You’ve likely spent decades saving for your retirement, and now that you’ve finally left your nine-to-five, you may feel like your investing days are behind you as well. However, retirees face a number of challenges that make investing a lifelong pursuit, including maintaining safe income streams, outpacing inflation, and avoiding the risk of running out of money. Here’s a look at some factors and options retirees may consider to help choose the right investment path.
What to Know About Investing During Retirement
Assessing Your Income and Budget
Retirees who are no longer working don’t have a steady income in the form of a paycheck. Rather they are likely drawing on a mix of income sources, such as Social Security, retirement and savings accounts, and perhaps passive sources of income such as rental properties. Retirees should make sure they understand where their income is coming from and how much is coming in. Is it comfortably covering necessary expenses, and how much is left over for discretionary spending or new investment?
Understanding Time Horizon and Risk
Retirees who plan to continue investing must consider time horizon and risk. Time horizon is the amount of time an individual has to invest before they need to use investment earnings for living expenses. For example, someone in their mid 40s who is saving for retirement has a time horizon of roughly 20 years.
It may seem that once an individual has retired, their time horizon is now zero. Yet, for many retirees, their retirement and time horizon may be many decades long. Consider that the average average life expectancy for a 65-year-old in the US is roughly 83 years of age for men and 86 years for women. What’s more, one in three 65-year-olds today will live until age 90, and one in seven will live to see 95. That means retirement could last for three decades or more, as could an individual’s time horizon.
Time horizon has a big effect on risk tolerance, the balance an individual is willing to strike between risk and reward. Generally speaking, individuals with a long time horizon of a decade or more may invest in riskier assets, such as stocks, because they have time to ride out any short-term downturns in the market. Individuals with a short time horizon of just a few years may stick to more conservative investments, such as bonds.
Diversification may be another familiar concept from pre-retirement investing, yet it bears continued consideration after retirement. Diversification involves spreading out investment across asset classes, such as stocks, bonds, cash, and real estate. Within each asset class, diversification also involves spreading investments out among factors such as sector, size, and geography.
Diversification helps investors protect their portfolios from unsystematic risk that’s unique to a specific type of investment. For example, if demand for oil decreases, the price of energy stocks may fall. A portfolio that holds stocks in other sectors may be less affected by the hit to the energy sector.
The investments held in an individual’s portfolio are allocated among asset classes according to that person’s goals, risk tolerance, and time horizon. However, those factors can change over a person’s lifetime and the market is always in flux, which can shift the proportions of assets a person holds. As a result, it may make sense to rebalance the assets inside a portfolio on a regular basis.
For example, say an assets allocation calls for 60% of a portfolio to be invested in bonds. If stocks do well over the course of a year, they might make up a higher percentage of a portfolio than planned, say 65%. In that case, an individual may want to rebalance by selling stock and buying more conservative assets, such as bonds. Alternatively, they may use other income to make new bond investments.
Watching out for Inflation
While living on a fixed income, retirees may be particularly susceptible to inflation risk, the risk that their money will lose value over time. Inflation measures the increased costs of goods, or in other words the decreased spending power of money. For example, if inflation is at 2% per year, then $100 a year from now will only be worth the equivalent of $98 in today’s money. Retirees must keep up with inflation to avoid the risk they will run out of money.
Investments that pay out based on a fixed interest rate, such as bonds, are most vulnerable to inflation risk as inflation may outpace the interest rate being earned.
Investors can help protect themselves against inflation risk by owning assets that tend to outpace inflation, such as stocks.
Smart Investments for Retirees
Retirees have a lot of choice when it comes to making new investments. Yet their age and retirement status can have an impact on which investments they choose to make.
Stocks are generally considered some of the riskiest assets a person can hold. That’s because they tend to be more volatile than more conservative assets like bonds. Their high potential returns have a flip side, which is high potential losses.
Yet retirees may want to invest in stocks to outpace inflation and ensure that they have enough income in the later decades of their retirement. It may not make sense for older investors to chase returns from typically riskier stocks, such as stock in start-ups. Rather, retirees may want to look for proven companies whose stocks offer steady growth. Retirees may want to consider stocks that offer dividends that can generate a regular source of income, or mutual funds that offer built-in diversification.
Bonds don’t offer the same potential for high returns that stocks do. Since 1926, bonds have had average returns of about 5% to 6% . However, they are a tool that helps investors achieve slow and steady growth, and in most cases they can help investors outpace inflation. These features may not be that appealing to pre-retirees who are trying to build their nest egg, but these conservative investments are an important tool for preserving capital once an individual has retired.
Retirees may consider using a bond ladder to generate retirement income. To build a bond ladder, an individual buys bonds that have staggered maturity dates. For example, a person could buy a series of bonds in which a portion of the bonds mature each year to provide regular retirement income.
Keeping cash on hand can help cover necessities like housing, utilities, and food. Cash is the most stable way to hold money. There is no risk that it will lose value due to market fluctuations or because a company fails or defaults on its loans. However, the interest paid out in typical savings or checking accounts tends to be very low and may not beat the rate of inflation. That means money in these accounts may slowly lose its value over time. Retirees may want to consider holding a portion of their cash in a money market account or high-yield savings account that allows them to make a little bit of money while having easy access to their cash.
Certificates of Deposit
Certificates of deposit (CDs) are a low-risk investment option that may offer higher rates than typical savings accounts. Investors put their money in a CD and choose a term, or length of time, that the bank will hold their money. Term length is generally anywhere from one month to 20 years and, typically, the longer the investor’s money is in the account, the more interest the bank will pay.
Retirees can build a CD ladder that works much like the bond ladder described above. By buying CDs that have maturity dates at regular intervals, an investor can ensure a constant source of retirement income. For example, an investor has $10,000 with which to build a five-year CD ladder. They could put $2,000 in five CDs with maturity dates spread out over each year of the five-year periods. After the first year, the first CD would mature, and the investor has access to their $2,000 and whatever interest it has accrued. At that point they have a choice: they can use all of the cash, or they can pocket the interest and reinvest the principal in another 5-year CD.
Letting Your Money Work for You
Even though you might be done working, your money can still work for you. Investment during retirement years doesn’t have to mean staying on top of the markets. With a SoFi automated investment account, you can choose your risk tolerance and a diversified portfolio will be built for you, and rebalanced regularly.
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