It's the old dilemma. When stocks perform strongly, you can take as much risk as you want and never notice it. When they fall, though, it feels like every single penny you have invested in stocks carries more risk than you can afford to take.
But in good markets and bad, you constantly face the same question: How much risk should you really take? Even when times are good, the specter of a potential bear market lurking right around the corner always hangs in the back of your mind.
Too much risk?
The Center for Retirement Research at Boston College tried to answer that question by doing a study on whether retirement savers are taking on too much market risk. Examining losses over the one-year period ending last October, the study determined that losses in stocks were roughly split between retirement-related accounts and non-retirement assets. Moreover, within the retirement account portion, traditional pension plans shared about the same level of losses as investors in 401(k) accounts and IRAs.
For workers, of course, it makes a huge difference whether losses come in traditional pensions or 401(k) plans. Workers don't have to worry about whether a company's traditional pension plan assets gain or lose value in a given year. Sure, companies with pension shortfalls may suffer a hit to earnings, as Goodyear Tire (NYSE: GT ) and PPG Industries (NYSE: PPG ) are having to do in 2009. But as long as an employer is able to maintain pension benefits without jeopardizing its financial stability, workers will be happy.
But in 401(k)s, workers bear the full brunt of losses -- and see a very real and immediate hit to their prospects for a comfortable retirement, especially if they're close to retiring.
Ways to cut risk
As fewer employers provide traditional pension coverage for employees, more workers will bear sole responsibility for providing for their own retirement -- along with the huge risks involved. So to manage that risk without sacrificing the possibility of a comfortable retirement, consider some of the following options:
- Diversify. For more than a year now, stocks of all types have fallen virtually in lockstep with each other. That's a big departure from past bear markets like the tech bust from 2000 to 2002, where high-growth stocks like Amazon.com (Nasdaq: AMZN ) and Intel (Nasdaq: INTC ) suffered huge losses but mainstream value companies like Bank of America (NYSE: BAC ) and Berkshire Hathaway (NYSE: BRK-A ) (NYSE: BRK-B ) actually enjoyed healthy gains.
Nevertheless, there are always ways to diversify. Treasury bonds have been the saving grace of many retirement portfolios, and even higher-yield bonds have recovered somewhat in recent months. Although most commodities have plummeted, traditional safe havens like gold have flourished. By spreading your money around, you can make sure you won't suffer a complete loss -- no matter what happens.
- Annuitize. Even if you invest well and diversify your portfolio, you can't be completely sure that you'll outlive your money. That's where putting a portion of your assets into an immediate annuity can be useful -- by guaranteeing a stream of income for life, supplementing what you'll get from Social Security and any employer pension you might receive.
Sure, by choosing the certainty of an annuity, you'll sacrifice the potential for much greater gains if the market does reasonably well. But that's a small cost to pay in exchange for laying off longevity risk onto an insurance company.
- Save more. The ultimate way to ensure a better retirement is to save as much as you can. During downturns, having a high savings rate means your net worth won't fall as much as it otherwise would. Later, knowing how to economize will mean that you can make ends meet with whatever you earn after a lifetime of smart retirement investing.
Granted, handling risk is never easy, and right now, it might seem impossible. But once you learn how to make sure market risk doesn't overcome your assets, you'll be much better off -- and much more secure in knowing where you stand.
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