Conventional wisdom says aggressive when young, becoming more conservative as you age
Published in the August 20 – September 3, 2014 issue of Morgan Hill Life
By Dan Newquist
Dan Newquist
How aggressive should you be when saving for retirement?
I get asked this questions all the time. The right answer will depend on a number of key factors. These include, among others, your income and assets, your attitude toward risk, whether you have access to an employer-sponsored plan at work, the age at which you plan to retire, and your projected expenses during retirement.
The conventional wisdom has traditionally been that you should invest aggressively when you’re young and then move gradually toward a more conservative approach. By the time you retire, you would probably end up with a portfolio made up mostly of high-grade bonds and other low-risk investments. However, the retirement landscape has changed dramatically in the past 20 years or so. As a result, many of our basic assumptions about retirement planning have been overturned.
The dwindling number of traditional pension plans and concerns about Social Security have led people to take greater responsibility for their own retirement. Investing more aggressively over the long term has become common as people realize that, without anyone else to take care of them, they need to build the largest retirement nest egg they possibly can. In fact, many people these days primarily use growth investments such as certain stocks and mutual funds for their investment portfolios and tax-deferred retirement plans like 401(k)s and IRAs), and likely reduce the allocation of these investments as they near retirement.
Other factors have changed the way we think about, plan and invest for retirement as well. People are tending to retire younger, live longer, and do more during retirement than they used to. With the likelihood that you will have more than 20 years of living to fund, it’s well worth it to sit down with your financial advisor to determine if your investment strategy is in line with your future retirement needs. Keeping a suitably balanced portfolio, including some of your assets in growth-oriented investments, even after you retire, may be appropriate for your situation.
It’s not always easy to determine where you stand on the spectrum of risk aversion versus risk-seeking, but it’s very important to try to get an accurate assessment. Risk isn’t an either-or proposition; many investors consider themselves risk-seekers until they actually experience a loss that gets too painful. Your tolerance for risk affects your choice of investments and the overall makeup of your portfolio. Components of your risk tolerance include:
Personality: Are you able to sleep at night knowing that you’ve put a portion of your hard-earned dollars at risk in a particular investment? Remember, it might be easy to tolerate a high-risk investment while it is generating double-digit returns, but consider whether you’ll feel the same way if the market takes a downward turn. It’s best to invest at a level of volatility that you are comfortable with.
Time horizon: The sooner you may need to use your investment dollars, the shorter your time horizon, the lower your risk tolerance.
Capacity for risk: How much can you afford to lose? Your capacity for risk depends on your financial position (i.e., your assets, income, and expenses). In general, the more resources or assets you have to fall back on, the higher your risk tolerance capacity.
Your risk tolerance profile is typically determined by answering a specific series of questions, each scored according to how you answer. The score translates into a measure of your risk tolerance and may be matched with an investment strategy deemed appropriate for someone with your risk profile. Although this profile is an important element, your investment plan should always be tailored to your unique circumstances.
Reviewing your personal situation and retirement goals with your investment advisor on a regular basis will help you determine the asset allocation strategy best suited for you. Keeping in mind that your personal situation can change from year to year, it’s important to factor any life changes into reassessing your strategy on at least an annual basis.
Dan Newquist, CFP®, AIF® is a Principal Investment Advisor Representative with RNP Advisory Services, Inc., a registered investment advisor, in Morgan Hill. He can be reached at 408-779-0699 or [email protected]. Securities offered through Foothill Securities, Inc., member FINRA/SIPC, an unaffiliated company.
