86% of high-risk retirees fail a crucial diversification test, raising concerns among financial experts

As retirement approaches, many investors shift their focus to reducing risk, often by moving away from stocks in favor of safer assets like bonds and cash. However, a new study reveals that this strategy may leave retirees dangerously vulnerable to a different kind of risk: not having enough long-term growth. According to research by Jackson National Life Insurance Company, a staggering 86% of high-risk retirees fail the crucial test of proper diversification.

As experts warn, this kind of over-reliance on bonds and cash can undermine long-term retirement security, making it essential for retirees to balance out growth assets like stocks in their portfolios.

What the diversification test reveals

The Jackson study assessed investors’ exposure to market risk based on five main financial criteria: spending, saving, allocating cash, stock and bond splits, and asset diversification. Those who met fewer than two benchmarks were classified as high indices, or more exposed to market risk.

To test diversification, the study examined whether investors held assets in at least four of five categories: stocks, bond funds, cash, bonds, and other investments, and 86% of high-risk investors failed to meet this basic criterion.

Instead, many allocated too much of their portfolios to cash or bonds, leaving them vulnerable to inflation and outrunning their savings. The study found that 49% of these retirees hold nearly half of their assets in cash, well above the recommended 20% of assets.

Why do retirees struggle with proper diversification?

Experts warn that retirees seeking safety in bonds and cash may be ignoring the biggest risks: inflation and the possibility of outliving their assets. “Most retirees think they are avoiding risk by accumulating bonds and cash,” says Ryan Graves, founder of Bemiston Asset Management. However, since inflation eats away at the value of cash and bonds, “too much cash and bonds will not save you, it will guarantee you will fall behind.”

In fact, Greaves says the most common mistake he sees is equating security with cash. At the same time, he adds, other investors similarly seeking safety may overemphasize dividends on stocks and bonds, becoming too focused on current income rather than growth.

Malissa Marshall, founder of Soaring Wealth, notes another issue with her clients’ investment portfolios: Many of them accumulate a “hodgepodge” of investments over time without understanding the importance of diversification. “They pooled money at the target date and picked individual stocks, inadvertently duplicating holdings,” she says.

When retirees become overly exposed to one asset class, Marshall likes to point to Callan’s league table as evidence that past performance is no guarantee of future success. For example, cash was among the worst-performing asset classes in 2016 and 2017, only to reach the highest investment returns in 2018, according to Callan.

Another problem is that retirees often overly rely on the S&P 500, believing it provides complete diversification. But Bo Kemp, an advisor at financial planning firm Switchpoint, warns that the S&P 500 is “skewed too heavily toward large U.S. companies,” which could underperform in certain markets. Kemp points out that during the 2000s, for example, small companies and emerging markets outperformed while large companies struggled. “We don’t have to look far back to see how painful it can be when US big stocks underperform for a prolonged period,” he says.

How financial experts recommend solving the problem

Financial advisors stress the importance of a balanced approach. Instead of simply relying on cash and bonds or relying heavily on stocks, experts recommend diversifying across different asset classes. Kemp points out that experts often advise holding retirement expenses for three years in low-volatility assets such as money markets, short-term bonds, or individual bonds, but he suggests paying closer to five years or more if you can.

Kemp also stresses the importance of diversification within your equity portfolio – not just US large-cap companies, but also small- and mid-caps, international developed markets, and emerging markets. “This type of diversification helps manage the sequence of risk-returns in retirement because it ensures that some parts of the portfolio work when other parts do not,” he says.

Moreover, dynamic strategies are key to managing market risk. “You need dynamic withdrawal strategies — the flexibility to spend less money in recession years and spend more in strong markets,” Graves says, adding that dynamism also means adjusting your investments when the numbers don’t add up. For example, in early 2021, 10-year Treasury bonds were paying less than inflation, meaning investors who stuck with a fixed mix of bonds risked guaranteed losses — while shifting more into stocks might make more sense.

Bottom line

For many retirees, the temptation to play it safe can actually be a risky move. In fact, retirees who focus too much on cash or bonds may be unwittingly exposing themselves to greater long-term risk — and according to Jackson’s research, many high-risk investors fall into this trap.

But true diversification means more than just investing across asset classes — it also requires building a strategy that takes into account inflation, longevity, and market volatility. When in doubt, consulting financial professionals can help ensure your portfolio aligns with your long-term financial goals.