The conventional advice to retirees is that they should invest in low-risk financial instruments during retirement. Alternatively, the advice of some advisors is that “safe” investments would simply expose your accumulated fund to other retirement risks. There is merit in both positions, which is why portfolio diversification can be a great strategy at any life-stage. Ultimately, retirees must invest so that they can sleep well at night and protect the real value of their investment. They should base their investment decisions on the following:
1) Risk tolerance
Some people are gamblers, while others are ultra-conservative. Your risk tolerance is primarily influenced by your personality. The main point about investing and risk is that you should be comfortable with the level of risk that you’re taking. No one else can tell you what your comfort-level is. You certainly do not want to invest exclusively in growth options that leave you perpetually worried.
2) Depth of reserves
The level of risk that you can withstand would be dependent on the depth of your reserves as well. Someone who invests 40% of his retirement fund in growth options would find that the nominal amount exposed to loss would be significant. 40% of a 200,000 retirement fund is a significantly higher risk than the same percentage of a 2,000,000.00 retirement fund in terms of the actual Euro value.
3) Inflation risk
Although you’re seeking to provide security for your money, you may inadvertently cause a real loss or substantially lower real returns in the long-run. The good news is that you do not have to put your retirement fund at risk to beat inflation. Use the Consumer Price Index as a guide and seek high-yield CDs or bonds that provide rates of return that outstrip the inflation rate.
4) Understand the risk-return trade-off
The higher the risk associated with a financial instrument, the greater the potential return is. This trade-off is a primary reason that diversification should take place. This is because neither extreme is optimal for the retiree. Low risk-low return increases inflation risk while high risk-high return increases the risk of loss. Conservative investing does not necessarily imply investing exclusively in low-risk funds. It suggests that the majority of your investment should be split between cash and income options and a relatively lower percentage assigned to growth instruments.