Take a Strategic Look at your Retirement Plan

By Mike Rowan, www.Erollover.com 2008

Before you begin drawing income from your 401k's, IRA's, and retirement accounts, make sure its asset allocation is the right one for your new circumstances. Unfortunately, it's easy have one of many misconceptions about common retirement beliefs.

Here are 4 you'll want to carefully consider:

1. Stocks pose too much risk for retirees.
Not necessarily. Chances are, if you were comfortable with a proportion of stocks in your portfolio before you retired, you'll be comfortable with some proportion for a time during retirement. For a retirement period that could easily last 20 to 30 years, you'll still need the growth that only stocks can provide. Over time, you may want to become more conservative.
2. Bonds are the best investment for retirees because they produce income.
The interest that bonds generate can indeed be an important source of income. Bonds also provide balance and diversity critical to all portfolios. But retiree portfolios need to be prepared for an amount of inflation-beating growth, too, which stocks have delivered by the widest margin over time. And there's nothing wrong with selling stock holdings for income.
3. For absolute safety, stick with cash investments.
These investments, which include money market funds, bank certificates of deposit, and Treasury bills, offer relative stability and safety. So they're a great place to store cash temporarily and to use as an emergency fund. However, since cash investments will barely keep ahead of inflation over time and typically yield far less than bonds, most retirees shouldn't keep a significant portion of their assets in them.
4. Don't forget about the effect of inflation!
You'll note that, in countering these investment misconceptions, the subject of inflation in retirement keeps coming up because inflation never retires. Even at a mere 3% annual inflation rate (the national average rate for the relatively low inflation period from 1986 to 2002)*, you'll need income of around $72,000 in 20 years to buy what $40,000 buys today.

Your individual inflation rate in retirement may be even higher than the national average. Retirees tend to use more health care services and pharmaceuticals, and these costs have been rising faster than the overall inflation rate by 5.4% a year over that same time period.**

Of course, inflation is only one factor to consider in evaluating the asset allocation of your investment portfolio. No asset class single handedly makes the best portfolio. For retirees, as for all investors a portfolio that includes all the asset classes can provide the right mix of growth, income, and stability and make the fluctuations in the financial markets tolerable.

Keep your portfolio balanced and diversified
Your goal in developing the correct asset allocation for your retirement portfolio should be to make sure it's well-balanced and diversified. Such a portfolio aims to control risk, as opposed to focusing on the highest returns.

Consistently and accurately predicting which investments will produce the highest returns is all but impossible, even for the experts, but you can control the level of risk by assembling and maintaining a well-thought-out asset allocation strategy. Unfortunately, many retirees have a collection of investments acquired over time, not an investment plan. If this is the case for you, it's possible you're exposed to more portfolio risk than you should be at this point in your life.

A balanced portfolio is diversified among asset classes to reduce risk: Subpar performance of one asset class can often be tempered by the performance of another. Wide diversification within an asset class is also a key risk-reduction strategy. This protects your portfolio from the unforeseeable temporary or longer-term problems that might afflict specific stocks, bonds, or other investments. That's why, for example, retirees who hold large amounts of their former employer's stock should probably shed much of it in favor of more diversified holdings.

There's no one correct asset mix because each person's financial situation and risk tolerance differ.

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