Many things in life follow a high-risk, high-reward system but few more so than stock investing. There are no guaranteed returns, and there's always a chance you could lose a lot of your investment over a short period of time. There are "safe" stocks that offer a greater degree of stability in the long run, but even then, historical performance does not guarantee future results.
Investments like bonds and certificates of deposit (CDs) typically carry less risk, but as a result, their returns may not even be high enough to keep up with inflation, much less provide decent long-term growth. Conventional investment wisdom tells us that in our younger years, we should be comfortable taking on more risk (investing in stocks) to grow our wealth rather than playing it safe (holding bonds, CDs, or cash) and risk falling short of our savings goals for retirement.
But this guidance only applies when you have time on your side to ride out market volatility. Unfortunately, that's just not the case when you're close to retirement. With so much uncertainty in the stock market and economy right now, if you have retirement on the horizon, here's why it's time to play defense.
You don't have to ditch stocks
Even with the current bear market and fears of a recession, that doesn't mean you have to abandon stocks entirely, but you should reconsider which types of stocks you own. Small-cap stocks may offer higher return potential, but they're also way more susceptible to volatility and carry more risk. Mid-cap stocks can often fill that sweet spot -- small enough to have room for growth but large enough to weather periods of economic weakness.
But as you near retirement, you typically want small-cap and mid-cap stocks to make up less of your portfolio, instead letting large-cap and blue-chip stocks lead the way. Large-cap stocks will be even more stable than mid-cap companies, though that comes at the cost of reduced growth potential. Blue-chip stocks are well established, household names that have stood the test of time as leaders in their industries.
How your stock portfolio might be broken down
You want your overall investment portfolio to become more conservative as you near retirement -- more bonds, CDs, cash, etc. -- but you want to reallocate the stock portion of your portfolio as well. Remember, though: Just because your focus switches to defense doesn't mean you have to quit playing offense altogether. To illustrate, someone in their 30s might break down their stock holdings as follows:
- Large cap: 50%
- Mid cap: 15%
- Small cap: 15%
- International: 20%
A few decades later, with retirement on the horizon, the above scenario may pose more risk than they want to take on. Instead, their portfolio has gradually evolved with the allocations below:
- Large cap: 70%
- Mid cap: 5%
- Small cap: 5%
- International: 20%
That's just enough exposure to small-cap and mid-cap stocks that they reap some of the benefits from the greater growth potential, but it's also small enough that in a down market like the one we're experiencing in 2022, any losses are unlikely to have an outsized impact on their portfolio or set their retirement plans back tremendously. Any financial setback can be scary, but not all financial setbacks are created equal. By playing defense closer to retirement, you can help ensure your decades of hard work and saving aren't thrown off by a single bear market.