People save money for several decades before retirement, but your career isn’t over when you leave your job. It’s important to monitor your nest egg and make sure it aligns with your long-term financial goals.
While putting everything in stocks is risky, there are some costly mistakes that some retirement savers overlook. These are three red flags to look for in your portfolio.
1. Exposure to more money than you realize
Inflation eats away at the purchasing power of idle money. It’s something that retirees especially need to be aware of as they lose their paychecks at a time when they may have to spend more money on health care, which costs rise especially quickly.
Although the average inflation rate is between 2% to 3%, some years see inflation that is much higher. In 2022, for example, inflation jumps to 9%. Retirees should crunch the numbers and check whether their income can keep up with inflation. If you haven’t tested your portfolio against inflation, now is a good time to do so. That way, you won’t be surprised if inflation rises unexpectedly.
2. Relying too much on one source of income
Putting all your eggs in one basket is a risky proposition, especially in retirement. Social Security, a pension and an investment account can make sense as a group, but relying exclusively on one of those sources of income leaves you vulnerable. Stocks can lose value, and even though pensions are stable and Social Security is slowly increasing, inflation can still erode their purchasing power.
Diversification in stocks, bonds, Social Security, investment income and other assets reduces your risk. Stock dividends can supplement Social Security benefits, and some assets can serve as valuable hedges against inflation.
3. The sequence of return risks is ignored
The stock market has a long history of outperforming inflation and delivering long-term returns for patient investors. While it may be easy to adjust the weather in your 20s, it becomes more difficult in retirement because of the sequence of returns risk.
This risk reflects the fact that retirees need to withdraw from their portfolios to cover living expenses regardless of whether the S&P 500 is up 10% or down 30% in one year. A significant adjustment in your first or second year of retirement may force you to sell more stocks to cover your living expenses. Fewer stocks mean you won’t have as much exposure to a stock market rebound, and it can pose a challenge to your long-term retirement plans.
Investors can get around the sequence of return risk by having enough money to cover at least a year of living expenses. You can put this money in a high-yield savings account so it can grow over time. You can also save a little and use a certificate of deposit (CD) ladder to help the money grow.
You should establish a withdrawal plan for the first five years of retirement. While you can cut some equity positions, it often makes sense to hold onto stocks that you won’t need to sell for many years. Stocks are one of the most growth-focused assets in a retiree’s portfolio, and it’s important to own those types of assets instead of relying solely on cash and bonds.
