When it comes to investments, most of the time risk means volatility: the likelihood of a price to go up or down unexpectedly.
Let's be clear – no one likes to see the value of their investments drop. No one. But it's also true that the safer an investment is, the harder it is to grow your money. So the trick is balancing the amount of growth you need with the amount of risk you can handle.
Cash has basically zero volatility, but almost by definition your savings account can't keep up with inflation. (If banks paid interest at a rate higher than inflation, they would go out of business.) Bonds tend to have lower volatility than stocks and do a pretty good job of staying ahead of inflation, but also don't tend to appreciate a lot in value. Stocks are very volatile in the short-term, but surprisingly dependable for growing wealth if you can zoom out your time frame to 15+ years. (And, since retirement literally lasts the rest of your life, that 15+ year time frame is actually very relevant.)
When you're weighing your need for growth against volatility risk, you need to be clear about where you are in your retirement savings journey.
If you are nowhere near your 25x Rule target, you need your money to grow a lot. That means taking on more risk by having a stock-heavy investment mix. It's important to note that this has nothing to do with your age: if you are no where near having 25x your annual expenses in savings & investments, then you just have to keep working and continue to grow your investments as much as you can.
As you approach your 25x target, you still need to accept some risk – but not as much. If you're in the range of 15-20ish times your annual spending in savings and investments, it's time to downshift your investment mix to a little bit less in stocks, a little bit more in bonds & cash. Again, still focused on growth, but just not as much risk.
And if you've already passed your 25x target, your main concern should be outpacing inflation. You've already got enough money, so now you just need to maintain your spending power by earning a little bit more than inflation each year.
Notice that you shouldn't suddenly turn all of your investments into cash when you reach your target number. That money needs to last you for the rest of your life, so you still need to take on some investment risk. But once you're in the ballpark of having enough, you can shift your investment mix from a growth mindset to a preservation mindset.
Does all of that make sense? Nothing too crazy, right?
Here's where I see people getting it wrong most often: trading short-term stability (which feels good) for long-term growth by choosing an investment strategy that is way too conservative for where they are on their financial independence journey. That doesn't mean I want everyone taking on a ton of risk in their investments. But I do want you to take on the right amount of risk for your financial reality.
Want to get your own retirement savings reality check? Send me an email to start a conversation.
Thanks,
Timothy Iseler, CFP®
Founder & Lead Advisor
Iseler Financial, LLC | Durham NC | (919) 666-7604
Iseler Financial helps creative professionals remove stress while taking control of their financial lives. We'll help identify current your strengths and weaknesses, clarify and refine your long-term goals, and prioritize decisions to improve your financial well-being now and later. Reach out today to take the first step.
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