The Time Is Right to De-Risk Your Retirement Portfolio

In the years following the financial crisis, my husband decided it was time to refinance our mortgage to take advantage of the fact that interest rates had declined substantially. He watched mortgage rates like a hawk until he finally pounced: 2.875% on a 15-year loan. It was a terrifically low interest rate; his timing was excellent. The day we refinanced, we recalled how our first mortgage in 1994 was 8.75% and we were happy to get it; here we were with an interest rate of just a third of that amount!

Yet in the weeks following our refinancing, mortgage rates dropped a little bit more. My husband kicked himself: If only we had waited, we could have shaved our payments even more.

I've been thinking of those events lately, in the context of the current stock market environment. Just as my husband had picked a really excellent time to refinance, even if he didn't lock in the absolute lowest 15-year mortgage in recorded history, so is this likely to be a decent time to de-risk an equity-heavy portfolio even if it's not precisely the right time.

Yes, stocks have fallen a bit recently, and many investors would quite reasonably prefer not to sell into weakness. As is so often the case after periods of market distress, stocks could well shoot up again, making new highs. Getting every last drop out of a strong market seems enticing. But if you’re getting close to retirement and expect to begin tapping your portfolio, it’s a mistake to try to find the absolute top before you lighten up on stocks. Just as it was generally a good time for us to refinance our mortgage a decade ago, so does it seem like a generally reasonable time to reduce equity exposure. That’s especially true if you’re retired or retirement is on the horizon within the next five or so years.

What to Do Depends on Who You Are For one thing, stocks have already had an exceptionally strong run: If you had $100,000 in the S&P 500 at the start of stocks' current rally in March 2009, you'd have $350,000 today. Moreover, broad U.S. equity market valuations, despite the recent pullback, still aren't incredibly attractive. In my early 2019 compendium of market outlooks from various investment firms, there was scant optimism for equity returns that were meaningfully better than what bonds would offer. If you've been practicing a policy of benign neglect, your equity positions have gotten larger even as the risks of owning stocks have also increased. And here's the really crucial part: It won't be at all obvious when stocks hit their top. The market peak, whatever it turns out to be, will only be apparent in hindsight.

Before I go any further, I'll note that de-risking isn’t a must-do for everyone. If retirement is many years into the future, say more than 10 years, and you’re comfortable with the swings that an equity-heavy portfolio can experience, you should sit tight with a stock-heavy portfolio. If you have the guts to do so, you could even use periodic market swoons as an opportunity to add to them. Short-term volatility can be uncomfortable, but the greater risks for you while you are in accumulation mode are that you don’t save enough or harness your long time horizon by embracing equity risk. In fact, if you’re early in your accumulation period, you can do yourself more harm by too actively managing your asset-class exposure than you can by standing pat and doing nothing.

And even if retirement is close at hand, you still need stocks. If you’re in good health, retirement could be a 25- to 30-year proposition, or even longer, so you absolutely need the growth that they can provide; an all-safety portfolio isn’t going to cut it. But balance is key. If retirement is close at hand and you haven’t de-risked your portfolio along the way, you’ve probably already accumulated a tidy sum for retirement. Falling short by not investing enough or investing aggressively enough isn’t your biggest risk factor. Because your portfolio’s equity exposure has likely grown as a percentage of your portfolio, sequencing risk--the chance that you’ll encounter a terrible market just as you’re entering drawdown mode--is the bigger land mine to avoid. Having to sell off depressed equity assets, which is what you might be forced to do if you don’t have a cash/bond buffer to draw living expenses from, could force you to push retirement further into the future, reduce your standard of living in retirement, or run short later on.

I like the idea of using your proximity to spending to drive allocations to higher-risk/higher-returning assets like stocks and safer assets like cash and bonds. Because stocks have landed in the black in approximately 90% of rolling time periods longer than a decade but have been much less reliable for holding periods shorter than 10 years, I consider a decade as a minimum holding period for equities. In other words, if you expect to spend from your portfolio in fewer than 10 years, give yourself a 10-year buffer of bonds and cash to ensure that you don’t have to risk selling stocks when they’re even further down.

'Chicken' Ways to Get There Even if you're sold on the concept of de-risking, how should you do it? The good news is that, unlike the single-point-in-time decision of locking in a mortgage interest rate, you have some flexibility around de-risking, especially if you're not already retired and don't expect to be within the next couple of years. You don't have to take your equity exposure down all in one go, much as it seems a reasonable time to do so.

Instead, you could take a more deliberate approach, dollar-cost averaging into a higher position in more-conservative securities. That could take the sting out of selling a larger chunk of stocks and watching the equity market continue to rise. Remember that you can also adjust your allocations gradually through other means than selling. You could direct all new contributions to cash and bonds, for example; that's particularly advisable if your taxable accounts need to be rebalanced. Another underdiscussed way to address portfolio imbalances would be to take the dividends and capital gains distributions from your appreciated stock holdings and steer them into your underweight positions.

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