The Biggest Mistake Made by Pre-Retirees
For most retirees, retirement means financial independence, an opportunity to step away from employment-related obligations thanks to the financial portfolio they’ve spent their working lives building. It’s a new stage of a person’s life, and one to many people look forward to.
Unfortunately, many soon-to-be-retired or just-retired people immediately undermine their financial standing by making a basic and incredibly common mistake: underestimating their time horizon.
Here’s what I mean: just because someone retires at 60 to 65 doesn't mean they should make a wholesale and immediate shift from riskier assets like equities into “risk-free” (to whatever extent anything is risk-free) instruments like cash. Yet that’s exactly what many people do.
However, at age 65, most people will have a reasonable expectation to live for another 20-25 years, which means they must think about continuing to meet expenses decades into the future. When you deconstruct it that way, equities are still the best place to be as retirement begins. In fact, I’d also argue that the level of risk associated with decades-long equity investing isn't worse than it is in decades-long bond investing. Time is a risk mitigator.
Since the Great Depression, stocks have averaged 9.59% annual returns and bonds 5.59%. To illustrate, let’s imagine one newly retired individual puts part of their retirement into cash but reserves $250,000 for stocks. Another retiree puts everything into bonds. Twenty years is a long time in investing terms, and the retiree who stayed at least partially in equities will gain over half a million dollars in net wealth more than the other investor by age 85.
Investor A: Split Between Equities and Bonds
Investor B: Everything in Bonds
This is obviously an oversimplified example. Most retirees would and should gradually move money out of equities into cash over time, and they would be spending down on their savings during that time as well. The point here is that moving into cash all at once and all upfront will incur a significant opportunity cost.
That said, retirement strategy is not one-size-fits-all. Every retiree needs to adjust their approach based on their unique situational factors: one’s overall net worth, any medical conditions or family history that may affect life expectancy, whether you’re supporting others or just yourself, etc. are all questions that can affect how you approach your pre- and post-retirement financial planning. Just make sure you’re not inadvertently leaving money on the table but underestimating how much time is left for your investments to grow in value for you.