Most of the decisions we make in retirement planning become easier once you understand why you are making them, but that does not mean they always feel intuitive. Investing is a good example. You spend your working years accumulating savings, often with the understanding that accepting some market risk is necessary to grow your money. Once you retire, continuing to expose those savings to market losses can feel much harder to justify. You have spent decades building the portfolio, so why not protect it?
For some retirees, that may be perfectly reasonable. For others, becoming too conservative can create a different problem. Your portfolio does not stop having a job to do because you have stopped working. It may need to support spending for another 20 or 30 years, keep pace with rising costs, and provide enough flexibility to handle expenses that do not unfold exactly as expected. Preserving the balance is useful only if the balance can continue to support those goals.
Why “Safer” Can Be Misleading
Part of the confusion comes from the way we normally talk about investment risk. In traditional portfolio analysis, risk is often measured through volatility, or the uncertainty surrounding investment returns. Stocks have greater volatility because their values can change substantially over relatively short periods. Cash has very little volatility, which is why we typically describe it as a safer investment.
That definition makes sense when we are evaluating an investment, but it is incomplete when we are evaluating a retirement plan. In retirement, a more meaningful definition of risk is the possibility that you will not be able to meet your financial goals. Market volatility can certainly threaten a retirement plan, particularly when poor returns occur early in retirement and withdrawals compound the damage. But eliminating volatility does not eliminate retirement risk. You can own investments that barely fluctuate and still run out of money.
For a retiree, how much the portfolio might decline is only part of the concern. What matters just as much is what that decline would mean for the retirement plan.
When “Enough” Still Requires Growth
Reaching retirement with enough money to sustain your financial plan does not necessarily mean investment returns no longer matter. Having enough to retire is not the same as having so much that investment performance no longer matters. For someone whose Social Security and other reliable income cover part of their expenses but who still expects the portfolio to fund a meaningful portion of future spending, those assets still have work to do.
This is also when becoming more conservative can feel particularly appealing. You are no longer trying to reach a retirement savings target because you have reached it. You spent your working years trying to accumulate enough to retire. Now those savings need to help support you for the rest of your life.
That may allow you to take less investment risk than you did during your working years, but it does not necessarily eliminate the need for growth.
The Cost of Giving Up Growth
Consider a couple retiring at age 65 with $1.5 million in investments and $70,000 of annual Social Security income. They would like to spend $120,000 per year, so their portfolio initially needs to provide approximately $50,000 annually. For purposes of this simplified example, assume taxes are already accounted for. Their financial plan shows that they have enough to support their retirement, but there is not so much excess wealth that investment returns are irrelevant.
After experiencing a few uncomfortable markets leading up to retirement, they decide that $1.5 million is enough and they do not want to risk losing it. They move most of their savings into cash and other conservative investments. What they aren’t seeing is the cost of giving up some of the future growth.
Now suppose we isolate $1 million of their portfolio and compare two hypothetical long-term outcomes. If that money earned an average annual return of 5% over 20 years, it would grow to approximately $2.65 million without withdrawals. At 3%, it would grow to about $1.81 million.
These are hypothetical returns, and an actual retiree would be taking withdrawals along the way, so neither figure represents what we would expect the couple’s account balance to be. That two-percentage-point difference may not seem like much in any single year, but over 20 years it can add up to about $850,000 of potential growth. For someone whose plan still depends on earning a reasonable return, that matters.
A Stable Balance Does Not Mean a Stable Retirement
The couple in our example is not trying to grow $1.5 million for the sake of having a larger account balance at age 85. The portfolio needs to grow because the expenses it supports are also changing. If their $120,000 lifestyle increases by 2.5% annually with inflation, the same spending would require approximately $197,000 per year 20 years from now. Social Security receives annual cost-of-living adjustments, which helps, but the amount they need from their investments is still likely to increase over time.
The rising cost of living is why the growth in the previous example is so important. The couple is not trying to maximize the size of the portfolio because they feel that a larger balance is better. They need some portion of that growth to help maintain the purchasing power of the income provided throughout retirement.
Judging safety by what happens to the account balance can therefore be misleading. Cash can protect principal from market volatility, but it does not necessarily protect purchasing power. A retiree can avoid a major market decline and still find that the portfolio gradually supports less spending as the cost-of-living rises. The answer is not just to own more stocks, but to make sure the investments you choose collectively provide the combination of growth, stability, and income your plan requires.
More Risk Is Not the Answer Either
Recognizing that your portfolio may still need growth does not mean you should take as much investment risk as possible. You only need enough growth potential to support the financial plan, and there is little benefit to accepting additional volatility if your goals can be met with a more conservative allocation.
You may be able to reduce your exposure to stocks and still earn enough to fund your spending needs over time. In that case, becoming more conservative can make sense. But if the plan still depends on investment returns, moving too much into cash or other conservative investments can work against you. The goal is not to avoid losses at all costs, but to find a balance between protecting what you have accumulated and allowing the portfolio to continue doing the work you need it to do.
How much market risk you can comfortably take also depends on how much a downturn would affect your day-to-day retirement. Someone whose essential expenses are largely covered by Social Security or a pension has more room to ride out a difficult market than someone who relies heavily on portfolio withdrawals to pay those same expenses. The same is true for someone who could postpone a major purchase or temporarily spend less on travel and other discretionary expenses. It is important to consider whether a market decline would force you to change the retirement you planned.
Start With the Plan, Not the Portfolio
Retirement investing should not begin with a predetermined stock allocation or a rule about how conservative someone your age is supposed to be. The appropriate investment strategy depends on what you need your assets to accomplish, including how much spending the portfolio needs to support, how much income you already receive from other sources, and how much flexibility you have if markets do not cooperate.
A financial plan puts those pieces together and gives you a better sense of how much growth you still need. Our How Much Do I Need to Retire workshop walks through that process step by step, helping you translate your spending goals and other income sources into the return your portfolio actually needs to provide. If you are comfortably on track, you may be able to reduce investment risk without affecting your ability to meet your goals. If your plan still depends on asset growth to support future spending and keep pace with inflation, becoming too conservative may create a different problem.
Having enough may allow you to take less investment risk than you did while accumulating assets, while still requiring a reasonable return. It depends on what your portfolio still needs to do for you. Once you understand that, you can determine how much growth you need, how much volatility you can afford to accept, and which risks matter most to your retirement. The safest portfolio is not necessarily the one that moves the least. It is the one designed to give you the best chance of accomplishing what you saved the money for in the first place.
Want to learn more? Listen to Episode 241 of the Retire With Style Podcast.
