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Investing for retirement security

By Barbara Whelehan ·
Monday, March 5, 2012
Posted: 10 am ET

In Friday's blog post, called "Averting retirement disaster," I described the risk-averse approach to retirement planning that Erin Botsford writes about in her book, "The Big Retirement Risk: Running Out of Money Before You Run Out of Time."

I'll reiterate: It's a must-read for those who are approaching retirement. If you don't want to subject your portfolio to the whims of the market and take a chance on having to postpone your golden years due to market mishaps, you need to adopt a defensive stance. But how can her philosophical investing approach be put into retirement-planning practice?

A hypothetical couple's retirement plan

I asked Botsford if she would design a portfolio for a hypothetical married couple, age 55, with $500,000 between them in retirement accounts, plus a cash-balance plan worth $130,000. They want to retire at 62 and plan to continue saving 15 percent of their income in their respective workplace plans until then. They expect to have the house paid off by the time they retire. They will need a minimum of $4,000 a month to meet basic needs and would like an additional $2,000 a month to fund vacations, hobbies and dining out. They harbor no illusions about buying a second home or a boat.

How should they allocate their portfolio now, and then at age 62?

Botsford stipulates that each couple's circumstances are different, so this would not be a one-size-fits-all solution. But here's her advice for the hypothetical couple while they're in their mid-50s: Allocate 50 percent to short-term bonds, another 30 percent to intermediate-term bonds and 20 percent to blue-chip stocks at this point in time.

"This couple is close enough to retirement that they should not be taking any significant risks with their investments," Botsford says. "Since they have the ability to invest tax deferred into their 401(k)s and have a company match, it makes sense for them to continue to do so.  However, investment options are often limited inside of 401(k) plans. They should consider short-, medium-term bond funds to get some return on their money without taking too much risk from a high-equity position."

If all goes according to plan, Botsford calculates that their retirement portfolio will be worth about $835,000 in seven years if they continue to contribute 15 percent of their salary, assuming a 4 percent annualized return.

The distribution phase

The couple's after-tax needs are $48,000 per year, and Botsford projects that their Social Security benefits would amount to about $28,000, assuming a tax bracket of 15 percent.

"This leaves a shortfall of $20,000 to cover their needs," she says. "I like to use lifestyle investments to fund the needs category. These could be investments such as bonds, annuities, non-traded real estate investment trusts and a number of other similar investments. These are all income-producing investments that, as of today, we should be able to get an average income of 5 percent from. At their 15 percent tax bracket, it would take $470,000 invested in these types of products to produce the additional $20,000 needed.

"Next, our couple told us they wanted an additional $24,000 a year to use for leisure activities," Botsford continues. "These types of expenses I am more comfortable funding with hybrid investments. Remember, these still produce an income but may be more risky than our lifestyle investments. However, they typically come with a higher return in exchange for that risk. These types of investments could include master limited partnerships, dividend paying stocks, bonds and a variety of alternative investments. At an average rate of return of 7 percent from this portfolio, it would take approximately $400,000 to get the couple the additional $24,000 a year they wanted."

The hypothetical couple could put the rest of their money, about $100,000 from the cash balance plan, in an emergency fund, or they could invest that money in stocks or stock funds that provide more growth potential, she says.

"At the end of the day, in order for you to feel successful with your investments, they need to be structured to match your specific lifestyle expenses," Botsford says. "There is no one-size-fits-all strategy when it comes to investing. Examine your lifestyle to see how much cash flow you need, and then look for appropriate income-producing investments to get you that cash flow. Ideally, you are able to live off the income for the rest of your life and can leave the principle to future generations."


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Barbara Whelehan
March 10, 2012 at 10:34 am

Hi Dun -- You're referring to an article I wrote in January 2011 called "Social Security benefits vs. taxes" in which I wrote about a study showing that we get a whole lot more out of Social Security than we put in via the payroll tax. Social Security was put into place to prevent people from living in poverty in their old age, and I firmly believe that it's an important part of our system and that it accomplishes that goal for the most part. Of course, it's time lawmakers intelligently address the upcoming shortfall in Social Security funding. I agree that you can invest your earnings and reap huge benefits; that's why we should be maximizing our workplace retirement plans and IRAs -- so that we can maintain our lifestyle in retirement. Social Security was not designed to do that. That's my opinion. Thanks for writing.

Dun Scott
March 08, 2012 at 9:59 am

Hey, Barbara! thanks for the article -- I want to get a better undertsading of your coment -- " A male average earner who retired at age 65 in 2010 paid out $345,000 in total Social Security and Medicare taxes, but will receive $417,000 in total lifetime benefits ($464,000 for a woman)."

Isn't it true that if that average malke had invested the taxes he paid instead at a modest rate -- say 4 % -- he would OWN a chunk of capital -- probably about $800,000 - on which he could earn a retirement income AND pass it on to his heirs?

That seems like a much better deal than the current Ponzi scheme. What do you think?

Dun Scott