As retirement nears, it’s important to reassess your investment strategy and make sure you’re setting yourself up with enough income to cover your needs and meet your personal goals. And if you largely built your retirement savings by investing in the S&P 500 index, you may be inclined to stick to that strategy in retirement.
It’s a strategy investing giant Warren Buffett is a fan of. In a 2013 Berkshire Hathaway shareholder letter, Buffett said that in his will, his advice to the trustee could not be simpler: “Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.”
But does Buffett’s advice hold up today? Is going all-in on the S&P 500 a safe bet for retirement?
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It’s an incomplete income strategy for retirees
There’s a reason financial experts often advise savers to lean on S&P 500 ETFs or index funds. They offer diversification, low costs, simplicity, and a strong record of returns over time.
As a refresher, the S&P 500 tracks the roughly 500 largest publicly traded U.S. companies by market capitalization. When you “buy the index,” you get exposure to hundreds of established businesses with strong financials.
But while you may want to make an S&P 500 ETF part of your retirement income strategy,
Joseph Patrick Roop, President of Belmont Capital Advisors, says it’s important to proceed with caution.
“The S&P 500 alone is not a complete retirement strategy,” he insists. “The S&P 500’s dividend yield is historically quite low, typically in the 1-2% range. For someone living off their portfolio in retirement, that’s not nearly enough income to cover real expenses without regularly selling shares, which becomes a problem if those sales coincide with a downturn.”
Of course, many financial planners today like to focus on total returns and not just yields. Retirees can, for example, harvest capital gains from their portfolios by selling shares systematically, which helps make up for the lower yield an S&P 500 ETF might produce. That total return approach, however, becomes dangerous and less viable during a market crash.
While an S&P 500 ETF may be a great tool for long-term growth, in retirement, Roop explains, it’s important to focus on income. Dividend-focused ETFs, REITs, and bond ETFs may all do a better job of providing stable income when it’s needed most.
As a single holding, it’s inherently risky
Yields aside, another issue with going all-in on an S&P 500 ETF for retirement is volatility.
“From its March 2000 peak, the S&P 500 fell nearly 50% through the dot-com crash and didn’t fully recover until 2007,” Roop says. “Then, almost immediately, the global financial crisis hit, and the index fell more than 55% from its October 2007 peak to its March 2009 low. Put those two events together, and you get what’s often called the lost decade.”
As Roop explains, an investor who put money into the S&P 500 at the start of the 2000s may have essentially had nothing to show for it 10 years later, even though the index has historically trended upward over many decades.
“Let that sit with you for a minute,” he says. “You retired in 2000, and by 2009 you would have seen your retirement life savings lose around 50% two times.”
Of course, even during that lost decade, for some retirees, reinvested dividends may have kept total returns ahead of raw price returns. But given that stock valuations today are high, retirees who invest heavily in the S&P 500 could see their portfolios significantly underperform in the coming years.
Investing too heavily in the S&P 500 also exposes retirees to what’s known as sequence-of-returns risk.
“It’s the piece that gets lost when people say just buy the index and call it a day,” Roop says. “A retiree who’s forced to sell shares for income during a 50% drawdown locks in losses they may never fully recover from, even if the index itself eventually bounces back. The math of ‘the market always recovers’ works fine for someone still working and contributing. It works very differently for someone withdrawing.”
Evan Mills, MBA, Associate Financial Adviser at Scholar Advising, says that while it’s certainly okay to hold an S&P 500 ETF in retirement, you need assets that aren’t subject to the same level of volatility.
“If you have a truly well-diversified portfolio, you can pull from bonds, you can pull from the cash you have separated from your invested assets for one to two years, and you don’t have to sell into a down market,” he says.
It’s not as diverse an index as you might think
The S&P 500 is often touted for its diversity. But Roop cautions it isn’t nearly as diversified right now as most savers assume.
“Because it’s weighted by market capitalization, the largest companies dominate the index regardless of sector,” Roop explains. “Today, the 10 largest companies, names like Nvidia, Apple, Microsoft, Amazon, and Alphabet, make up somewhere in the range of 35 to 40% of the entire index’s weight. Technology alone accounts for roughly a third of the index by sector.”
This means that if the tech sector stumbles and the bulk of your retirement portfolio is in an S&P 500 index fund, you could be looking at serious near-term losses.
Roop says that by comparison, in 1990, the 10 largest S&P 500 companies made up only about 19% of the index’s weight and were spread across unrelated industries like oil, industrials, and consumer goods.
“That’s not a minor shift,” Roop cautions. “An investor who thinks they own 500 different companies is, in practice, making a heavily concentrated bet on a handful of mega-cap tech names.”
Mills says that even though S&P 500 ETFs do lend to diversification, that’s not enough.
“When you start looking at a well-diversified portfolio, it’s not just equity diversification or company count diversification,” he says. “You’re looking at sector diversification, bond allocation, international exposure, small cap exposure. That’s what people actually mean by diversification.”
It’s a piece of the puzzle, not the finished product
All told, there’s nothing wrong with investing in the S&P 500 in retirement. But going all-in on an S&P 500 ETF isn’t a wise move.
“The S&P 500 can be a reasonable building block, but treating it as a complete, stand-alone retirement strategy ignores the income problem, the very real risk that a bad few years at the wrong time can derail decades of saving, and the fact that the diversification it’s sold on isn’t nearly as broad as it used to be,” Roop says.
Mills suggests using an S&P 500 ETF to fuel the growth portion of your portfolio but branching out to other assets that can provide more stability.
“It’s really more meant to be the backbone of a portfolio than the whole body,” he insists.