Stocks Are The Best Place For Your Retirement Savings

Don't make the mistake of putting too much of your retirement savings into "safe" assets like treasuries. Stocks are by far the best way to create the kind of wealth that will give you true financial freedom.

Aug 23, 2014 at 10:31AM

One of the most common investment strategies people use is to reduce their exposure to stocks as they get a little older. However, many people go overboard in reducing their exposure, putting way too much money in lower-paying assets like treasuries and corporate bonds, and depriving themselves of high returns when they need it most.

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Despite the common perception, it is possible to maintain an acceptable level of risk while keeping most of your portfolio in stocks, even if you're very close to retirement age or retired already. The secret is that the type of stocks you invest in should change as your risk tolerance declines.

Not all stocks are high-risk
One of the most common misconceptions, especially among casual investors, is that the word "stocks" is synonymous with the word "risk."

Some stocks are indeed very risky investments, and can lose a lot of money just as easily as they can make money. However, these are never a good idea for your retirement savings regardless of your age, or for any other money you can't afford to lose.

On the other hand, if you choose dividend-paying stocks with solid track records of raising their payouts, and have low volatility, stocks can be just as safe as some fixed-income assets, but with much more potential upside.

Basically, you want to look for a significant dividend payout (2.5% or higher) and a record of raising the dividend every year. Not only will this help your money compound faster between now and when you retire, but it will help you to keep up with inflation and cost of living increases once you're relying on your investments for your primary source of income.

Check this list of all the major companies that have raised their dividends for at least 10 consecutive years. There are certainly a lot to choose from.

Of course, not every dividend-paying stock is low risk. You'll want to choose companies that have a low "beta", or low volatility. A stock's beta basically tells you how reactive it is to market swings and other economic events.

A beta of exactly 1.00 means the stock tends to move in line with the overall market, and a beta of less than one means the stock is less reactive than average (good for retirement investments). So, a stock with a beta of 0.7 should be 30% less volatile than the S&P 500. You can find a stock's beta through any online brokerage or most publicly accessible stock quotes.

Consider the following graphic for some ideas of dividend stocks with good histories of raises, as well as low volatility.

A better alternative than bonds
Another good idea for retirement savings is preferred stocks.

These are somewhat of a cross between a stock and a bond. Like a stock, these trade on the major exchanges and pay quarterly dividends. And, like a bond these have a fixed dividend rate that will never change. So, if a preferred stock pays out $0.30 per quarter, that's what you can expect in perpetuity.

However, preferred stocks are below bonds in terms of seniority. If a company were to go bankrupt, bondholders would be first to recoup their investments in an asset sale, and preferred shareholders would be after them, but before common shareholders.

Because of this, preferred stocks tend to pay slightly higher dividends than bonds. And, as long as you buy preferred shares from stable companies, they are just as safe as bonds.

For example, Wells Fargo's preferred shares currently yield between 5.5% and 6% annually, and the company is considered one of the strongest banks in the world. Some other banks have much higher-paying preferred shares, like JPMorgan Chase, whose preferred stocks pay around 6.5% as of this writing.

These securities offer much better yields than investment-grade bonds and treasuries, and without much more risk.

Maybe you can have the best of both worlds...
As long as you use low-volatility, high-dividend stocks in your portfolio, there is no need to keep a large percentage of your money in fixed-income assets before you're ready to retire.

Stocks offer much more compelling upside potential, and the type of dividend stocks mentioned here allow you to create a consistent, growing income stream while allowing your principal to grow as the share prices appreciate.

A portfolio with safety and high-growth is entirely possible, and is the most reliable way to long-term wealth.

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Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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