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A recent Wall Street Journal article Retirement Investors Flock Back to Stocks (not behind their paywall as I write this) discussed how retirement savers are putting more money into stocks. Nothing like waiting for the stock market rally to pass its fifth anniversary, with many of the major market averages in record territory, to get retail investors interested in the stock market. Two excerpts from this article:

“Stocks accounted for 67% of employees’ new contributions into retirement portfolios in March, according to the most-recent data from Aon Hewitt, which tracks 401(k) data for 1.3 million people at large corporations.”

“What cash I have, I’m going to use to buy more if the market dips,” said Roy Chastain, a 68-year-old retiree in Sacramento, Calif., who put an extra 10% of his retirement account into stocks in September, bringing his total stock allocation to 80%. Mr. Chastain, who had put all his retirement assets into cash in May 2008, has gradually rebuilt his stockholdings.”

If I understand Mr. Chastain’s situation, he sold out about half way through the market decline, he likely missed a good part of the ensuing market run-up, and now he’s bulking up on stocks 5+ years into the market rally. I sincerely hope this all works out for him.

What’s wrong with this picture?

Part of the rational cited in this article and elsewhere is that stocks appear to be the only game in town. At one level it’s hard to argue. Bonds appear to have run their course and with interest rates at record low levels there is seemingly nowhere for bond prices to go but down.

Alternatives, the new darling of the mutual fund industry have merit, but it is hard for most individual investors (and for many advisors) to separate the wheat from the chafe here.

But a 68 year old retiree with 80% of his retirement investments in stocks is this really a good idea?

I’m not advocating that anyone sell everything and go to cash or even that stocks aren’t a good place for a portion of your money. What I am saying is that with the markets where they are investors need to be conscious of risk and at the very least invest in a fashion that is appropriate for their situation.

Can you say risk?

With the stock market flirting with all-time highs and in year six of a torrid Bull Market I’m guessing things are a bit riskier than they were on March 9, 2009 when the S&P 500 bottomed out.

Let’s say an investor had a $500,000 portfolio with 80% in stocks and the rest in cash. If stocks were to drop 57% as the S&P 500 did from October 9, 2007 through March 9, 2009 this would reduce the size of his portfolio to 272,000.

Not devastating if this investor is 45 years old with 15-20 years until retirement. However if this investor is 68 and counting on this money to fund his retirement this could be a total game changer. Let’s further assume this occurred just as this investor was starting retirement.

Using the classic 4% annual rule of thumb for retirement withdrawals (for discussion only retirees should not rely on this or any rule of thumb), this investor could have reasonably withdrawn $20,000 annually from his nest egg prior to this market decline. After the 57% loss on the equity portion this amount would have declined to $10,880 a drop of 45.6%.

Assuming this retiree had other sources of income such as Social Security and perhaps a pension the damage is somewhat mitigated. Still this type of loss in a retiree’s portfolio would be a disaster that could have been partially avoided.

Am I saying that the stock market will suffer another 57% decline? While my crystal ball hasn’t been working well of late I’m guessing (hoping) this isn’t in the cards, but then again after the S&P 500 suffered a 49% drop from May 24, 2000 through October 9, 2002 many folks (myself included) felt like another market decline of this magnitude wasn’t going to happen anytime soon.

Diversification still matters

I agree with those who say investing in bonds will likely not result in gains over the next few years. But given their low correlation to stocks and relatively lower volatility than stocks, bonds (or bond mutual funds) can still be a key diversifying tool in building a portfolio.

When I read an article like the Wall Street Journal piece referenced above or hear “experts” advocating the same thing on the cable financial news shows I just have to wonder if investor’s memories are really this short.

Individual investors are historically notorious for their bad market timing. Is this another case of bad timing fueled by greed and a short memory? Are you willing to bet your retirement that the markets will keep going up? Or perhaps you think that you might be able to get out before the big market correction.

Perhaps you should consider doing some financial planning to include an appropriate investment allocation for your stage of life and your real risk tolerance.

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