Especially for Retirees

It's natural to think that you'll need to make a lot of changes in your investments once you retire. After all, you're leaving your "accumulation" phase and are entering your "withdrawal" phase. Not so fast. You'll find from your retirement income and expense projections that you're probably going to continue adding to your retirement investments until you're 80 or so, in order to keep up with rising living costs in later life. Life expectancies are so long these days that it's no longer sufficient to just keep your principal intact. You need to add back some of your investment gains so that you can withdraw ever greater amounts in the future as your cost of living rises. Therefore, one of the most important decisions made at retirement is the percentage of your retirement money that you can prudently withdraw in your first year of retirement.

The days of "living off interest and dividends" are past. Way back, it used to be possible to live quite well in retirement solely from dividends and interest. Back then interest rates were higher in relation to inflation as were dividend payouts. Moreover, inflation was benign and retirees weren't living as long as they are now. Short of having an enormous retirement nest egg, you simply can't earn enough interest and dividends to pay your bills. Attempting to do so may lead a retiree to prefer risky high yield bonds and stocks that offer big dividends but limited appreciation potential like real estate investment trusts, utilities, and preferred stocks. Such a strategy could work for a few years but risks leaving you short later on.

Common retiree investing mistakes. Retirees have less time to make up for investment bloopers, so it's doubly important to avoid mistakes. Here's a list of four common investment snafus that plague retired investors:

  • Investing too conservatively. It's the fear of losing money that impels many retirees to invest too conservatively, emphasizing low-yield short-term securities like CDs and money market funds. But investing this way has its own risks. Low yields will just as surely erode long-term cash flow as the failure of a zirconium limited partnership. Investing too conservatively always risks the loss of purchasing power, because the return on these "safe" investments can rarely if ever keep abreast of inflation.
  • Chasing high interest investments. This is very common, especially when interest rates are declining or are quite low. Rita Retiree was doing very well with her 7% CDs, but when they come up for renewal, and the bank is only offering 3% because of a decline in overall interest rates, she starts looking for something that pays 7%, not realizing this investment maxim: The higher the interest, the higher the risk. Faced with declining investment income, many retired investors unknowingly take on increased risk in order to gain more income. Since we are in a period of relatively low interest rates, and they are likely to remain relatively low, retirees need to understand that it's no longer feasible (unless you have an awful lot of money) to simply live off interest and dividends. Invading principal is anathema to many retirees. But if a retiree's nest egg is well diversified among stocks, bonds, and temporary investments, invading principal is not a concern so long as the overall value of the nest egg continues to grow in the early years of retirement. Of course, unfriendly investment markets may cause the nest egg to decline periodically. But so long as the longer-term trend is upward, no problem.
  • Succumbing to spurious investment ideas. At the other end of the spectrum from the overly conservative retiree is the retiree who pays too much heed to the latest investment fad. Many retired people want to devote more attention to their investments because they now have the time to do so. I heartily encourage you to do the same. But that same enthusiasm for investing can lead some astray. The airwaves are infested with people touting their latest investment products or ideas. They're awfully slick to boot. Retirees should be particularly wary of any investment product that they don't fully understand. My longstanding guideline is: If it can't be satisfactorily explained to you in one sentence, don't buy it. Even if someone from a respected company recommends an investment on a respectable TV or radio station, proceed with caution. These touts often have a hidden agenda that is not in your best interests.
  • Holding onto investments for sentimental reasons. Some retirees refuse to sell consistently awful investments out of feelings of loyalty or emotional inheritance. Often it's something that was inherited, or it might be a sizable holding in a former employer's stock. But there is only one reason to own an investment: It is an attractive long-term investment. Two salient points come to mind. First, the retiree should consider the financial impact of holding investments with no discernable potential. Second, if a retiree is holding onto a large block of stock for sentimental reasons, couldn't he or she be just as sentimental holding only one share?

So how should retirees invest? There's usually not much to change in the way you invest when you retire. That may seem a bit odd, and it is often violated by persons nearing retirement age. Retirees often think they need to reduce the riskiness of their investments. After all, they're no longer adding to their investments to make up for losses. Also, retirees think, quite appropriately, that they're going to need income from their investments to help meet living expenses. But investing during retirement requires balancing the dual goals of income and investment growth. After all, a typical retiree will need income to last for 30 years or more. So the most important consideration is how long you're going to need your money to last. That's called your investment horizon. Think about it. Your investment horizon your first day of retirement is only one day less than it was the last day you worked. So in most instances, if you were already well diversified before retirement, major shifts in your investments should not be necessary.