Balancing Risk for Older Investors

Traditional wisdom says that as you get older and enter retirement, you should reduce your equity positions and increase assets invested in lower risk investments, such as bonds.

One formula you may have encountered is to keep the percentage of stocks in your portfolio equal to 100 minus your age.

The rationale for a more conservative investment stance as you grow older is the concern that should your portfolio lose value, you won't be able to make up the loss through work earnings or have the time for a market recovery to return your portfolio to break even.

But there's another risk you have to consider when allocating your portfolio: The risk of running out of money.

Retirement planning always has to work with two major unknowns: How long will you live and what will happen with inflation during those years?

Today's average 65-year-old is going to be around for another 18.7 years (17.1 if male and 20.0 if female). Taking a look at your parents and factors that impacted their health can give you an idea of where your lifespan might line up with the average.

When you are talking investments, 13 to 20 years is typically considered a long-term investment horizon suitable for equities.

Over the past 40 years, inflation has ranged from 13.3% to 1.1%, with an average of 4.6% annually. While the Federal Reserve is focused on controlling inflation, there's a new factor that may take control out of U.S. hands. In recent history, the U.S. economy has dominated world consumption. That's changing.

There's tremendous competition for energy, resources and goods from emerging countries throughout the world from China and India to the African and South American nations. Competition is pushing up costs for finished products, raw materials and energy.

All of which leads to a new directive in portfolio allocation for retirees. Increasingly, the recommendation is that regardless of age at least 50% of retirees' portfolios be allocated to equities. The exception would be individuals with sufficient assets that there is little risk of outliving their retirement funds.

The reason is simple. Bond yields historically have offered minimal return once inflation and taxes are considered. If your portfolio is not all it should be or inflation moves up, you need to see genuine appreciation in the value of your retirement portfolio. While past performance cannot be considered indicative of future returns, higher rates of appreciation have historically required investing in equities.

Among the 50% equity position should be exposure to international markets and smaller companies where some of the highest rates of appreciation tend to occur.

Through active management, we have the data and tools today to identify and invest in the better performing segments of the market and stop losses when a portfolio position turns against us.

Twenty years ago, many of our investment strategies would have been prohibitively expensive in terms of data and trading costs. Specialized funds and exchange traded funds, restructured transaction costs and better computer systems are just part of the difference.

Dearborn & Creggs Can Help

Choosing among the thousands of stocks and stock mutual funds available to investors can be a complicated, time-consuming endeavor. Find out more about investment strategies that can make a different in your retirement by calling your Dearborn & Creggs financial representative today.