5 Reasons You Should Not Put 100% of Retirement Nest Egg in Stocks
When a lot of people think about investments, the first thing that comes to their minds is stocks. Unfortunately, for a good amount of these people, that’s also the only thing they think of.
As a result, they have very one-dimensional portfolios that are extremely vulnerable to market volatility. This is no way to prepare for retirement.
An approach like that is how well-intentioned people who were only trying to save a modest sum end up with nothing.
In case you need more convincing, let’s look at five reasons your nest egg needs to consist of more than just stocks.
Stocks Are an Emotional Rollercoaster
This may not seem like the end of the world, but putting 100% of your retirement savings into stocks will do a number on your nerves. None other than Walter Updegrave of Real Deal Retirement recently pointed out this problem with stocks:
“Simple. I’m not convinced that most investors, and especially those near or in retirement, fully appreciate the emotional and psychological impact of watching the value of their stock holdings dwindle during a severe and prolonged market setback.
I’ve found that people tend to be less certain about their conviction to hang in when the you-know-what really hits the fan, and stock prices are tumbling, investors are panicking; pundits are predicting Armageddon, and all the financial news is bad and seems to be getting worse. It’s during such dark times that investors understand the concept of “capitulation,” which describes what happens when even the most gung-ho investors lose hope of a rebound, hoist the white flag and begin selling stocks however low the price.”
This is an important reality to understand for a number of reasons. For example, during retirement, you want to be relaxing as much as possible. You don’t want to be racked with stress and anxiety because the market is being unpredictable.
Bear Markets Can Drain Your Savings
People who put a lot of faith in stocks for retirement purposes often point out that if they have at least two years of living expenses in savings, they’re basically guaranteed against the worst case scenario.
To back up their claim, they cite that there have been 20 bear markets since 1929 and none of them have ever lasted two years.
Here, too, Updegrave sets these people straight:
“ It’s true that the 20 bear markets (defined as a drop of 20% or more in stock prices) since 1929 have lasted roughly one year on average, according to this recent Yardeni Research report on bull and bear markets and corrections. But two have lingered on for more than two years — 31 months and 26 months for the bears of 2001-2002 and 1930-1932 respectively — and five others have lasted a year and a half or so.”
On top of that, a bear market doesn’t need to last two years to do permanent damage to your retirement goals.
What if the severity of the market downturn is so bad that your portfolio drops beyond repair? Just because you have two years of spending, that doesn’t mean you actually want to spend it.
Keep in mind, too, that we might be years removed from the recession, but that doesn’t mean we’re completely safe. A full-on stock market crash is still very possible.
A Diversified Portfolio Is Essential
If you think that your 100%-stock-portfolio can be considered diverse as long as you choose stocks from different industries, you’re wrong. A truly diverse portfolio includes bonds, at the very least.
Bonds are a natural hedge against the kind of volatility you’ll see from investing in stocks.
Going back to the above point, if a bear market does strike again, you want bonds over stocks to help carry you through.
Bonds Are Essential for Retirement
We touched on this a bit earlier, but one excellent reason for not putting all of your nest egg into stocks is that this won’t leave you with any funds for bonds, arguably the best option available for retirement.
For one thing, corporate bonds are more likely to pay out than stocks. This is self-evident. Corporations have cut dividends countless times in the past. The only consequence they really have to worry about is a drop in their stock’s price.
On the other hand, their bonds are much higher up on a corporation’s list of priorities. If they don’t meet their obligations where payouts are concerned, they’ll find themselves staring at the prospect of default.
That’d definitely be much worse than the possibility of having to cut dividends.
Another great thing about bonds is that they mature. When the date of maturity arrives, the issuer is obligated to pay every cent of the bond’s face value. If they don’t, once again, they risk having to default.
You Can’t Create Ladders with Stocks
Along the same lines as the above, stocks don’t offer the same potential to continue growing your portfolio in retirement. It’s possible but very unlikely that you’ll have enough returns every year that you can take out the amount you want and re-invest a substantial amount back into the stock market.
Bonds, on the other hand, are perfect for ladders. Bond ladders are a collection of these investment vehicles with progressive dates of maturity. This way, the bonds don’t all hit maturity at the same time. As they mature, the returns are used for living costs.
The other benefits of this approach are that you minimize your exposure to interest-rate risk. Obviously, with numerous maturity dates, you increase your liquidity as well. Finally, you diversify your credit risk as well.
Aside from liquidity, you’re just not going to get the same benefits from putting your nest egg into stocks.
I’m not saying that stocks need to be avoided at all costs. However, they clearly have their limits and are probably unduly popular with most investors. As far as your retirement hopes are concerned, you need to make bonds part of your portfolio.