The heart of conservative investing lies in the low tolerance for risk. Conservative investors generally express that thinking through action when they weight their portfolios heavily in bonds and large cap domestic stocks.

A weighting like this will lower the apparent volatility of the portfolio. In fact, the volatility can get lower and lower as the proportion of bonds increases. This is the basis of the old saw about allocating your age in percentages to bonds during retirement. The common adage goes that since you can handle less risk as you get older, you should have less money invested in stocks.

Bonds are not "Safe Investments" for Retirement

In truth, allocating more money towards bonds is kind of like cheating. You don’t reduce the stock volatility so much as hide it. With 50% of your wealth invested in stocks, you should enjoy a total portfolio volatility of around 9% per year, versus the SP’s 18%. With an allocation like that, volatility has not truly been reduced however. The stock volatility has been hidden by putting bond allocations on the same statement. It makes for a rosy picture, but it’s not a prudent way to lower volatility and certainly it fails as a prudent method to preserve wealth over several decades.

Focus on Spending Power more than Account Balance

A truly conservative strategy would focus on conserving spending power rather than capital. The most important thing about your nest egg is that it provides you with the power to maintain your lifestyle over the course of your retirement. Most plans need to provide for the lifetimes of two retirees, with one surviving a bit longer than the other. In that sort of planning, the conservative investor’s worst fear should be inflation and taxes, even though volatility gets all the headline coverage.

Inflation is the Pensioner's Enemy

Average rates of inflation just about halve the value of a dollar over the course of 15 years. Volatility may do that to a portfolio once or twice in a decade, but at least it has an upside. Over the last thirty years (the length of time you probably will want your retirement to last) the market has had various ups and downs, most of which you can remember. Even so, its value doubled almost four times in spite of the bear markets that have interrupted its progress. Inflation has unrelentingly worn away the value of the dollar since 1978. The inflation threat is far more serious and constant than market volatility.

Prudent Investment Planning Fights Inflation Risk

In order to truly safeguard your wealth, you need to switch to a prudent paradigm when considering what to do with a nest egg that needs to produce income for several decades.

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