In Retirement, There Are Two Investment Risks and Both Are Happening Now

There’s an old, dumb rule that says you should have 100 minus your age in stocks.

The idea is flawed — especially for those trying to live off their portfolio.

When you are retired, you have two major investment risks: volatility and inflation.

There are only four characteristics that an investment has — safety, tax advantages, growth and income. As you seek more of one characteristic, you give up more of the others.

Safety is often described as knowing you can get at your money when you need it. Bonds (other than junk bonds) are often viewed as safe. When your money is available but buys you less stuff, how safe is it really?

While inflation has been under control for many years, it has always existed. And when inflation is low, interest rates also tend to be so. I have a relative who, since the 1980s, only invested in “safe” instruments like CDs and government bonds. Back then, you could get double-digit returns on Treasuries. Now, you barely reach single digits! My relative’s income from those investments has fallen 90%.

What about stocks dropping in price? That’s volatility. Because the value of stocks is a function of their future somewhat unpredictable earnings and dividends, their values bounce around.

While volatility is incredibly painful in the short-term, the lack of predictability is partly why stocks grow and bonds don’t. Stocks generally focus more on growth and tax advantages (with potentially some dividend income), and bonds generally focus more on income and safety.

If you were 70 years old with total investments of $500,000 and had 70% of your portfolio in 10-year Treasuries (paying 2%), you would be earning $7,000 a year for the next 10 years plus whatever dividends paid on your stock investments. In 10 years, 70% percent of your portfolio would be worth exactly what it is today, regardless of whether your personal costs have risen.

A better strategy is to carve out two to three years worth of spending needs and place that amount in online savings accounts, where rates typically rise with interest rates.

Diversify the rest of your portfolio by tilting more heavily to baskets of different types of stocks. Hold some bonds as protection in case markets fall and you don’t want to sell your stocks. Spend a percentage of your portfolio rather than the income the portfolio generates.

Unless you have far more money than you will ever need, ignore that silly age rule.

Spend your life wisely.

Related: Why Emotions Often Overtake Personal Financial Analysis