Forex Articles

Common stock is only one of two asset classes that have consistently grown faster over time than inflation, which is why many retirement savers use stocks as their primary investment vehicle. But it's possible to have too much of a good thing. Those who overload their retirement portfolios with stock can get burned when the markets take a turn for the worse.

Many investors lost a great deal of money when the stock market crashed in 2007 - 2008, kicking off the Great Recession. The markets slowly recovered, but it took the majority of those investors years to recoup those losses. (For more information and analysis, read How Do Investors Lose Money When the Stock Market Crashes?)

That insight should burn stronger in your mind as you get nearer to retirement. What would happen if a severe bear market roared into view just as you were getting ready to finally enjoy some freedom. That's why, as you move into your 50s and beyond, it's time to start moving a portion of your portfolio into bonds or other more conservative holdings. The fancy technical term for what's at stake is drawdown risk, and the Subprime Mortgage Meltdown that began in 2007 provided a classic example what can happen.

Drawdown risk had previously received scant attention from the media or many financial experts. But this risk is very real, and millions of retirement savers learned about it the hard way. In a nutshell, drawdown risk can be measured by the length of time that it takes to recover from a loss in the markets. For example, if a stock rises to $40 a share in 2015 and then plunges to $10 a share in 2016, it may take four years for the stock to get back to its previous high. When the markets tanked in 2008, it took until 2014 for the Dow and the S&P 500 to break through their previous highs, which means that their drawdown risk was significant.

Many people planning to retire in 2008 were forced to continue working for another five years or so because their portfolios suffered such severe losses. This shows how the mathematical sequence of returns plays a significant role in the total return that an investor will receive from a given investment or portfolio. If you sustain a major loss in a given year, then you will have less capital with which to make up that loss the following year. This is also why it can be perilous to choose investments based solely on their average annual total returns over time; it can take just one bad year to wipe out years of gains.

Investors who are near or at retirement should take a close look at the worst years of that investment's performance in order to get an idea of the type of loss they might sustain if those years repeat themselves. (For a look at what some experts believe is in store, read 6 Factors That Point to Global Recession in 2016.)

Another problem with having a high concentration of stocks in a retirement portfolio is the volatility that often comes with them. Many investors use dollar-cost averaging (DCA) into mutual funds to save for retirement because this strategy can lower the average cost per share of funds purchased over time. This principle works in reverse for systematic distributions, where volatility will cause investors to sell fewer shares when the price is high and more shares when it declines. This, of course, is bad news for retirees who need to draw income from their savings in order to pay their living expenses.

Keeping a portion of your retirement portfolio in stocks can be a great way to give yourself a hedge against inflation. But keeping the majority of your funds in stocks as you near retirement can open you to the risk of a major loss that can take years to recover from. For more information on how much stock you should own in your portfolio, see Retirement Planning: Asset Allocation and Diversification. Also check out The Best Buy-and-Hold Stocks for Your Retirement Portfolio and Assets for Your Retirement Portfolio – or consult your financial advisor.