When investors have a
balanced portfolio (approximately 50 percent
to 60 percent in stocks and 40 percent to
50 percent in bonds), I tell them that they
can expect to withdraw about 4.5 percent from
their portfolio each year for income. This
will allow for the portfolio to grow in value
even as money is being withdrawn each year
for living expenses. In the Millers' case
this would result in an income of $36,000
from their investment portfolio.
Since the Millers are currently only earning about 5 percent in their CDs and bonds, this does not allow the portfolio to both fund their lifestyle and grow in principal at the same time. At 3 percent inflation, prices double in 24 years, so the Millers can expect to have their standard of living reduced by inflation in the future. Even though a more balanced portfolio of stocks, bonds and CDs could result in short-term losses, it is the best alternative for long-term prosperity.
Reposition assets for long-term growth
The Millers need a diversified investment portfolio. Jim's reluctance to invest in a more balanced portfolio is not unusual among new retirees. He knows it is very unlikely he will be adding new assets to his nest egg for the rest of his life, so he is disinclined to invest in anything that could result in loss of principal. Even though the risk of short-term loss to principal is real, he cannot afford to absorb the long-term damage that inflation will certainly do to his investments.
I recommend that the Millers invest 50 percent of their portfolio into stocks and 50 percent into fixed-income investments. The overall portfolio should look similar to the following:
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Asset allocation strategy for the Millers |
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This portfolio has the risk of short-term losses if the stock market were to go down over one or two years. But overall, the long-term inflation protection provided by the portfolio outweighs the short-term risks.
The Millers face a dilemma
that is all too common in America today. They
have saved wisely during their earning years,
but now face unexpected medical bills that
may derail their retirement dreams. Facing
the reality of their health coverage needs
head-on will give them the best chance for
a successful financial future. Educating themselves
about the long-term risks of inflation, while
at the same time understanding the nature
of short-term fluctuations in the financial
markets, will help them use their financial
resources wisely to produce the most income
for the long term.
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