Many retirees and pre-retirees are drawn to fixed annuities and CDs because they do not want to assume much risk. After all, there is no stock market risk involved with these fixed-return investments. Some people use them as their only vehicles for retirement planning.
But stepping out of the stock market altogether may not be such a good idea. In fact, for some it could be a serious retirement planning mistake. Here’s why.
Risk-averse investing has risks of its own. Every investment has advantages and disadvantages. Fixed-rate investments are no exception. While you eliminate market risk with a fixed annuity or CD, in a sense you are trading one kind of risk for another. You now contend with opportunity risk (or opportunity cost) and inflation risk. The fixed return you get might be far less than the return that stock market investing could bring you (in the short term and the long term). That fixed return might also fail to match the rate of inflation, leaving you with less purchasing power.
Volatility is something many of us endure in order to try for the kind of returns that may help us reach our financial goals. In the last year, the stock market has been quite volatile. But through the years, some investors have built considerable wealth through long-term stock market investment.
Do you really want to ignore the potential of the stock market? While short-term market movements may make stocks and funds seem too risky, the big risk could be the possibility of severely underfunding your retirement by clinging to fixed-rate investments. The stock market offers opportunities for considerable financial gain – and the chance of returns exceeding those of most fixed-rate investments. While there is risk involved, there also exists a potential for considerable benefit.
If you say “no” to the market’s potential, you may regret your choice later in your retirement. In fact, you may find that you need long-term stock market investment to work toward certain retirement goals.