A Time to Limit Risk

As he neared retirement, George Johnston of Los Angeles stuck to his conservative guns.

Johnston, an airport worker, kept 75% of his 401(k) in fixed-income investments even as his co-workers were boosting their stock-market exposure and enjoying double-digit annual gains. Although he sometimes envied their returns, Johnston felt he didn’t have the time or temperament to ride out a big market drop.

“I was always told I could never lose what was in the fixed-income side,” said Johnston, 67, who retired two years ago and still keeps 75% of his retirement money in fixed income. “I never wanted to play the stock market.”

Other workers nearing retirement should take note of Johnston’s caution, financial planners say. While Johnston may have gone too far in search of safety, the market debacle of recent weeks highlights the importance of limiting stock-market risk as you near retirement.

Planners suggest that near-retirees use the market scares as an opportunity to reevaluate their portfolios and, if necessary, make changes, perhaps by selling some stocks and stock funds and replacing them with bonds and cash.

The need for diversification had been a hard sell for some planners, who say many investors have been unwilling to put up with the lower returns from bonds and cash while stocks were soaring year after year.

“I’ve always been an advocate of a diversified portfolio with a certain portion in fixed income,” said Mitchell Freedman, a Sherman Oaks financial planner and certified public accountant who chairs the personal financial planning committee for the California Society of CPAs.

“But in the past three or four years, I’ve met a lot of resistance from clients because [stocks] have been doing so well, and greed sets in,” he said.

The problem with holding a stock-heavy portfolio near retirement is that workers have less time to recover from a prolonged market downturn. Unlike younger workers, near-retirees don’t have 20, 30 or 40 more years to boost their savings and ride out bear markets.

At the same time, most retirees and near-retirees need the kind of growth that only the stock market can offer to offset inflation and provide enough funds to get them through 20 to 30 years of retirement, said Harold Evensky, a certified financial planner in Coral Gables, Fla. Some workers may even need to boost their stock-market exposure as they near retirement, he added.

“If you haven’t saved very well, you probably need even more growth in your portfolio to make up for screwing up earlier,” said Evensky, who serves as chairman of the Institute of Certified Financial Planners’ board of governors.

Financial planners say the actual proportion of stocks, bonds and cash a near-retiree should have depends on the individual’s situation and tolerance for market downturns, such as the recent plunge. As a starting point, many recommend a proportion of bonds and cash equal to the investor’s age.

Evensky, however, advises those within five years of retirement to gradually shift an amount equal to five years’ worth of post-retirement expenses into cash and bonds. Evensky’s retired clients keep two years’ expenses in liquid investments, such as money market accounts and short-term bond funds. He recommends another three years’ expenses be kept in a laddered bond portfolio, with maturities ranging from one to five years. That gives clients five years before they would have to cash in stocks, giving them plenty of time to ride out most market cycles, he said.

“If you know you’ve got the cash, you don’t have to pay as much attention” to the stock market, he said.

But current market volatility makes making any adjustment perilous right now, Evensky said. Selling stocks could mean missing some gains if the market recovers, but stocks could also fall further, increasing an investor’s losses.

“If they’ve got five years until retirement, I’d say hold on,” he said, and make adjustments when the stock market has recovered somewhat. “If they’re six months away, I wouldn’t know what to tell them. It’s like tossing dice.”

Evensky and some other planners say they fear there may be another market sell-off in the next few weeks as individual investors begin receiving monthly brokerage and 401(k) statements showing big losses.

“I think people are going to go ballistic,” he said.

But panic selling is counterproductive for anyone who’s saving long-term, said financial planner Joel Framson of West Los Angeles. Framson says his clients have so far stayed calm. Most retirement savers should continue investing regularly, figuring that their money is now going farther, he said.

“For some people, we’re recommending actually buying stocks and looking at it as a fire sale,” Framson said.