time the market yourself or that you have fund managers who are taking care of this for you.
What most people don’t realize is that while it is not difficult at all for them to time the markets, funds don’t really have the means to do so very well due to the sheer size of the funds they have under management. While an individual can exit all of their positions in a flash, it is not so simple for them.
Mutual funds also are required to be long the market only, and in bear markets, this is going to be a big disadvantage to them. They also generally need to have most of their money invested, and this means that most of your money will have to be exposed in times where it is not wise to be.
Individuals have no such restraints placed upon them, and the only real one is being told by people that they should never tinker with their investments. With some people, they may indeed may want to tinker with this too much, but at the very least one can look to balance the amount of money they have in the different asset classes, the percentage of their overall portfolio held in growth, income, and in savings at any given time.
While this does require that we pay attention, it is not difficult at all to figure out what sort of market we’re in, a bull or bear market, and there are some very simple tools like using long term moving averages on stock index charts that can give us a good idea of where we are at.
Generally though, such things are pretty well known, and we even see situations like we’re going down but batten down the hatches and put on your life jacket, don’t even think of looking to board one of the lifeboats.
These decisions, to exit trades or funds, to re-allocate funds to a different type of investment with less risk exposure like bonds, or even going short the market should not be made without careful thought, but there are times where thinking about such things is clearly to our benefit.
Taking Action in Retirement
Whether one should even be in the stock market in retirement, or even in the decade preceding it, is an open question, as the goal should be to reduce one’s risk as one’s time horizon shrinks. This is where we are least able to handle risk, and stock investments are famously risky, whether we trade them or just hold them, and perhaps especially if we just hold them and endure whatever pain the market dishes out.
This does not mean that we need to just avoid stocks in retirement though, but if we do choose to still stay in the stock market, we’re certainly going to have to manage risk well.
Warren Buffett can just hold his investments into advanced age, and not worry about selling them in his lifetime, but he has $80 billion, so if he loses half of that, he’s still got $40 billion which he presumably could get by on quite well, especially given his relatively frugal lifestyle.
The great majority of the rest of us do need to worry about such things though, and don’t want to necessarily imitate those with no such concerns.
Depending on our capacity to manage our own investments, we may want to set aside a certain portion of our retirement savings to speculate on stocks, understanding that all stock plays are speculative in nature.
The growth component of our portfolio provides for additional growth potential along with a higher degree of risk generally, and if one is relying on this component to be reliable, this risk must be managed properly in order to make sense out of the allocation.
Many retirees don’t really pay much attention to this though, and end up being too exposed to risk, and their retirement can be ill effected by the drawdowns that these investments can produce.
There are others whose investment plan may benefit or even require a more aggressive approach, and they therefore may be better served by shooting for bigger returns than income investments like bonds tend to produce, but at the same time should not wish to take on the full risk of the buy and hold approach.
Should one wish to take more control over their stock investments and look to manage their risk, and also increase their returns, this is a possibility, although one should ensure that one comes up with a good plan here and not just jump in without knowing enough about what they are doing.
The ideal approach would be to take a more risk averse approach to one’s investments from the outset, where one can deflect a lot of the risk involved at the very least, and end up with considerably better long term returns than the buy and hold strategy provides.
It is particularly important though to pay close attention to managing risk in the years leading up to retirement as well as during one’s retirement years, as the goal is to be able to provide for oneself comfortably, or as well as may be reasonably expected given the amount of resources one has. While you can overprotect these resources, not investing aggressively enough, it’s very important to have enough protection.