Retirement Investing: The End Game

If you're approaching retirement, finding safety for your investments—especially in this environment—isn't as easy as locking your money away

By Ben Steverman

In times like these, it's tempting to squirrel away your hard-earned fortune in the safest place you can find: a federally insured bank, government debt, or maybe, if you're especially scared, convert it to cash and lock it in a big, strong safe.

The temptation is greater if you're lucky enough to already have all the money you need for retirement. You don't need to earn more in the market, so why not just protect what you already have?

If only it were that simple.

Unfortunately for skittish investors—especially those within hailing distance of retirement age—there is no obvious path to perfect safety.

Inflation, the Portfolio Killer

Of course, there are conservative investments. U.S. bank accounts and certificates of deposit are insured by the federal government (up to certain limits). You can be assured that most conservative money market funds won't lose money. Investors have no reason to worry that bonds issued by the federal government or financially secure state governments won't be paid back.

As a short-term protection strategy, these work beautifully. But over the long term, such conservative approaches can undermine even a massive fortune. The reason is inflation.

"Inflation is the big threat," says Milo Benningfield of Benningfield Financial Advisors in San Francisco. "It's the silent killer of portfolios."

And most investors should be thinking long term. A 65-year-old investor might need to cover 30 years of retirement expenses—something financial advisors call "longevity risk." (And a long, healthy life is one risk many of us wouldn't mind taking—even if it's a lot more expensive.)

Your portfolio may be safe from losses, but that's no help if it doesn't keep up with the rising cost of living. Economists and investors differ on the outlook for inflation in the near term, but even slow steady price increases can take a toll.

According to U.S. government data, in the 30 years from 1978 to 2008, the cost of energy for U.S. homes rose by 3.8 times. Increasing by 3.5 times were the average rent on a primary residence and the price of breakfast cereal.

Health-care costs are a special worry for retirees. The cost of inpatient hospital care is up 88% in the past 11 years.

Deflation, the Bigger Concern Now?

As investors have learned recently, however, the stock market is no easy fix for the inflation problem. The past 15 months have wiped out half the value of U.S. stocks, eating up more than a decade of gains for major indexes.

And there's the possibility—though not the likelihood—that conditions could get worse. Aaron Gurwitz, head of global investment strategy at Barclays Wealth, says investors should be more worried now about deflation—the threat of falling prices and asset values—than inflation.

Deflation is so destructive that it's the top enemy of the world's policymakers.

"Most likely all the things that all the governments in the world are doing will work," Gurwitz says. But, "a downside scenario is a lost decade," with no gains for investors. Long-term, high-quality government bonds protect against this scenario.

"We're not making this investment recommendation because we think it will make money," he says. "We're making it because we're worried it might."

TIPS, for Peace of Mind?

For conservative, risk-averse investors who are also worried about the long-term inflation threat, there is one relatively simple solution: Treasury Inflation-Protected Securities, or TIPS, are bonds issued by the federal government that are guaranteed to keep pace with increases in the government-calculated consumer price index.

There are disadvantages to TIPS, however. In the unlikely event of deflation, the value of your TIPS will decline. And in a low-inflation environment, your post-inflation earnings on TIPS will be low. One advantage is that, even after persistent deflation, you're guaranteed to get back at least your principal investment in the security.