Market volatility over the past year has had many baby boomers scrambling to figure out how best to protect their retirement portfolio. With the possibility of a recession coming, boomers need to know how much risk they are carrying in their retirement accounts.
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Christopher Tuck, CFP®, Wealth Advisor from SJK Wealth Management discussed with Fox Business how to recession-proof your retirement. Here is what you need to know.
Boomer: For those nearing or in retirement, how do I know how much risk I can tolerate in my portfolio?
Tuck: Determining risk tolerance should take a multi-faceted approach. Too often, risk tolerance alone becomes the determining factor. While it is a very important factor it tends to change hand in hand with current market conditions. Financialplanning.com recently reported record low confidence/risk tolerance after the recent market correction in December 2018. It makes sense that as investors start to see their portfolio values going down, there is a knee-jerk reaction to take less risk. History shows avoiding this impulse is wise. Therefore, investors should not base their risk allocation on just their current optimism or pessimism. Other factors like time horizon, required return, and principal withdrawal rate are factors that are not as influenced by market gyrations. As an advisor I am currently having many conversations with clients about the risk in their portfolios. The most common initial request is to be less risky after the recent market correction and fears of negative political outcomes. After taking a step back and looking at the bigger picture we usually end up in the same allocation from before we started the conversation. While not guaranteed, becoming less risky after a market correction tends to leave investors remorseful.
If doing it on your own, there are many free tools online to help determine your personal risk tolerance. Just Google “risk tolerance questionnaire”. These are a great starting place, just remember if you are taking a questionnaire after a market correction you might be answering more conservatively and might want to tweak up the outcome. On the other side, after a big run up in equities, you might be answering too aggressively and should tweak down. If using an advisor there should be open communication around your allocation and they should be able to provide you with a risk tolerance questionnaire and compare the results with your current allocation.
Boomer: How do I find the right balance of stocks and bonds?
Tuck: Stocks and bonds carry different levels of risk which is why they often work well together when crafting your allocation. Looking back historically can help investors find the right mix for their portfolio. For example, if their risk tolerance questionnaire shows a 60/40 equity to bond ratio, how did that perform in previous good and bad times. I see a lot of focus on the 2008-2009 financial crisis which is useful but should not be used as the sole period to determine your allocation. That period was an outlier. To explain a little more, if your risk tolerance can accept 20 percent down and your allocation was down 25 percent in that period, I would chalk that up as a win. The right balance of stocks and bonds should carry a volatility that allows you to remain invested. The right balance should also very much be a factor of your required return. If you have under saved for retirement and refuse to spend less, the cost is a riskier allocation. In the end, something has to give.
Boomer: What is portfolio diversification and should I be using this?
Tuck: Diversification is a proven method to help add consistency to the returns in your portfolio. Diversifying can be as simple as owning equities and bonds and maybe even alternatives but under the surface diversification can dig much deeper. For example, in equities you can diversify by market capitalization (large, mid, small), sectors (technology, financials, etc.), style (value, growth momentum,etc.), just to name a few. In bonds you can diversify by type (corporate, municipal, agency), term (short, intermediate, long), quality (investment grade, junk), also just to name a few. Overall the idea is that all these different categories will counteract each other in different ways. When one is having a great year, another might be having a bad year and offset the bad returns to some extent with the good returns. Diversification can also be fluid by tactically increasing and decreasing exposure to different areas based on market conditions and predictions about future returns. This is called tactical asset allocation. You can also set a long-term allocation and not mess with it much which is called strategic allocation. Regardless of your preference of allocation style and the amount of diversification you choose it is important that you also rebalance your allocation on a regular basis such as annually or semi-annually.
An example that really illustrates the power of all of these principles is Ray Dalio’s, the famous hedge fund manager, All Weather Portfolio. It is easy to find details on that portfolio now so not to go into details here, but the point is by allocation alone the portfolio as provided positive returns in all but three of the last 70 years. And the worst year was down about 3.5 percent. This is not to say it is the golden solution because the returns might not be sufficient for everyone. It is just to illustrate that picking your allocation can be more important that all the other financial decisions going into retirement.
All of this can seem like a lot but if boomers can take away one piece of information it is that asset allocation and diversification work. Do not doubt their power and stay committed to the allocation that fits them and their needs.