Stock market performance in the most recent bear market was largely a train wreck that left many older investors wondering what to do. Should they purge their investment portfolios of stocks altogether or risk running out of money?
Between October 2007 and March 2009, the Standard & Poor's 500 Index ($INX) lost 55% of its value. An investor with a $1 million exposure to an S&P 500 fund would have lost $550,000 in the span of 17 months.
Unfortunately, many investors' retirement accounts were top-heavy in equities and, as a result, suffered significant losses in the recent crash.
Nearly one in four investors ages 56 to 65 had more than 90% of his or her account balances in equities going into 2008, and more than two in five had more than 70% in stocks, according to a report (.pdf file) by the Employee Benefit Research Institute.
Younger investors typically have time to weather downturns in the market because they have more time before retirement. But if you're older than 50, huge investment losses could be harder to recoup. It all depends on how close you are to retirement, how the stock market performs in the future and your asset-allocation mix.
Fortunately, over the long haul, the stock market has produced attractive returns for investors. And in the three months following the bottom in March, the S&P 500 rebounded 50%, according to Morningstar.
But investors need another 50% gain just to (almost) break even.
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Stocks trend upward over time
Between 1883 and 2008, the stock market averaged a 7.6% return after inflation each year, according to the Center for Retirement Research at Boston College.Remarkably, $1 invested in 1926 in U.S. large-company stocks would have been worth $2,270 by the end of July 2009 after inflation and taxes, according to Ibbotson Associates.
That historical performance has some experts suggesting that older investors shouldn't get gun-shy about investing in stocks even as they approach retirement age, because the right mix could improve the likelihood that they'll reach their goals and stay ahead of inflation.
"At 50 years old, you still have 15 years before you're going to retire, which is a long time," says Judith Ward, a senior financial planner at T. Rowe Price in Owings Mills, Md.
"Our research has shown with stocks, including in 2008, that there has never been a 15-year period where average stock returns were negative. So we still think stocks are an important part of the portfolio."
Video: The right moves for retirement
So how do you figure out what percentage of stocks you should hold in your retirement portfolio?
The trick is to tweak the equity allocation in a way that makes sense based on your risk tolerance, time horizon and financial goals.
With most Americans relying on defined-contribution retirement accounts such as 401k plans to fund their retirements, it pays to understand how those accounts are funded.
Some financial advisers recommend that investors subtract their age from 100 to arrive at the percentage of stocks they should hold in their portfolios.
So if you're 55, you should have a 45% exposure to stocks, according to this general rule. But in the aftermath of the financial crisis, that wisdom is being challenged.
Continued: Are target-date funds the answer?
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