Diversification is still important for retirees
By Sarah Cecil
During your working years, your primary investment goal is generally growth – you need your money to grow so that you can eventually afford the comfortable retirement lifestyle you’ve envisioned. But when you retire, should you change course and adjust your investment strategy from “offense” to “defense”?
Actually, it’s not quite that simple. To begin with, even while you are working, you don’t want your portfolio to be completely filled with growth-oriented investments, such as stocks. If it were, you would likely be taking on a degree of investment risk that’s too high, because, as you may know, stocks will fluctuate in price – sometimes significantly. And if you only own stocks, you could take a big hit during a market downturn. That’s why you need to have an array of investments – stocks, bonds, certificates of deposit (CDs) and so on. By spreading your investment dollars this way, you can give yourself more opportunities for success while reducing the impact of volatility on your portfolio. (Keep in mind, though, that diversification, by itself, can’t guarantee profits or protect against all losses.)
Now, let’s fast-forward to your retirement date. Once you retire, you may need to look at your investment portfolio somewhat differently – instead of “building it up,” you may now want to think of “making it last.” So, your first impression might be that instead of maintaining the diversified portfolio you had when you were working, you need to switch to predominantly “safe” investments, such as CDs and Treasury bonds, to reduce the risk of losing principal.
And such a strategy might indeed be effective – if your retirement were only going to last a year or so. But the chances are reasonably good that you could be retired for two, or possibly even three, decades. If that’s the case, then you will have to deal with a threat to your lifestyle that you might not have considered: inflation. We’ve had low inflation for several years, but that could change in the future. Consider this: Even at a relatively low 3% inflation rate, prices double roughly every 25 years. And depending on your personal needs and spending patterns, your personal inflation rate might be even higher.
To protect yourself against inflation, you will find that investments such as CDs and Treasury bonds are typically not much help. In fact, in a low-rate environment, your returns on these investments may not even keep up with inflation, much less keep you ahead of it. That’s not to say they have no value – they can provide you with an income stream and help lower your overall investment risk.
But to defend your purchasing power, you will still need some growth potential in your investment portfolio during your retirement years. Your exact percentage of stocks and other growth-oriented investments will depend on a variety of factors – your projected longevity, other sources of income, family situation, risk tolerance and so on. You may want to consult with a financial professional to ensure that your portfolio mix is suitable for your needs.
Many things may change in your life when you retire – but the need for investment diversification is not one of them.