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Dr. Don Taylor, CFA, advice columnist Reducing portfolio risk before retirement

Dear Dr. Don,
I heard somewhere that you should transfer a mutual fund into some sort of guaranteed interest account five years before retirement. Is this an urban legend or is it valid? I'd rather keep going in a mutual fund. Thank you for your time.
-- Dennis Distribution

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Dear Dennis,
I don't know if I'd call it an urban legend, but it is a commonly held notion taken to an extreme. As you approach retirement, your retirement investments lose the ability to recoup large investment losses. There aren't many "rebuilding years" left in the portfolio. A common reaction to that is to dial down the risk in the portfolio so the probability of a large investment loss is unlikely.

Switching to a guaranteed interest account five years before retirement is an extreme example of the decision to reduce risk in the retirement portfolio. The problem is that it only protects you against one risk -- the loss of principal -- and doesn't do anything to protect the purchasing power of that principal from inflation. Purchasing-power risk can be as big an issue in retirement as risk to principal. Both of these risks relate to another risk -- longevity risk -- in retirement. That is the risk of outliving your retirement income.

It's good to take a look at the big picture as you approach retirement and not just focus on one part of your asset base and expected retirement income. To the extent that Social Security and any pension benefits will provide a steady stream of income, they allow you to accept some risk in your investment portfolio. Owning your home free and clear, or at least having a large equity position in that home, also helps you to accept some risk in investing.

If you're having trouble putting the pieces of the puzzle together, get some professional help. A fee-based financial planner can help you sort through your income, assets and goals and build a plan that improves on using some conventional wisdom that isn't all that wise. This earlier Dr. Don column, "Picking a financial-planning professional," can help you choose a planner right for you.

To ask a question of Dr. Don, go to the "Ask the Experts" page and select one of these topics: "financing a home," "saving & investing" or "money."'s corrections policy-- Posted: March 3, 2007
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