Q: I recently retired, and have a 401(k) worth a substantial amount of money. Should I move my money out of stocks to reduce my risk?
The short answer to this question is no. All retirees should have some exposure to stocks or stock-based funds in their portfolio. While they are indeed more volatile investments than bonds, for example, they are essential for achieving long-term growth, which you'll need if you want your retirement portfolio to keep pace with inflation.
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Having said that, it's a good idea to reduce your exposure to stocks as you get older. A rule of thumb I like to use is to subtract your age from 110 to determine the percentage your portfolio that should be in stocks. For example, if you're 65 years old, this formula suggests that your asset allocation ought to be roughly 45% stocks, with the rest in less-volatile fixed-income investments.
Companies with rock-solid businesses and long histories of consistent dividend growth can work well for retirees; stalwarts such as Microsoft, ExxonMobil, and Johnson & Johnson immediately come to mind.
Or, if you don't want to worry about company-specific risk, you can get stock exposure through mutual funds and ETFs. I'm a big fan of index fund investing, especially in retirement, as it keeps costs low and spreads out your risk.
My favorite stock fund for retirees is the Vanguard High Dividend Yield ETF (NYSEMKT: VOO), which invests in about 400 stocks that have above-average dividend yields. (The three that I mentioned above are among them.) The fund provides the regular income retirees need, plus growth potential to help them keep up with inflation. And dividend stocks tend to fare better during recessions and market crashes than their non-dividend-paying counterparts.
The bottom line is that while retirees generally have lower risk tolerance than younger investors, a reasonable stock allocation is still a good idea.
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Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Matthew Frankel has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Johnson & Johnson. The Motley Fool owns shares of ExxonMobil. The Motley Fool has a disclosure policy.