Growth stocks and growth mutual funds can fit into investment portfolios of people planning to retire in the coming few years, retirement experts say.
Growth stocks and growth mutual funds: Aren’t those for young people with decades until retirement?
Not necessarily. But getting pre-retirees to consider growth stocks and growth funds might be tough considering recent history.
With memories of the stock market’s sickening 40% plunge during the 2007-2009 recession still fresh for many, there’s a real reluctance among investors of any age to put their funds into anything risky. A recent survey by the FINRA Investment Education Foundation showed that just 21% of Americans are willing to take on risk with their investments.
Even so, retirement experts say a little bit of risk is essential if investors don’t want to outlive their money. And with the same FINRA survey finding that 56% of Americans worry about running out of money in retirement, it seems logical to look into how much risk and what kind of risk future retirees should consider.
“Pre-retirees and retirees who are looking for their portfolios to outpace the rate of inflation may want to consider including (growth stocks) as part of a diversified portfolio,” said Dara Luber, Senior Manager, Retirement, at TD Ameritrade.
However, Luber adds, investors should also take into consideration their own individual situation, including risk tolerance, objectives and goals.
Consider a 60-year old investor, perhaps one of the many who’s reluctant to take on risk amid global events like Brexit, sinking oil prices, and terrorist attacks. She decides to stay safe and keep her retirement savings in bonds, cash, and CDs. With all of her money in safe investments, she’s not counting on much, if any, growth of principal.
But if inflation were to average a typical 3%, the same investor who’s meeting her daily needs today with around $40,000 a year would need more than $72,000 a year in 20 years to have the same kind of living standard. Where is that additional money going to come from? Either the investor would have to cut back expenses, or eat into her nest egg faster, putting her at risk of outliving her assets.
“Investors confuse safety with certainty,” writes financial planner Harold Evensky, in his 2015 book, Hello Harold: A Veteran Financial Adviser Shares Stories to Help Make You Be A Better Investor. “Putting your nest egg into insured CDs may offer the certainty that when they mature, you get your principal back with the promised interest; however, if expenses go up with inflation, over time your safe investment is likely to buy you less and less of the goods and services you need. This is called purchasing power erosion and it’s one of the biggest risks retirees face.”
Growth stocks and growth mutual funds provide exposure to products that potentially could help investors keep up with inflation. As always, historic performance can’t predict the future, but U.S. large growth stocks had average annual rates of return of nearly 9% from 1990 through 2015, according to Fidelity. That stretch included a 40% drop in 2008 and losses of 20% or more per year from 2000 through 2002. A bond index posted average annual returns of less than 5% during those 26 years.
Evensky popularized an idea called “bucket” investing, in which pre-retirees put their funds in several different buckets, with one for money needed immediately, another for moderate-term needs, and yet another for long-term investments that have the potential to grow and help the investor replace money coming out of the first two buckets. This potentially helps investors avoid that purchasing power erosion Evensky speaks of. Growth stocks (and growth mutual funds) may fit into the third bucket for some investors.
Bucket investing, used properly, can also help investors get a better sense of their future needs and plan for retirement using an incremental approach.
“It’s a good way to visualize the money you will need in retirement in set timeframes, for example (years) 1-5, 5-10 and 10+,” said Luber, of TD Ameritrade. “This way you can get more aggressive the further out you go and be more conservative with the money you may need sooner. It’s important to review your retirement plan on a regular basis and reallocate as you deplete one bucket.”
But how much should investors approaching retirement consider putting into riskier holdings like growth stocks and growth mutual funds? There’s no magic formula, retirement experts say. Each investor is unique, and their circumstances, including how much they’ve been able to save, their expected Social Security income, their plans on when to retire, and the type of lifestyle they want to lead in retirement, can all help determine how much risk they need to take on.
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