Financial Futures

Although some might say that because they have already retired, it is too late for John and Mary to plan for their retirement, I disagree entirely. It might be too late to hire an attorney to seek disability benefits from the Social Security Administration, but they should plan the remainder of their retirement as soon as they can to give them more time. So what if they carefully examine their financial horizon and determine that their money will probably expire before they plan to expire? What are their choices? What options do they have? Planners may disagree as to specifics, but I assure you they all agree that the Sellers have a lot more options now than they will after their money is nearly gone!

Budgeting
One of the first steps as you plan for retirement is to reduce your monthly budget. John and Mary have already reduced their monthly income to two-thirds of their previous income needs by moving to a more modest neighborhood. As a bonus, the sale of their former home provided them with some cash that they can put to good use. This leads us to investment choices.

Investing
Years ago, interest rates were sky-high and retirees could put their money into CDs and live off of the interest without touching principal. And because bank savings are protected by FDIC, their money was safe. They had the best of both worlds -- high returns and safety, too! This investment approach to retirement was also made easier by the fact that Americans of older generations were penny pinchers. They saved as much from every paycheck as they could. But there is a paradigm shift occurring that most may not realize yet.

Boomers retiring now have not saved the way our grandparents' generation did, so today's retirees have not accumulated sufficient wealth to live only on interest received from their investments. This problem is made worse by relatively low interest rates, and economists seem to generally agree that they see no significant rate increases in the near future.

You must consider other investments if you know you can't live on interest alone or if your planning shows that you could run out of money during your lifetime. You must seek investments with higher returns as soon as possible. Certainly, the longer you can earn a higher return, the larger your assets can grow. Timing is also important because a longer holding period will reduce the risk associated with those investments. In other words, the longer the investment time horizon, the lower the market risk.

Asset Allocation
The ideal way to invest one's portfolio to achieve higher returns is based on an asset allocation strategy. In fact, studies have shown that the vast majority of a portfolio's performance is determined by its asset classes. Market timing and specific security selection account for only 6 percent of the performance.

Asset classes are merely different types of securities whose risk and expected returns are different. It is a method of investing that incorporates the concept of diversification in two ways:

• Within each class, such as owning many different large or small company stocks
• Owning securities in a number of different classes, including stocks and bonds

There are many factors that are evaluated to determine an appropriately allocated portfolio. Among those are risk tolerance, time horizon, liquidity and designed rates of return. However, asset allocation is definitely not an exact science and planners have developed rules of thumb to serve as guidelines.

One rule of thumb is to use your age as a measurement of the percentage of your portfolio that should be invested in bonds. For example, if you are 60 years old, you should consider having approximately 60 percent of your portfolio in bonds. Unfortunately, recent studies reveal that Americans are far too conservative and invest 37 percent in bank deposits and CDs, 16 percent in bonds, 18 percent in mutual funds, and 29 percent in stocks. The studies further reveal that nearly 70 percent of the money invested in mutual funds is in fixed income and money market accounts.

Asset Allocation Benefits
Asset allocation has become a buzzword among financial planners and investors, but it's important to understand its real benefits. The purpose of asset allocation is not to guarantee higher returns, although the returns of a properly allocated portfolio should be higher than bank deposits and CDs. The risk associated with the properly allocated composite portfolio will be lower than the risk associated with each of its equity components. Furthermore, a properly allocated portfolio lightens the psychological impact of investing in equities and increases the compound annual return.

In conclusion, retirees shouldn't get too comfortable investing conservatively even during their retirement. Asset allocation is the ideal way to earn higher returns and reduce the risk associated with investing in equities. My advice to John and Mary is to review their IRA, profit-sharing plan and other savings to determine what adjustments need to be made so that they can continue to enjoy their retirement and enjoy financial freedom for the rest of their lives.

Expert Advice for John and Mary
The Need to Plan
Asset Allocation
Required Distribution of an IRA
Preparing for the Home Stretch, from our sponsor, Merrill Lynch

back to Financial Futures intro