Every time I hear a retiree confidently tell me that they are invested in “safe stocks” so they’re not concerned about a bear market, I silently shudder.
Are stocks safe for retirement? It all depends on your risk tolerance, net worth, stock market valuations and other factors explained below.
After investing for almost 40 years in both bull and bear markets, both with financial advisors and without them, I’ll share 8 hard learned lessons to provide some perspective on whether stocks are safe for retirement.
While I am an AFC® (Accredited Financial Counselor), I write mostly from the school of hard knocks while investing for 40 years. I do not sell wealth management services so I get to be unbaised except for those biases which may have arisen from my own experiences.
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What Determines a Stock’s Safety?
A stock’s safety is evaluated by fundamental factors such as it’s financials, competition, management, and political change.
In other words, the fundamental factors determine the quality of a stock. And quality is obviously important no matter what. When investors say they’re invested in “safe stocks” they’re usually referring to the fundamental factors for those stocks.
But the safety of a stock can’t be based on a stock’s quality alone. There is another big risk factor which is broad stock market risk.
This post addresses how safe stocks are for retirement based on broad stock market since fundamental risk can be lowered significantly from both careful analysis and diversification. Plus, stock market risk seems to be the least understood and overlooked risk of stock investing, so I want to focus there.
How Important Is Overall Stock Market Risk?
Let’s put overall stock market risk in perspective for someone retiring soon. The overall market falls on average about 32% in bear markets.
This means a bear market decline can be a lot more or a lot less than 32%.
Between October 2007 to March 2009, the Dow Jones Industrial Average dropped 54%, for example. The Nasdaq dropped over 70% in the early 2000’s tech bust. On the other hand, during the short and slight bear marketos December 2018 and again in 2022, the market fell only 20%.
A decline of 20% or more defines a bear market, so the later hardly counts as a bear market.
I don’t want to make stock bear markets seem like a bigger threat to your financial security than it is. And it’s important to realize that a 32% decline may seem like a nonissue given the amount that the stock market usually rises during extended bull markets.
For example, the market can rise by 32% in one year alone. And in the 10 years after March 2009, the stock market rose over 300%!
The two bear markets between 2000 to 2010, however, saw declines of over 54% in at least one of the major stock indexes. These bear markets created overall negative returns as a whole for stock investors in the entirety of the 2000’s decade!
An investor that retired in 2000 would almost certainly say that stocks are not safe in retirement.
While a 32% average decline doesn’t look so bad, a 54% decline in your stock portfolio is really bad when you don’t have decades to recover or the ability to increase retirement savings.
These facts compel me to write this post for retirees or soon to be retirees wondering if stocks are safe for retirement.
Are Funds Safer than Stocks?
Many investors today are invested in funds of some type, such as index funds, ETFs (Exchange Traded Funds), or mutual funds instead of individual stocks while some investors still have individual stocks.
Many high net worth investors, for example, have private wealth managers invest in individual stocks for them instead of funds.
While funds provide instant diversification, possibly making them a little safer than individual stocks, both funds and individual stocks are subject to the risk issues outlined below.
This is contrary to the belief many investors have that funds are safer than individual stocks. This is simply not a given.
The Overall Stock Market Affects Stock Risk
The reality is that investing in stocks is about investing in the stock market as a whole since most stocks move up or down relative to the overall stock market.
In other words, most stocks go up during rising (bull) stock markets and most stocks decline during falling (bear) markets.
Here is what typically happens that gives investors a false sense of security about stocks, often as they head into retirement.
Investors (or their financial advisors) buy stocks that go up during a strong rising (bull) market.
They feel brilliant for either choosing the stocks or hiring the financial advisor responsible for the increase.
It’s usually the bull market as a whole that should get credit for those gains, however, not stock (or fund) picking prowess. I’ve been there and done that more than once so I get to write this.
While a stock’s fundamentals (financials, earnings, competition, management, etc.) are extremely important in evaluating an investment, the stock will almost certainly move with the overall market trend up or down even when the fundamentals are very good.
This means that when determining if stocks are safe for retirement, investors must consider overall market trends as well as company fundamentals for the stocks owned.
Stock Purchase Price Affects Risk
It’s often said that the money is made at the purchase. The amount you pay for any asset defines whether you will have a gain or loss from the sale of that asset.
This means that the purchase price affects how safe a stock is. And the purchase price of a stock is a factor of the overall stock market trend and valuations or earnings multiples.
Here is an example to illustrate this point: If you bought a stock in 2009 at $20 and the value is now $ 120, a decline of 34% won’t create a loss if you sell the stock.
On the other hand, if you bought a stock in 2019 at $120 and it falls 34%, you’ll have a loss if you need to sell the stock.
This math is obvious but here is the important thing to notice: the amount of profit in a stock holding affects how safe stocks are in retirement or any other time.
Not only this, but in 2009, the stock market as a whole was very cheap because the 2007 – 2009 bear market ended in March of 2009. “Very cheap” means stock market “valuations” were low.
This means the purchase price for almost all stocks were low. In the second scenario above, in 2019, the stock market was expensive, meaning the market had high valuations.
When stocks are bought at low valuations they are safer to own and when stocks are bought at high valuations they are more risky to own since a loss is more probable.
It’s not so much whether the investor is in retirement as it is that stocks become overvalued making them less safe.
Many investors don’t realize this important fact since there is a lot of promotion to invest in stocks no matter what stock valuations are. This leads investors to feel unnecessarily pressured to invest in stocks, even when they’re overvalued, and often at inopportune times such as in retirement.
Of course, the amount a retiree has in retirement savings is another huge factor since someone with very large retirement savings can weather downturns much easier than someone with small retirement savings.
A Stock’s Safety Is Ever Changing
Investors sometimes forget that a stock defined as “safe” 10 years ago may not be safe today based on valuation changes alone.
The good news is that valuations can be measured with the PE, or price-earnings ratio. The price-earnings ratio shows how much an investor has to pay for a company’s earnings.
While the PE ratio can be misleading at times, it is still considered a very reliable and basic way to know how much you are paying for the earnings of a company before buying a stock.
It can also be used to show investors if the stocks they already own are selling at very high valuations.
As a very general rule, lower PE ratios are associated with safer stocks. It’s important to note that the quality of a stock based on fundamentals is also important because bad fundamentals also cause low PE ratios.
Timing Is Everything
Unless you are very wealthy already, retirement is not the time to plan on long term appreciation from stock ownership.
The exception to this is if stocks are bought at low valuations since quality stocks return to normal (average) valuations often within short time frames following extremely low valuations. This allows investors to build wealth as stocks climb again.
Stocks move back toward the mean pricing, which is an average. But they swing both under and over the mean when creating that average creating opportunities for stock investors paying attention to long term stock market trends.
This means that how safe stocks are for retirement is a factor of the valuation which they were bought.
Define How Much Risk from Stocks You Want
If you’re headed into retirement and want to know if stocks are safe, consider the following.
It’s easy to feel like a victim to the stock market, especially during times of talk about potential stock market crashes. At any given time, however, you can choose how much stock market risk you want to take and adjust your protfolio holdings accordingly. This is especially important just before and during retirement.
As addressed previously, you can check to see if the stocks you own are selling for high valuations.
One way to lower stock market risk rather than simply selling your stocks is to use stop loss orders, which can be entered to keep your stocks at, or at least near the risk level you choose.
While you can get “whipped around” due to markets rising right back up after your sales get executed, times of increased volatility are usually worth the extra risk management.
If you work with a financial advisor, you have probably defined your chosen stock risk level with her. You can simply ask her to implement strategies to stay within those chosen risk levels.
If you buy your own stocks or funds, you can enter stop losses in your brokerage account if you decide this is best for you. This can help reduce risk while continuing to build wealth as stocks increase.
Alternatively, you can increase cash as stocks become overvalued.
Tactical Stock Investing in Retirement
Technical investing strategies that have been developed over the past few decades. Many of these strategies invest in stock, bond and other ETF’s or index funds, allowing for reliable back testing over up to 50 years.
It can be very hard to figure out when to buy and sell stocks. I find Allocate Smartly a valuable resource in selecting and managing investment strategies that rotate into stocks when appropriate and out of stocks as needed. Being in official retirement, I don’t want to own stocks during high risk times so I invest using a portfolio I created in Allocate Smartly.
You Don’t Have a Loss If You Don’t Sell
Common theory around buy and hold investing (regardless of stock market valuations) emphasize that you don’t have a loss if you don’t sell stocks at a loss. The plan is to “ride out bear stock markets”.
This can work well for those with decades before retirement but not so well for those about to retire or retirees. Even if you don’t incur a (realized) loss from the sale of stocks, you have a painful net worth decline and your overall financial plan is affected.
Dividend Stocks Are Safer
Fortunately, during bear stock markets, most higher quality stocks that pay dividends tend to fall less than the overall stock market. For example, quality dividend stocks may fall 35% during a bear market with an overall decline of 50%.
Many retirees are invested in dividend stocks for income. The income benefit those stocks provide makes them safer in retirement than stocks relying only on growth as a way to make money for investors. This is compounded by the fact that the needed dividend income usually continues even during bear markets so retirees tend to hold onto dividend stocks thereby making them safer in overall market declines.
Beta Measures How Safe a Stock Is
You may feel like you have no way to know if stocks are safe based on the likelihood of a bear market; this can be hard even for the most experienced investors. But you can easily see how safe a stock or stock fund is from a broad stock market perspective with a measure called Beta.
Think of it like this. The overall market drops on average about 32% during a bear market. The Beta measures how much a stock or a stock fund moves in relation to the overall market.
If a stock (or fund) has a Beta under 1.00, for example, it tends to drop less than the overall market during overall market declines. An example would be a stock with a Beta of .92.
If a stock drops more than 1.00, it tends to drop more than the overall market. An example would be a volatile fund with a Beta of 1.50.
Of course, this works both ways. Stocks also rise in relation to the overall market based on the Beta. Logically, then, it makes sense to invest in higher Beta growth stocks in the early phases of a growing economy and lower Beta stocks near a slowing economy.
An investor can also apply beta logic to owning stocks with low betas in retirement since the low beta implies the stocks are safer.
The Beta is based on logic and math, two of my favorite investing tools.
You can see how using the Beta can help you evaluate how safe particular stock investments are during retirement. The Beta is a free tool that is easily available if you invest yourself. Here is one of many sites that publish the Beta of a stock.
Notice that Beta is based on historical data. If you work with a financial advisor, you have hopefully had a good conversation with him about using Beta as a risk management tool and how it applies to your investments.
Summary: Are Stocks Safe for Retirement?
As you can see, whether stocks are safe for retirement depends on many factors.
There is rarely a one size fits all answer here at Retire Certain because every investor’s situation is unqiue. You’ll want to understand the basics of investing as well as define your needed investment returns and acceptable risk to be able to live how you want in retirement.
Once you have done this, you’ll know if stocks are safe based on the risk that you choose to take at any given time before or after retirement.
The best place to start is with my Ultimate Wealth Plan. You can get it here now.
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