Why you cannot switch to bonds after retirement

A common misconception among investors is that an investment portfolio in retirement should be “conservative” because a retiree cannot afford to “lose” money. Unfortunately, investors often use the wrong definitions of the words “conservative” and “lose.”

Too often, investors are worried about current—and usually short-term—market fluctuations. They fear “losing” money when the stock market falls. That temporary decline in value represents a loss of principal and potential retirement security. They feel safer investing in a bond or other fixed income instrument that pays an interest rate and that doesn’t fluctuate much in value. That way, they live off of their “income” and protect their “principal.”

These misperceptions of interest earned with “income” can be so wrong as to seriously damage a retiree’s chance of living comfortably throughout retirement. A retiree who hopes to live for 20 or 30 years cannot base his investment portfolio on “income” earned through the yield on his investments. History proves that the highest-yielding investments have lower overall returns than lower-yielding investments. Even worse, higher-yielding investments often have trouble keeping up with inflation, and inflation is a retiree’s biggest financial enemy, not temporary fluctuations in the stock market.

Consider the last 50 years, a period during which bonds and Treasury Bills have usually offered much higher yields than did stock dividends. Yet the returns on bonds and notes barely kept ahead of inflation on an after-tax basis. Treasury Bills had an average annual return of about 5% during this period, just ahead of inflation’s 4% annual gain, while five-year Treasury Notes returned about 6.9% per year. Meanwhile, the U.S. stock market, as measured by the Standard & Poor’s 500 Stocks index, returned 10.4% per year, nearly three times the rate of inflation. Retirees should emphasize total return—yield plus market appreciation—and include stocks in their portfolios.