Intriguing title to this post, don’t you think? I thought so when I read the Money magazine article with a similar title. So what is the worst investment mistake that a retiree can make? Taking risk when you don’t have to.
When you have “won” the retirement investing game, why do you keep playing it?
He was referring to those investors who had accumulated substantial retirement nest eggs before the crash of 2008. When the market tanked, they sold at or near the bottom. They are still trying to recover.
What if, before the market crash, these investors had analyzed their nest egg, determined that they could cover most of their retirement liabilities, and got out of equities altogether? Think of the pain they would have saved themselves.
Of course, such a decision would have been contrary to conventional advice given by financial advisers, most of whom depend on the income they receive from buying, selling and managing equity investments for their clients.
Bernstein has written a book called “The Ages of the Investor” which discusses what economists often refer to as “life-cycle” theory. In a nutshell, this is Bernstein’s take:
How risky stocks are to a given investor depends upon which part of the life cycle he or she is in. For a younger investor, stocks aren’t as risky as they seem. For the middle-aged, they’re pretty risky. And for a retired person, they can be nuclear-level toxic.
(The emphasis on the last sentence is mine.)
I agree with Bernstein. Actually, I came to a similar view after reading some of the work of Professor Zvi Bodie.
A significant component of the equity risk problem is that as you approach retirement age, the value of your “human capital” is diminished. In other words, your ability to work and earn your way out of a market decline disappears.
A common response from the investing industry to the “no equities in retirement” position is that you need stocks in your retirement portfolio to manage inflation.
Bernstein’s answer to that is to put money in short term bonds and CD’s. If there is an inflationary shock, interest rates on short duration financial instruments will rise so you can quickly move in to them. Owning TIPS will also help.
Bernstein has an interesting rule of thumb for retirement investing. He says that before you retire, you should have saved 20-25 times the amount of your “residual expenses.” Residual expenses are measured by the difference between what you will spend each year in retirement and what your guaranteed retirement income (Social Security, pension, and annuity benefits) will provide.
For example, assume that you expect to receive $20,000 each year in Social Security income against planned annual retirement spending of $40,000. This leaves $20,000 in “residual expenses.” Bernstein says that you should therefore have retirement savings of at least 20 x $20,000 = $400,000 before you retire.
And when you do, he says, you have won the game and therefore should stop playing it by putting that $400k in something safe (not equities). If you have $600k saved, you can take risks with the extra $200k if you wish.
If you don’t have the $400k, work longer.
Investing like this may cause you to miss out on periods of market gains but so what? Your goal is to win your retirement game, not some other game.
Here is the entire Bernstein interview which is definitely worth your time to read: The worst retirement investing mistake.