Retirement wealth is vulnerable to current market conditions. What can investors do the protect their nest eggs?
Investors struggling to both grow and protect retirement wealth in times of extreme volatility may need to revisit the concepts of diversification and risk.
Investors planning for retirement have always weighed risk against yield, but current economic conditions make these calculations even trickier. Increasing market volatility, combined with record-low interest rates, is testing traditional models of retirement planning. From a short-term perspective, the models seem to be lacking.
Three-fourths of baby boomers and nearly 90 percent of financial advisors expressed concerns about sharp swings in retirement accounts in a MetLife survey conducted in spring. Nearly 60 percent of the baby boomers were unsure whether “retirement portfolios should be set and left for the long term” and 42 percent expressed an interest in learning about alternatives to traditional retirement portfolios.
In the past year, U.S. stock markets took their biggest dives since the financial crisis of 2008, and investors saw their stock portfolios plummet accordingly. During the same period, the U.S. Federal Reserve announced plans to keep short-term interest rates near zero and launched a program to hold down long-term interest rates. All the while, inflation inched up and, according to the latest government data, the cost of living is increasing at the rate of 3.8 percent per year.
Investors seeking to preserve and grow retirement wealth are looking for ways to offset these negative effects, but the process might require a new look at old theories. The theory of diversification is the Holy Grail of modern portfolio theory, but the practice doesn’t seem to hold up as well in extremely volatile conditions. In theory, diversification lowers portfolio risk by investing in a variety of financial products that perform inversely to each other. The idea is that when one financial sector – such as international stocks – is down, another sector, such as small U.S. companies, is up.
“For example, diversification should operate like pistons in an engine – while some pistons are going up, some are going down, but the car is moving forward,” said David B. Armstrong, a certified financial analyst and director of Monument Wealth Management, in a recent blogfor U.S. News and World Report. Recent market conditions are undermining the theory of diversification as asset classes that historically move independently of each other are moving up and down together, said Armstrong, explaining that “uncertainty, intense investor emotions, and high volatility are resulting in unusual market behavior.”
Volatility is especially worrisome for older investors building or protecting retirement wealth. Investors with long-term horizons are typically more comfortable assuming market risk and can better weather a turbulent market, but few investors toward the end of their work life can afford to take chances with their retirement wealth. Recent market volatility is prompting some to speed their transition to a more conservative portfolio, reducing their exposure to equities on accelerated schedule. Others are purchasing insurance products known as annuities to provide guaranteed income in retirement.
Investment risk is a double-edged sword for even the wealthiest investors, according to Millionaire Corner research. More than 60 percent of high net worth Millionaires, those with a net worth of $5 million to $25 million not including primary residence, say taking risks helped them build their wealth. Yet as they age, the investors lose their appetite for risk. By the time they are 65 or older, 46 percent of high net worth Millionaires say it’s more important to protect principal than grow assets, including retirement wealth, and only 26 percent are will to take on significant investment risk to earn a higher return on investments.