Protecting Your Portfolio
As you get closer to retirement, you'll want to take less risk but maintain solid growth. Here's how to tend your nest egg
Call it a Catch-65. As baby boomers get closer to retirement age, they're being bombarded with two conflicting messages. One is that, as they approach 65, boomers should keep the majority of their investments in stocks. The other is that after an average annual return of 20 percent for stock funds since early 2003, it may be time to get more conservative.
So which is the safer course? Should you dial down your stock exposure to guard against an economy and a bull market that are showing their age? That might not be so smart. A study by T. Rowe Price found that even though a portfolio with only 40 percent in equities might last for 20 or 30 years--provided you withdraw only a tiny amount annually--inflation will chew away at that nest egg's purchasing power over time. Or should you hang on to your stocks to fight the long-term battle against inflation?
Fortunately for risk-averse investors, you may not have to choose. There are ways to tweak your retirement portfolio and lower your risk--by emphasizing different types of stocks--without giving up the historically higher returns of equities.
No bargains. One reason to stick with stocks is that there may not be a great alternative at the moment. "It's very hard to find undervalued asset classes right now," says Nick Nanda, asset-allocation specialist with the investment-management firm GMO. In recent years, just about every other asset class--including gold, commodities, and real estate--has shot higher, as the Federal Reserve has sought to reflate the economy following the 9/11 terrorism attacks and the 2001 recession. And bonds, the normal safe haven for aging investors, are even more overvalued than stocks, many believe. Indeed, while 15 percent of money managers surveyed by Merrill Lynch think equities are too expensive, 67 percent consider bonds to be overpriced.
Remember, this is not an attempt to swing for the fences. Instead, you are trying to reduce risk in your portfolio by emphasizing undervalued asset classes while lightening up on pricey ones. Don't make too many dramatic shifts, cautions James Peterson, vice president of the Schwab Center for Investment Research. Stay within 5 or 10 percentage points of your normal allocations. If you generally keep 40 percent of your investments in large, blue-chip stocks, say, then don't go below 30 percent blue chips or above 50 percent.
Get dividends. Of course, this raises the key question: What types of stocks and bonds should investors favor or shun to reduce their risk in today's market? One simple answer is to tilt your portfolio toward dividend-paying stocks, says Colorado Springs, Colo., financial planner James Shambo. Not only are dividend payouts usually a sign of financial health--as companies that pay dividends typically generate more cash than they need to plow back into the business--but dividends offer a cushion should the stock market decline. A company whose shares decline 2 percent but which pays out a 3 percent dividend would post a positive total return of 1 percent.
One way to increase your stake in dividend payers is to put more money into mutual funds focusing on companies that consistently raise their dividends. Among the better-known and low-cost options are Vanguard Dividend Growth and T. Rowe Price Dividend Growth. And Barclays iShares offers an exchange-traded fund that tracks the Dow Jones Select Dividend Index.
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