Long after you have retired, your money should keep growing and working for you.
By Albert B. Crenshaw
(c) The Washington Post
Tuesday, April 30 1996; Page Z10
Saving for retirement is an often-discussed topic these days, but much of the talk treats the actual
retirement as if it is the end of the process. If you make your goal, supposedly the rest is cruising.
But the reality is often quite different. With life expectancies growing and the private pension
system shifting more money management to the individual, today's retirees must be prepared to
continue investing and planning for many years.
Even with inflation running at less than 3 percent, today's seemingly adequate nest egg can take a
major beating over a period of years.
"Most retirees at 65 have a life expectancy of 20 years, and for a couple, statistically, one of you
will reach age 90. Inflation can do an awful lot of damage in 20 or 30 years," said Ric Edelman of
Edelman Financial Services in Fairfax.
Suppose you figure you will need $35,000 a year to live comfortably in retirement today. In 20
years, with an annual inflation rate of "only" 2.5 percent, that $35,000 figure would climb to more
than $57,000. Can your portfolio, plus Social Security, produce a corresponding increase? If not,
your standard of living will decline.
The key, Edelman said, is to devise a portfolio that grows at the same time it provides income for
living expenses. This isn't easy, but if the retiree's assets are adequate to begin with, it can be done.
For one thing, the growth does not have to be absolute. A $500,000 portfolio does not have to
become $1 million, for example. Growth in this context means that after needed income is drawn
out, the remaining balance increases enough so that future withdrawals can be made for the
retiree's lifetime without exhausting the money.
It does mean, though, that some riskier investments are required.
"An all-CD [certificate of deposit] program here isn't a good idea," said Mary Malgoire of
Malgoire Drucker Inc., financial planners and investment advisers in Bethesda. "I don't believe that
anybody can ignore growth."
The first step, Malgoire said, is to evaluate your current situation. "Figure out your cash flow and
see if you're spending within your means." These are routine, day-to-day living costs, not
extraordinary items.
Don't count "the new roof you put on, the new car," she said. "Look at the basic amount and
include taxes. Are you covering your expenses with your income? If you are, then you have a little
more flexibility with respect to your investment plan."
But check also to see if any of your current income will stop, she said. Are you getting alimony,
child support or anything else that is scheduled to end at some point? If so, your other income will
have to make up for it later on.
A lucky minority, of course, likely already know that their current portfolio is large enough so that,
even invested cautiously, it not only covers their expenses but grows nicely. This is the moment
when these folks realize that their lifetime of sacrifice and saving really did pay off.
For those who need growth, experts advise a mix of high-quality stocks, high-quality corporate
bonds, government bonds and a cash reserve.
There are other investment categories, of course, ranging from limited partnerships to precious
metals to collectibles to real estate. These can be quite profitable, but typically entail quite a bit
more risk and are suitable only for the most sophisticated investors.
High-quality stocks, generally those of big, profitable companies, typically pay dividends and grow
at least as well as the overall economy over the long haul. They are not immune to the short-term
ups and downs of the market, though.
In fact, there is no escaping risk. What's important is to understand the kinds of risks that are out
there and to try to diversify your investments to minimize the impact of an adverse development.
Everybody knows that stock prices can fall, but some of the other risks aren't so obvious.
CDs, which are generally government-guaranteed to return your money plus interest, can be subtly
eroded by inflation. Treasury securities are similar.
Corporate bonds, which generally pay a higher yield than CDs, can default. They also can lose
value if interest rates rise (this is called interest rate risk, although it only affects investors who wish
to sell their bonds).
Foreign investment faces currency risk, when changes in the value of the dollar or other currencies
cut your return when you convert your investment back into dollars.
And of course, there are always taxes, which can wipe out your gains.
Retirees should consider buying individual stocks and bonds only if they have some knowledge of
investments and the time and willpower to track them closely. Stocks are not an investment you
can forget.
On the other hand, managing a portfolio personally can be fun and rewarding. After all, no one has
your interest as much at heart as you do.
For those not willing or able to manage stocks and bonds on their own, mutual funds offer a cheap
way to employ a professional to choose stocks and bonds for you. They also provide the
diversification advisers recommend. Choosing the right fund takes some research, but one from a
reputable company and with a good long-term record can usually be relied on to turn in decent
performance year in and year out.
You can assemble your own portfolio, allocating portions of your money among, say, a large
company growth fund (stocks) or a balanced (stock and bond) fund and all-bond funds. Or you
can use the growing number of "asset allocation" funds that aim to do this for you.
You don't need a broker to invest in mutual funds. Many of the largest and best-known fund
operators, such as Fidelity, Vanguard and T. Rowe Price, sell shares directly by mail. And a
growing number are opening offices in Washington and other cities to provide walk-in assistance
to investors who are more comfortable dealing with someone face-to-face.
As time passes and you find your portfolio doing well and yourself becoming more comfortable
with investing, you may want to put a small portion of money into a small company stock fund or
even an international one.
Small companies and foreign stocks are riskier, but they offer the possibility of greater gains than
big U.S. stocks and corporate bonds. Also, non-U.S. stocks don't necessarily follow the U.S.
market, so investing in them might provide some protection in the event of a big decline here.
"The goal is to create a conservative portfolio that generates stable yet consistent returns,"
Edelman said. "This kind of portfolio is really lower in risk than a portfolio with CDs and Treasury
securities."
"People tend to put all their money in CDs because they think of default risk, but there's credit risk,
tax risk, inflation risk, interest rate risk, currency risk. Not one investment is immune to all of them.
So we put 12 eggs in 12 baskets. That's what gives us an overall level of risk that's lower than just
U.S. bonds and also generates an income level that's higher," he said.
The Language of Money
The world of investing contains an array of terminology and jargon that beginning investors often
find confusing. Here are simplified explanations of some of the more common terms:
Stock: A share of stock is an ownership interest in a corporation. Companies sell stock to raise
money for a variety of reasons, and investors buy it in hope of sharing in the company's future
success. Stock exchanges provide a mechanism for buying and selling shares, whose prices rise
and fall with the market's assessment of the company's future prospects.
Stocks over the long term have outperformed all other kinds of investments in this country, and are
generally regarded as the best way to build value in an investment portfolio. However, they are
subject to periodic sharp drops, so they are best suited to investors who can simply wait out any
downturn.
Bond: A bond is a company's IOU. When a company "sells" bonds it is really borrowing money
from the bond "buyers." Typically, a bond promises to pay a certain amount of interest on certain
dates each year. This payment is called the "coupon," which dates from the days when bonds
literally had paper coupons you had to clip off and send in to get paid. A bond with a face value of
$1,000 that promises to pay $100 a year would be said to have a 10 percent coupon. At a certain
date, known as the maturity, the company that issued the bond promises to repay the face value
amount.
Bonds may also be "called," in certain circumstances, meaning that the issuer can repay early. This
often happens when interest rates fall and can be a nasty surprise to investors who thought they
were locking in a high interest rate.
Bonds can be bought and sold by investors just like stocks. Since the coupon is fixed, if interest
rates change in the marketplace, the price of the bond changes to bring the coupon into line with
prevailing rates. If overall interest rates rise, the bond's price falls; if rates fall, the bond's price
rises.
Treasury security: Often known simply as Treasuries, these are IOUs issued by the federal
government. They are issued for periods ranging from a few months to 30 years and are backed
by the full faith and credit of the government. There are billions of dollars' worth of these on the
market and they are readily bought and sold. They can be purchased from the Treasury
Department directly or through banks and brokers. They are about as safe from default as you can
get, but that safety means they typically carry relatively low interest rates that may be subject to
erosion by inflation.
Mutual fund: A special kind of investment company set up to pool investors' money and buy
stocks, bonds or other assets. An "open end" fund, the most common, can sell as many shares at it
wishes, and its share prices will reflect the value of its underlying investment portfolio, the value of
the stocks, bonds or whatever that it owns. A "closed-end" fund sells only a set number of shares
and the price of those shares may be higher or lower than the value of the assets.
Fund shares may be sold by the fund company itself or through brokers. Those sold through
brokers, and some sold directly, may carry front-end sales charges, known as "loads," that are
deducted from the money you invest. In other cases, funds impose annual sales charges or exit
charges when you sell. Under Securities and Exchange Commission rules, each fund's
"prospectus," the formal description of itself and its objectives, must include a table showing the
impact of fees over various periods.
Mutual funds come in a bewildering variety, but much has been written about them, and
bookstores and public libraries are crammed with guides for the beginning investor.
