Coasting in Retirement – Episode 89
You have worked for decades to build your retirement savings. Now that retirement is approaching, your priorities may be changing. You are no longer as interested in taking risks for the sake of growth. You want to protect what you have built.
For many investors, protecting their money means moving more of it into investments traditionally viewed as “safe”: cash, money market funds, certificates of deposit, bonds, or certain types of annuities. These investments can absolutely serve important purposes in retirement.
However, there is more to the story.
Every investment carries some form of risk. Sometimes we become so focused on the possibility of seeing an account balance decline that we overlook the risks that do not appear as clearly on a monthly statement.
Therefore, the question is not, “What’s the safest investment?” Instead, it is, “Safe from what?”
Is your money safe from market losses? Inflation? Rising or falling interest rates? Unexpected expenses? Taxes? Running out too soon? Failing to grow enough to support a retirement that could last 20 or 30 years?
Once you begin asking those questions, the definition of “safe” becomes more complicated.
Protecting Your Balance Is Not the Same as Protecting Your Retirement
Suppose you have $1 million and place it somewhere the balance is unlikely to decline. That may feel reassuring. You can open your statement, see the same number, and know that market volatility has not reduced your principal.
But now suppose inflation averages 3% over the next 20 years. At that rate, $1 million would have purchasing power equivalent to only about $554,000 in today’s dollars.
Your statement might still show $1 million. The number did not decline, but the amount of life that money can purchase did.
You then have to consider: was that really a safe investment?
Perhaps it was safe from a market decline. It was not necessarily safe from inflation.
That distinction matters for retirees because retirement may last much longer than expected. Someone retiring at 65 could need their money to continue supporting them into their 80s or 90s. Over that amount of time, even modest inflation can significantly increase the cost of groceries, utilities, healthcare, insurance, travel, and nearly everything else.
Your dollars do not have to disappear for you to lose financial ground. They only have to buy less.
Cash and CDs Solve Some Problems, But Not Every Problem
Cash is important. Retirees need access to money that is not exposed to short-term market swings.
If your air conditioner stops working in the middle of an Alabama summer, you should not have to worry about whether the stock market is having a bad week before replacing it. If you expect to make a large purchase next year, that money probably should not be invested aggressively.
Cash provides liquidity, stability, and immediate access. Those are valuable benefits.
But cash is not risk-free. Its primary weakness is purchasing-power risk. Your dollars don’t have to disappear for you to lose money, they just have to buy less.
Imagine keeping most of your retirement savings in cash because you do not want to lose money. The balance may remain steady, but your expenses will probably not. If prices continue rising while your money produces little growth, maintaining the same lifestyle will require an increasingly large portion of your savings.
Savings accounts, money market accounts, and CDs may offer more interest, but the same basic issue remains.
A 4% CD may sound attractive. Whether it actually increases your purchasing power depends partly on inflation. If inflation is 2%, a 4% return tells one story. If inflation is 4%, it tells a very different story. Taxes on the interest earned may reduce the real return even further.
CDs also introduce reinvestment risk.
Suppose you purchase a five-year CD with an attractive rate. You know what you will earn during those five years, which can be reassuring. But when the CD matures, you must decide what to do with the money next. If interest rates have fallen, a comparable CD may offer a much lower return.
None of this means cash or CDs are bad choices. Both can have appropriate roles in a retirement plan. The problem begins when you expect one financial tool to do a job it was not designed to do.
Cash can provide liquidity. CDs can provide a predictable return for a defined period. Neither is designed to provide all the growth and inflation protection a long retirement may require.
Bonds Are Not a Magical Safety Blanket
For decades, investors have heard a familiar phrase:
“Stocks are risky. Bonds are safe.”
There is some truth behind that distinction. A high-quality bond held to maturity is very different from owning shares of an individual company. Bonds can provide income, reduce some forms of portfolio volatility, and play an important role in retirement planning.
But “less volatile than stocks” does not mean “risk-free.”
Bonds can carry several risks, including:
- Interest-rate risk
- Inflation risk
- Credit risk
- Liquidity risk
- Reinvestment risk
Bond prices and interest rates generally move in opposite directions. When interest rates rise, the market value of existing bonds typically falls because newly issued bonds may offer more attractive yields. If you are investing through a bond fund, that change can appear directly in the fund’s value.
Investors received a memorable reminder of this in 2022, when stocks and many traditional bonds declined at the same time. Someone holding a traditional mixture of stocks and bonds may have expected the bond portion to offset losses in the stock market. In that particular environment, the protection was not as strong as many investors anticipated.
That does not mean bonds no longer belong in a retirement portfolio. It means they should be understood for what they are.
Diversification is a strategy for managing risk. It is not a guarantee that one investment will always rise whenever another falls.
Before buying a bond or bond fund, ask what role it is expected to play. Is it there to provide income? Reduce volatility? Preserve money for a future expense? Diversify other holdings?
Calling it “safe” does not answer those questions.
Annuities Transfer Risk, They Do Not Eliminate It
Few financial products generate stronger opinions than annuities.
Part of the confusion comes from discussing annuities as though they are all the same. They are not. Fixed, variable, fixed indexed, immediate, deferred, and income annuities can have structures and purposes that accomplish very different things.
That is why “Are annuities safe?” is not a complete question.
Which type of annuity are you considering? What does the contract guarantee? What problem are you trying to solve?
An annuity may be useful when someone wants to transfer certain longevity or income risks to an insurance company. For example, a retiree concerned about outliving a particular stream of income may value the contractual income features offered by an annuity.
However, transferring one risk can introduce others.
Depending on the contract, an annuity may involve:
- Insurance-company credit risk
- Limited access to your money
- Surrender charges
- Product and investment fees
- Complicated contract provisions
- Inflation risk
- Restrictions on withdrawals or benefits
Annuity guarantees generally depend on the claims-paying ability of the issuing insurance company. A fixed payment can also lose purchasing power over time if the payment does not increase with inflation.
Annuities are not automatically good or bad. What matters is whether the specific contract solves a real need and whether you fully understand what you are giving up in exchange.
An important distinction to remember is that an annuity does not make risk disappear. It changes who carries certain risks and which risks remain with you.
You Cannot Eliminate Risk, You Can Only Choose It
Let’s get to the heart of this discussion: there is no investment that removes every form of risk.
You have to decide: “Which risks am I willing to take?” You can accept stock-market risk, inflation risk, interest-rate risk, credit risk, liquidity risk, reinvestment risk, tax risk, or the risk of outliving your money. You can also take behavioral risk; the possibility that fear or excitement will cause you to make a damaging decision at the wrong time. And finally, a risk that is largely underestimated, you can take the risk of doing the wrong thing because you are scared.
Consider someone who reaches retirement at age 62 with $1.5 million and decides to leave the stock market entirely. They move everything into CDs because they no longer want to see their account fluctuate.
For a while, the decision may feel wonderful. The account is stable, the interest is predictable, and there are no alarming market headlines to worry about. Then inflation remains elevated. Interest rates eventually fall. The CDs mature and must be renewed at lower rates. Meanwhile, the cost of maintaining the retiree’s lifestyle continues to increase.
That person eventually realizes they did not eliminate risk. They exchanged market risk for inflation and reinvestment risk. That trade-off may still be appropriate for part of the portfolio. The important thing is recognizing that a trade was made.
The word “safe” can be dangerous because it often causes people to stop asking questions. Once an investment receives that label, “safe” can begin to sound like “nothing can go wrong.”
A more useful question is:
What risk does this investment protect me from, and what risks am I accepting in return?
Cash provides liquidity but may not preserve purchasing power. A CD offers a known rate for a certain period but may create reinvestment risk later. Bonds can provide income and diversification but remain exposed to interest-rate and inflation risks. An annuity may provide contractual income while limiting liquidity. Stocks offer long-term growth potential but can experience substantial market declines.
Every investment is a trade-off.
Give Each Part of Your Money a Job
Rather than searching for one investment that feels completely safe, consider what jobs your money needs to perform.
Some of your money may need to provide liquidity. These are funds you might need during the next year or two for regular expenses, home repairs, healthcare needs, or planned purchases. That money does not need to produce the highest possible return. It needs to be available when you need it.
Another portion may need to provide income. It may supplement Social Security, a pension, or other dependable income sources.
Some of your savings may still need to provide long-term growth. Even after you retire, part of your portfolio may have a time horizon of 20 or 30 years. Without sufficient growth, your future income may struggle to keep pace with rising costs.
Another portion may need to provide some degree of inflation protection. Retirement will not be lived entirely at today’s prices, it will be lived at tomorrow’s, and the day after, and so on and so forth.
These jobs are different, which means the same investment may not be appropriate for every dollar you own.
Once every part of your money has a purpose, investment decisions become less about which product is “best” and more about which tool is appropriate for each job.
Do Not Build Your Retirement Around Fear
If you are approaching retirement and feel nervous about the stock market, that does not make you irrational. After spending decades building your savings, the idea of watching a portion of them disappear during a downturn can be frightening.
Becoming somewhat more conservative as your needs and time horizon change may be appropriate.
The danger is allowing fear of one risk to push you blindly into another.
An investment that feels safe today could create a serious problem 15 years from now if it fails to provide sufficient growth. At the same time, an investment that appears risky on a daily statement may play an important role in helping your retirement plan keep pace with inflation over several decades.
The goal does not have to be avoiding every temporary decline in your account balance. A more beneficial goal is having enough liquidity, income, growth, and flexibility to support your life throughout retirement.
Retirement investing should not be about finding that “safe investment.” It should be about building a safe retirement plan. Those are two completely different things.
Build a Safe Retirement Plan, Not Just a Safe Portfolio
Cash is not risk-free. CDs are not risk-free. Bonds are not risk-free. Annuities are not risk-free. Stocks are certainly not risk-free.
That does not mean you should be afraid to invest. It means you should understand what you own, why you own it, and which risks you are accepting in exchange for its potential benefits.
Your retirement goal probably is not simply, “I never want to see my account balance decline.”
It is something much more meaningful:
I want my money to support the life I want to live for as long as I live.
That is not a lofty goal, it just requires you to think about liquidity, income, growth, taxes, inflation, longevity, market declines, and your actual spending needs. It may require several different financial tools working together rather than relying on one investment to solve every problem.
The next time someone describes an investment as “safe,” do not stop there.
Ask what it is safe from. Ask which risks remain. Ask whether it is being given the right job within your plan.
The objective is not to find an investment with no risk. It is to build a retirement plan in which the risks you take are understood, intentional, and connected to the life you want your money to support.
Watch the complete discussion in Episode 89 of Coasting in Retirement: “Why Safe Investments Aren’t So Safe Anymore.”
What Does “Safe” Mean for Your Retirement?
If you are approaching retirement, Gulf Coast Financial Advisors can help you consider whether the different parts of your financial plan are prepared to do the jobs you will need them to perform.
Call 251-327-2124, or click this link to schedule a meeting.
Meeting options include:
- A 15-minute introductory phone call
- A 30-minute Zoom meeting
- An in-person meeting in Fairhope, Orange Beach, or Mobile
No pressure. No obligation. Just a conversation about building a retirement plan that looks beyond the balance on your account statement.
This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.