Money Expert Discusses Down Times


Wednesday, July 12th 2000, 12:00 am
By: News On 6


DENVER (AP) — One of the major questions for those retiring or soon to retire is what mix of assets they should have in their nest egg.

An investment expert at the College for Financial Planning suggests a way geared toward allowing retirees not only to comfortably meet their regular living expenses, but to help them ride out down markets.

``Someone retiring or retiring soon doesn't have the time to make up investment losses,'' says Donald Johnson, a senior academic associate and investment expert at the college.

``They have to be careful in controlling and managing risk. Yet if they are in good health, they may have a 15- to 20-year life expectancy. They have to worry about inflation eroding their nest egg over that period of time.''

This creates the dilemma, Johnson says, of needing to generate sufficient returns to keep up with inflation, yet control for the increased risk that's required to do that.

That's where asset allocation comes in. Asset allocation is the investment mix of your overall portfolio: what portion is in stocks, bonds, cash, and so on. ``Studies have indicated that asset allocation is the main determinant of the kinds of return you can expect from your portfolio,'' Johnson says.

One asset allocation for the early years of retirement is to put three years worth of living expenses into cash equivalents, and the rest in a diversified portfolio of stocks. These ``safe money'' cash equivalents assets typically are certificates of deposit (CDs) and money market accounts.

The portion of the portfolio that's not in cash equivalents would either be 100 percent in stocks, or if that's too risky for you, perhaps 75 percent in stocks and 25 percent in bonds, Johnson says. The stocks would be in S&P 500 index funds or other broad stock market funds, or a well-diversified selection of high quality stocks. Bonds would be short term or intermediate bonds, with maturities no longer than eight years in order to control interest rate risk.

``The idea is that you can live on the cash equivalents for up to three years while riding out any bear markets,'' Johnson explains. ``Three years usually is enough to recover from a down market, so that you don't have to dip into your capital when the market is down.

``Being forced to sell during down markets not only cuts into your long-term capital but also takes away the opportunity to recoup those losses. When the market is up, however, you then sell off some of your appreciated stock holdings and use that money to replenish the cash equivalents.''

Here's how the strategy would work. Start with three years of living expenses and determine how much of those expenses can be met from reliable sources of income such as Social Security benefits, pension payouts, fixed-income annuity payments, or a part-time job.

Say that covers 65 percent of your needs. The remaining 35 percent must come from your investment portfolio. Enough of your portfolio should be invested in safe cash equivalents to cover that 35 percent for three years. The remaining part of your portfolio might be in stocks, or stocks and bonds.

If you lost money during the three or six-month period, you have two choices. One would be to postpone replenishing the cash portion of your portfolio. You still have at least two-and-a-half years' worth. If you really feel the need to replenish the cash equivalents, but stocks haven't done well, Johnson recommends selling some of the bonds you may have in the portfolio, since they are apt to have lost less than stocks or even have increased in value.

Johnson also recommends using any stock dividends or bond interest to replenish the cash equivalent portion, rather than reinvesting the dividends or interest.

This three-year cash-equivalent strategy works whether your next egg is in taxable accounts, qualified retirement accounts or individual retirement accounts (IRAs), or a combination.

The only tricky part with qualified plans and IRAs is that generally once you reach age 70 1/2 , you must make minimum withdrawals from those accounts. If the amount of the minimum withdrawals is larger than the living expenses you need, Johnson suggests reinvesting the extra in stocks or bonds.

``This may be a lot of work for people, but from a financial standpoint the key is to avoid selling stocks when they are down,'' Johnson says. ``This will go a long way toward preserving your retirement capital.''