Overall performance, not yield, should be emphasis

by Troy E. Kennedy

for the Business Journal

People work and save their entire lives in order to have the ability to retire comfortably at some point. Most people, if they have been prudent investors, have utilized higher returning assets, such as stocks, to assist them in preparing for retirement.

Many retirees feel that once they switch to the retirement mode, they should shift assets into a more conservative portfolio of fixed securities, such as government bonds and CDs.

As they need more income, they instinctively look for investments that pay large yields. The problem is, if you invest only for yield, you will leave yourself vulnerable to inflation.

With medical and health care advances, most retirees are enjoying 20 to 30 years of retirement. Over a long period of time, inflation will eat into your standard of living during retirement.

Suppose you buy a bond and use the interest payments for monthly living expenses. As inflation takes its toll, the real value of both the interest payments and the bonds principal value will gradually shrivel. Even at a modest 2 percent inflation rate, the amount of groceries you can afford will be down 18 percent after 10 years, and 33 percent after 20 years.

CDs and bonds, their interest rates being as low as they are, have very little attraction to most investors. However, if you are considering buying higher-yielding bonds, keep in mind that with increased returns come increased risks.

What is the answer? To fight inflation, retirees need to keep at least a portion of their portfolio in stocks so that they earn some capital gains. This will allow you to outpace inflation over the long term. As an alternative, consider putting half of your money in high-quality, large-company stocks and half in bonds with short- to intermediate-term maturities.

With this mix, you should be able to withdraw an amount equal to 6 percent of your portfolio's value the first year of retirement. Thereafter, even if you increase your annual withdrawals along with inflation, historical returns suggest that your money should last long enough to see you through a 25- to 30-year retirement.

While a 6 percent withdrawal rate might be reasonable for this investment mix, this portfolio will not yield 6 percent. It will more likely be in the 3.5 percent to 4 percent range. But remember, you should ignore yield and concentrate on total return.

Instead of worrying about your retirement portfolio's yield, focus on generating decent overall portfolio performance using a mix of income and capital gains. Then, sell investments periodically to supplement your dividend and interest income.

Sounds easy, right? Well, there are two drawbacks to this approach.

1. Investor psychology mandates that most individuals feel they should never dip into capital.

2. It's easier to sell investments that have done well than it is to sell those at depressed prices.

However, with volatility in the market, your portfolio will occasionally be down in value.

To combat this, I would recommend keeping a portion of your retirement money in a money-market fund, or other short-term liquid investment, to cover your living expenses for the next 18 to 30 months.

All dividends and interest collected on your portfolio should be swept into that money-market fund. At that point, once a year, you could look at replenishing your money-market fund reserves by selling some of your other securities.

Just remember, the most important criteria is that you feel comfortable with your investments so you can rest easy and enjoy your retirement.

(Troy E. Kennedy is a senior vice president and shareholder of Springfield Trust Co.)[[In-content Ad]]