This is a short note to explain why it might make sense to take a very conservative approach to your retirement portfolio. It’s a response to the blanket advice so often given that you’re making a massive error if you go ultraconservative.
First, let’s consider the argument for a more aggressive approach, and why it’s usually the right strategy. Marie is 56 with \$800,000 in a retirement account and contributes \$20,000 a year. She wants to retire at 62 if she has about a million dollars in inflation-adjusted savings. Social Security, pension, and withdrawals on a \$1 million portfolio will cover basic living expenses, travel and recreation, and major home and car expenditures.
An 8% real return, combined with her annual contributions, will bring her account to \$1.3 million at age 62. Marie could even retire a year early with those returns. The downside is that if stocks are flat (defined as a 0% real return after accounting for dividends) she’ll only have \$900,000 at 62. Retiring at 62 isn’t an option without permanently downgrading her travel and recreation. Even worse is the case where a major correction leaves her with an inflation-adjusted \$500,000 portfolio at 62. With luck, she’ll be able to have a scaled-back retirement at 65. More likely, she’ll work until 68 or 70, unless her health forces her to retire early, cutting her budget down to basic living expenses and nothing more throughout retirement - her budget wouldn’t even include money to eat at nice restaurant or buy a bottle of wine once a month.
Contrast that with putting the full portfolio in TIPS with a 2% real return. Many would scoff at her for being so conservative. The math disagrees. She’ll know with certainty that she’ll have \$987,345 by age 62 - close enough to a million dollars that she’s comfortable retiring. Think about how radically different this is from putting most of her retirement savings in the stock market. At age 56, she knows for sure that she’ll be able to retire at 62 and that she’ll be able to do the things she wants when she does. She can sleep at night if the stock market drops 5%, and she can start planning out her travel and hobbies. Having an extra \$250,000 in the portfolio wouldn’t be a bad thing, but it wouldn’t change the fact that she’s retired and able to get what she wants out of retirement. She’d spend the next six years hoping for the best and planning her response if the stock market isn’t performing. If you’ve got enough to retire, you should take enough money off the table to make sure you don’t lose it, and if you need, you can use a few dollars to buy a pair of earplugs so you don’t need to listen to people telling you you’re too conservative.