The Risk of Being Conservative

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Conventional wisdom used to hold that the common “do-it-yourself” investor tends to invest too aggressively, and take on unnecessary risk, usually through lack of diversification or overinvesting in complicated, illiquid or risky investments like derivatives, real estate or limited partnerships. For many investors, the decision to hire a financial advisor would be a step toward a stable, more conservative portfolio.

But since the recession of 2008, that idea has taken a 180 degree turn. Nowadays investors are far more likely to make the mistake of investing too conservatively.

At a recent panel discussion held by the Insured Retirement Institute, Cetera Financial CEO Larry Roth talked with other financial executives who concurred. Clients want advisors to keep their money “safe.” In fact, more than six years after the markets bottomed out, $11 trillion of investable assets is still sitting in cash. Robert DeChellis of Allianz Life Financial Services says “we’ve lost a whole generation of investors that just won’t come back.” His firm is focusing on addressing his clients’ market fears and helping them stay invested.

Bob Steinke of Janney Montgomery Scott agrees. “People are hiding out on the sidelines when they shouldn’t be. We’re trying to tell clients that it’s still risky to behave really conservatively.”

What is the risk to keeping your money in cash? Simple math makes it very clear. You work for about 40 years, and need to save enough during that time to live off of for another 30 years. Short of saving every penny you make, you just aren’t going to have enough saved up by retirement age, unless your money works for you. And that doesn’t happen when you are sitting in cash, or low-risk bonds for that matter.

Let’s illustrate with some more math. In Scenario #1, you save $1,000 per month every month for 40 years. You keep the money in cash in the closet. If you don’t get robbed or you don’t accidently donate the suit you hid the money in to Goodwill (yes, that really happened, in Illinois in 2011), how much will you have to live on in retirement? Let’s see:

Scenario #1 – Cash Under the Mattress

Working years: 40 (age 22 – 62)
Savings $1,000 per month
Annual return on investment: 0%
Ending balance: $480,000
Safe withdrawal rate (5%): $24,000 per year

Even with Social Security benefits, $2,000 per month is not a whole lot of income. Now let’s look at how the numbers change with a still-too-conservative, all bonds strategy:

Scenario #2 – Government Bonds

Working years: 40 (age 22 – 62)
Savings $1,000 per month
Annual return on investment: 2%
Ending balance: $734,436
Safe withdrawal rate (5%): $36,722 per year

Better, but probably not affording the lifestyle most of us want in retirement. That would be best accomplished with a diversified, moderately aggressive portfolio. Here’s how those numbers look:

Scenario #3 – 60/40 Stock/Bond Mix

Working years: 40 (age 22 – 62)
Savings $1,000 per month
Annual return on investment: 6%
Ending balance: $1,991,491
Safe withdrawal rate (5%): $99,575 per year

It’s pretty clear, as is our role as your financial advisor. To keep our clients invested properly, and exposed to the proper level of risk to reach their financial goals.



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