For many people, as they enter their 50’s, they begin to feel the pressure of not having as much money as they want for their upcoming retirement. The reason can be from any number of factors such as spending above their means, higher than expected education costs for children, unfavorable market returns, unexpected medical needs, divorce, you name it, it can all impact one’s savings. From self-inflicted to total misfortune, it happens more often than you think. And while the path getting to this worrisome point can be very different, the future actions taken, unfortunately, are often similar.
One of the many retirement planning mistakes that a person can make is how they manage their investment risk during the later portion of their working years. In an effort to eliminate the retirement savings shortfall, many people opt to be more aggressive with their investment selections. The reason is simple, they believe that they ‘need’ to achieve an above average return in a short period of time. This makes perfect sense too, considering that for the vast majority of our lives (from childhood through adult) we have learned this behavior. In almost every sport, the losing opponent will become more aggressive towards the end of the game to try and turn it around. Often resorting to high risk plays/shots hoping for success. In the end, that is all that it is though, a win or a loss. In most sports, all that matters is that you are in the winning position at the end of the event. The scoring margin is irrelevant. A one point win is just as good as a thirty-one point win. If you are in the losing position as the event is ending, it could make perfect sense to be more aggressive to see if you can change the outcome. But should you do the same as you approach retirement?
Since being more aggressive is often akin to accepting more risk, doing so in the few years leading up to retirement could have a devastating impact on your future financial situation. Saving for your retirement is not a win or lose event like sports. Each dollar becomes more meaningful as you get closer to the day that you will stop working. A decision to accept a higher degree of volatility, and a potentially large loss, in the hope of achieving an above average return, is one that should not be made until you have done your homework.
When trying to determine how aggressive one can be with their investment strategy it is important that they first consider their desire and ability to take on more risk. Desire would be measured by ones willingness to accept and tolerate variable market conditions. Since we all agree that higher investment returns are good, we should focus on negative returns. If your investment values were going down, at what point would you begin to feel uncomfortable and what would you say is the minimum acceptable return? Would you be uncomfortable at -5% and unwilling to accept anything below a -12% return, or are you willing to incur an even greater loss because the invested money is not necessary to you anytime soon? One’s desire is difficult to accurately measure because it is purely an emotional assessment. And in the case of someone feeling like they need to be aggressive in order to “catch up,” emotions tend to get skewed.
The ability to be aggressive would be measured by a number of factors including your time horizon, net worth, and your total liquid assets. These measurements cannot be skewed by emotions. For someone with a short time horizon, an average net worth, or relatively low liquidity of assets, (ie: majority of money tied up in real estate or personal business) an aggressive investment style could be detrimental to their upcoming retirement objective.
Consider this, in the first quarter of 2000 the tech heavy NASDAQ Composite Index closed above 5,000, (March 2000) but by August 2002, it had lost more than 75% of its value and stood at 1,206, with several individual companies folding along the way. It took 15 years for the index to return to its 2000 highs! In the 1st quarter of 2000 the S&P 500 Index managed to close above 1,500. After significant losses during the tech bubble burst from 2000 – 2003 and the financial crisis in 2008 – 09, the S&P 500 index finally passed the 1,500 mark again in January 2013. In most cases, those who were positioned aggressively with their investments during those periods incurred even greater losses.
The time to take a risk with your investments is early in your professional life when your ability to recover from poor market conditions is high and your need for the money is low. The worst time to invest aggressively is when you are hoping to be able to retire within the next 10 – 15 years, but are behind your estimated savings goal. The risks of hoping to maintain gainful employment beyond your expected retirement age far outweigh the reward of a few extra percentage points for an annual return. At this point, one may consider evaluating their annual income and expenses to see where there are opportunities to generate more savings over the next few years before retiring. Doing so would increase the chance of successfully accomplishing your goal.
Kevin Warman
Last Updated 4/19/2017