By Glenn Ruffenach
The closer you get to retirement, the more attention you need to pay to your tolerance for big swings in financial markets. Here’s how to estimate the level of risk that’s right for you.
The bull market, now five years old, will end at some point. (Perhaps sooner rather than later, if conflicts overseas widen and/or corporate earnings at home disappoint.) So now is the time – before the current party ends – to ensure that your retirement savings are invested in a way that will allow you to sleep at night no matter what happens on Wall Street. In a recent article in The Wall Street Journal, Walter Updegrave reviewed some strategies for doing just that.
To gauge your appetite for risk, you can start by completing a questionnaire such as the one offered by FinaMetrica. The Australian firm’s 25-question risk-profile survey (cost: $45 at myrisktolerance.com) scores you on a scale of 0 to 100 and comes with a 10-page report for interpreting the results. An asset-allocation guide at the company’s website for advisers (riskprofiling.com) translates your score into an appropriate percentage of “risky assets,” such as stocks.
Vanguard Group, the large asset manager, offers a shorter Investor Questionnaire for free online. After answering 11 questions focusing on such issues as what size loss you feel you could comfortably stand and how long you intend to invest your money, you will come away with a suggested mix of stocks and bonds.
Next, examine how that recommended portfolio might fare under stress and determine whether you would be comfortable with the results.
Example: Let’s say your risk-tolerance assessment recommended a portfolio of 70% stocks and 30% bonds. Between mid-2007 and early 2009, stocks lost roughly 55% and bonds gained about 7%, which means holding a 70-30 mix over that period would have left you down more than 36%.
If that kind of setback might have prompted you to act rashly – for example, by selling all your stocks and putting the proceeds in a mattress, thereby missing the subsequent bull market – then you may need to consider a less aggressive allocation (say, 50-50) which would have lost less than 25%.
Remember, though, that while limiting your stock exposure should give you more shelter during market storms, the lower returns that come with a more conservative mix could make it harder for you to draw sufficient income from your savings in retirement.
You can get an idea of how various stock-bond mixes could translate into different levels of retirement income by using a retirement calculator, such as the one provided by T. Rowe Price Group, another large mutual-fund firm.
The goal: Create a portfolio that meshes with your underlying tolerance for risk, and then largely stick with it despite the ups and downs of the market.