Jonathan I. Shenkman, Contributor
Jan. 28, 2022
2021 is now in the rearview mirror, yet many of last year’s concerns still weigh heavy on the minds of investors. These worries are magnified for those approaching retirement since their nest egg may need to last for decades into the future. The inability to manage these risks appropriately may have devastating consequences. However, implementing a sensible plan could allow folks to navigate these challenges relatively unscathed. Below are three headline risks for 2022 and approaches to help keep investors on track to achieve their retirement goals.
Sequence of returns risk: The market seems to continuously be going up but, with evaluations high by historical standards, what happens if the market plummets and delivers a string of unfavorable returns over the next few years? The risk of entering retirement and beginning to withdraw on your portfolio while the market is falling is known as “sequence of returns” risk. An extended market downturn is not a farfetched scenario. Investments move in cycles and experiencing unfavorable returns from time to time is par for the course when investing. Such a situation can be devastating to retirees since it increases the likelihood that they may run out of money while in retirement.
One of the best strategies to help a retiree’s portfolio from sequence of returns risk is implementing a strategy known as a “bond tent.” A bond tent is where an investor allocates several years’ worth of money within their portfolio to short-term high-quality bonds or cash as they near retirement. The goal is to reduce volatility and protect the portfolio against large stock market declines in the early years of retirement. If the market does crash, the retiree can use funds from their bonds or cash holdings instead of liquidating their stocks as they are falling in price. Presumably the value of the bonds and cash should remain relatively unchanged even as the market falls and can serve as an important cash cushion in such a circumstance.
Inflation: Over the past few months, inflation has been a top news story in both mainstream and financial media. It has impacted all aspects of life including gas prices, groceries, and even the rental car market. While this may be an inconvenience to younger folks as the spike in costs of goods and services makes life more expensive, it is deeply concerning to retirees who live on a fixed nest egg.
There are several practical strategies for this problem. The first is to continue working for a few more years. It’s impossible to determine whether this inflationary environment is transitory due to the Covid-19 pandemic or something that will be with us over the long-term. If you are willing and able to work for a few more years, you can pay for expenses out of compensation, allowing your portfolio to continue to grow and also providing you the opportunity to continue saving for a few more years. Those benefits can put retirees in a much more favorable financial position despite rising prices.
The second solution is to position a portion of your portfolio in asset classes that tend to outpace inflation over the long-term. Dividend paying stocks, real estate, Treasury Inflation Protected Securities (TIPS), and commodities you may want to consider
Dividend paying stocks have the potential to provide yields that outpace inflation and can be increase in value over time. Similarly, the appreciation associated with owning real estate and the landlord’s ability to raise rents on tenants provides a natural hedge against rising prices. When it comes to bonds, TIPS are issued by the federal government and have a mechanism where the principal increases along with inflation. Finally, commodities have performed well historically during inflationary environments as their prices tend to rise along with inflation. That is because commodity producers can pass price increases along to consumers.
Uncertainty in Washington: The one sure thing about Washington is the constant level of uncertainty. That is particularly true this year, with midterm elections coming up in November, which may change the makeup of Congress. If history is any guide, positioning your portfolio based on politics is a poor decision. Whether you look back at the elections of Barack Obama, Donald Trump, or current President, Joe Biden, there were always naysayers and those who were concerned that the new leadership will destroy the country as well as the market. In each case, the US stock market continued to flourish despite disagreements on policy, gridlock in Washington, and other political headwinds. This is not to say that markets will only go up. At some point there will undoubtedly be another market correction or a stretch of mediocre returns. Unfortunately, when these downturns will occur is unpredictable and likely not tied to any politics.
The best way to prepare for the political uncertainty is diversification. While it may be tempting to overweight certain areas of the market based on what you believe will transpire in Washington, that is ill-advised. The wrong portfolio positioning can be devastating, especially to those in retirement who don’t have the luxury of time to recoup their losses.
A better approach is to maintain exposure to a variety of asset classes, both domestic and foreign stocks, large and small companies, a variety of industries and sectors, as well as fixed income investments. It is the only prudent way to navigate a landscape of unpredictability. It is also the one strategy that increases an investor’s probability of financial success.
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