Retirement Plans

Making Wise Decisions for Your Retirement Investment Portfolio

Saving money to fund a comfortable retirement is perhaps the biggest reason people invest. As such, finding the right balance between risk and investment return is key to a successful retirement savings strategy. Here are 5 suggestions for ensuring you make the smartest possible decisions with your retirement savings:

Construct a Total Return Portfolio
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One common way to create retirement income is to construct a portfolio of stock and bond index funds (or work with a financial advisor who does this). The portfolio is designed to achieve a respectable long-term rate of return, and along the way, you follow a prescribed set of withdrawal rate rules that will typically allow you to take out 4-7 percent a year, and in some years, increase your withdrawal for inflation.

The concept behind “total return” is that you are targeting a 10 to 20-year average annual return that meets or exceeds your withdrawal rate. Although you are targeting a long-term average, in any one year your returns will deviate from that average quite a bit. To follow this type of investment approach, you must maintain a diversified allocation regardless of the year-to-year ups and downs of the portfolio.

You take withdrawals using what is called a systematic withdrawal plan. Be cautious of how you project your potential results—when regular withdrawals are coming out in retirement the sequence of market returns can affect your outcome.

There are many variations to a total return investment strategy such as time segmentation and asset-liability matching, where safe investments are used to meet near-term cash flow needs, and growth-oriented investments are used to fund future cash flow needs.

The total return approach is best used by experienced investors, those who enjoy managing their money and have a history of making logical, disciplined decisions, or by hiring an advisor who uses this approach. When done right, a total return portfolio is one of the best retirement investments you can make.

Use Retirement Income Funds
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Retirement income funds are a specialized type of mutual fund. They automatically allocate your money across a diversified portfolio of stocks and bonds, often by owning a selection of other mutual funds. The investments are managed with the goal of producing monthly income which is distributed to you. These funds are constructed to provide an all-in-one package that is designed to accomplish a particular objective.

Some funds have an objective of producing higher monthly income and may use some principal to meet their payout targets. Other funds have a lower monthly income amount combined with a goal of preserving principal.

With a retirement income fund, you retain control of your principal and can access your money at any time. Of course, if you do withdraw some of your principal, your future monthly income will subsequently go down.

Buy Bonds
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When you buy a bond, you loan your money to either the government, a corporation or a municipality. The borrower agrees to pay you interest for a set amount of time and when the bond matures your principal is returned to you. The interest income, or yield, you receive from a bond (or from a bond fund) can be a steady source of retirement income.

Bonds have quality ratings to give you an idea of the financial strength of the issuer of the bond. There are short-term, mid-term, and long-term bonds. There are also bonds with adjustable interest rates, called floating rate bonds, as well as high-yield bonds, which pay higher coupon rates but have a lower quality rating. Bonds can be purchased as a package in the form of a bond mutual fund or bond exchange-traded fund, or you can buy individual bonds.

In retirement, individual bonds can be used to form a bond ladder with maturity dates set to match your future cash flow needs. This investment structure is often referred to as asset-liability matching or time-segmentation.

The principal value of bonds will fluctuate as interest rates change. In a rising interest rate environment, you can expect existing bond values to go down. If you plan on holding the bond to maturity principal fluctuations won’t matter. If you own a bond mutual fund and need to sell it to use the funds for living expenses, principal fluctuations will matter.

Buy bonds for the income they produce and/or for the guaranteed principal you will receive when they mature—don’t buy them expecting high returns, or expecting to make a gain on capital appreciation.

Rental Real Estate
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Rental property can provide a stable source of income, but there will be maintenance requirements, and when you own real estate, you will inevitably incur unanticipated expenses. Before you buy rental property you need to calculate all the potential expenses you may incur over the expected time frame you plan to own the property. You also need to factor in vacancy rates—no property will be rented 100 percent of the time.

Investment property is a business, not a get-rich-quick proposition. For those with real estate experience, or those who want to put the time in to make it a business rental real estate can make a great retirement investment.

If you’re not sure where to start, consider reading books on real estate investing, talk to experienced investors, and join a real estate investment club.

Don’t go out and start investing in real estate without doing your homework. We see people jump on the real estate bandwagon simply because they knew a friend or neighbour who did very well with real estate. Your friend or neighbour may have knowledge or experience that you don’t have. Getting into an investment because someone else was successful with it is not the right reason to do it.

Keep Some Safe Investments
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You always want to keep a portion of your retirement investments in safe alternatives. The primary goal of any safe investment is to protect what you have rather than generate a high level of current income.

I recommend all retirees have some a reserve account (an emergency fund). This account should not be included as an asset available to produce retirement income. It is there as a safety net; something to turn to for unforeseen expenses that may come up in retirement.

Also, if you are not sure what to do with your money, park it in a safe investment while you take the time to make an educated decision. Too many people rush to put their money into an investment because they feel like it should not be sitting in the bank for too long. They end up making a rush decision, which is never a good idea.

Making thoughtful, well-informed investment decisions takes time. While you are educating yourself or interviewing advisors it is perfectly okay to park your money somewhere safe. No reputable professional is going to pressure you into making a quick investment decision. If you’re feeling pressured you may not be dealing with someone who has your best interests in mind.

If you’ve made it to the end of this list, congratulations! Learn all you can, and remember, it makes the most sense to choose your retirement investments as part of an overall investment plan. Investments are best chosen to work together—not as individual solutions. All 5 options presented can be mixed and matched and used as part of a plan.