Why All-Cash Retirement Portfolios Can Be Risky, Too

My husband is 41 and currently has his money invested in a low-return money market account. Given our age, I think we should put our money into more aggressive funds. But my husband is very leery of any kind of gamble, which is how he views the stock market. What do you suggest? -- S.M., Juneau, Alaska

It makes perfect sense for your husband to keep a reserve for emergencies and such in an FDIC-insured money market account. But if he's investing all of your money that way, including dough that you'll be counting on for long-term goals like retirement, then he's probably being way too cautious.

But you need to be careful about how you deal with this issue. His fear about losing money in the market is understandable given some of the tumbles stocks have taken over the past dozen years.

So you want to acknowledge his legitimate concern, but at the same show that he may be taking an even bigger gamble by investing too conservatively.

Related: Retirement Investing in Uncertain Times

Here's an example that may help bring him around. Let's say a 41-year-old who earns $60,000 a year already has $100,000 saved for retirement in a 401(k) or similar savings vehicle and with his own contributions, plus the employer match, adds 15% of salary to that account each year. Let's further assume that this person would like to retire at 67 -- the age a 41-year-old today will be eligible to collect his full Social Security benefit -- and live on 75% of his pre-retirement salary.

So the question is, how does that 41-year-old's investing strategy affect his odds of pulling this off?

To find out, I ran several scenarios through an online retirement income calculator that, among other things, allows you to plug in different allocations of stocks, bonds and cash to see how your chances of achieving a secure retirement go up or down.

I started by assuming the $100,000, plus all future contributions would be invested the way your husband prefers: 100% in cash. The probability that investing this way would provide a combination of draws from savings plus Social Security equal to 75% of his pre-retirement salary between the ages of 67 and 95 was just 2%.

That's right. A 2% chance. Not exactly comforting.

I then stepped things up a bit but only slightly, assuming a portfolio invested 100% in bonds. The outlook was better, 31%, but I doubt that most people would say a one-in-three chance inspires confidence.

Next, I began throwing some stocks into the mix. By investing just 10% into a diversified portfolio of stocks and leaving the rest in bonds, the probability of success jumped to 47%.

With 30% in stocks, the prospects improved even more to 69%, and a 50-50 portfolio, yielded a bit more than a three-in-four chance, or 76%.

Interestingly, the likelihood of success inched up only a smidgen, to 78%, when I tried a portfolio of 70% stocks and 30% bonds.

Related: Retirement Savings: Quick Guide to How Much You’ll Need

And going to an 80% stocks-20% bonds portfolio didn't increase the chances. They remained at 78% (although with both the 70-30 and 80-20 portfolios, I assumed the allocation changed to 50-50 at retirement, as I doubt many retirees would want to remain so heavily invested in stocks once they've retired).

The fact that the chances of success plateaued at 78% in this example doesn't mean that adding more stocks can't improve your odds of retirement success.

It's likely that going to 70% or 80% stocks would result in a larger nest egg that could support even larger withdrawals so that you might be able to live on more than 75% of your pre-retirement salary. But going to ever-higher stock allocations also has a price. Your portfolio will get whacked harder during market downturns, and a setback on the eve of retirement could prove especially problematic.

It's important to remember that all these percentages are estimates, not guarantees.

But based on the returns of stocks, bonds and cash equivalents over very long periods, it's extremely unlikely that an all-cash portfolio would outperform a diversified group of stocks and bonds over a span of two decades or more. That's no accident. That's the way the markets work given the risk and reward potential of different investments.

So what should your husband make of this little example?

The main lesson is that by keeping all his money in cash he is gambling with his retirement -- that is, jeopardizing his chances of building a nest egg large enough to maintain the standard of living he enjoyed during his career throughout retirement.

But another important takeaway is that he doesn't have to go banzai with stocks to do a lot better. Even a little exposure to stocks can have a big impact on returns over many years.

Related: Your Pension: Lump Sum or Lifetime Payments?

So while your husband's anxiety about stocks' volatility might prevent him from putting 70% to 80% of his portfolio in equities -- which is the percentage that many advisers would recommend for someone his age -- maybe he'd be willing to try between 30% and 50% for the payoff of greater retirement security down the road.

Of course, if he's intent on sticking with cash, there is another way he can boost his chances of success. He can save more. But he'd better be prepared to really sock it away.

In the example above, our 41-year-old would need to save 30% a year in an all-cash portfolio in order to have the same shot at retiring at 67 on 75% of his salary as he would saving 15% annually and splitting his money evenly between stocks and bonds.
Even if you could manage such a prodigious feat, diverting such a large chunk of income into savings year after year would seriously impinge on your ability to enjoy life.

So I suggest you go over this column with your husband and see if you can arrive at a compromise that allows you both to feel better while also improving your financial prospects. Otherwise, your hubby better start doing some heavy-duty saving.