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By Jason Stipp and Christine Benz | 07-31-2014 11:00 AM

3 Retiree Pitfalls in a Still-Lofty Market

Beware the dangers of complacency, remember the virtues of defensive holdings, and resist the temptation to overreach for yield, says Morningstar's Christine Benz.

Jason Stipp: I'm Jason Stipp for Morningstar. The markets have been volatile recently with uneven economic news and geopolitical tensions buffeting stocks. But despite this, stocks and bonds have still had quite the run. Stocks are up 18% annualized over the past five years; bonds are up 5% over that same period. It may be counterintuitive, but such strong markets like this can actually be a breeding ground for common investor mistakes. Here to discuss some common pitfalls that retirees might be facing is Christine Benz, our director of personal finance. Christine, thanks for being here.

Christine Benz: Jason, it's great to be here.

Stipp: We've had some volatility recently, but it's hard to complain about market performance when you look over a longer time period. But you say there are some risks out there in this kind of market, and the first big one that should be on your radar is complacency.

Benz: Complacency about equity risk in particular. I often speak to groups of retirees. And I've heard from people who say, "I'm worried about bonds, so I'm comfortable having 100% of my portfolio in stocks. I'm able to get the income I need from my dividends, and so I'm just going to hang with that aggressive portfolio allocation."

The thing that I worry about is that in some sort of equity market shock that they may not be so comfy with that asset allocation after all. So, if they see that $1 million portfolio drop down to a $700,000 value, they may be inclined to make some changes at what might be a poor time. So, I think it is a good time to get in there and take a look at your asset allocation relative to your targets as a starting point.

Stipp: And one way that investors can get a gut-check on the risks that they might be taking in a portfolio that's overallocated to equities is to look at standard deviations.

Benz: That's right. You don't need to know how to calculate standard deviation, but you do need to know that it's a good measure of volatility and that can be predictive of future downside volatility. The reason I point people to standard deviation is that you can do those apples-to-apples comparisons.

So, you can look at the standard deviation of your equity holdings and compare it to your fixed-income holdings or prospective fixed-income holdings. If you have some sort of a total stock market index, right now it has a 10-year standard deviation of about 15. A total bond market index, by contrast, has a standard deviation over the past 10 years of three. So, that's a huge discrepancy in terms of volatility.

I think that relationship will hold going forward as well. Even though bond yields certainly are pretty uninspiring right now, I think they will hold their ground certainly better than equities in some sort of shock to the market. So, I think that investors should do that little bit of checkup on their holdings.

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