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Investing In Retirement: 2 Unique Approaches To Minimize Risk


A buy-and-hold approach may not protect retirees from market risk.

Don't avoid risk completely; many "risk-free" investments are also "return-free."

Use a "bucket strategy" to diversify by time horizon in addition to asset class.

Investors have enjoyed one of the longest bull markets in history over the past eight years, but the first two months of 2018 have shown that the risk of volatility is always present. As of March 2, the S&P 500 and the DJIA were both negative on the year. The question for many investors is whether the bull market’s inevitable end is upon us.

For retirees, this question can be especially important. If you’re recently retired or are nearing retirement, a downturn could have a serious impact on your savings. You’ve worked hard to accumulate assets to fund your retirement. A sharp downturn may reduce your assets and suppress your income.

Commonly accepted financial wisdom is that what goes down will rise again. That is, if you have a long enough time horizon, you will eventually recoup your losses and more following a downturn. However, retirees don’t have the luxury of a long time horizon. You may need income from your retirement assets as soon as you leave the working world. How do you minimize your risk exposure, limit your losses, and continue to grow your investments?

There’s no easy answer. However, many financial professionals are rethinking the buy-and-hold investing approach for retirees. Below are three strategies that - if implemented correctly - could help you better manage risk and protect your retirement assets.

Avoid “risk-free” assets that are also “return-free.”

Many retirees shift to so-called “low-risk” or even “risk-free” investments once they leave the working world. These assets usually include things like CDs, high-quality bonds, or even fixed annuities. There’s no market exposure, thus no risk of loss.

It’s understandable why a retiree would become risk averse. After all, you’ve spent decades accumulating your retirement assets. You rely on them for income. The last thing you want to see is a steep decline in value.

However, the safe investments aren’t always risk-free. While many of these assets may not have risk exposure, they also offer little in the way of returns or growth potential. That could be problematic for retirees.

It’s possible that you could live for decades in retirement, and inflation will likely drive up your cost of living over that time. Consider that Medicare premiums alone have risen by an average rate of 7.7 percent annually over the past 51 years. That rate is reflective of the rise in overall healthcare costs in retirement.

According to Rodger Sprouse of Sprouse Financial Group, many retirees overcompensate by shifting to an allocation that is too conservative. “Many people are terrified of the stock market, so it’s understandable that they gravitate towards things like CDs, bonds, and cash,” he says. “But the fact is they don’t have to accept pitiful returns. There are strategies that can minimize risk exposure and offer higher returns.”

Sprouse says the key is to develop an investment strategy that is unique to your specific needs and goals. “It’s possible with a proactive approach,” he says. “There are a variety of tools available that can be used to minimize risk, including alternative investments, insurance products, annuities, and actively managed portfolios. The critical piece is building a strategy based on each client’s specific objectives.”

Diversify by time horizon in addition to asset class.

A common investing approach is to build a portfolio with a variety of allocations to multiple asset classes. The idea is that each asset class will perform differently depending on a various market factors. With your funds spread across many different assets, you minimize the risk that any one asset class will have a significant impact on your returns.

However, the success of this idea is also heavily dependent on a long-term time horizon. Sprouse said many investors buy into this idea because they are seduced by average returns, which can be misleading.

“Looking at average returns when building a portfolio really isn’t a sound approach,” explains Sprouse. “For example, assume a $100,000 portfolio that is up 20 percent, down 50 percent, and then back up 30 percent over a three-year period. That’s a flat average annual return, but the portfolio would be down about $20,000 at the end of that timeframe.”

Many retirees are also exposed to sequence-of-returns risk. That’s the possibility that you could suffer down years at the very beginning of retirement. If you start retirement with a sharp loss and then take annual retirement distributions, your balance may never recover, no matter how well the market rebounds.

Instead, Sprouse suggests not only diversifying by asset class but also by time horizon. He favors a bucket approach, so that assets are divided by short-, medium-, and long-term need. The short-term bucket takes a more conservative approach, while a more aggressive stance may be implemented in the long-term bucket. Of course, the client’s unique needs, goals, and risk-tolerance are also important factors.

According to Sprouse, this approach is effective because if separates the money needed for near-term distributions from the funds that could have risk exposure. This limits sequence-of-return risk and allows the client to be more flexible with their strategy.

“I am a big advocate for the bucket approach,” says Sprouse. “In that framework, there’s room for just about any type of investment, so instead of generally shifting to a more conservative approach, we can really find the specific tools and assets that are right for that individual client.”

Retirement is a sizable financial challenge in any market environment. However, volatility and the prospect of a downturn can complicate your planning. It may be time for many retirees to rethink commonly accepted wisdom and develop a strategy that is unique to their specific needs and goals.