Two Huge Considerations Before Being 100% in the Stock Market in Retirement

One of the most common questions I receive: "Can I be 100% invested in the stock market in retirement?" Or put a few other ways:

• "I've always been 100% in the stock market through my working years, why not continue to be invested in the stock market in retirement?"

• "If stocks always outperform bonds, why even consider bonds in retirement?"

• "I've been through stock market 'crashes' in the past. The market always rebounds. Why should that matter in retirement?"

Personal finance (and life!) is full of trade offs. If you want one thing, you probably have to give up another. Every decision has a consequence and the decision to allocate your portfolio a particular way is no different.

Generally speaking, pursuing a portfolio that will hypothetically deliver a higher return, tends to bring more volatility. Or in other words: risk. This is what the questions above are driving at:

"Am I ok to take more risk with my investments in retirement to pursue higher returns?" 

There is no right or wrong answer to this question. Instead there are tradeoffs. The two biggest being: investor psychology and unnecessary risks. 

Investor Psychology

Investing in retirement is VERY different from investing in your younger, working years. And I'm not talking about investing returns or portfolio allocation or any of the technical stuff. I'm talking about the concept of going from working and saving to NOT working and NOT saving (in fact, you're spending!). 

You tend to be ok taking on more risk in your investments in your early years. Why not, right? You have years of working and saving to make up for any 'lost' returns or income should a strategy not pan out. 

When you're in retirement, it's the opposite. You don't have income from your job (and the accompanying savings) to fall back on should a plan not work out. In retirement, you might view the risk in your portfolio very differently. 

To illustrate being 100% invested in the stock market in retirement and the associated risks, let's look at an example:

• Retire in January of 2007 with $1,000,000 in investable assets

• You are 100% invested in the stock market (100% in VTI )

• You are going to take $4,000 from your portfolio every month for retirement income

• The $48,000 needed annually will increase every year with historical inflation

Given those parameters, your retirement balance would look like this from January 2007 to December 2022:

When you look at the graph, you might think: "wow, it looks like it worked out nicely!" From a pure numbers standpoint, yes, it did work out. But there's more to the story.

From the fall of 2007 to the spring of 2009, this investor saw their retirement investments balance drop from about $1,068,000 to $480,000. That is a 50%+ drop in value in 18 months. 

Here is where the investor psychology comes into play: think about the pain this investor is feeling watching their account slowly go down MORE THAN HALF. All of their hard earned money that they saved for decades, was suddenly gone in a just a short span of time.

Ask yourself: is this something that you can handle in retirement? Really put yourself in the shoes of this investor? Could you REALLY stand the pain that must have felt? Do you honestly think you'll continue to pull retirement income from this portfolio when you're facing such a huge loss in the portfolio?

Remember: hindsight is 20/20. It’s easy to look at at the graph and say "oh yeah it all worked out." But the market (and the country overall) was HURTING after the 2008 Great Financial Crisis. Sentiment was low and people were panicking that the 2008 crash was only the beginning.

The point of bringing up investor psychology is to question how you would handle the volatility (and risk) that higher return assets bring. This investor was able to take advantage of the higher returns that followed the big crash, but not without paying the painful price and seeing their account be cut in half. Are you ok with the that trade off?

Unnecessary Risks

You take more risk, you expect more return. Less risk, less returns. You can say this about any project, task, or endeavor in life. If the return from the activity isn't enough to justify the risk, you typically don't pursue the action. 

The same concept applies to retirement planning. Let's say you map out your retirement plan and you determine that you need a 5% annual rate of return on your investments to fund all your retirement, legacy, and financial goals. You would probably want a portfolio that satisfies a 5% rate of return.

You would NOT be in a portfolio that's aiming for a 7% rate of return. A portfolio aiming for a 7% annual rate of return is probably taking on more risk, due to the needed higher return on their investments. The question this gets down to: why take on unnecessary risk in the 7% portfolio, when you're math shows you that a 5% portfolio gets the retirement plan completed.

Getting back to our original question: why are you 100% invested in the stock market, when that level of risk isn't even necessary for your particular set of goals.

If your goal is to die with as much money as possible in the bank or if you're trying to maximize your retirement spending, then maybe being 100% in the stock market makes sense for you. 

The whole point of this is to not take on unnecessary risks. Let your retirement plan costs drive your portfolio allocation (and not the other way around) and you'll find that you might not need to take on as much risk as a 100% stock portfolio brings. 

Wrap Up

There's no right or wrong answer to the question of whether a 100% stock allocation in retirement makes sense. Can you handle the emotions involved with big market dips? Are you taking on more risk than needed? Consider the trade offs before making the decision. 

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