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Four steps to a more secure retirement portfolio


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by Diane M. Pearson, CFP

The best way to ensure a financially secure retirement is to have a comprehensive plan. And that means having enough money to last for 30-40 years beyond one's working life, allowing for the possibility that you'll live to be 100.

Think that sounds like a stretch?

Within the next 10 or 15 years, it is widely expected that there will be a big leap in human longevity that will radically change our society, primarily due to advances in medicine, genetics, and technology.

With people living longer-and with about 76 million baby boomers nearing retirement-it is more important to plan much further ahead for retirement and beyond than ever before.

The following are four steps that you can take to help ensure a more secure investment portfolio for your retirement years.

Step #1: Understand the hidden risks in your portfolio

When asked to identify what forces pose risks on investment returns, few investors recognize inflation as a likely counterpart.

Yet for traditionally risk-averse retirees, increasing consumer prices often pose the greatest risk of all.

Older investors have historically favored lower-yielding investments such as CDs, money market accounts, and treasury bills, which have a far lesser chance of maintaining purchasing power.

Inflation is expected to inch upward as the economy gains its footing. Therefore, investment portfolios must be tailored accordingly.

Step #2: Be willing to diversify

It is important for investors to look beyond traditional stock and bond allocations to find steady, low-risk returns. True diversification is the process of spreading noncorrelated investments across asset classes (they tend not to move in tandem).

Although large and small U.S. stocks move in nearly identical patterns, asset classes such as international real estate, commodities, alternative fixed-income investments, managed futures, currency investments, and hedge-like investments exhibit return patterns that are different from Standard & Poor's (S&P) 500.

The S&P 500-an index consisting of 500 stocks chosen for market size, liquidity, and industry grouping-is designed to be a leading indicator of U.S. equities.

The combination of these investments in conjunction with bonds and large U.S. stocks helps protect the overall portfolio in troubling market conditions while allowing it to participate in market gains.

Portfolios built on this premise are likely to earn returns typically associated with stocks while exhibiting almost bond-like risk levels.

Step #3: Understand the relationship between bonds and interest rates

There is no doubt that fixed-income investments play a critical role in the formation of a retiree's portfolio.

However, the pricing of nearly any fixed-income instrument is directly related to movements in interest rates. Prices of bonds go down as interest rates rise.

Unfortunately for those currently nearing retirement, this can have a dramatic effect.

However, it's important to note that not all fixed-income investments have the same sensitivity to interest rate fluctuations.

Some alternative fixed-income vehicles, such as bank loan mutual funds, floating rate mutual funds, and Treasury Inflation-Protected Securities, adjust in value in the same direction as interest rates.

Investors facing retirement should examine the fixed-income investments in their portfolio to determine how sensitive they may be to shifts in interest rates.

Step #4: Make tax efficiency a priority

Even in retirement, the lack of tax efficiency remains one of the biggest detriments to overall portfolio performance.

The following are a few tips to increase efficiency:

» Keep detailed records of cost basis. This enables investors to identify specific share lots for the tax-efficient selling of gains and the timely harvesting of losses.

» Do not reinvest dividends. This allows for an easier and more tax-efficient portfolio rebalancing, provides cash to live on, and spares investors from a tax-basis paperwork nightmare.

» Be aware of asset location. Fixed-income investments, hedge-like investments, and real estate investment trusts, when possible, should go into tax-advantaged accounts, because the majority of their returns are made up of ordinary income, whereas equities are prime candidates for taxable accounts.

Building a portfolio that takes into account both hidden and obvious risks, diversifying to minimize those risks, and avoiding unnecessary income taxes will provide a safe and secure retirement.

Editor's note: Pearson is the director of financial planning for Legend Financial Advisors, Inc., in Pittsburgh. Contact her by phone at 412/635-9210 or via e-mail at legend@legend-financial.com.