What do many investors worry about in retirement?
They seem to worry about the stability of their principal. This can be a big mistake. Fixing the value of your retirement portfolio using predominantly fixed-income investments like bonds, CDs and fixed annuities to avoid temporary market declines can make it more difficult to maintain financial independence throughout retirement.
The biggest financial foe you face over a lengthy retirement is not temporary investment portfolio declines; it’s the long-term erosion of the purchasing power of your income. Consider the cost of a postage stamp 40 years ago. In the summer of 1972, first-class mail cost just 8 cents. Today it costs 46 cents, an annualized increase of more than 4% per year. Today it’s virtually impossible to put your money into a fixed-income instrument (except risky high-yield bonds) with a rate anywhere near 4%. The average inflation rate for 2012 was 2.1%.
Fixed-income interest rates are currently at historic lows. As interest rates increase, bond values decline.
Over the last 40 years, the stock market returned about 10% per year, despite numerous temporary declines in value. Even if the next 40 years do not provide the same average annual return, it’s likely that the long-term return of stocks will exceed that of bonds.
Generally speaking, people are unable to remain invested when their portfolio experiences 100% of the stock-market declines. That is why most investors are better served with a balanced portfolio of both stocks and bonds. A balanced portfolio helps reduce the volatility of the investment portfolio, giving people the confidence to remain invested during the inevitable market swings.
Remember to focus on the right objective. Retirees need to preserve their purchasing power with a gradually increasing income. Avoiding temporary declines in one’s portfolio should not be the primary objective. Focusing on the latter will likely be counterproductive to the former.
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