5-Year Treasury Note Yield data by YCharts .
The consequence of these rates was that retired investors could afford to take part of the income they received from their investments and use it for spending money while still having an unspent portion of their interest available to reinvest. That way, their nest egg would rise in value steadily, helping retirees keep up with rising costs as they aged.
Since then, though, low-risk investments have been a lot less generous with their interest. With current rates between 1%-2%, bank CDs and Treasuries don't pay enough interest to fund even half of a typical retiree's annual withdrawals from their retirement accounts, let alone keep up with the impact of inflation and taxes on their spending power.
In response, many investors have turned to higher-risk fixed-income investments, including longer-maturity bonds and lower-quality corporate junk bonds. Long maturities typically have slightly higher yields, but they're more vulnerable to interest rate increases, as you've effectively locked in a subpar rate for a longer period of time. As for junk bonds, they do pay higher yields, and as long as times are good, they can provide at least some protection from inflation while also helping retirees meet their cash needs. But high-yield bonds also carry greater risk that the issuing company will default on its debt obligations, leaving retired investors out in the cold.
The long-term way to reduce your retirement risk
The seemingly contradictory solution to retirees' risk problem is simple: To cut the risk of running out of money, you have to embrace the risk of the stock market to a larger extent than many people feel comfortable doing. By doing so, you add the potential for growth in your portfolio to the income it can generate.
Source: Ian MacKenzie via Flickr .
The thing about a bond is that it won't provide growth. If you buy a typical bond for $1,000, it'll pay you back the same $1,000 when it matures, having made interest payments along the way.
But many stocks pay current income and have the potential to see their share prices grow over time. Many dividend stocks have yields that are well above the 1%-2% that five-year Treasury bonds have paid recently, and they've also enjoyed share-price advances during the bull market that have added greatly to their total returns. Retirees who have invested in dividend stocks have been rewarded for taking the risk, as the value of their portfolios has increased along with their income stream.
Obviously, putting more of your money into the stock market carries risks of its own. After a five-year bull market, many believe stock prices are too high, and corrections and bear markets are inevitable in the long run. Yet even many retirees have time horizons measured in decades when it comes to how long they need their money to last, and over those periods of time, stocks have historically far outpaced the returns you can get elsewhere -- even in relatively weak periods for the market.
Running out of money is a huge risk in retirement, and being too conservative with your investments can, paradoxically, increase that risk. By taking on the right amount of stock market risk in your investments, you can greatly reduce your risk of running out of money and instead live out the retirement you've always wanted.
Get the right dividend stocks for any retiree
The smartest retirement investors know that dividend stocks simply crush their non-dividend-paying counterparts over the long term. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. That's why our top analysts put together a report on a group of high-yielding stocks for any income investor's portfolio. To see our free report on these stocks, just click here .
The article This Could Be the Biggest Risk to Your Retirement originally appeared on Fool.com.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
