“Now YOU can learn about retirement planning in plain English. Planning for retirement can be confusing. I cut through all the industry jargon so YOU can learn how to achieve your retirement goals.”
When you get closer to retirement you may get a little bit more apprehensive when it comes to risk.
I’m reminded of the times when I was younger and had to perform at a piano recital. Talk about being nervous.
Well, that nervousness is how a lot of people (perhaps even you) feel when it comes to investing their retirement funds. Especially when you are approaching the day of retirement within the next 5 to 15 years.
What’s the difference?
Why is it harder to handle volatility in the stock market when you near retirement?
It’s simple. When you retire you lose your paycheck. You are dependent on your savings to supplement any income you get from Social Security and a pension.
If your savings take a hit in the market it hurts a lot more when you don’t have a regular paycheck from work to fall back on.
This means investing in (and near) retirement is a bit different than investing during your accumulation years.
The mindset has to shift to one of responsible de-accumulation of savings. The savings are being used to support your lifestyle, and you need them to last a long time. And when the investments are not properly handled it increases the likelihood of running out of funds during retirement.
There are 3 important aspects to investing for the retirement stage of life:
- Avoiding losses
- Generating growth to keep pace with inflation
- Generating sufficient income
Because these are important goals for retirees, here are some popular options of investments for retirement.
#1: Diversified Portfolio
This first one is admittedly not an investment in itself. Instead, it is a combination of investments. Typically it’s going to include some equity exposure and bond exposure with a little bit of cash thrown in as well.
What is it about a diversified portfolio that can help a retiree with investing?
The whole point of a diversified portfolio is to smooth out performance, while also giving growth potential that help a retiree keep pace with inflation.
When done properly diversification should help reduce the volatility of a portfolio, this means less of the up and down wiggles in account value that are so scary to many people near (and already in) retirement.
Smoother performance helps minimize the risk of having to make withdrawals from a portfolio that has had a large downturn in the market. The duel effect of a market downturn along with simultaneous withdrawals from a portfolio can be hard on a retirement portfolio.
Sometimes making it too hard for the portfolio to recover to give long-term growth potential that retirees need to keep pace with inflation.
#2: Dividend Stocks
Dividend stocks can be another investment for retirees. They can help generate additional income to supplement Social Security and pensions.
If you don’t feel comfortable researching individual stocks that pay good dividends, you can opt for a dividend income fund. One fund can diversify your dividend strategy across multiple different individual stocks, and you don’t have to worry about managing it.
The good thing about dividends is they can provide income that can possibly go up if companies choose to increase it. The downside is the income is not guaranteed, and dividends can be reduced or even stopped.
Understand that investing in dividend stocks is a form of investing in the market. You are taking on risk with your investment. So be sure you understand this and that the risk is line with your risk tolerance.
The basic premise of a bond is that you are lending money to a borrower, whether that be a corporation or the government. You give them money for a set time frame, they give you interest payments. At the end of the time frame you get your original premium back that your lent them.
Don’t expect high returns from bonds. They are good at producing income, as well as helping provide more stability to a diversified portfolio.
You can add bond exposure to your portfolio by purchasing individual bonds, or by purchasing a bond mutual fund or exchange traded fund.
#4: Fixed Annuities
Annuities often times get a bad rap. And that’s not fair.
Social Security is very much like an annuity. If you have a pension it acts very much like an annuity.
Annuities are not technically investments. They are insurance products.
A fixed annuity has no market risk. You can use it to preserve principal when you just want a guaranteed return on your money.
Or you can use it to guarantee an income stream now or in the future.
Most fixed annuities have no fees. The fixed annuities that typically do have fees are the ones that include an optional attached rider, such as an income rider or death benefit rider.
When used properly, they can help increase your lifetime guaranteed income sources. This takes pressure off your investment portfolio from having to generate as much income from withdrawals.
Another feature of fixed annuities is they protect your principal. This is another important feature for many retirees who understand the importance of preserving their assets.
#5: Variable Annuities with Income Riders
Variable annuities are one reason annuities get a bad rap. The traditional variable annuity is notorious for having high fees, sometimes in excess of 3% annually.
They have market risk exposure because they have sub-accounts, which are very much like mutual funds. If they perform poorly, so will your variable annuity’s account value.
If they perform well, your account value will go up. But remember, you will typically have a high internal fee that will reduce your growth potential.
What typically happens is variable annuities have market growth potential, but the high internal fee causes market growth potential to never actually materialize.
That’s why if you want to use a variable annuity for market growth, it is a good idea to consider a no-load variable annuity that is primarily used a tax deferral wrapper for your non-qualified funds. This is often times a better option than using the higher-fee traditional variable annuities that are so often recommended.
With traditional variable annuities, since the internal fees inhibit growth potential, what is often left is the guarantee on the income rider. If you attach an optional income rider to a variable annuity for a fee, it will give you certain lifetime income guarantees.
This can be very beneficial to retirees who need ways to turn their lifetime savings into an income stream they can never outlive.
But before you invest in a variable annuity with a lifetime income rider, be sure to check what type of income guarantees you can get from a fixed annuity with an income rider. A lot of times the guarantee will be higher.
#6: Rental Real Estate
This is one a lot of people won’t be on board with, and that’s ok. Perhaps the thought of being a landlord sends images of renters that won’t pay and vandalized property you are stuck paying to fix.
But if you know what you are doing, rental real estate can be a good source of income.
Be sure to calculate all your expenses before making an offer on a house. There will be more than just the loan repayment each month. You will need to set aside enough for house insurance and property taxes. Also, you need to assess if there are any big expenses (like a new A/C unit) that will be coming up too.
After calculating the expenses, you can determine if the rent you could get out of it would cover these expenses and give you a reasonable profit for the risk you are taking.
Just do your homework before taking the plunge.
If directly owning a single house and playing the role of landlord is not your cup of tea, then you can still have real estate exposure in your portfolio through REITs. These are real estate investment trusts.
Think of it as a mutual fund that uses real estate instead of stocks. Also, you wouldn’t have to do any property managing with a REIT.
REITs must pay out the bulk of their income to the shareholders (called unitholders). This helps a retiree generate income in retirement.
But since they payout most of their earnings, it may make sense to hold them in a tax deferred account, like an IRA.
For retirees, REITs can be used as an alternative asset in a diversified portfolio. When done properly it can help decrease volatility in a portfolio and help smooth out performance.
Commodities can be quite volatile. Gold can be a risky investment. Also, they don’t pay any interest or dividends.
So why should an investor consider commodities as a retirement investment?
It can be used as a portion of a diversified portfolio. Just like REITs are considered an alternative asset class, so are commodities.
While by themselves they can have a lot of volatility, when they are included in a properly diversified portfolio they may be able to help reduce the volatility of that portfolio.
This is because commodities are not highly correlated with traditional asset classes like stocks and bonds. This means that when stocks go one direction (up or down) commodities may go the other direction.
This helps smooth out results in a diversified portfolio, which is so important for retirees that are looking to protect their portfolio’s downside.
See this Investopedia article under the section “Why Commodities Add Value.” http://www.investopedia.com/articles/trading/05/021605.asp
#9: Bank CD’s
Bank CD’s are another financial vehicle retirees can use in their overall financial plan. The big benefit of CD’s is they are backed up by the FDIC up to $250,000. So there is incredible safety here.
Also, they can be used as a source of liquidity for a retiree.
It is important to have a reserve account for emergencies when you are retired.
Another benefit of having a reserve account is that you can draw from it to supplement your income needs if your investment portfolio is currently depressed in the market. By having this access to liquidity, it can help you ride out market downturns and help avoid having to sell shares at a lower price.
This is another way to help preserve assets in retirement.
#10: Money Market Account
Money market accounts will pay you an interest rate and you can move your money at any time without penalty. So they are a good place to safely hold your funds and provide additional liquidity.
Compare the interest rate you can get on a money market account with a bank CD, such as a 1-year CD. If the rate is comparable, you may want to go with the money market account as it gives you immediate access to your funds.
Money market accounts can also be used as a place to park your funds temporarily as you look for better investing opportunities.
Remember, this is a list of different investments that can be used to help retirees (and people 5-15 years away from retirement) manage their portfolio for income, asset preservation, and growth potential.
Choose your investments based on an overall plan, not as a stand alone solution. Think of it as a recipe. There are a lot of ingredients that go into a recipe. And it’s not just which ingredients you choose, but also the quantity of each ingredient, that will determine the success of the recipe.
It’s the same with investments. You need to make sure that your overall investment plan takes into consideration your income needs, your risk tolerance, your retirement goals, and what you feel comfortable owning.