Volatility is part and parcel of investing so if your retirement plan – or indeed any other financial planning goal – is reliant on investing in equities it is something that you are going to have to deal with at some point or other.
The fact is that most of us are not cut out to wheel and deal and timing the markets is definitely not a strategy I advocate to any of my clients. Stocks are a long term asset to build wealth over decades not days. And your overall financial plan should take into account the fact that markets are cyclical and be robust enough to deal with those periods of uncertainty which will always come along to throw the cat amongst the pigeons, spook investors and send share prices tumbling.
You should formulate that strategy taking into account just how close you are to retirement. Conceived financial planning wisdom is that if you need funds within the next five years, you should put them in ‘safer’ investments and with the investment landscape as uncertain as it is right now, a conservative approach is definitely advisable.
Volatility-proof financial planning in the run up to retirement
If retirement is imminent – within five years – and you have reached your target investment goal, it is time to think about cashing out some of your more risky investments. Given the market rebound since the low it hit in March, you can do this now without incurring major losses. However, I would advise balancing the need for liquid funds in the next five years with staying invested in the hope that stocks will recover further in the half decade to come.
To give an example, if you have two years left until retirement and you have a stable job and/or income, cash out enough to give you an income over three years, taking into account any state pension or other benefits you are entitled to. Stash those funds somewhere easily accessible such as a high interest savings account. Interest will be, at best, 1.5% so you will be compromising on return but it’s a sensible and calculated trade-off given the probable volatile investment landscape we are likely to see over the next few years.
If you are not so fortunate and haven’t saved enough for retirement yet, your strategy will be different as you need to generate a higher return than bank deposit interest can offer. I suggest rebalancing your portfolio and switching at least a part of it into lower risk assets – equities and funds which are less susceptible to volatility. Think established and resilient companies with a solid track record that pay dividends regardless of what is happening in the markets. Sectors to consider are healthcare, utilities and consumer staples.
Of course, as ever, diversification is key. None of us know how quickly the economy is going to recover from its current malaise but it’s best to protect yourself against an extended recession by not overinvesting in equities. I’d advise that stocks make up a maximum of 60% of your portfolio with the rest invested into other assets including cash, bonds, property and commodities. Another factor to bear in mind is the expense ratio – beware of costly funds which will adversely affect your return.
Volatility-proof financial planning if retirement is more than five years away
If you aren’t planning to retire in the next five years, you are in the fortunate position of being able to ride out the current economic chaos! It may still be necessary, however, to make some minor changes to recession-proof your investments.
You too could consider switching to less risky equities but there is also the option of increasing the percentage of your portfolio invested in bonds. One very simple calculation you can do to balance building wealth with volatility is the rule of 110. Subtract your age from 110 and that gives you the ideal percentage to invest in stocks versus bonds. If you are 50, for example, the composition of your portfolio should be 60:40 stocks to bonds. This is of course a very simplified way of assessing the situation and we would always advise consulting a financial adviser to tailor your financial plan to your unique personal circumstances.
The importance of risk management when investing
What I hope to have made clear in this post is that whatever your age, the investments you make must take your risk tolerance into account. This will be closely linked to your retirement timeline and the level of risk you can afford but also to the level of risk necessary to produce sufficient return to achieve your retirement goals and your ability to cope on an emotional level with the volatility of the market.
Right now, with uncertainty high, those approaching retirement can limit their exposure by protecting the funds they will need in the short term while still retaining some growth in the medium to long term. It can be a tricky balance to strike which is where having a professional on board can be reassuring. For assistance with balancing your portfolio, why not give me a call?
Chartered Financial Planner
It is my fundamental belief that financial planning makes life better. I enjoy helping my clients work towards their financial goals to give them freedom and choice.