Why Low-Risk Investments Won’t Sustain You in Retirement

There’s an assumption among many retirees that they should be investing very conservatively, sticking strictly to low-risk investments. But in talking to several retirees at our Cabot Wealth Summit last month, I was encouraged to hear that most of them prefer fast-growing momentum stocks. With good reason. The fact is, if you’re already retired, but know you still need to be focused on growing your nest egg, the safest, lowest-volatility investments are simply not going to meet your needs.

Of course, choosing what type of investments you want to buy depends on your personal investing style. Some investors love buying cheap stocks and waiting patiently for them to go up. Others get bored waiting around for value stocks to get moving and would much rather buy an “expensive” but fast-moving stock and sell it after a few months.

Financial advisors will try to tell you that you have to invest a certain way based on your age or your portfolio size … or whatever products they’re selling. But knowing what type of investing you’re best at and most comfortable with is invaluable knowledge. If you’re a round peg, trying to force yourself into a square hole is going to be both counterproductive and costly.

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A retirement calculator, like the Monte Carlo Simulation run by Vanguard, gives you a different way to look at risk. Rather than assuming you should only be investing in conservative, low-risk investments because of your age, running such a simulation can help you quantify actual risks of various investment strategies.

The lowest-risk strategy, of course, is keeping your savings 100% in cash. The only variable in this simulation is inflation (putting aside variables on the cost side like unanticipated expenses and how long you live), so there are few risks to account for. If you’ve saved $2 million, for example, Vanguard’s calculator assures you that you can spend $50,000 per year and still have 100% confidence that your savings will last 30 years in cash. On the other hand, if you start with only $1 million in cash, you’re guaranteed to run out before 30 years are up.

Both these situations minimize risks, technically, but only one is a viable retirement strategy. It’s important to wrap your head around the concept of risk as more than the concept of the unknown.

Risk can be quantified, and sometimes you will choose to take risks. The investor who has saved $1 million and wants to spend $50,000 a year for 30 years would be much wiser to take some risks with his money than to try and eliminate risk altogether. Using this situation again but allocating 60% of the million to stocks, 30% to bonds and 10% to cash, the Vanguard simulator calculates a 79% chance that his money lasts 30 years.

That’s not a low-risk situation—his money ran out in 21% of simulations—but it’s certainly preferable to guaranteed poverty.

Even with 100% of the money in stocks—what most investors would consider a “higher-risk” allocation—the Vanguard simulator still finds that the money lasts in 78% of simulations. But with 100% in low-risk investments like bonds, the money lasts in only 32% of simulations. So risk doesn’t always work how you’d expect.

Timothy Lutts

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