Choppy markets, like the ones we've had in recent weeks, are nerve-racking for everyone who watches the market news closely. But if you're about to retire, the market's turbulence may seem particularly daunting. Making the transition from a steady paycheck to an income stream from investments is a leap of faith for many in the best of times; when the markets are down and the talking heads are sounding worried, it's much harder.
Worse, the turbulence is pounding the fixed-income markets this time as well. The mortgage-market jitters that have clobbered lenders Countrywide Financial (NYSE: CFC ) and Doral Financial (NYSE: DRL ) and homebuilders Toll Brothers (NYSE: TOL ) and Hovnanian Enterprises (NYSE: HOV ) have also hit some bond funds particularly hard. Ultra-short-term bond funds, often thought of as being just a step or two more risky than a CD, have taken a lot of damage (at least by short-bond standards), with many showing a net loss for the year at the moment. Even money market fund performance is lagging, as fund managers flee asset-backed commercial paper for "safer" (and lower-yielding) territory.
It's almost enough to make you want to bag this retirement thing and stay at work, isn't it? OK, maybe not. But can we find a relatively safe passage through these choppy waters?
Let's back up for a minute and review a couple of key points:
- Market volatility happens. As I pointed out recently, it's natural for markets to go up and down. Unfortunately, it's also natural for people to feel the pain of the downs more acutely than they feel the joy of the ups. Don't sweat it too much: The market has always recovered from downward swings, and odds are very good that it'll recover this time too. Try to discipline yourself to take the long view.
- Asset allocation helps shield you from volatility. Robert Brokamp, lead analyst for the Fool's Rule Your Retirement newsletter service, recommends this approach to asset allocation:
- If you need the money in the next year, hold it in cash (or a cash equivalent, like a money market fund).
- If you need the money in the next one to five years, choose safe income-producing investments. (We'll look at what "safe" means in a moment.)
- Any money you don't need for more than six or seven years is a candidate for the stock market.
- Always own at least some stocks, which are the best investments over longer time periods.
Finding that passage
So we know that a retiree's portfolio should have a cash component, a fixed-income component, and stock investments. How much of each will depend on your own situation and risk tolerance, but as a general guideline, you can't go too far wrong by assuming that you'll be spending 4% of your nest egg a year and then using the guidelines described above to divide up your assets accordingly.
For the moment, I'm not going to focus on stocks -- your stock investments should have plenty of time to recover from the current ruckus in the markets. And I'm going to deal with the "cash" component of the portfolio by suggesting that you choose a good money market fund, giving due consideration to a municipal money market fund if you're holding the cash in a taxable account. (It'll have a lower yield, but the tax-advantaged treatment of that yield will make it a better bet for many.)
So what do I mean by a "safe" income-producing investment? In general, I mean Treasuries, CDs, and bonds with maturities of less than five years. Longer-term bonds are best avoided by most investors. But in this market, when much of the bond market has been churning and Treasuries have been bid up (and yields crunched) by investors fleeing more volatile territory, we'll have to think a little more creatively.
Given that interest rates may start to fall, buying longer-term CDs that allow you to lock in higher rates may be a good bet. If you live in a high-tax state, consider municipal bonds, which are generally exempt from state and income taxes and have been largely unaffected by the goings-on in the market to date. And if you're feeling ambitious, consider searching out good corporate bonds that have been beaten up recently -- their higher yields may start to look especially attractive if and when interest rates start falling.
Finally, you should be laddering your fixed-income portfolio -- buying investments with staggered maturity dates in order to provide cash (that can be reinvested in your money market fund) on a scheduled (usually annual) basis.
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