Wednesday, February 1, 2012

The Retirement Recipe

There are numerous analogies floating about concerning what retirement is. For each of us it represents something different. Perhaps it is only a dream, distant and more or less unfathomable. For others, it might seem close and still too far enough away to embrace the concept that one day you might actually do something different. And for Baby Boomers, the path is much clearer, the distance is much closer and the journey much easier to define.
But one thing that is certain: the retirement you envision is a recipe, a cooking lesson of sorts that follows some basic concepts and some self-determined experiments in taste. The degree of cooking you actually engage in when it comes to concocting this plate of retirement options is dependent on the desire and the passion you bring to the process.

Consider the effort it takes to make spaghetti. Everyone has made this at one time or another. Noodles are the prefect vehicle for a meal, sustainable and filling and without adornment, plain and simple. Spaghetti is like an index fund. 

It does a great deal but is not a stand alone ingredient. It needs enhancement, flavors and improvements to make it whole. Building a retirement portfolio with an index fund as the backdrop is an excellent place to begin.

The sauce can be that enhancement and once again, your degree of involvement in the process will make the dish much more vibrant and appetizing. Simply opening a store bought jar is fine for when you are inexperienced, but the concept of all of these ingredients pre-determined by someone else in a production plant somewhere other than your own kitchen is much like the target-date fund. These funds offer a combination of investments already mixed and stirred to the proportion dictated by your age.

For some of, this pre-mixed sauce of investment choices is flavor enough. Like many pre-made food products, the salt level is too high and these manufacturers do this for a good reasons. Salt is the ultimate flavor enhancer, and the perfect seasoning to make unappealing ingredients more so. Store bought jar recipes are quick and easy and for those who have taken the time and effort to make their own sauce (or as my Italian household refers to it: gravy) know the difference a little time and energy can provide to the plate of pasta.

But who has the time to make a great sauce/gravy? When it comes to your retirement plan or simply your investment strategy, we want convenience. But this isn't always the best strategy. A little effort, such as making a sauce/gravy recipe from scratch can make all the difference to the end result. The making of your retirement plan may seem complicated but in truth, it isn't as difficult as we often perceive it to be.

As I mentioned earlier, the index fund is a great foundation and is the pasta in this dish. The sauce enhances the meal's appeal and you can do the same thing with your retirement. We are by our nature prone to certain biases. We fear many things (such as loss) and we tend to follow what others have done (herd mentality). We think we know what we like and dislike but the bottom line is, we gravitate towards what we have been taught to like. In many instances, this is risk.

Risk is a necessary ingredient but it doesn't have to be risky. A portfolio of index funds or similar exchange traded funds can offer some spice to an otherwise risk-free and rather plain approach to your retirement plan. How do you add risk? The simple answer is diversification. Creating a portfolio of index funds (or ETFs) that spread the risk over large swaths of certain sectors can increase the risk without embracing too much risk. In other words, index funds provide seasoning in melodious way, adding flavors that are harmonious.

The subtle blend of not only an index funds that tracks the largest companies (an S&P 500 fund) can add nuanced flavors. Index funds that track mid-cap, small-caps, international offerings, emerging markets and bonds can create the broadest of opportunities for even the most conservative palates. And it can do so with low expenses.

But some have worried that using just indexes leaves the portfolio simply mimicking the cycles of the market. In other words, your attempt to get good flavor may achieve little more than what opening a jar of sauce might provide your spaghetti will. This is where the actively managed fund enters the equation.

While actively managed funds are continuously maligned in the press and by index/ETF advocates everywhere, they can add a kick to a portfolio in the right dose. Like many overpowering flavors, used in moderation can increase the enjoyment of the dish. I suggest moderation (which is another term for diversification) because too much can overpower; too little can make the process boring.

This sort of dish, once created and joined together, spaghetti and sauce, provide nourishment and satisfaction. And like your retirement plan, depends on how much is on the plate to get to that point. Few of us put a couple of strands and spoonful of sauce on the plate and expect to be satisfied. Your contribution, kept at a minimum is somewhat like that: not enough to quell the appetite. But if you pile it on, as many do, you will have a filling meal even if you don't eat it all. Your contribution to your retirement has similar results: more money when you do finally retire than you can consume.

Yes, the analogy is a stretch but the concept is clear: your retirement is dish made with care and served in heaping portions. What sort of retirement meal are you cooking?

Paul Petillo is the Managing Editor of and a fellow Boomer

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