It is becoming apparent that the No. 1 concern of investors today is if they will have enough income to sustain the lifestyle they wish to have in retirement. A stock market that has been flat for about the last decade has squashed dreams of an easy retirement based on continuous, above average capital appreciation. Extremely low yields on guaranteed fixed income investments leave those who thought they could safely save and retire shaking their heads.
Add in complicating factors of the healthcare debate, tax rates and longer life expectancies and it is easy to see why many are worried. Still, despite our recent troubles, I don’t believe that the logic behind a diversified portfolio has been totally turned on its head.
Generating a reasonable total return in the mid-single digit range, which can then be accessed to support household cash flow in retirement, does not have to be complicated. Let’s review some basics:
n Equities — Owning a share of corporate America through purchase of common stock has proven to be one of the best wealth-builders over time. High single-digit returns from capital appreciation and dividend income over long periods is a reasonable expectation based on history. Primary risk is failure of the corporation.
n Bonds — Bonds are loans made by the investor, who is paid interest for the use of the loaned funds. These fixed-income securities are issued by governments and corporations with a promise to pay periodic interest and principal at maturity. Bond returns vary with the risk level of the issuing entity, but generally range from 3 percent to 10 percent annually during “normal” times. There are risks in owning bonds related to potential default of the issuer and fluctuations in value during periods of rising and falling interest rates.
n Cash — Cash investments, including money market funds and CDs, do not fluctuate in principal value and pay low levels of interest. They are great for funds which have a designated purpose in the very near term, or for a reserve held for emergencies or investment opportunities which come along. We never expect returns on cash investments to outpace inflation on an after-tax basis, and tend to average around 3 percent historically, but are much lower today.
Using investments from these three categories in a common sense way to construct a portfolio and should allow investors to create a mid single-digit rate of return, and keep volatility reasonable enough to avoid having to hit the panic button. Even a simple 1/3 – 1/3 – 1/3 mix of these investments could have generated a return (using major indexes for return estimates) of a little more than 3 percent a year for the last 10 years, a period where the stock market component of the plan returned effectively zero.
Of course, what goes around comes around and lately, the equity component of the portfolio would be providing the bulk of recent returns. And future results may be better if equity returns go back even close to historical levels.
My message for 2010 is unchanged. Have a plan, don’t change it for news events or react emotionally, both of these tend to reduce returns over time. There are many ways to invest, but changing plans like the wind is the surest way to lose.
Tom Breiter, the president of Breiter Capital Management, Inc., a registered investment adviser, can be reached at (941) 778-1900 or by e-mail at tom@ breitercapital.com.