Should I Change My Investment Strategy?

Dear Carrie,

My husband and I plan to retire in the next five years or so. He thinks we should move away from stocks because they’re too risky, especially given all the recent market volatility. I don’t want to miss out on the potential for gains once the markets straighten out. What are your thoughts?

—A Reader

Dear Reader,

It’s a fair question. While it will be several years before you'll need to rely on your investments for your retirement ‘paycheck,’ a bear market can quickly wipe out years of savings and investment gains, as we’ve recently experienced. On the other hand, once things turn around, a bull market can boost your ability to spend.

My first reaction is that you and your husband are both correct. As investors, we continue to evolve depending on our circumstances, and retirement is when we might want to move away from the risks of the stock market. That said, many of us are fortunate enough to enjoy a long and active retirement, so will continue to benefit from having the potential for growth that stocks can provide.

And regardless of your life stage or current market conditions, the basic investing principles of asset allocation, diversification, holding down costs, and regular rebalancing still hold. Let’s take a closer look at the steps you can take now to prepare for a secure future—no matter what the market does.

First understand where you are now

Before you make any changes to your investments, take inventory of where you are now.

Start with your net worth—your assets (investments, cash savings, equity in your home or other real estate) minus any liabilities (all your debt, including your mortgage).

Next, examine your annual cashflow by comparing your expenses to your income. Hopefully, you’re in the black, including annual savings since that's the key to any successful retirement.

Have a clear plan

Once you know where you stand, run the numbers (or rerun them if your plan hasn’t accounted for big changes) to see if you’re on track to reach your retirement goals. One general guideline is that you can safely withdraw about 4 percent of your portfolio with adjustments for inflation from a well-diversified portfolio (including around 30-60 percent in stocks) for approximately thirty years.

To get more specific, I suggest you work with a financial professional to create a personalized financial plan that takes into consideration all aspects of your financial life. A financial planner can also help you examine options by running various “what-if” scenarios.

Understand risk

Every kind of investment has risks, just different kinds and levels. Nothing is risk free.

When you and your husband discuss exposure to the stock market, you’re setting what financial professionals call your ‘asset allocation.’ This is important because your mix of assets plays the largest role in controlling the amount of risk and potential return in your portfolio.

A portfolio heavily weighted in stocks has the most potential to grow, but also the biggest potential to lose value, especially in the short term. On the flip side, a portfolio that doesn’t include stocks will have very limited growth and increase the risk that your money won’t last your entire retirement.

Cash has the least amount of risk over short periods of time, but the greatest long-term risk of losing value compared to inflation. Bonds fall somewhere in between and, like cash, may add ballast to your portfolio when investment seas get rough.

Wise investing involves making choices that take into account these trade-offs.  

Stay diversified

Another foundational principle of successful investing is diversification. Commonly described as “not putting all of your eggs in one basket,” it means owning different types of investments within each asset class. For example, a diversified portfolio of stocks would include large, small, foreign, and domestic companies in different sectors of the economy. This is because different investments are less likely to all go up or down at the same time. If your portfolio is concentrated in just a few individual stocks, you’re not diversified.

Rebalance

As markets shift, so will your portfolio. If the stock market has been on a tear, you’ll likely find yourself over weighted in stocks. On the flip side, if the stock market drops as it has recently, you can find yourself underweighted in stocks.

What's one fix? Rebalancing. Rebalancing is a bit counter-intuitive because it involves selling things that have gone up and buying what’s not done so well. This is what's meant by “buy low and sell high.”

Although there are no hard and fast rules about how often to rebalance, it’s smart to do it at least annually. Another approach is to rebalance if your portfolio is more than 5-10 percent out of alignment, as can happen when markets have dramatic swings.

Rebalancing is simpler in tax sheltered accounts like IRAs and 401(k)s as there are no tax consequences. That said, when you rebalance a taxable account you may be able to lower your tax bill by taking advantage of ‘tax-loss harvesting.’ This is essentially selling an investment that has lost money and using that loss to reduce your taxable gains, potentially offsetting up to $3,000 of ordinary income. It's best to consult with a financial planner or tax professional to understand how this may work for you. 

Reduce costs

Low expenses help improve your results no matter what the market does. Take time to understand investment fees, sales loads, commissions, and other account servicing fees. To get this information, read your prospectuses and statements carefully. If you have questions, consult with a trusted financial advisor. And if costs don’t look reasonable, look for lower cost alternatives.

Maintain exposure to stocks and stay involved

As you get older, it can make sense to gradually reduce how much you have in stocks. A general guideline is to have about 40-60 percent in stocks at your retirement date depending on your risk tolerance and individual circumstances. As you continue in retirement it's generally still wise to maintain at least 20-30 percent in stocks.  

The key is staying involved. If you have a well-thought-out plan and a balanced portfolio, rebalance on a regular basis, stay diversified, watch costs, and consult with a financial planner when you have questions, you’ll be well on your way to a financially secure retirement.

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.