The baby boomer generation is starting to retire, and with that comes a new set of challenges. Investing can be scary at any age, but the fear becomes particularly acute as people grow older.
Between 1928 and 2016, the S&P 500 averaged an annual return of 9.53 percent, according to numbers from the New York University Stern School of Business. Yet, such a history of stellar returns does not help the person who puts in money at the top of the market, only to see stocks nosedive over the next year.
Purchasing stocks works best when the investor has a lot of time to ride out market volatility. As an investor nears retirement, volatility becomes a bigger issue.
With that in mind, here are 10 tips to help boomers lower their levels of risk. Remember, none of the following tips should be considered investment advice. Instead, sit down with a good financial advisor and discuss your financial needs so you learn how to invest your money safely.
1. Hold Bonds in Proportion to Your Age
The old saw states that investors should hold bonds roughly in proportion to their age. So people who are 25 should hold 25 percent of their portfolio in bonds. By contrast, investors who are 75 should hold 75 percent of their portfolio in bonds.
This is just a rough rule of thumb, but it is a useful axiom to guide investors toward stable and safe assets as they age and cannot afford greater risks in their investments. That rule is harder to follow these days because bond yields are lower, which means the bond portion of a nest egg throws off lower returns.
However, there are ways to deal with that issue, such as holding variable-rate bonds and using senior loan exchanged-traded funds (ETFs) as a substitute for bonds.
Related: What Is an ETF?
2. Look at Your Home as an Investment
For a lot of people, a home is their biggest single investment. And a house that was appropriate for a family of three kids and two adults might not make as much sense once the kids have moved out.
That does not mean all boomers need to run out and sell their houses, but it’s worth having an honest conversation with your financial planner to see if you need all that space. Selling your home and investing some of the proceeds might be a smart retirement strategy.
3. Capitalize on ETFs
ETFs are investment vehicles that are similar to mutual funds in that they hold baskets of stocks. Unlike mutual funds though, ETFs trade on stock exchanges. They are usually passive investment vehicles, which means that no one is there actively trying to “pick” stocks on your behalf. As a result, costs tend to be relatively low, often lower than those of mutual funds.
Low costs can add up to better returns over time. There are thousands of ETFs out there, so some research is required. But ETFs are definitely worth considering.
Learn More: Find the Right Brokerage Account for You
4. Do Not Take Risks You Cannot Handle
Today, yields on bonds, savings accounts and many other investments are very low. As a result, a lot of investors need more money than previously anticipated to achieve a given level of income.
Instead of working and saving a little longer, or accepting a lower level of income, many investors turn to high-yielding investments that also carry big risks. Investors need to understand the risks they are taking on, and make sure they are comfortable with them.
Bonds that are not investment grade are much more likely to default than investment-grade bonds. Sure, the former potentially offer a higher return, but that comes with the risk of a big principal loss. Investors need to make sure they can handle that level of uncertainty.
5. Exercise Caution With Annuities
There are many types of annuities, but unfortunately, most investors know very little about these products and simply jump on them as soon as they hear a promise of a guaranteed income.
That guaranteed income can come with a lot of caveats, including the risk that in the future, better opportunities will come along and the investor will be stuck with a low-yielding annuity. Investors need to understand the risks surrounding annuities before investing.
6. Dump TIPS in Favor of a Ladder of Maturities
Treasury inflation-protected securities (TIPS) are designed to pay a variable yield that increases along with inflation. But inflation has not hit boomers the way many thought it would. TIPS do not yield much right now because inflation is so low.
With that in mind, investors should consider skipping TIPS in favor of a sequence of bonds that mature slowly over time. Consider buying a combination of short-term, medium-term and longer-term bonds to protect against various risks.
7. Diversify If You Are Going to Invest in Stocks
It is tempting for investors to look at stocks like Apple and Amazon, which have had huge runs over the last decade, and just decide to park all of their nest egg in a few high-flyers. But that is a mistake. No one knows which stocks will be tomorrow’s big winners, and which will be the big losers.
Diversification is the best way to hedge the risk in individual stocks and ensure your nest egg remains safe regardless of what happens to individual stocks.
8. Look for Stocks With Stable Dividends
The nice thing about stocks is that the investor can earn returns in two ways — from capital gains and from dividends. You do not reap capital gains until you sell the stock, while dividends just keep rolling in.
Sage investors know that if they do a little research, they can find stocks from companies that pay high dividends and can afford to keep paying those dividends regardless of what happens to the broader economy. Those companies merit a premium. The decision to buy dividend stocks can make sense both for young investors and retiring boomers.
9. Prepare Your Bond Portfolio for Higher Rates
The Federal Reserve is now in the midst of what appears to be a long, slow cycle of interest rate increases. As that unfolds, bonds will fall in value.
Of course, outstanding bonds will pay the same amount in interest before and after a rate increase. However, after a rate increase, those outstanding bonds will command a lower price. As a result, investors will find that the value of the bonds in their portfolio drops as rates rise.
To help compensate for that fact, investors can add stocks such as financials that should rise as the Fed raises rates. Or, they can make sure they choose the right bonds. For example, look for lower-duration bonds, including those with a shorter maturity. Such bonds will suffer less from an interest-rate hike.
Regardless of the strategy investors pursue, they need to make sure they are prepared to weather Fed rate hikes in a way that will not damage their long-term financial security.
10. Do Not Worry About the Highs and Lows of Your Portfolio
Most investors trade far too often. Investors get wrapped up in the day-to-day movements of the market and let it affect their psychology. That’s particularly true for retirees who might have fewer things to do, and thus enough extra time to follow the markets.
Markets are volatile, and it’s easy to get wrapped up in the daily movements and forget about the big picture. The stock market can easily move 1 percent in a given day. In a retirement portfolio with $1 million that is fully invested, that might mean a loss or gain of $10,000. For most people, $10,000 is a huge amount.
As a result, investors can become consumed by the movements in their portfolio and even start making trades based on those movements. That is a bad idea. Investors should invest for the long term and avoid worrying about day-to-day price fluctuations. After all, isn’t the “long haul” what retirement is supposed to be about?
Up Next: 5 Secrets to Become a Great Investor
About the Author
Michael McDonald is an assistant finance professor and consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance and his research has been quoted in the Wall Street Journal and Bloomberg. He provides corporate consulting through Connecticut Expert Witness Consulting and teaches classes in the areas of corporate finance and investments.