Market risk is the possibility that the funds you’ve invested in the stock market will lose value if the financial market is down. It is one of the primary risks for people in retirement, but hedging strategies, diversification and rebalancing, you can withstand market volatility.
Market risk exposure exists with direct investments, investment funds and retirement plans accounts, such as 401(k)s.
Investors assume this risk because, on the flip side, these investments offer the potential for more growth than conservative investments can provide.
Overall, the advice from financial experts amounts to this: fasten your seat belts.
In other words, be prepared to ride out the ups and downs. Don’t get off the train, but take precautions. You may wind up a little battered along the way, but you’ll be in better shape than you would be if you hadn’t invested.
Strategies for Mitigating Market Risk
If the market dives just as you’re getting ready to retire, you may have to delay retirement — or at least delay withdrawing or reallocating that money.
Your investment needs time to recover. Withdrawing the money on a downturn will cement your losses in place.
This is known as the sequence of returns risk. When you withdraw from your original principal because the investment has limited returns, you shrink the principal and compromise your future returns.
There are ways to invest in stocks that are less risky than others. Investment advisors suggest some strategies to lower the risk to your retirement from your stock holdings.
One preliminary step is to evaluate your own risk tolerance. Figure out how much risk you are willing to take with your finances in order to get the optimal reward. Stressing yourself out to the point that you’re afraid to invest won’t serve you well in the long run.
Also, consider your investment horizon, or the amount of time you have before you plan to start tapping into your retirement investments. This determines how long you would have to recover from a significant market loss.
Diversify Your Investments
Diversify, diversify, diversify. This is the most effective way to limit your risk exposure. With stocks, this means including a mix of companies and types of stocks, such as energy, technology, medical and commodities, in your portfolio. You can also select both foreign and domestic stocks and real estate.
Spreading your money around gives you the opportunity to benefit from growth in different areas. And importantly, if one company or sector does poorly, having your money spread around will limit your financial loss.
You should also have your money distributed between different classes of investments, such as stocks, bonds and money market funds. This is known as asset allocation.
At the same time, your diversification should be done with thought and research. The Securities and Exchange Commission warns consumers not to engage in “naïve diversification,” which is when an investor chooses to invest equally in all investment options. This may increase your risk exposure.
Mutual Funds for Retirement Planning
Mutual funds pool money from thousands of clients to invest in a selection of hundreds or thousands of stocks, bonds and other investments.
They do the diversifying for you and can be an effective retirement investment. Many 401(k)s offer a selection of mutual funds for investing your retirement savings.
Look for funds with low fees. This results in low expense ratios, the measure of administrative costs to total value of the fund. The higher your expense ratio, the lower your return. You can save a significant amount of money by selecting funds with lower management costs.
Also investigate funds that are specifically designed for retirees, known as retirement income funds. These funds have stocks, bonds and cash that seek to balance the need for preserving your principal with having a decent amount of monthly income. These funds are diversified in a way that may make them sufficient for your entire investment portfolio.
Safe Investments for Retirees
If you have a low risk tolerance, you may feel more comfortable with investments that have a more conservative rate of return and a lower risk. The downside of this is that your money will not grow as much, and you will need to set more aside to have enough in retirement. This strategy will also increase the impact of inflation on your nest egg.
At any rate, some of your money should be invested in places outside the stock market so that your entire nest egg isn’t at risk. But if the very idea of risking losing any of your money keeps you from investing for retirement, then picking a high concentration of conservative investments may be for you.
A better option might be to tolerate more risk when you are younger and have years to recover from any losses. As retirement approaches, you can move your funds into safer vehicles, such as certificates of deposit, bond funds and fixed annuities.
Rebalance Your Portfolio
If you want a certain percentage of your investments as stocks and another percentage as bonds you should revisit your portfolio each year to make sure the balance hasn’t changed. It could change, depending on the performance of the investments.
For example, if the stocks do well, their worth could grow to the extent that they comprise a larger percentage of your overall investments. You should make sure the balance of investments meets your goals and your comfort level with risk.
The closer you get to retirement, the less risky your investments should be.
If you’re investing through a 401(k), you will have a limited number of funds to pick from. Some will be more vulnerable to market volatility than others. Some will include bonds, which are less sensitive to market losses and pay interest on a regular basis. Research your choices before committing.
When You Retire, Have Some Money Set Aside
When you retire, you’ll still have basic expenses to cover. Buying an annuity, which provides a guaranteed stream of income regardless of market conditions, is an effective strategy for ensuring your ability to pay your bills. Annuities also protect you from your risk of longevity, insuring against you outliving your savings.
You’ll want access to enough money to cover typical costs, as well as emergencies.
If you’re near retirement, it’s a good idea to have ready access to enough cash to pay your expenses for one to three years. Most of that money can be put into certificates of deposit set to mature when the funds will be needed.
Keep Investing During a Market Downturn
It may feel like you’re throwing your money into an abyss to be swallowed up. But when stocks are down, you get more for your money. Investing during a downturn is like buying during a sale.
Whatever you do, don’t panic and withdraw your money at the bottom of the market. If you do that, any losses will become permanent. The odds are good that any downturn will end, and the market will recover. Between 1970 and 2016, the average annual return on the stock market was 10.31 percent. And that average includes some of the Dow’s worst years, such as 1987, when on Black Monday stocks fell by 22.6 percent.
Timing aside, a downturn in market conditions can actually be an opportunity if you strategize wisely.
- Do a background check on your investment advisor.
- Don’t fall into detrimental investing behaviors.
- Consider the expense ratios of your investments.
- Pay attention to world events that may impact the market.
The commission also stresses the importance of confirming that the security you’re considering is registered with the SEC by consulting the EDGAR database or calling 1-800-732-0330.
13 Cited Research Articles
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