Is Our Investment Mix Right, Especially If Markets Fall?

An investment mix isn't simply about how much you have in stocks and bonds. It also depends on your time horizon, spending needs, other income, ability to withstand losses, and willingness to accept investment volatility. A portfolio that fits one household may not fit another.

Now let's talk about investment risk.

Not when the market is going up.

When it's going down.

Because that's usually when you find out whether your investment mix actually fits your retirement plan.

What does "the right investment mix" mean?

It doesn't mean finding the portfolio that will produce the highest return.

We don't know which investment will perform best in advance.

Instead, the question is whether the mix of investments makes sense given what the money is supposed to do.

For someone decades away from retirement, the time horizon may be very different from someone who expects to begin withdrawals next year.

And even two retirees can have very different portfolios because their income, spending, assets, and risk tolerance can be different.

What happens if the market falls?

Let's use a simple hypothetical.

Suppose you have a $1 million portfolio.

The market declines 20%.

Before considering any withdrawals, that portfolio would be worth approximately $800,000.

That's an illustration, not a forecast.

Markets can decline by more or less, and the timing and duration of market declines are unpredictable.

Now add withdrawals.

If you're taking money out of the portfolio while its value is down, the amount remaining invested can be affected by both the market decline and the withdrawals.

That's why investment risk and retirement income planning are connected.

Is a lower-risk portfolio automatically better?

Not necessarily.

Reducing exposure to investments that can fluctuate significantly may reduce some forms of volatility, but it doesn't eliminate investment risk.

There are other risks.

Inflation can reduce purchasing power.

Interest rates can affect fixed-income investments.

Concentrated positions can create additional risk.

And holding too much in lower-returning assets may create a different set of tradeoffs over a long retirement.

There isn't a portfolio that eliminates all risk.

The question is which risks you're taking and why.

How much does your income matter?

A retiree receiving a pension and Social Security that cover most basic expenses may have a different portfolio need from someone who expects investments to provide most of their retirement income.

Let's say two households each have $1 million invested.

Household A has $70,000 of predictable annual income and expects to spend $80,000.

Household B has $30,000 of predictable annual income and expects to spend $80,000.

They have the same portfolio value.

But they don't have the same income gap.

That doesn't tell us what either portfolio should look like.

It does tell us that portfolio risk shouldn't be evaluated without looking at the income plan.

What about your ability to stay invested?

Here's an important question:

What would you do if your portfolio declined 20%?

Not what you think you'd do today.

What would you actually do after seeing the account statement?

If a decline would cause you to sell investments because you couldn't tolerate the loss, that's relevant information.

Risk tolerance isn't just a questionnaire.

It's also your ability to financially and emotionally withstand losses.

What should you review?

A retirement investment review can start with a few basic questions:

What is each investment supposed to accomplish?

When might you need the money?

How much income needs to come from the portfolio?

What other income sources are available?

How would a significant decline affect the retirement plan?

How much volatility can you reasonably tolerate?

Are there concentrated positions or other risks worth understanding?

How does the investment mix fit with the broader income plan?

The goal isn't to predict the next market decline.

We can't.

It's to understand what could happen to the plan if markets don't behave the way we hope.

Because the most important question isn't:

"Will the market go up?"

It's:

"If the market doesn't go the way we expect, can the plan still function?"

That's a much more useful retirement-planning question.

Happy planning.