Reducing portfolio risk before retirement
I heard somewhere that you should transfer a mutual fund
into some sort of guaranteed interest account five years before retirement. Is
this an urban legend or is it valid? I'd rather keep going in a mutual fund. Thank
you for your time.
-- Dennis Distribution
I don't know if I'd call it an urban legend, but it is a commonly
held notion taken to an extreme. As you approach retirement, your retirement
investments lose the ability to recoup large investment losses. There aren't
many "rebuilding years" left in the portfolio. A common reaction
to that is to dial down the risk in the portfolio so the probability of a large
investment loss is unlikely.
Switching to a guaranteed interest account
five years before retirement is an extreme example of the decision to reduce risk
in the retirement portfolio. The problem is that it only protects you against
one risk -- the loss of principal -- and doesn't do anything to protect the purchasing
power of that principal from inflation. Purchasing-power risk can be as big an
issue in retirement as risk to principal. Both of these risks relate to
another risk -- longevity risk -- in retirement. That is the risk of outliving
your retirement income.
It's good to take a look at the big picture as you
approach retirement and not just focus on one part of your asset base and expected
retirement income. To the extent that Social Security and any pension benefits
will provide a steady stream of income, they allow you to accept some risk in
your investment portfolio. Owning your home free and clear, or at least having
a large equity position in that home, also helps you to accept some risk in investing.
If you're having trouble putting the pieces of the
puzzle together, get some professional help. A fee-based financial
planner can help you sort through your income, assets and goals
and build a plan that improves on using some conventional wisdom
that isn't all that wise. This earlier Dr. Don column, "Picking
a financial-planning professional," can help you choose
a planner right for you.
To ask a question of Dr. Don, go to the "Ask
the Experts" page and select one of these topics: "financing
a home," "saving & investing" or "money."