As someone who plans to re-retire under the Biden administration after grinding during the pandemic, I've been thinking about how much investment risk to take in retirement.
Clearly, I should tone down investment risk if I'm no longer going to be earning active income. Further, with how strong stocks, real estate, and other risk assets have performed since 2020, let alone 2009, it may be prudent to reduce risk. But how by how much is the question.
If you are wondering how much investment risk to take in retirement, I will offer up various portfolio compositions to consider in this post.
Retirement Should Ideally Be Peaceful And Free From Money Worry
Once you retire, you don't want to take excessive risk. Instead, you want to enjoy life to the maximum thanks to your steady passive income streams.
In 2012, I retired from the the finance industry. I thought I had enough to provide a humble life for a family of up to four in San Francisco. But once I stopped receiving a bi-weekly paycheck, reality hit home. Maybe my ~$80,000 a year passive income and side hustle income wouldn't be enough.
The fact that I tried to sell my primary residence in 2012 to live in an apartment 65% smaller and cheaper shows that I had reservations about early retirement. But I was determined to provide a free life for my wife and I both before the age of 35.
In early retirement, I concluded I needed to take the least amount of risk necessary to maximize my chances of never having to go back to work again. At the same time, I was still pretty young and it looked like the economy was recovering.
Therefore, I ended up constructing a 60%-70% stock and 30% – 40% bond portfolio. I hoped to achieve a 4% – 6% rate of return each year. Doubling my investments by the age of 50 seemed like a good enough goal to have.
But thanks to a bull market in stocks and bonds since 2009, my public investment portfolio returned more. And thanks to a strong recovery in San Francisco real estate, everything has turned out fine so far. I wasn't smart, I just stuck to an investment framework that fit my risk profile.
But I “Missed Out BIG TIME” On Making More Money
In 2017, my public investment portfolio returned 15.9%. Given my annual return objective was only 4% – 6%, I was feeling pretty good about the performance. Then of course a reader left this lovely comment after reading my investment lessons from a surreal 2017 post. I wrote that due to uncertainty, I didn't pile into stocks at the beginning of the year.
You missed out BIG TIME then. Seemed pretty obvious that the stock market would soar once Trump was elected despite what many so called experts said. Regardless of accomplishments, investors gained trust in the market again once a businessman was elected as opposed to another career politician (on either side).
Isn't it interesting how all investment decisions are obvious in hindsight? Yes, my combined stock and bond portfolio underperformed the S&P 500 index by about 3.5%, but my stock only exposure outperformed since I was heavy in tech. I didn't invest my entire portfolio in the stock market because I wasn't comfortable with the risk.
Thankfully, I made up for my underperformance in 2020 when my investment portfolio rose by a surprising 40%! 40% compares favorably to the S&P 500's 18% return.
How Not To Feel Bad About Portfolio Underperformance In Retirement
For those of you who may feel bad about your investment performance or were criticized by others for not doing better, let me share some following thought gems.
1) You're already free.
Money is a means to an end. If you're able to earn or accumulate enough to be free to do whatever you want every day, you win. It's much better to only be up 10% and do your own thing than be up 50%, but still have to report to someone.
2) Don't forget the absolute dollar return.
As someone who is close to retirement or in retirement, you've likely already got way more capital than someone who is still far away from retirement. Therefore, the absolute dollar amount you return is also much greater. It's much better to be up $1 million due to a 15.9% return than be up $100,000 due to a 100% return.
3) Don't forget all your other assets.
You likely have a wide assortment of investments as part of your net worth compared to most Americans who have most of their net worth in their primary residence. Even if your public investments underperform, your other asset classes such as coastal city real estate, private equity, venture capital, real estate crowdfunding, venture debt, fine art, etc might outperform.
4) More money won't make you happier.
After you earn more than ~$100,000 a year in a non-coastal city or ~$300,000 a year in a coastal city, you won't be happier. The same can be said with building a greater net worth beyond what you've deemed necessary to retire on.
But if you want a specific net worth number, I will say anything above a $3 million net worth won't make you much happier if you are truly free to do what you want and don't have to make your partner work to enjoy your lifestyle.
5) It's great to sleep well at night.
All retirees know what it's like to lose money because we've been through enough down cycles. When you can combine the freedom to do what you want with not having to worry about ever going to work because your investments are generating enough income, you feel like the luckiest person on Earth. Not only have you won the game, you get invited back as a VIP with front row seats and all you can drink and eat privileges.
Retirement Investment Risk Levels
Now that we've got a lot of the FOMO side of the investment equation out of the way, let's talk about how much investment risk to take in retirement. Ideally, our investment income generates enough to cover our desired retirement lifestyle expenses.
Alternatively, we can also consider investing returns surpassing active income as a good indicator for living a low-risk retirement lifestyle.
Zero investment risk in retirement
Your baseline investment goal in retirement is to at least beat inflation. You can easily beat inflation with no risk if you invest all your money in Treasury bonds.
Treasuries usually yield more than inflation, providing real returns. So long as you hold your Treasury bond until maturity, you will get all your principal back plus the annual coupon.
You can also invest in CDs where the FDIC guarantees up to $250,000 in losses per person. The problem is finding a CD with a high enough interest rate to comfortable cover inflation. CDs also have early withdrawal penalties.
Minimal investment risk in retirement
The next investment you can make is to invest your entire liquid net worth in a portfolio of the highest rated municipal bonds in your state.
AAA-rated municipal bonds have default rates under 1%. In 15.5 years, you'll double your money. So long as you hold your municipal bond until maturity, you will get all your principal back plus the annual coupon, if the municipality doesn't go bankrupt.
Moderate investment risk in retirement
The Barclays U.S. Aggregate Bond Index provides about a 5% annual return each year, depending on which 10 year time frame you're looking at. You can take more risk buying individual corporate bonds, emerging market bonds, or high yield bonds. But overall, buying the aggregate bond index is a moderately risky investment.
If you buy an index fund, you have no guarantee of getting your principal back. You are riding appreciation or depreciation and collecting coupons. Corporations can default or corporate bonds can lose principal value if a corporation experiences financial difficulty.
There are no guarantees. If you bought Venezuela sovereign bonds you'd be down big as the government is in disarray and inflation is sky high.
Higher investment risk in retirement
The stock market has returned anywhere from 8% – 10% a year on average, depending on the time frame you are looking at. Just like in the bond market, you can buy all sorts of different stocks with different risk profiles.
For example, for investors under 40, I recommend investing more heavily in growth stocks. It's better to try and rapidly build your capital base while you are younger and have appetite for more risk.
For investors over 40, I recommend investing more heavily in dividend stocks for passive income. When you're older, you won't want as much volatility given you will have much more money and more responsibilities. Generating enough passive income to cover your living expenses is the holy grail of personal finance.
But as we know, the stock market can have violent corrections. See the recent number and magnitude of corrections below in the chart. Then of course, we had the 32% one-month correction in March 2020 and the 19.6% correction in 2022.
As a retiree, it's OK to sell stocks to pay for life and things. Otherwise, you'll never be able to enjoy your stock gains.
Retirees will have a combination of different types of risk levels. The question to ask is what type of investment weightings one should have in each based on their risk profile.
There is no right answer because everybody's risk tolerance is different. But we can start by looking at the risk / reward metrics of different types of portfolios.
Income Based Retirement Portfolio
Income based portfolios are what the typical, truly satisfied retirees should focus on. There's minimal risk to principal and only modest medium-to-long term growth of principal. Given retirees are generally in a lower tax bracket, an income based portfolio is also usually more tax-efficient.
Even with a super conservative 100% allocation in bonds, your average annual return would be 6.1%, beating inflation by roughly 3.6% a year and twice the current risk free rate of return. In 14 years, your retirement portfolio will have doubled.
With a 30% allocation to stocks, you could improve your investment returns by 1.1% a year. But if you are already satisfied with the amount of money you have, who cares about an extra 1.1% a year? Your stock allocation matters by bond yield.
The improved performance will make no difference in your lifestyle. With a potential improvement of 1.1% a year, you increase the magnitude of a potential loss by 40% (from -10.1% to -14.2%) based on history.
Balanced Retirement Portfolio
A balanced-oriented investor seeks to reduce potential volatility by including income-generating investments in his or her portfolio and accepting moderate growth of principal. This type of investor is also willing to tolerate short-term price fluctuations.
For most retirees, allocating at most 60% of their funds in stocks is a good limit to consider. An average annual return of 9.1% is more than 4X the rate of inflation and about 5X the risk-free rate of return. But you've got to ask yourself how comfortable you'll feel losing over 20% of your money during a serious downturn. If you're over 65 years old with no other sources of income, you will likely be sweating some bullets.
For the first two years after leaving work, my public investment portfolio was around 60% stocks / 40% bonds. Once I got out of early retirement mode by working on my online business, I got more aggressive in stocks because my business income began to surpass my investment income.
Growth Based Portfolio
To be comprehensive, let's take a look at the risk / reward metrics for portfolios with 70% – 100% allocations in stocks. These portfolio allocations are mostly for those who are looking to build a retirement nest egg you've already built.
Even with a 100% allocation in stocks, the average annual return is only 10.3%. But there have been 25 years of losses out of 95 years, and in the worst year you would have lost 43% of your money. Losing 43% of your money is fine if you are 30 years old with 20+ years of work left in you. But not so much if your goal is to spend the rest of your days cruising around the world.
Unless you retired before the age of 50, have a variety of passive income streams, run a lifestyle business, or have a net worth equal to over 30X your annual expenses in retirement, I wouldn't have greater than a 70% allocation to stocks.
Eliminate Financial Worry In Retirement
Below is a chart that shows how much investment risk you should take in retirement, depending on your age and risk tolerance.
Now that you know what the risk/reward metrics are for the above portfolio compositions, you can decide on an investment strategy that best suits your needs. The ideal financial scenario in retirement is low volatility and steady income.
Don't let money get in the way of a wonderful retirement. Your investments should be a relatively worry-free tailwind that ensures you never have to return to the salt mines again. If you are starting to worry about your risk exposure, then dial down risk. Raise more cash or rebalance more towards treasury bonds or top-rates muni bonds.
Yes, it can get annoying if you underperform your respective benchmarks. But you've got to remember that you've already won the game. Every single dollar you make above the rate of inflation is gravy. During bull markets, you'll sometimes be able to return a greater amount from your investments than you would make at your job.
The pain of losing money is always much worse than the joy of making money. If you've already got all the money you'll ever need, there simply is no point taking outsized risk.
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Diversify Your Investment Risk With Real Estate
Investing in retirement doesn't only mean buying stocks and bonds to diversify investment risk. Many successful retirees invest in real estate as a way to minimize volatility, earn income, and growth capital.
Real estate is a core asset class that has proven to build long-term wealth for Americans. Real estate is a tangible asset that provides utility and a steady stream of income if you own rental properties.
I've personally invested $810,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America. I feel much less stressed investing in real estate than I do investing in stocks. Further, I can earn much higher yields from real estate.
Personally, I like investing with Fundrise, which offers real estate funds that invest primarily in the Sunbelt region. Valuations and rental yields in the Sunbelt are higher. Fundrise manages over $3.3 billion and has over 400,000 investors.