Preserving your portfolio
Baby boomers nearing retirement need to start shifting their investing gears
At 57, Don Vellek has already enjoyed two full careers--first in sales in the telecommunications industry, where he worked for roughly three decades. Then, a few years ago, the Atlanta resident shifted his focus to the travel agency he co-owned throughout much of his corporate life. While Vellek has since sold his share of that business, he still works there full time.
By most standards, Vellek has put in enough time to call it a day. But he says: "I have absolutely no thought of retiring."
Why should he? For years, baby boomers like Vellek have rewritten the rules of the good life. Now a generation living longer and more unpredictable lives than its parents is trying to rewrite the rules for retirement. But as the first wave of the boomers approaches 60, there is one thing it cannot change. That's time.
Though many have no plans to retire immediately, those in their mid to late 50s will probably end up leaving the workforce over the next decade or so. In the coming decades, some 77 million Americans are expected to do so in what is likely to be the biggest wave of retirement in U.S. history.
Fuddy-duddies? That tidal shift has enormous implications for investing. No longer will the sole goal be accumulating capital as fast as possible. Now, the focus will most likely shift to reducing volatility and preserving a portfolio amassed over a lifetime. That will require a generation of Americans brought up on the cult of equities--through 401(k)'s, mutual funds, and online brokerages--to develop tastes for such fuddy-duddy investments as bonds and even cash.
Vellek, who at one point in his career held 100 percent of his nest egg in his employer's stock, is already making the transition. Today, he keeps about 42 percent of his assets in a diversified mix of U.S. equities and 8 percent in foreign stocks, with the remainder invested in bonds and cash. But, says Vellek, who will turn 58 on New Year's Day, "the next step is to ratchet that down to around 32 percent U.S. stocks and 13 percent foreign." The adjustment would cut the share of equities in his account below 50 percent for the first time.
That is more conservative than many of his peers. While the general perception is that older workers are wary of the stock market, particularly after the recent bear market, today's 50-somethings actually have nearly two thirds of their retirement savings in stocks, according to a study of 401(k) plans by employee benefits consultants Hewitt Associates. The average 60-something has around 60 percent in stocks. Investors have a strange tendency to be "overly aggressive until the day they retire," says Mike Scarborough, president of the Scarborough Group, a 401(k) investment advisory service. "Then they become overly conservative. It's like a light switch."
But financial planners suggest that instead of flipping a switch to go from almost all stocks to almost all bonds, boomers should consider gradually dimming their exposure to equities. Doing so won't be easy. "It's all on the worker to make the right decisions," says Carol Geremia, president of the retirement services group of asset managers MFS. Boomers are the first generation of workers to have lived under a retirement savings system dominated by self-directed investment plans like 401(k)'s and IRA s, which require workers to bear all the risk and make all the decisions. As recently as a decade ago, nearly 60 percent of working families were covered by a guaranteed pension. Today, that's down to just over a third.
Add in the fact that many in the boomer generation will also be paying for college and taking care of an elderly parent, and the task of managing an investment portfolio in transition seems overwhelming. To assist, the giants of the mutual fund industry have recently launched advisory services such as Fidelity's Retirement Income Advantage and T. Rowe Price's online retirement program. The target of these new services: the more than $4 trillion in financial assets held by 60-somethings.
Still, boomers are "the between a rock and a hard place generation," in the words of financial planner Harold Evensky in Coral Gables, Fla. If they're too conservative with their money, there's a distinct possibility of outliving it--or at the very least, seeing inflation eat away at their future purchasing power.
On the other hand, if you are too aggressive, you run the risk of losing a chunk of your investments early. And such early losses can have a devastating impact on the longevity of a retirement plan. Say you had retired in 1963 with $1 million in the bank. Assume you invested half of that money in blue-chip stocks and the other half in high-quality bonds. And further assume you withdrew 7 percent of your nest egg each year, starting in 1963, for 30 years. At the end of this period, you'd still be left with $784,000. Now assume you did the exact same thing but retired at the beginning of 1962. You'd be left with no money at the end of 30 years.
What happened? Well, the S&P 500 fell 12 percent in 1962, reducing that initial $1 million nest egg from the beginning. By contrast, stocks soared 19 percent in 1963, giving that nest egg a nice start--growth that compounded over time. "This does suggest that luck can play a very important role in the success of your plan," says Philip Cooley, a finance professor at Trinity University in San Antonio.
"If you plan to withdraw 8 percent of your money in the first year of retirement and your portfolio happens to lose 4 percent that year, you're down 12 percent from the get-go," says Christine Fahlund, a senior financial planner with T. Rowe Price.
Further complicating matters for boomers is that they may have seen the best of times already. Many market watchers say we could be in for a prolonged period of mediocre returns, such as we saw in the 1970s, instead of the outsize gains of the 1980s and 1990s. If so, Scarborough says emphasis will then have to shift back "to protecting principal."
The trick will be to become conservative but not too much so. Even minor tweaks to a portfolio can reduce risk without necessarily giving up good returns. Mutual fund giant Vanguard recently studied the performance of various asset allocation strategies between 1960 and 2003. A typical portfolio of 60 percent stocks and 40 percent bonds generated average annual returns of 9.5 percent during that time. But in 11 of those 44 years--25 percent of the time--this strategy produced annual losses.
Say, though, you were to shift to 50 percent stocks and 50 percent bonds. That would have yielded 9.2 percent on average every year. Barely a difference. But you would have lost money only eight times in that 44-year stretch. One thing is certain: You probably shouldn't give up on stocks altogether. Workers who not only invest through 401(k)'s and IRA s but also have the comfort of a traditional pension have enough security to take more risks, says William Reichenstein, a professor of finance and investment management at Baylor University. He says that "Social Security income and defined benefit payments can be thought of like fixed-income exposure."
Staying invested. In the early years of their retirement, Tom and Sheila Carranza have discovered that they can live primarily off the income generated by their two pension checks and Social Security. Tom, 67, a former machinist and production engineer, recently retired, while Sheila, 62, retired from her job working for a school district about seven years ago. This has allowed the Las Vegas couple to keep a majority of their self-directed assets, held mostly in mutual funds, primarily in equities.
But for those who don't have this luxury--and that is the majority--there are things you can do to reduce risk while still enjoying the potentially higher returns of stocks. Within your equity allocation, you can choose more stable, consistent types of stocks that are likely to help you sleep at night. You can pare your exposure to company stock. The average 60-something has 29 percent of his or her 401(k) assets in company stock. Scarborough recommends having no more than 5 percent of your holdings in your employer's shares.
You can also reduce your exposure to aggressive growth stocks, while emphasizing blue-chip dividend payers. "Dividend-paying stocks give you a bird in the hand," says Colorado Springs, Colo., financial planner Jim Shambo.
Moreover, because of the income they pay out, dividend payers tend to protect portfolios in down years. In 2001, for example, dividend payers in the S&P 500 fell 0.1 percent, versus losses of 5.4 percent for non-dividend-paying stocks.
Meanwhile, since the end of 1979, dividend-paying stocks in the S&P 500 have earned 15 percent on average, vs. 12.4 percent gains for non-dividend payers.
Shambo says his desire for consistent returns--even if they're in the form of income, rather than capital appreciation--would suggest putting a small portion of your money, perhaps 5 to 10 percent, in real estate investment trusts.
A portfolio of 50 percent stocks, 40 percent bonds, and 10 percent cash would have produced average annual returns of 10.9 percent between 1972 and 2003, according to Ibbotson Associates. Had you taken 5 percent of that equity allocation and another 5 percent of the bonds and shifted that into REIT s, your portfolio would have earned slightly more--11.2 percent a year--with less risk.
Westfield, N.J., financial planner Paul Westbrook also suggests older boomers consider lightening up their exposure to small caps while moving more of their equity holdings into large-cap stocks. The reason? "Less volatility," he says. Meanwhile, he says, large-cap stocks can offer more protection in down markets.
And at the end of the day, isn't that the goal for aging boomers--to find a way to still accumulate money to pay for their longer life spans but to do so while preserving what they have already have?
BEGTAB^
Adjusting your mix
As you age, there is less time to make up for losses in your portfolio. That's why investors should consider increasing their stake in fixed-income securities and gradually reducing their equity holdings as they get older. There are many asset allocation strategies to undertake, but here is one suggested allocation:
In your 30s - 20 pct. bonds, 80 pct. stocks
In your 40s - 40 pct. bonds, 60 pct. stocks
In your 50s - 50 pct. bonds, 50 pct. stocks
In retirement 75 pct. Bonds, 20 pct. Stocks, 5 pct. cash
Source: Vanguard
This story appears in the October 25, 2004 print edition of U.S. News & World Report.