Many investors are nervous about investing in the stock market because of the recent volatility. This is understandable. But it is necessary to take a long-term approach no matter how close you are to retirement.
If you are far from retirement, don't be too concerned about the recent volatility. In the long run, common stocks will outperform bonds. It makes sense to have a higher portion of stocks in your portfolio than bonds.
Whether you prefer mutual funds or exchange-traded funds, you have to pay attention to costs. There are many diversified index funds and ETFs that are available with low annual costs.
U.S. common stocks currently are still more expensive, based on price-earnings ratio comparisons, than foreign common stocks. Accordingly, it makes sense to have a percentage of your common stock portfolio in international funds or ETFs.
It is likely that there will continue to be more volatility in the stock market than in the last few years. To take advantage of this volatility, you should use dollar-cost-averaging for new investments. It also makes sense to rebalance frequently, at least annually.
A significant mistake investors have made over the years is to bail completely from stocks after significant drops in stock market prices. This is dangerous in the long term. Nobody can predict tops and bottoms in the market. No one can tell you when stocks will rebound after significant decreases in prices.
By being completely out of the market, you will not be able to profit from stock market increases after they rebound. Maintain a diversified portfolio of common stocks in some form as long as business conditions are favorable; corporations are able to maintain and increase their earnings; and employment rates are high.
Even as you approach retirement, it still pays to maintain a significant portion of common stocks in your portfolio. I have been retired for more than 20 years, and during that time, I have always maintained at least 45 percent of my total investment portfolio in some form of common stock investments. It has worked well for me and other investors.
It is not unusual for me to hear from retired readers who lament the fact that they didn't maintain a significant portion of their assets in some form of common stocks.
Even with the recent fall in common stock value, investors who had maintained a significant portion of their assets in diversified common stock index funds or ETFs for several years are much better off than investors who maintained most of their portfolio in conservative investments, such as money-market funds, Treasury bills or certificates of deposit.
As you do approach retirement, however, it does make sense to review whether you want to reduce the percentage of funds you have in the stock market. For example, if you have maintained 70 percent of your portfolio in common stocks, you may want to gradually reduce that figure. However, I believe a 50 percent allocation in common stocks during retirement is not that risky.
For people in retirement, it can be just as risky, if not more risky, to have an investment portfolio whose returns will not keep up with inflation.
Fortunately, many of us will be living 30 or more years in retirement. That means, however, that many of us will have to revise our investment horizons and the strategies that fit them.