A recent study by Bankrate.com showed that one in four Americans favored cash as the investment of choice for funds not needed for 10 years or longer. Cash beat out investments such as stocks and real estate in the study. Given the retirement savings crises that already exists in the U.S. this finding is a bit disturbing.
The biggest retirement risk.
I generally will tell anyone at or near retirement that the biggest financial risk they face is outliving their money. In my opinion this far outweighs the risk of loss from their investments.
A 3 percent rate of inflation will cut the purchasing power of your assets in half within 24 years. So someone retiring at 67 (the age at which many are eligible for their full Social Security benefit) would lose half the purchasing of their investment assets by age 91. For a couple retiring today the odds are fairly good that at least one of them will live to 90 or beyond.
Social Security and many governmental pensions do include a cost of living increase provision. Yet some COLA adjustments seem to lag real inflation and this may become more prevalent in the future given the fragile state of the federal budget and that of many states and municipalities.
Pensions from private employers typically do not have a COLA provision so annuitants are losing out to inflation from day one.
For many retirees, a significant portion of their retirement cash flow will come from withdrawals from their investments. This might include taxable accounts, tax-deferred accounts such as their 401(k)s and IRAs, and in some case tax-free accounts such as Roth accounts.
If these accounts are primarily invested in cash, it is likely that these investments will lag inflation. Add to this the taxes that might be due upon withdrawal and retirees can quickly find their nest egg being eroded at a faster than anticipated rate.
A balanced approach.
I've always advocated a more balanced approach to retirement investing. Certainly this would include some amount of cash to fund anticipated spending needs for a given period of time, say 1-3 years depending upon the individual's situation and risk tolerance.
In fact Morningstar's Christine Benz and others have written about this "bucketing" approach. While application of the bucketing approach will vary it generally involves a certain amount of liquid cash to ensure that spending needs are funded and that the retiree doesn't need to dip into their equity holdings during a down market. Other buckets might include investments of medium risk such as bonds or low risk alternative holdings, and the last bucket might include and allocation to stocks for growth beyond inflation.
Being overly invested in cash (including money market funds, CDs, etc.) may let you sleep better at night, but understand that an over-allocation to cash might relegate you to a future of poverty due to the impact of inflation.
Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides financial planning and investment advice to individual clients, 401(k) plan sponsors and participants, foundations, and endowments. Roger is active on both Twitter (@rwohlner) and LinkedIn. Check out Roger's popular blog The Chicago Financial Planner where he writes about issues concerning financial planning, investments, and retirement plans.
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