You may have been told that you shouldn't invest too heavily in stocks as you age, because their volatility could put older investors at risk of huge losses when they need their savings most. While that's true, it's wrong to assume seniors should move their money out of stocks completely. Stocks can still be great investments for older adults, and below, we'll look at a few reasons why.
1. Stocks have greater earning potential than bonds
There's definitely a risk to investing too much in stocks when you're nearing retirement, but there's downsides to not investing in them too. The average annual stock market return over the past 10 years has been about 13.9%. The average bond return, by contrast, is usually only between 5% and 6% per year.
Switching all your savings to bonds will reduce your risk of losing what you already have, but there is a real opportunity cost in missing out on the larger gains offered by stocks.
For example, let's say you're 60 years old with $750,000 of retirement savings so far. If you invested all that money in bonds and left it there until you retired at 65, you'd have just over $1 million if you earned a 6% average annual rate of return. Not bad, right?
But if you invested 50% of that money in stocks and 50% in bonds, you'd end up with over $1.1 million if your stocks earned a 10% average annual rate of return (and the same 6% on the bonds). And this assumes you don't contribute any more money to your account between now and your retirement. If you were making regular contributions during this time, you could end up with a lot more.
Pulling all your savings out of stocks will slow the growth of your nest egg, forcing you to set aside more of your own money every month to reach your retirement savings goal. If you're not able to save enough, you may have to push back your retirement date. Keeping some of your savings in stocks can help you reduce this risk.
2. Dividends could provide extra income in retirement
Some businesses are so successful that they earn more money than they can effectively reinvest in their companies. If you own stock in one of these companies, you might get a dividend, usually once a quarter. Dividends are the excess capital that businesses pass on to their shareholders.
The amount of money you'll receive from a dividend stock varies depending on how the company has been performing and how much of its stock you own. You may not get a dividend every quarter, but when you do, it can provide an additional source of income for you, above and beyond the stock's return.
You can either spend your dividends or reinvest them in the stock to help your savings grow even faster. If you're keeping the dividends in a retirement account and you're not ready to withdraw them yet, it probably makes more sense to reinvest them.
If you want to spend your dividends in retirement, focus on companies that have a long history of paying dividends to their shareholders. The S&P 500 Dividend Aristocrats Index is a good place to begin your search. This keeps a record of which companies have increased their dividends every year for at least 25 years.
How much of your savings should be invested in stocks?
So now that you understand the benefits of investing in stocks as a senior, the next question you're probably asking is: How much should I invest in stocks? Everyone has to come up with their own answer to that based on their risk tolerance and retirement timeline, but the general rule of thumb is to invest 110 minus your age in stocks.
So if you're 50 years old, you'd invest 60% of your savings in stocks and 40% in bonds. Then, when you turn 51, you should readjust your asset allocation so 59% of your savings is in stocks and 41% in bonds.
The old rule used to be to invest 100 minus your age in stocks, but as people live longer, they need more money for retirement. Keeping more money in stocks for longer increases their chances of having enough saved.
You can use the "110 minus your age" rule as a starting point, but know that the best asset allocation for you may be different than this. If you don't plan to retire for many years yet, you may be able to keep more of your money in stocks because you'll have time to recover from a market crash before you need your savings. So consider your individual situation when deciding how to allocate your portfolio.