Wednesday, October 28, 2009

The Aha! Moment

There is no doubt that an enormous amount of confusing information is still floating around about retirement planning. Folks are trotting out old mares, suggesting that slow and easy is still the best approach. Some a taking the rider off the horse altogether, instead putting them in a wagon - you know, for safety's sake. Others still are suggesting that if you don't whip this beast more than you currently are (I am in this camp) you will run out of money when you retire. That is, unless you keep working until you are so old, retirement lasts only a decade or so.

How do you sift through it and come up with a feasible plan, one that takes into consideration all of the threats and possible missteps that can occur? How do keep the plan rigid enough that you can make better-than-probable predictions about what you might be able to live on and how not to outlive your money?

Risk is in the Spotlight
Judging from what I have encountered, it must be very difficult indeed. Risk has jumped to the forefront of conversations. Many investment advisers are falling back on this thinking: If you lose less than you thought you would, then you can give us credit for suggesting the low-risk approach to your retirement investing. On the other hand, who will get the blame if what you projected your retirement accounts to hold comes up a decade short of where it should be?

We have spoken about the risk of too little risk. We have discussed the effects of only looking at upside potential, ignoring the downside (diworsifying) as an indication of future returns.

We Want New
Yet there are still those that think protection of assets is what your tax-deferred accounts should be. This is understandable. We want fast fashion as economist Juliet Schor describes it. If what we had no longer seems to be working, then something new, something better might work. For many of us who have never tried it, the something new often means less risk, not more, fewer opportunities to grow your money by slowing the potential to a trickle. This approach relies on a much heavier stake than many of us are accustomed to doing: increasing our contributions.

The gradual shift from stock exposure to bond exposure over time is a sort of false diversification. Yes, there was a ten-year period when bonds did better than stocks. And there was a twenty year period when stocks did better than bonds. In either instance, the differences were almost insignificant. Neither has outperformed the other so indisputably that you should go with one or the other.

Which is why so many suggests a mix of the two. But this ignores innumerable possibilities, allowing what could be beneficial to fall by the wayside. It encourages single index investing (if you do it outside of the popular target-date funds) and relying on a mutual fund manager to do it for you (inside a target date fund).

Doing this, you pass up the international and emerging market exposure that global investing has become. Tying your fortunes to one country, no matter how you structure your investments is no longer diversification.

There is the lack of investor acknowledgment that commodities drive a great deal of our marketplace and invested by the right hands, can add some protection over long periods of time. This cannot be accomplished inside funds that promise to decelerate your risk exposure over time using what would appear to be conventional techniques. Not to mention the fact that these funds have not been around long enough to have any provable track record, and now, their exposure to stocks has found the concept worthy of SEC scrutiny.

You can add a great deal of the risk you need simply by keeping your 401(k) actively involved. This is where you should harbor the risk you need to undertake the difficult goal of creating enough wealth. This will come at a cost that many are suggesting is not worth paying. Increased fees can be problematic, but some exposure to these markets through index funds that track smaller and more specific areas often harbor competitive fees and far better returns than their large company counterparts.

Index funds that track the largest companies or mutual funds that mimic indexes should be kept on the outside of your tax-deferred retirement accounts. (I make this argument here.)

So How Much is Retirement Going to Cost?
Attempting to predict what your future needs in retirement will be is as easy as looking at your current spending and debts. How much of those bills will you be carrying into those golden years?

If you look at your retirement plan as a risky undertaking, something you can orchestrate to be in the right place at the right time - or better, diversified enough that no one place hurts the whole of your investment plan - then you will find yourself looking to stocks as a greater portion of your portfolio.

If you still want to add a conservative element to your plan, I suggest that any new investment contribution should be directed towards that, a move preferable to diverting funds away from another investment. The key isn't increased risk, it is maintaining levels of risk that allow portfolio growth and it is increased contributions.

Paul Petillo is the Managing Editor or and a fellow Boomer

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