Recent retirees with withered 401(k)'s have been the hardest hit by the recession. They still need growth to finance 20 or even 30 years of retirement, but they also need to protect their principal, since there’s no income from work to help recoup losses. Declining balances mean many retirees need to reevaluate their income strategy. Here are five ways retirees could alter their investments, according to a handful of money managers, along with an assessment of how your investments are likely to fare in each scenario.
Diversify and rebalance. One way to weather the recession is to rebalance into a reasonably diversified portfolio: perhaps 50 percent in stocks, 40 percent in bonds, and 10 percent in cash. That generally means reallocating more money to stocks during bear markets and shifting money into bonds or cash during bull runs in order to maintain the same percentages. “You should rebalance at least once a year back to your original asset allocation,” says Stephanie Giroux, chief investment strategist at TD Ameritrade. “But if you think that risk level is no longer appropriate, you may want to reconsider it.”
Taking a slightly higher risk of losing principal can potentially mean higher long-term returns. “The sweet spot between reliable and sustainable income and the potential for upside growth is 40 to 60 percent in stocks,” says Rande Spiegelman, senior vice president of the Schwab Center for Financial Research. “No matter how aggressive you are, retirees who are just retiring and [are] going to start relaying on their portfolio for income should have no more than 60 percent of their portfolio in stocks. If you are risk-averse, have at least 20 percent in stocks so you can keep up with inflation.”
Shift slightly more conservative. The recession has many people reevaluating the level of risk they can live with, and some are seeking safety. “You could become more conservative in terms of your overall asset allocation, and still have your assets last when you combine that more conservative portfolio with several different lifestyle changes--such as a reduction of overall expenses and not taking any cost of living adjustments on withdrawals for a five-year period,” says Ken Hevert, vice president of retirement income product management for Fidelity Investments, about switching to an asset allocation of 50 percent bonds, 20 percent stocks, and 30 percent cash in retirement. James Shelton, chief investment officer of Kanaly Trust in Houston, agrees that retirees should choose conservative investments in the short term. “We are encouraging all our clients to have no more than 30 percent in equities,” he says. “We like the highest quality corporate and municipals bonds, but we are avoiding high yield bonds based on the expectation that we are going to see a massive wave of defaults.”
Leave the market until it stabilizes. Some retirees don’t have the stomach for the wild swings in the stock market that have made headlines over the past several months. “Going all to cash for a two-year period, and then rebalancing to the 50 percent equity portfolio also proved to work well,” says Hevert. “You are giving up the potential for gain in equities in the short run, but it still improves the overall longevity of your money.” But exiting the stock market now may mean that you miss out on significant gains during the recovery. “You don’t want to market time, because if you liquidate everything thinking you will get out and get back in you will probably miss the opportunity to make the market work for you when it goes back up,” cautions Giroux.
Convert to all cash and bonds. In a month when the Dow Jones Industrial Average plunged below 7,000, it’s tempting to pull your money out of risky equities. “You need to be very careful about being too conservative,” cautions Dan Greenshields, president and chief investment officer of ShareBuilder. “You want to make sure you have assets that will grow when the market goes up again.” While cash investments preserve principle, most don’t pay enough interest to say ahead of inflation, which will eat away at your spending power in retirement. “Going all to cash, while it may feel safe in the short run, in the long term, that’s where the real risk is for retirees,” says Hevert. “The strategy that is the hardest to make work is if you go to an all cash position for the remainder of your retirement.” A better move for market-wary retirees is to keep between three and five years' worth of living expenses in cash, so you can avoid selling equities while they are low.