"Get Your Finances Ready for Retirement"-Reducing Risks When Investing During Retirement
Friday, April 10, 2009PAUL KANGAS: When it comes to investing during retirement, almost everyone agrees it's important to keep risk under control. Unlike younger people, retirees generally depend on their investments for cash flow and they don't have the luxury of time to help make up any major losses. So how can you reduce risk in your retirement portfolio? Last summer, before the stock market's major downturn, Connie Hicks looked at that subject.
CONNIE HICKS, NIGHTLY BUSINESS REPORT CORRESPONDENT: Ivan and Alfrieda Reents worked hard their entire adult lives on their Iowa farm. So, a few years ago, they decided to retire, meaning less work, more travel. When they sold their land, they were advised to put the proceeds into investments that happened to have a high degree of risk. The result?
ALFRIEDA REENTS, RETIREE: We had lost some money and other investments weren't doing as well as we thought, you know, investments should be doing.
HICKS: So the couple turned to Jerry Egermier, a certified financial planner in Omaha. He thought the Reents had been talked into questionable investments for a retirement portfolio. One was an IPO, the initial public offering of a company's stock.
JERRY EGERMIER, EGERMIER RETIREMENT & FINANCIAL SERVICES: Generally, you wouldn't -- we wouldn't normally recommend to do that, because of the fact that an initial public offering, many times, is of a higher risk nature. You're concentrated into one investment and you either live or die by what happens with that company and unfortunately, in this particular case, the company failed and all of that money was lost.
HICKS: Many retirees regard investing in any stock as being too risky, but while an IPO or a single stock could be something of a gamble, investing in a diversified basket of stocks is not the same thing as putting your money in a slot machine. In fact, history proves stocks as a whole, tend to do better than other investments over the long term. But the stock market can also go down for extended periods and Moshe Milevsky, an expert on financial risk management, says that poses a problem for many retirees.
MOSHE MILEVSKY, PH.D., FINANCE PROFESSOR, YORK UNIVERSITY, TORONTO: When you're accumulating wealth, the bull markets and the bear markets tend to even out. In the long run, you end up ahead. When you're in retirement, you don't have time for the bull market to cancel out the bear market and anybody that retired in the last five or 10 years is experiencing this.
HICKS: So how can you avoid the risk of having to sell stocks just when prices are plummeting? Wealth manager Harold Evensky deals with this situation by keeping two years of a client's expenses in cash at all times, along with three years of expenses in short-term bonds.
HAROLD EVENSKY, PRES., EVENSKY & KATZ WEALTH MANAGEMENT: So, that's where our five years comes from -- between the two-year that we carve out in cash and the short end of our bond portfolio. Our clients can weather a five-year bear market in stocks and bonds and never be forced to sell something at a loss or certainly not a substantive loss.
HICKS: Besides investment risk, retirees face longevity risk -- the possibility of outliving your money -- and inflation risk, which happens when you don't plan for the impact of rising prices. Financial planner Egermier says keeping stocks out of a retiree's portfolio can increase those risks.
EGERMIER: There's a lot of different types of risks out there. Inflation risk is one of the biggest and that's obviously where your purchasing power is going to -- you're going to have less and less each year, so you have to be invested in some things that are going to grow in value, such as stocks, mutual funds and different types of growth investments and so you can't be too conservative.
HICKS: The Reents periodically review their portfolio with Egermier to be sure the risks and returns are acceptable. That lets Ivan and Alfreida do just what they planned to do -- relax. Connie Hicks, NIGHTLY BUSINESS REPORT.
SUSIE GHARIB: Now, since that report first appeared, the stock market suffered a major downturn, inflicting serious damage to retiree portfolios. So, is it time to revisit the idea that retirees should invest in stocks? I talked with two experts with different opinions: Zvi Bodie, professor of finance at Boston University and Pamela Hess, director of retirement research at Hewitt Associates. I began by asking Professor Bodie why he thinks stocks are too risky for most retirees.
ZVI BODIE, FINANCE PROFESSOR, BOSTON UNIVERSITY SCHOOL OF MANAGEMENT: My point of view is that everyone should distinguish between their essential income needs in retirement and discretionary income. If they're living on a budget, all of which has to be devoted to essentials, I don't think they should have any exposure whatsoever to the stock market. I think it should all be invested in the safest assets -- Treasury-backed, inflation-protected securities.
GHARIB: Let's get Pamela Hess in on this conversation. Miss Hess, do you believe that retirees should limit their exposure to stock holdings?
PAMELA HESS, DIRECTOR OF RETIREMENT RESEARCH, HEWITT ASSOCIATES: Stock investments remain an important part of someone's portfolio that's near, at or in retirement. The amount's going to depend a lot on their individual situation. Right now, everyone's focusing on investment risk and it's hard not to do so with the markets down 40 or 50 percent, but we can't forget about longevity risk and the risk of outliving one's money. Retirement's a long-term investment and people are living longer and have more expenses in retirement.
GHARIB: Well, Professor Bodie, as you heard in our report, Connie Hicks, that she just did, we heard a financial planner saying that, if retirees don't have stocks in their portfolio, they run the risk that they won't be able to keep up with inflation or as Miss Hess was saying, that they're going to run out of money. How do you respond to that?
BODIE: Well, the notion that equities are a hedge against inflation is just plain, flat out wrong and my first published article was about the failure of stocks to provide protection against inflation. In fact, 1974- 75, the level of the broad stock market declined 50 percent at exactly the time when inflation was accelerating. So, I have no idea what the factual basis is for saying that stocks are an inflation hedge. That's what Treasury inflation-protected bonds were designed to do. At the moment, as we speak, you can buy 20-year U.S. Treasury inflation-protected bonds that are guaranteed by the U.S. government to beat inflation by 2.5 percent per year. Stocks don't do that and stocks have never done that.
GHARIB: Miss Hess, what are your thoughts on TIPS -- Treasury inflation-protected bonds?
HESS: TIPS are a great part of someone's portfolio. I wouldn't argue that they should be 100 percent in TIPS or 100 percent in stocks. It's about balance and looking at their whole portfolio. The thing that I think people forget is that they already have big bond exposure through their Social Security investments, which are the bond-like portfolio that pays out income. And also, they might -- they potentially have a defined benefit plan that is another income stream.
GHARIB: One thing, Miss Hess, that a lot of retirees and generally, most investors think that stocks historically go up at a rate of 7 or 8 percent a year and that's the basis that they're using for their investment planning. But, you know, actually historically, we've seen that not just in the last year or two, but over the past decade, that stocks are not going up that much. So how should retirees really look at this data as they do their investment planning?
HESS: It's important to know that the historical numbers are over the long term, not the short term, so that's where I think it's really important that everyone owns their retirement and that they have a financial plan just for their specific situation. So, the asset allocation of someone who's 65 is going to look very different than somebody who's 75 or 80. It's really about customizing it and making sure it's in line with their specific situation and their risk tolerances.
GHARIB: Miss Hess, Professor Bodie, thank you very much for your time.
