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Is the Upside Potential of Growth Stocks Worth the Risk in Retirement?

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February 17, 2016
Understand the retirement risks even with the benefits of growth stocks.

Cherish the idea of a little extra cash in your golden years that you’d like to put to work? Maybe you’re nagged by a traditional—if a little dusty—school of thought that says because you’re retired you should be conservative and stick to bonds or trusty dividend-paying stocks?

Regardless of your age or stage in life, you should have a diversified portfolio. According to Modern Portfolio Theory, a portfolio that is diversified across various asset classes can enable you to potentially generate higher returns for less risk than a non-diversified portfolio. Exposure to growth stocks is one piece of a diversified portfolio. So, yes, retirees might consider some exposure to growth stocks.

Inflation Beater and More?

Growth stocks can help drive a portfolio's growth. This matters to retirees who will need their nest egg to outrun inflation’s bite over time. Additionally, potentially plumping up a portfolio can limit the impact of spending drawdowns on your total holdings. That means you may be able to leave a larger legacy to the next generation, if that’s your goal.

“Growth stocks themselves can be more volatile than other investments,” stresses Matt Sadowsky, director of retirement and annuities at TD Ameritrade. “If you’re taking withdrawals from your nest egg over time, the volatility can cause your investments in growth stocks to take a nose dive in bear markets. That's a bad time to be withdrawing those funds—when you're selling low. So ideally, you want exposure to other asset classes that you expect could perform well (or at least better) when growth stocks are underperforming. And those other assets classes are where you might want to take your withdrawals from when your growth stock investments are down.

Chuck Carnevale, a 45-year securities industry (and Vietnam War) veteran, says go for it. But do it, he cautions, with caveats.

“I do not believe there is a perfectly correct answer to whether growth stocks are appropriate in retirement portfolios or not,” Carnevale says. It depends on a bevy of factors tied explicitly to investors' unique situations. “More specifically, these include their financial resources, investing goals and objectives, and perhaps, most importantly, their tolerance for risk,” he says.

One Approach: Five Years

A fairly new approach is to reduce exposure to equities in the five or so years before and after your retirement start date, and then actually increase exposure to equities slowly over time, Sadowsky details.

“The idea is that the impact of withdrawing in a down market compounds over time,” he says. “So if you can avoid withdrawals during down markets by limiting your equity exposure in the early years of retirement and just prior, then you might consider taking on more risk as you get older.”

For Carnevale, the most “appropriate” time to explore buttressing a portfolio with growth stocks may be when you’re feeling financially comfortable in your retirement. Let’s define that as having a portfolio and Social Security income that generates enough to cover the bills and then some, plus an emergency fund for backup, and even a rainy-day fund for, yes, fun. Carnevale, like a growing number of investment experts, thinks that retiree investing in growth stocks can go a long way toward pursuing what were once untouchable luxuries or vacations.

Another important question is how to get exposure to growth stocks. Some retirees get that exposure by investing in a mutual fund or an exchange-traded fund (ETF) that focuses on growth stocks, rather than picking individual growth stocks. Picking individual companies to invest in can be time-consuming and may require a lot of capital to be deployed in order to own enough different securities for adequate diversification within a sector. Keep in mind that an investor who only invests in one or two growth stocks is exposed to company-specific risks.

Is Time Is on Your Side?

The bane and the beauty of investing in growth stocks in retirement is time. “Thanks to the power of compounding, investing in growth stocks can, in effect, compress time,” Carnevale says, as long as investors are willing to accept the added risk.

Investment experts know all too well that you have to keep a watchful eye on growth stocks. Why? They can be volatile; their growth categorization tends to make them news-sensitive and news-making “story stocks,” inviting extra volatility at times.

For the sake of example, let’s pit a growth stock against a dividend stock. Start with a $10,000 investment in growth stock Tesla (TSLA) from July 2010 to July 2013—a bull market that included some notable dips. That 10K ballooned 645% to $74,543,000.

A $10,000 investment during the same period in AT&T (T), a dividend stock, garnered a respectable 25% gain to $12,515. Include the average dividend yield of 4% over that period and it bounces up to a 33% total return.

Keep in mind that TSLA is an extreme example, but a good one to highlight why growth stocks can be so enticing and worth careful consideration. Are dividends guaranteed? No guarantees there, either.

That also touches on time again.

A final consideration: In a bull market, growth stocks can be golden—but in a bear market, they tend to get crushed. That partly explains Carnevale’s assessment that “the risk differential between true growth stocks and blue-chip, dividend-paying stocks is equally significant and profound.”

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