Nearing retirement? Wondering where to invest your money so that it's fairly safe? The traditional answer has long been to invest retirement proceeds 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 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 a modest 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? There's one solution that might work. It's called asset allocation.
Learn more about retirement issues in our retirement area and in this piece on asset allocation. And don't miss our newest offering, a newsletter focusing on retirement investing. Sign up to be the first one to hear about it.
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