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Do You Have Too Much Stock in Your Retirement Account?

By Catherine Brock - Dec 14, 2020 at 6:48AM

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Stock funds are great for growth, but that's not always your top priority.

Swing for the fences in baseball, and you risk striking out. Swing for the fences in your retirement portfolio, and the consequences can be far more serious. An overly aggressive investing style in your 401(k) can backfire and threaten to put your retirement on hold indefinitely. Sadly, new data from Fidelity shows you might be making this very mistake by holding too much stock in your retirement account.

Fidelity's Building Financial Futures report, published in the third quarter of 2020, reveals that 23% of 401(k) savers are too heavily invested in stock funds. Even more concerning is that baby boomers are the most likely generation to be making this mistake.

If you're in that group, with a birth year between 1946 and 1964, you're either already retired or hoping to retire within the next decade. That's  exactly the time you should be less concerned about growth in your portfolio and more concerned about preserving your balance.

Baseball player at the end of his swing.

Image source: Getty Images.

The risk of too much stock

As a rule of thumb, stock funds show higher growth rates and more volatility than fixed-income funds and cash. For younger savers, volatility is less of a concern because if they hit a bad patch in the market, they have time to wait for the recovery. Older savers who are within 10 years of retirement don't have that same luxury.

The problem is that when the market crashes, you don't know how long the recovery will take. It could be quick, as it was after the coronavirus crash of 2020. But it also could take years. After the dotcom crash in 2000, for example, the S&P 500 didn't fully recover until 2015.

Imagine you plan to retire next year and, suddenly, the market takes a 30% dive. If you are 100% invested in stock, your account balance will fall as fast as the S&P 500 -- or faster if you're chasing growth with small-cap and mid-cap funds. Overnight, years of savings will be wiped away.

Even if you're left with enough money to retire, you may not want to. You'd have to liquidate positions to fund your distributions, precisely when share prices are at a low point. Unfortunately, the alternative is to delay retirement for five or 10 years until your portfolio bounces back.

Now, think through the same scenario with the assumption that your portfolio is 60% stock and 40% fixed income and cash. You'll still feel the sting of the crash, but it won't cut as deep. Maybe your balance drops 20% instead of 30%, for example. That's the benefit of shifting into more stable assets. You can manage through a crash with less severe consequences.

Two ways to lower your risk as you age

There are two ways to reduce your exposure to stocks as you age. You can do it manually by rebalancing your account each year or let a fund do the work for you.

Rebalancing manually involves selling off some positions and using the proceeds to buy others. The goal is to achieve a composition of stocks, fixed income, and cash that's appropriate for your age. As a guideline, subtract your age from 110 -- the resulting number is the percentage of stocks that's safe to hold at your age. At 60, for example, your portfolio should be 50% stock and 50% fixed income and cash. If you're holding 75% in stocks, you'd sell some of it and buy fixed income.

Alternatively, you could invest in a target-date fund, which automatically does this rebalancing for you. Target-date funds have blended portfolios containing stocks, fixed income, and cash. The composition of these gradually gets more conservative as you near the "target date," which is the year in the fund's name. That year should be the same as the year you expect to retire.

Note that a target-date fund is designed to be the only position in your retirement account. If you put half of your money in a target-date fund and the other half in an S&P 500 fund, for example, you wouldn't have the fund's intended composition. You'd be overweighted in stocks.

You should also know that some target-date funds are more aggressive than others. Take the time to look over the fund's "glide path," which defines how the fund's composition changes over time. If that glide path feels too aggressive, you can choose a fund from the same family with an earlier target year. That way, you'd reach the fund's most conservative composition sooner.

You don't need a home run

You don't need a home run when you're saving for retirement -- you need to get on base and stay in the game. Do that by shifting your mindset and investing style toward preserving your balance as you get older. Sure, you might miss out on some growth, but that's better than missing out on the first 10 years of your retirement.

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