Q. I'm nearing retirement. Where should I invest my money so it's safe?
A. The traditional answer has long been to invest retirement money in utilities, preferred stock, REITs, bonds, and other dividend-producing, interest-paying securities. You would take the interest and dividends as income for the year and let the principal ride. The focus was on income, and little attention was usually paid to increasing the value of the underlying investments. It was often assumed that too much risk was involved in seeking appreciation of your investments. And risk, according to many retirement investors, was to be avoided at all costs.
Times have changed, though. Fewer companies pay significant dividends, utilities have been deregulated, the bond markets can be volatile, interest rates have been low for quite a while, and, to top it all off, people are living longer! In this kind of environment, a "low-risk, income-only" investment strategy may not serve retirees too well. The worst-case scenario is that retirees could run out of money earlier than they expected. So, ironically, it can actually be very risky to not take some risk with your retirement savings.
Consider this scenario from Dave Braze, the Fool's retirement expert:
An all-bond portfolio with an average return of 6% might throw off enough income for a retiree today. But, with an annual inflation rate of, say, 3%, every $1,000 produced by that portfolio will be worth only $554 in 20 years. Worse, the principal available then for reinvestment wouldn't have grown through the years. As purchasing power declines, a retiree using such a strategy almost certainly will have to dip into principal to sustain her lifestyle, and the use of that principal will definitely shorten the life of her portfolio.
Conversely, an all-stock portfolio may produce growth from which one may take income. Yet stocks can plunge in value overnight, and they can stay down for five years or longer. To a retiree, that too can be a devastating result.
So, what's the answer? Asset allocation -- the study of how many eggs to put in which baskets. The right mix is different for everyone, but the longer you plan to live after retirement (you can plan such things, right?), the more you will have to get some growth from -- and take more risk with -- your portfolio.
Learn more about retirement issues in our retirement area and in our Rule Your Retirement Online Seminar, too.
If thinking about retirement makes you wish you had a financial pro with whom to discuss your specific personal situation, that's not a bad thought. An advisor can help ensure that you're saving enough and properly enough to meet all your needs. Read more about TMF Money Advisor, a valuable service we're offering, featuring customized independent advice from a variety of objective financial pros.
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This question and answer is adapted from The Motley Fool Money Guide: Answers to Your Questions About Saving, Spending and Investing. For answers to this and 499 other common money questions, check it out -- it's a handy resource.
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