Approaching Retirement

Financing retirement is perhaps the biggest challenge facing investors. With so many options available today, finding a suitable choice for your assets can be daunting. In this column, our hypothetical client is an investor on the cusp of retirement, has a long time horizon, seeks to grow his portfolio, and requires moderate cash flows.

Client: I am 64 years old and planning on retiring in the next six to twelve months. How should I reposition my investments?

Advisor: Retirement is an issue impacting virtually every investor, and the range of emotions can go from excitement to unease to downright panic. When retirement hits, many investors feel as if everything has changed in their personal lives, so it's only natural to believe everything must change in their financial lives as well. While the transition to retirement can certainly be a period of change requiring careful financial planning, it doesn't necessarily mean dramatic changes to a previously sound portfolio strategy.

Client: My portfolio has been heavily weighted towards equities since I was in my thirties. Should I be getting more conservative now that I will not be generating income from employment?

Advisor: When retirement hits, it's important for investors to sit down with their money manager and have a frank discussion about what this means for their finances. Any portfolio strategy evaluation should take into account the investor's objectives for the assets being managed. So when you retire you should ask yourself: "Have my goals changed? Am I still targeting the same type of return? Will I be taking income from this portfolio? Has my time horizon significantly changed?" The answers to these types of questions should determine the course your portfolio takes.

Regardless of whether goals have actually changed, when some investors retire, they drastically reduce their exposure to equities through the purchase of fixed income, CDs, annuities, or other "safer" income-producing securities. While this may seem like the prudent course of action, investors often underestimate their actual time horizon (length of time the assets will be needed) and income needs, running the risk of being too conservative and ultimately outliving their assets. A portfolio designed to last only ten years when it could be needed for thirty will put the retiree in a treacherous position later in life.

Client: That is interesting, but aren't equities a riskier bet for retirees?

Advisor: When time is on your side, as it is for many retirees, equities can be less risky than fixed income. Over longer time horizons (ten years or more), equities historically provide the greatest return, outperforming bonds in 98% of the 20-year rolling periods since 1926. Even at only ten years, equities beat bonds nearly 90% of the time.*

Client: Having a portfolio heavy in stocks just seems different from what the rest of my retired peers are doing. Should I be concerned about that?

Advisor: The next time a friend tells you that you are crazy for keeping most of your retirement assets in stocks, tell them to pull out a CD of that old Rolling Stones song, "Time is On My Side." Review your retirement expectations carefully and select an accomplished money manager to help guide you down the road of retirement. At the end of the day, you should spend less time worrying about whether your assets are going to make it, and more time just being retired. That's the point, right? After a lifetime spent working, you have earned it.

Client: OK, I see what you're saying, but the whole idea of that much of my money in stocks still makes me nervous. What if I just don't want to do it? What happens if my income needs increase?

Advisor: Of course, a portfolio almost entirely invested in equities is not going to be right for everyone. Depending on your investment objectives, it may be appropriate to invest a portion of your account in fixed income securities. In fact, there are several situations where a fixed income allocation makes perfect sense:

• Perhaps the time horizon of the assets is short, and cumulative income needs are modest;
• The investor does not desire portfolio growth;
• The investor can't handle short-term volatility, and therefore needs to reign in growth or spending objectives to match the expected return of a balanced account.

For the vast majority of retirees (particularly high net worth investors), time is on their side…especially if they are not planning to use all of their assets. Plus, age should not be the only determinant of time horizon. Earmarking all or part of your accounts for charity, kids, or your spouse might mean a longer time horizon than a simple life expectancy calculation will provide. It's important to keep in mind that life expectancy calculations use the mean, or average, expected age of a population. This means about half will actually live longer. In these instances, the case for stocks becomes even stronger.

-------------------------------------------------------------------------
* Source: Stocks as measured by the S&P 500 total return index. Bonds as measured by the Ibbotson US Long-term Government Bond Index, Ibbotson Associates.

Each week The Advisor's Corner tackles a common situation or issue facing financial advisors and their clients.