Retirement Ahead: Do You Have Enough Exposure to Stocks?
My parents plan to retire in 5-7 years. They have several income sources, including rental properties and 401(k)s that are invested in target retirement funds. These funds are quickly moving them to less than 30 percent in stocks. With the potential of a 30-year retirement, I’m concerned that they need more exposure to stocks. What do you think?
You're doing your parents a big favor by asking this question. No matter how well prepared we are, it's always a good idea to look under the hood to make sure all parts of the financial engine continue to run smoothly and work together. The fact that your parents have several sources of income is a real plus, but you're right to be concerned about whether their stock exposure is adequate—both for now and the future.
It sounds as if you're able to talk to your parents freely about their finances, so here are some things the three of you can discuss to perhaps help them do a retirement tune-up.
Understand why stocks are important
Historically, stocks have been the best investments for keeping up with inflation, consistently outperforming other asset classes. Although currently inflation is low, the average annual rate of inflation over the last 87 years has been roughly 3 percent. The average for the 1970s and 1980s was 6.7 percent.
Of course, investing in stocks carries a certain amount of market risk. But consider that, even with a mild inflation of 3 percent, $100,000 today will be worth only about $55,000 in twenty years. That's a pretty big risk in itself. So you don't want to ditch stocks—and their potential for growth—completely.
That said, you also want to make sure that you diversify your stock investments. That means having a mix of small-cap, large-cap and international stocks, as well as mix of industries and companies within those categories. While diversification cannot ensure a profit or eliminate the risk of investment losses, too much of any one stock carries a major risk of its own. Think mutual funds and exchange-traded funds for easy ways to get this diversification.
Get a big-picture view of your own retirement needs
With this perspective on stocks in mind, and with retirement 5-7 years out, now is the time for your parents to get specific about their retirement plan. For instance, what are their estimated annual expenses in retirement? How much of this will be covered by reliable income sources like Social Security or real estate investments? How much will have to come from their portfolio?
An industry standard is that your retirement portfolio should be 25 times the amount of your first year's withdrawal to increase the odds of your money lasting through a 30-year retirement. That way you can withdraw an average of 4 percent per year (increasing every year with inflation) and have about a 90% chance that you will not run out of money—assuming you keep a minimum of 20 percent of your portfolio in stocks.
Compare current stock holdings to recommended percentages
Worry about market volatility keeps a lot of retirees out of the stock market, but I believe it's important not to let that concern override everything else. While it's recommended that people gradually move away from stocks and toward fixed-income investments in retirement, as you can see, it’s also important to retain some stock exposure. The goal is to make sure you have continued growth while not risking the money you need to live on.
It's generally recommended that a pre-retirement portfolio contain about 60 percent in stocks, gradually moving to 40 percent in early retirement, and no less than 20 percent in late retirement. These are just guidelines, and a lot depends on your wealth, how dependent you are on your portfolio, and anticipated longevity, but it would appear that a 30 percent exposure at your parents’ point in life is pretty low.
Don't hesitate to make changes
Your parents' choice of retirement target funds may have to do with what's offered by their 401(k) plans, but that shouldn't stop them from reviewing the funds and making changes if needed. Target funds are designed to become more conservative as they approach the target retirement year. But, for instance, just because your parents may plan to retire in 2020 doesn't mean they couldn't invest in a 2030 target fund, giving them a larger percentage of stocks. (It’s also important to keep in mind that like any other mutual fund, the value of a target date fund is never guaranteed, not even at the target date (the expected date at which many investors are likely to begin withdrawing from the fund). The value of the fund will fluctuate up to and even beyond the target date as the asset allocation changes over time in accordance with the fund’s prospectus.)
I'd advise your parents to see what investments are currently available through their 401(k)s. There may be some new offerings that better meet their needs. Most plans allow changes in investments at least annually.Here's another consideration. You don't say whether your parents have stock investments outside their 401(k)s, for instance in a brokerage account or IRA. If so, they could take a more aggressive approach with those investments to counter-balance the more conservative target funds. Once again, it's important to look at everything together.
Talk to an advisor
Now would be a good time for your parents to meet with a financial advisor who can run some numbers and help determine if their current investment approach will carry them through a long retirement. But don't stop there. Encourage them to do another check-up in a couple of years, then again just before they plan to retire. And while you're at it, what about your own retirement plan?