Why Retirees and Investors Approaching Retirement Should Reduce Risk Today

On Aug. 5, the stock market experienced its biggest one-day selloff in two years, prompted by a weaker-than-expected jobs report and recessionary worries, among other factors.

Stocks recovered as the week wore on, and if you’re like most investors, you probably shook off the downturn pretty quickly. You’ve no doubt heard multiple admonishments about the value of hanging on during periods of market weakness, and the downdraft was so short-lived that it probably didn’t prompt a lot of angst anyway.

But my contrarian take is that some investors—specifically, people within five years of retirement or already retired—actually should consider using the recent market volatility as an impetus to sell stocks. Of course, it’s hard to generalize about what investors in any one age cohort are doing; not all preretirees and retirees are heavy on stocks. But in Vanguard’s 2024 How America Saves report, the typical asset allocation in equity for Vanguard 401(k) participants who are age 60 to 64 is about 60%. Meanwhile, the typical 2030 target-date fund has an equity allocation of 52% and the average 2025 fund stakes just 42% in stocks. Given that Vanguard’s figures encompass target-date fund participants as well as self-directed investors, that suggests that some of the self-directed folks have heavy equity weightings indeed. For my part, I’ve met plenty of older adults who have told me their portfolios consist mainly of stocks.

I know, stocks have been good to you, while bond returns have been disappointing. But scaling back on equities delivers multiple benefits for retirees and preretirees right now. It helps reduce risk in your portfolio, including the dreaded sequence risk; enables you to lock in still-robust yields on safer securities while you still can; and helps queue up cash flows for the years ahead so you won’t have to worry about your portfolio’s yield or the market environment.

Imbalance, Meet Rebalance

Reducing risk is a key reason to consider lightening up on equities if retirement is close at hand. A hands-off approach likely served you well during your accumulation years. But because stocks tend to beat bonds over most longer time horizons, the net effect of that inertia is that your portfolio becomes progressively more equity-heavy as the years go by. That tendency has been particularly pronounced over the past decade, as US stocks have gained about 12% per year, on average, while bonds have earned only modestly positive returns.

Thanks to those shifts, a hands-off portfolio that was 60% equity and 40% bond 10 years ago would be 80% equity today. That translates into higher loss potential for the more equity-heavy mix in down markets. During the global financial crisis, for example, a 60% equity/40% bond portfolio would have lost 27% from peak to trough, whereas an 80% equity/20% bond portfolio would have lost about 40% over that same stretch.

During the accumulation phase, reducing volatility through rebalancing is more of a creature comfort than anything else. But the benefit of reducing stocks—and in turn volatility—becomes much more tangible when you retire. If you’re actively spending from your portfolio and you have to take the money out of depressed equities, you’re turning paper losses into actual losses. Building up a bulwark of safer assets, as you naturally do when you rebalance from stocks into bonds and cash, helps reduce the odds that you’d be a seller of stocks in such a downturn. (Of course, if you’re selling stocks today, be sure to mind the tax implications, ideally making changes in tax-sheltered accounts to avoid triggering a big tax bill.)

In my Model Bucket Portfolios, for example, I carve out 10 years’ worth of portfolio cash flows in cash and bonds. That way, if a market downturn or another “lost decade” for stocks materializes early in your retirement, you know that you have a healthy cushion of assets to spend through before you’d have to touch stocks.

Opportunity Costs Aren’t That Great

Thanks to higher yields on cash and bonds today, the opportunity cost of building out that cushion is much less than was the case a few years ago. That’s because yields on cash and bonds—and in turn their long-term return potential—are still pretty darn good today and well ahead of inflation. While yields have recently fallen in expectation of Fed rate cuts in September, they’re still substantially higher than they were two years ago, when the Federal Reserve embarked on a series of rate hikes in an effort to pump the brakes on inflation. The yield on the 10-year Treasuries bond was just 1.7% in March 2022; today it’s roughly 4%. Cash yields have also risen significantly: High-yield savings accounts now yield more than 4% in many cases, and you can lock in certificates of deposit in the 5% range.

That translates into better return potential from those assets and makes a case for a higher allocation to them, especially for retirees aiming to pull a fairly consistent stream of cash flows from their portfolios. In the 2023 retirement income research that Amy Arnott, John Rekenthaler, and I collaborated on, for example, the highest safe withdrawal rates corresponded with portfolios with just 20% to 40% in equities. Of course, you may wish to run with a higher equity allocation than that, but that finding illustrates the value of bringing a balanced asset allocation into retirement.

You Can Get Off the Income Treadmill

Finally, another positive side effect of selling stocks to boost cash and bond is that you won’t need to be overly beholden to the interest-rate environment when sourcing your in-retirement cash flows. Retirees like income, and yields are decent today, as I just noted, but they may go lower in the months and years ahead. By peeling back on stocks and shifting more assets into cash and high-quality short- and intermediate-term bonds, you won’t have to worry if your portfolio’s organic yield doesn’t match the level of the income that you need. Instead, you can stay flexible about sourcing those in-retirement cash flows. You can use yield to provide most or all of your cash flow needs, but you could also withdraw from cash, bonds, or appreciated equities if doing so improves your portfolio’s long-term prospects.