RETIREE INVESTING
 
 

INVESTING WHEN YOU’RE RETIRED

Case Study:

Fine Tuning a Retirement Portfolio
 
 

Background.   Phoebe and Fred Fortuna are just about to retire and they're hearing a lot of conflicting information about how they should invest their retirement money. "We're in a real quandary," notes Phoebe. "We'll be retiring in about six months. Of course, we're concerned about what changes we should make to our investments. But the advice we are hearing or reading about is all over the place."
 
 

Fred adds, "Let me give you an idea of how divergent the opinions are. At one extreme is my 88 year old father who says that it's crucial to keep retirement money safe. To this day, his idea of a good retirement investment is a CD or Treasury bill. At the other extreme is an article I read recently which suggested that new retirees should actually become more aggressive in the way they invest, because of the need for investments to grow during retirement to keep up with rising living costs. I think we've been pretty aggressive over the years already, and the notion of taking even more risk is not very comforting at this point.

"In between these two extremes, Phoebe and I have had friends who tell us that bonds are the place to be because retirees need income and can't afford the risk of a bear stock market. Another acquaintance said that if we're happy with the way we are investing now, there is really no reason to change the way we invest just because we're retired. You know, the problem Phoebe and I are having is that all of these suggestions, even the extreme ones, have an element of good sense in them. This makes it even tougher to decide what we should do. I guess our biggest concern is that we don't want to make a major mistake. After all, we are no longer in our 20s and 30s where we would have plenty of time to make up for a bad investment or bad investment strategy. We don't have enough money to be able to afford that luxury at this point."
 

Investment Objectives
 

The Fortuna’s investment objectives are similar to those of all imminent retirees--and all retirees for that matter. They want to accomplish two things with their investments from here on out:
 

1.   To provide sufficient income from their investments which, when combined with Social Security retirement benefits, pension plans, and other sources of retirement income is sufficient to meet immediate needs.
 

2.   To provide enough income throughout retirement to avoid the possibility of having to reduce living expenses in old age or, worse, exhausting resources.

The reason why the Fortunas are so perplexed by the conflicting opinions about investing retirement resources is that the objectives themselves conflict. Retirees need both income and growth to meet their near- and long-term financial objectives. To further complicate matters, growth, which is essential to meet rising future income needs, should be achieved without unduly risking capital. This is a delicate balancing act. And although much of the advice that the Fortunas have been receiving makes sense, each recommendation tends to emphasize one objective at the expense of the other. For example, putting the money into CDs will preserve current capital and provide income, but will erode future purchasing power. Since the principal value of CDs does not increase, it loses ground to inflation. Investing very aggressively will provide the opportunity for capital growth to meet rising income needs, but may subject a retirement portfolio to an untimely decline in capital if stock or bond prices plummet.
 

Analysis
 
 

Many working age people harbor the notion that once they retire, they need to make major changes in the way they invest. This is usually not the case, particularly if you have invested wisely and well during your working years. Certainly, the investment time horizon for a new retiree has not suddenly diminished, as some would suggest. Your life expectancy on your first day of retirement is only one day less than it was on your last day of work. Retirees are still long-term investors. True, the investment portfolio will need to be accessed to help meet living expenses. But, unfortunately, many retirees tend to let the real need for income and the perceived need for safety dictate wholesale--and usually imprudent--changes in investment selection and strategy.
 

This is not to say that retirees should make no changes in the way they invest. But, generally, any changes made should be to fine tune their investment portfolios. It all depends, of course, on how retirees invest prior to retirement. In the Fortuna’s case, since they've invested well during their working years, the need for change is truly one of fine tuning--to reduce risk somewhat and to increase current income.
 

Allocation of investment portfolio
 

As the following table indicates, the Fortunas have an allocation of 60 percent stocks and 40 percent bonds. (While they also maintain some cash reserves, these have been omitted from this analysis.) This is an overall allocation that the Fortunas are comfortable with and is reasonable for a couple in their early 60s. Therefore, no change in their overall investment allocation should be necessary at this point.
 

Fine tuning the portfolio
 

While the Fortunas overall investment allocation is satisfactory, as the following table reveals, the categories in which their stocks and stock funds are invested are perhaps too aggressive as they approach retirement. With respect to bonds (all of their bond money is in bond funds), the emphasis has been on municipals because of the Fortuna’s high tax bracket.

As the table illustrates, the Fortunas should reallocate their stocks and stock funds to reduce risk somewhat and provide for additional current income, which they will need to help meet living expenses. Exposure to the higher risk categories--growth and small company stocks and stock funds will be reduced. These resources will be redeployed to lower risk stock categories that still offer growth potential including growth and income stock funds and international stock funds. Moreover, the greater emphasis on the income stock category will provide the Fortunas with higher dividend income to help meet living expense.

With respect to their bond funds, the Fortuna’s emphasis on municipal funds has been appropriate in the past because of their high tax bracket. But since their income tax bracket will drop at retirement (this is not the case with many retirees, however), a slight reduction in municipal bond fund investments in favor of government bond funds seems appropriate. Since they will soon be in a lower tax bracket, the government bond funds will provide a somewhat higher after-tax income than the municipal funds. Another advantage of increasing the emphasis on government bonds is that this will reduce somewhat the overall risk in their bond portfolio, which, up to this point had been largely invested in single-state municipal bond funds.
 

Not unlike many individuals and couples approaching retirement, the Fortunas have been perplexed by conflicting guidance on how to invest their money once retirement commences. But the prudent course of action for them--as is often the case with preretirees and recent retirees--is not one of making substantial changes in the way they invest. Instead, fine tuning their investments to reduce risk and increase income, while still providing for needed growth of capital, will help them achieve a financially comfortable retirement, both now and for the rest of their lives.
 

               FINE TUNING A RETIREMENT PORTFOLIO
 
 

	CURRENT	FINE TUNED
STOCKS AND STOCK FUNDS
Growth	30 %	20 %
Income	15	25
Small Company	10	5
International	5	10
Subtotal stock funds	60 %	60%
BOND FUNDS
Corporate	10	10
Government	5	15
Minicipal	25	15
Subtotal bond funds	40 %	40 %
TOTAL	100 %	100 %

 
 
 

Avoiding Investment Scams

While everyone who has any money at all is a luscious target for a scam artist, some people are more attractive than others. The older you are, the greater the likelihood that someone out there is going to test your financial mettle. Retirees, especially widows, are a preferred target.
 
 

Victims of investment scams almost always suffer from the dual afflictions of greed and ignorance. It was the Greek philosopher, Socrates, who affirmed that a knowledgeable person is distinguished by knowing what he or she doesn’t know. In financial matters, this should be your philosophical maxim: Know what you don’t know. Greed may be the more difficult impediment to overcome, because there is an element of greed in investing. After all, a higher return is better than a lower return. But when someone offers you an investment that promises stellar returns, remember that high return means high risk. In the hands of the scam artist — or even the unscrupulous broker — a promise of high returns is simply an attempt to appeal to your greed.
 
 

The fraud operators and investment opportunists are very good at their craft, but believe me, bunk is bunk, no matter how pretty the wrapping or flowery the words. In fact, the prettier the wrapping and the more flowery the words, the greater the likelihood that you’re being duped. So if it sounds too good to be true, it probably is. If it sounds too simple to be believed, it is probably very complex. It you think you are being misled, you probably are. And if you find you are being pressured, you most likely are being pressured. Words alone won’t suffice. The scam artist knows how to tell a tall tale and make it sound persuasive.
 
 

How do you avoid being taken? Here are a couple of guidelines:
 

Never buy on impulse, especially from a complete stranger.
 

The likelihood of disaster, no matter how safe it seems, is guaranteed to be titanic. Be especially careful of boiler room operators who will try to sell you virtually any investment. Often it is an investment that plays on people’s fears and greed. It is simply unbelievable how many people get taken over the telephone. If you are ever tempted to send in your money over the telephone, do the following. First, request information in writing. Of course, they’ll tell you that you must act now, but be firm. Chances are the information will never arrive, but if it does, you can examine it without a sales pitch.
 

Always get a second opinion from a relative or friend.
 

You get a second opinion before having surgery — you should also get a second opinion before somebody removes a good portion of your investment account. Here’s a rule that I urge senior citizens to follow: Always double-check any commitment of money for any reason. Ask a trusted friend, accountant, or lawyer — even your children or other relatives — before you plunk down a large chunk of cash. (I consider a large chunk to be anything over $500.)