Stocks: Too Risky for Retirement

Jan 21, 2016 by

small investors victimized by market meltdownWall Street has worked hard and spent billions over the past couple of decades to train small investors to expect regular market crashes. And with good reason: stock values may well be on their way to a third major crash in just fifteen years. The natural—and I would argue rational—reaction to such extreme and regular gyrations in any asset’s value is of course to be wary and regard the asset as highly risky. But such a sensible reaction would be very bad for Wall Street’s highly lucrative business. So stock sellers disguise a marketing message in the form of expert advice: “Oh no,” say the pundits and advisors—“that’s just the way equities are, don’t you see [you poor, ignorant sap]. Equities always go up in the long run. Just stay the course, and you’ll be fine” (with ‘only wimps, rubes, and losers sell’ being the usually unspoken but clear, underlying message).

Stocks Have Not Always Been Wildly Volatile

First, the Wall Street marketing message to “keep calm and carry on investing in equities” despite stock price volatility because that’s just the way stocks are, so not to worry, is wrong. Here’s a century-long graph of the Dow Jones Industrial Average Index.

100 year graph DJIA

Very clearly, stock markets have taken on a repetitive bubble up, and then crash profile just over the past 20 or so years. Extreme volatility is a recent phenomenon, and clear reasons underlie modern equity markets’ behavior, some of which I’ve explored on Money Counselor (check the Investing category on the homepage). So when stock sellers calmly ‘educate’ we ignorami not to panic when stock prices crash because that’s just the way stocks are, they’re partly right: stock markets are indeed very volatile. Omitted from the shtick is that stocks’ extreme volatility is a relatively recent development. And everywhere except on Wall Street, high volatility = high risk.

A Recent Retiree Case Study

Imagine someone (let’s call her Lucy) who just retired at age 60. Lucy has a tidy nest egg, and her investment advisor recommended that she invest 80-90% of her portfolio to stocks, which Lucy has dutifully done. (This isn’t unusual—I know someone in these exact circumstances.)

I wonder how Lucy is feeling today?

I know what her advisor is saying: Stay the course. You could live another 40 years. Don’t panic. Stocks always recover. Blah, blah, blah—you know very well all the standard lines.

But let’s say stock prices crash by half over the next 6 months, as they’ve done twice since 2000. Here’s Lucy’s new reality, and what might very logically and reasonably be going through her mind:

  • If Lucy is following the lazy advisor’s 4% rule (withdraw no more than 4% of your retirement fund annually to minimize the risk of running out of money), her post-crash 4% translates to half as many dollars as the amount on which she planned when she retired and stock prices were twice as high. Unfortunately, her retirement living expenses have not cooperated by similarly falling by half. That means that, to maintain her standard of living, Lucy would have to eat into the equity shares in her portfolio at double the rate she’d planned on her retirement day, because those shares are now worth half as many dollars. And that would mean the likelihood of Lucy running out of money before she dies would skyrocket. Since she’s smart, Lucy will recognize this potential catastrophe and opt to do everything she can to scale back her discretionary living expenses. So much for her long-anticipated retirement travel.
  • The more severe the crash and the more dismal the outlook for stock market recovery, the more Lucy may be thinking something like this: “If my portfolio doesn’t begin recovering soon, I’m going to have to go back to work, sell my home and move into something much less costly, cut back other living expenses, or maybe all of these if things get really bad.”
  • Lucy may also be thinking: “If I sell my depressed stocks now, at least I’ll know I can continue to pay my slashed living expenses and not have to look for a job (at age 60+). If I don’t sell and my nest egg drops more and doesn’t recover for a while, I may not be able to afford even a Spartan lifestyle. And what if I can’t find a decent job at my age? Or what if my health fails and I can’t work? Then what??

I don’t call these thoughts panic-driven. I call them rational, reasonable, and prudent.

There’s another big factor at play. As I noted, if Lucy continues to withdraw enough money from her portfolio to maintain her planned retirement lifestyle, she’ll deplete her capital (number of shares held) at a far more rapid rate than implicit in her original 4% withdrawal rate retirement plan. That means that, even if her stock holdings do recover, Lucy will never get back on track because she’ll own far fewer shares than originally planned of stock and mutual funds when the market recovery begins.

Lucy should not have been 80-90% invested in stocks in retirement. Given her overall situation, dedicating such a massive portion of her nest egg to equities was extremely risky, as the market crash has made clear to her. Aggressive equity investing was very risky because the consequences of another market meltdown while she’s retired—especially fairly early in her retirement years—would be catastrophic for Lucy. And regular market meltdowns are now routine. Observing that ‘that’s just the way stocks are’ is rather useless blather to Lucy right now, isn’t it?

Say Lucy decides to salvage what’s left of her portfolio after a crash and so, against her advisor’s recommendation, sells her equities. Then, over the next several years, stocks recover and in fact reach new highs. “See,” the pundits will crow. “Told you not to sell. Stocks always go up.” Unfortunately, Lucy didn’t own a functioning crystal ball at the time she made her anguished choice to sell. And here’s an inconvenient fact, made more pertinent by Lucy’s age and that she had already retired: Lucy is mortal. The real world, practical question she faced post-crash was not whether stocks will recover and reach new highs eventually, but rather would stock prices recover on a timeline that would prevent catastrophe for her—running out of money while she still had years to live. That’s a much tougher question to answer, one I think even the most optimistic stock seller would be reluctant to pretend to tackle.

I Am NOT Anti-Stock. I’m Anti-Wall Street Marketing Disguised as Advice.

I just made a substantial investment in Vodafone shares. (But, in our 50s, equities comprise only about 15% of our financial assets.) I’m attracted to Vodafone because its price has been dragged down along with everything else, it pays a big dividend, and its business is relatively insulated from economic downturns. Sure, Vodafone’s share price may well fall much more. Since I plan on holding it indefinitely, collecting many thousands of dollars in dividends along the way, I don’t care much about the company’s near term share price.

Further: If you’re more than 20 years from a hoped-for retirement, and you are immune to the natural human tendency to buy high and sell low in the face of volatile markets, then, knock yourself out: load up on stocks if you want. Many people have made a lot of money because of stocks. (Almost all of them work or worked on Wall Street, by the way.) I do have one suggestion though: do not rely for advice and an understanding of equity investing’s true risks on people whose livelihood depends on small investor stock buying volume. You’ll be duped.

Once you’re within 20 years of retirement, and assuming that, like most of us, your nest egg plus pensions are sufficient for a modest and comfortable but not lavish retirement lifestyle (i.e., you don’t have a big savings cushion), I suggest gradually adjusting your view on stocks. With respect to impacting your retirement date and lifestyle, the closer you are to permanent retirement, the riskier stock investing becomes. And I further suggest that, once you have retired, investing more than 20% of your nest egg in stocks is a highly risky strategy, given modern stock market behavior.

Regardless of how distant your retirement, please understand this: the conventional wisdom that the best, if not only, way to build a retirement-sized nest egg is through stock investing is CRAP. That “wisdom” is in fact an artifice, a message constructed by Wall Street’s marketing wizards with the sole aim of further enriching Wall Street, which it has done, magnificently. If you want to de-program yourself about wealth-building, read volume 2 of my Simple Guide series, “Build Wealth WITHOUT Stocks”.

If you feel that you need the potential returns from having the lion’s share of your nest egg in stocks to pay for retirement expenses, then you’re taking a huge risk of a catastrophic outcome. Your nest egg is too small to retire, in my opinion, if you must achieve a 6 or 7% annual return to pay your basic retirement bills. Keep working at least part time.

Of course there are myriad exceptions to my suggestions. For example, if you’re retiring fairly young and in good health and don’t mind re-joining the work force should the value of your nest egg crash, then investing in stocks is less risky. You should understand that your health could change markedly tomorrow, and your future marketability in the working world is not wholly within your control. Similarly and with the same caveats just noted, even if you’re over 60 and plan to retire in, say, three years, if you like your work and would be happy to continue full or part time if your nest egg takes a hit, investing a big portion of your portfolio in stocks is less risky, for you, than it would be if you were determined to quit working at age 63, come hell or high water.

Why Does Nearly Everyone Disagree With Me?

I think it’s safe to say that virtually every single financial advisor in the USA and CNBC pundit would disagree with me.

Am I crazy? Stupid?

That’s for you to decide. But I suggest you ask yourself this with respect to professional advisor and Wall Street pundit advice: who’s likely to be (and has been) rewarded more, and more certainly, if small investors are persuaded to trust Wall Street with their retirement savings: you and all those like you, or the universe of stock-promoting advisors/pundits?

What do you think? Please rip me to shreds or log your agreement in the comments below! What portion of your retirement nest egg are invested in stocks? If you’re comfortable with that portion, why?

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