When you're picking investments during your working years, having one fail is annoying, but likely not catastrophic -- after all, you have a salary to live on and plenty of time to recover from the loss. But once you retire, you no longer have the safety net of a regular paycheck. During retirement, having an investment fail can threaten your whole livelihood. That's why choosing investments wisely during retirement is so important.
Hands-on versus hands-off
When it comes to stock and bond investments, retirees have two potential investing styles to choose from. In the hands-off approach, you invest everything in mutual funds or exchange-traded funds (ETFs) and leave the details up to the fund manager. In the hands-on approach, you get actively involved in choosing your own investments. For example, you might set up your own bond ladder instead of investing in a bond ETF.
The right approach for you depends on how comfortable you are with investing and how much you enjoy it. For some people, spending hours poring over prospectuses and financial reports is two tons of fun; others would rather have a cavity drilled without Novocain. If you fall into the former group, by all means dedicate at least part of your portfolio to investments of your own choosing. If you're in the latter group, there's no point in torturing yourself when a low-fee fund will do just fine for you.
Hands-off investors: Picking the right fund
If you'd rather keep your investments as simple as possible, pick a balanced income fund that charges a low fee and has the right allocation for you. Some target date funds are designed to keep working throughout your retirement; the fund managers will continue to rebalance stock and bond investments within the fund in order to meet your changing needs as you age. Balanced income funds are usually designed to be all-purpose for retirees of any age. Allocation-wise, you can use the formula of 110 minus your age to figure out how much of your investment should be in stocks, with the remainder in bonds. Then look for a fund that roughly matches this allocation.
Hands-on investors: Choose your own stocks
Even investing-loving retirees would be wise to keep the bulk of their stock money in an index fund. These funds offer excellent diversification at a low cost, making them far less risky than a jumble of individual stocks. Most funds have a risk rating that indicates how volatile or otherwise risky the investment is; stick with the ones that fall on the low end of the spectrum. But if you like to experiment, by all means put 10% to 15% of your money into individual stocks. As a retiree you can't afford to indulge in high-risk stocks, which means most growth stocks are not an option. Instead, focus on high-quality value stocks, particularly the ones that produce large and reliable dividends. Those dividends will do a bang-up job of compensating for the lower capital gains that large, established companies usually produce.
One quick-and-dirty way to assess a company's financial stability is to check its bond rating: If the company is AAA rated, that means experts believe the company is on extremely solid financial footing. And any stock that qualifies as a "blue-chip" is likely a good choice for retirees, because they're about as safe as a stock gets.
Hands-on investors: Build a bond ladder
As you age, more and more of your investment dollars should go into bonds rather than stocks. Laddering your bonds by choosing a wide range of issues that mature at different dates allows you to maximize your interest income, minimize your risk, and keep from tying up all your principal at once. Keep the bulk of your bond investments in Treasury bonds and the highest-quality corporate bonds to keep your risks low, and stay away from callable bonds that could leave a big hole in your ladder.
As a retiree, you'll have two primary costs associated with your investments: fees and taxes. Keep fees low by using a discount broker, minimizing the number of trades you make, and choosing funds and ETFs with the lowest possible expense ratios. Minimize your tax bill by keeping most, if not all, of your investments inside a tax-advantaged retirement account. If you have both a tax-deferred retirement account and a Roth-type account, you can juggle your distributions in such a way as to minimize your taxes on both the distributions themselves and on your Social Security benefits. In fact, you should prioritize tax planning when you choose your investments. After all, what's the point of working for great returns on your investments when the extra money ends up in the tax man's pocket?