Safe Investing-A Balancing Act
Many times, when people are about to retire, they may adjust their retirement portfolios to reflect conventional wisdom: safety, income, and growth. They worked hard for that money and do not want to lose it. The prospect of not working worries them. Their portfolio needs to replace their current income while negating inflation and keeping a certain standard of living. There is no magic solution for this problem except in a perfect world. Since there is no one solution, a balance between solutions is necessary. Realize that any solution to safety, income, or growth will affect the other.
Do Not Eat Your Seed Corn
One piece of advice commonly given is “do not touch the principal”, or “do not eat your seed corn”. This metaphor probably came from agricultural-based times, but can lead to many problems. For example, an investing goal should be to eliminate risk, but this advice can create more risk. It can lead to over conservatively managing investments such as “living on interest and leaving principal intact”. Then, when interest rates go down, the advice requires investors to accept more risks for the same amount of income. One can develop a portfolio that limits principal fluctuations, but there is a risk of missing investment opportunities.
Do Not Invest Too Much in Alternative Investments
Too much refers to a proportion, not a dollar amount. Alternative investments sometimes have longer surrender periods and/or higher/more fees. For example, sometimes investments like these have simple interest as opposed to compound interest. One pays interest on interest while the other pays interest once, then you start over. Another reason alternative investments may not be for you is that the payback may be principal first and interest at the end. This can look like a “guaranteed growth rate”, assuming you are still alive. Do not trade safety for more income.
While one might could live on dividends, concentration on such does not allow one to be completely diversified. This brings up opportunity cost: how many other opportunities are you willing to forego? In addition, dividend investing is not a good tax strategy when trying to minimize taxes. Standard knowledge tells one to focus on either high dividend yield or high dividend growth rate. But one needs to be careful when doing this remembering that high-yield implies a high risk.
The Total Return Approach
This view does not focus on individual sources of income. This view allows one an opportunity for full diversification, allows you to get market returns, and provides an investor with tax efficiency. In addition, allocating your portfolio correctly can produce the goals mentioned: safety, income, and growth. Remember that these goals often contradict each other. Safe investing of your money is truly more complicated than you may think.