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 This will allow for the portfolio to grow in value even as money is being withdrawn each year for living expenses.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:
Asset allocation strategy for the Millers
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.