Wisdom and age leads us to look at risk differently than we did when we were young, and not necessarily in that order. Climbing a risky mountain trail or draining that collegiate beer keg probably is not worth it anymore.
Or is that incorrect? You probably still should avoid doing a keg stand, but perhaps you have always wanted to conquer a mountain trail, and now you have the time, resources, and remaining good health to do it. Who are we to tell you otherwise?
The point is that risk is a concrete thing, but risk tolerance is a personal and somewhat abstract decision. You may have different risk tolerances toward different things in life, and some risk tolerances are almost certainly going to change as you age, while others may not.
With respect to financial risks, the analogy still applies.
You face unavoidable risks as you age that affect your finances, such as health problems. Failing to have proper insurance or Medicare coverage, or ignoring insurance and preventative health measures, is just plain foolish and irresponsible – much like draining that collegiate keg.
On the other hand, considering risk with your retirement investments is more like the mountain trail. You can get your necessary exercise with regular walks or visits to the local health club. However, if you find the mountain trail exhilarating, and you have reasonable caution and sufficient skill, why not take the more dangerous trail while you are capable? This is how you should approach asset allocation as you near retirement.
Unless you are quite wealthy, conventional portfolio theory suggests you should rebalance to conservative investments as you near retirement age. This is because you have less time to recover from large market losses. An old rule of thumb is to invest your age in bonds, thus at age 60 you may hold 40% stocks and 60% bonds.
For those who look at retirement investments as a necessarily evil or are not very skilled at it, following a plan of this sort makes sense. However, if you enjoy investing and are good at it, why should you blindly follow a philosophy?
As you approach altering your portfolio near retirement, consider the following factors:
- Baseline Risk Tolerance – You will change somewhat, but you usually do not stray too far from your baseline personality. Don't talk yourself into taking more risk than you can handle at any point.
- Investing Enjoyment and Skill – If you like managing your investments and have skills, raise your risk accordingly. If you like managing and you think you have skills, let your past results guide you and do not kid yourself. If you have never directly managed your investments before, near-retirement may not be the best time to start.
- Flexibility of Retirement Plans – Are you willing to scale back your retirement plans if your investments tank – either delaying retirement or living with less income during retirement? If not, you may want to dial back risk-taking tendencies.
- Progress to Your Goal – Are you behind in your retirement goals? Then you are going to have to either increase your risk through higher-returning stocks, scale back your future plans or current lifestyle, or all three. Are you ahead of your retirement goals and have some house money to play with? Treat it like a visit to a casino. Do not go beyond your risk tolerance with anything you cannot afford to lose.
Of course, as you redefine your financial risk tolerance, be responsible to yourself and those who depend on you. In other words, do not attempt the keg stand while scaling the mountain trail!
Let the free Retirement Planner by MoneyTips help you calculate when you can retire without jeopardizing your lifestyle.