Prior to retirement your greatest source of wealth is you. Your ability to earn income allows you to set aside funds for future uses in your retirement, and it also allows you to recover from market setbacks. If you have investments and they go down during a correction, or a bear market of some kind, the income that you are earning allows you to make that loss back reasonably quickly. A lot of people don't think about the fact that their greatest source of wealth is their earning power and their income during their working years, not their investments.
Very few people get rich from investing in the stock market. It's their savings rate that actually brings them their wealth. This ability to generate income is referred to as human capital. In your prime earning years, this human capital provides the cash flow, funds your current consumption and, allows you to save for future consumption, such as future lifestyle expenses in retirement. When you are working, this ability to generate income is like holding a bond, as this is an investment that provides a regular stream of income in ideal circumstances, one that is dependable from one year to the next. Since that bond provides a significant source of income as it is, many younger investors may choose to invest their savings in higher volatility securities like stocks in an attempt to grow their savings for retirement at the fastest pace possible.
So why should you have more stocks when you are young and less stocks when are older or in retirement? Because you have a source of income (like a bond) called your career. A portfolio with higher exposure to equities fits the typical strategy of younger investors, of holding more stocks than those that are older. Once you reach retirement, your human capital starts to disappear and your income is going to be affected.
The loss of human capital has implications for investment strategies after you retire. In the event of a significant downturn in the stock market you have lost the ability to replace that lost value. For many people, they do look at their asset allocation strategies and make changes in retirement to include a larger allocation to some of the lower volatility securities, such as bonds or other income investments. When we think about investing in investment strategies in retirement, we need to consider are the unique risks that exist for retirees.
For more details on these risks and other factors that might affect your retirement listen to The CM Group’s Free Lunch Podcast Episode 48 “How Goldilocks Invests In Retirement.”
Stay happy, stay safe, stay well!
The CM Group