Only two years ago it looked as if any fool could build a retirement fund in stocks. Now even investors who didn't get crushed by the tech-stock collapse are learning just how hard it is to make money in the market.
Still, when we asked some financial planners for advice on what to do now, they in no way suggested bailing out of stocks. On the contrary, they're advising clients to save more and rearrange their portfolios to an age-appropriate diversified mix of stocks and bonds. They say the biggest mistake people can make is replacing the bulk of their equities with 30-year Treasury bonds, whose lowly 1.8% total return for the year through Dec. 14 looks good compared with the 13.9% loss for the Standard & Poor's 500-stock index.
"There are going to be many people who want to go late" into bonds, says Jerry Wade of Wade Financial Group in Minneapolis. "We feel that party is over."
SHIFTING THE MIX. Wade is one of three planners who provided us with suggested portfolios for investors of different ages: 45, 60, and 75 (table). Not surprisingly, the younger you are, the larger should be your concentration of stocks to allow for maximum growth over time. As you get older and come to rely more on the income from your investments, you should shift the mix more toward bonds.
For a couple in their mid-40s, Ross Levin of Accredited Investors in Edina, Minn., says the right mix is 80% stocks and 20% bonds and cash. He recommends making the investments through mutual funds, including exchange-traded funds, to increase diversification and reduce risk across more securities. The exception would be for clients who have at least $250,000 portfolios and can afford to buy enough different bonds to be diversified on their own.
Within the stock group, more than half should be in in large- and small-cap U.S. companies. He also suggests that 27% of the equity allocation go to international stocks. He now tilts toward smaller foreign companies -- using the First Eagle SoGen Overseas Fund -- because they're less likely to move in step with major U.S. market indexes than large companies based overseas. A much smaller portion -- 5% -- is reserved for investments than can help hedge risk. For that purpose he currently favors a fund that sells stock short, the Grizzly Short Fund.
OVERSEAS BONDS. Unlike many planners, Levin prefers that the bonds in his portfolios be government issues only. Corporate bonds carry company-specific risks that he likes to confine to stock holdings. "We're holding bonds as a mitigator of risk," he says. For the middle-aged couple, he recommends 10% in an international bond fund that hedges currency risk, such as Pimco Foreign, plus 5% in U.S. Treasuries, and 5% in money-market funds. Levin thinks the foreign bonds' yield is attractive and they will rise in value because interest rates abroad seem poised to go down more than in the U.S.
Among the Treasuries, Levin has been shifting lately toward the Treasury Inflation-Indexed Securities (TIIS). They promise a yield above inflation, so they work well to maintain a portfolio's purchasing power. Rising inflation could be a concern for investors when the economy rebounds, he says. But the securities are best kept in tax-deferred accounts because they'll otherwise create taxable income before they return cash.
Karen Altfest of L.J. Altfest & Co. in New York took a crack at a portfolio for an empty-nest couple of 60 who's still earning income. She says it's best to hold 60% stocks and 40% bonds through mutual funds. Within the stock group, Altfest says large caps are still too expensive compared with small- and mid-cap stocks. So she has pared back on the big issues. She recommends that only 17% of a 60-year-old's portfolio, or a quarter of the stock holdings, be in large-cap shares. Stocks of smaller and midsize companies, in which she invests 20%, have more room to grow and return value to shareholders, she says.
COUNTERING EXTREME MOVES. Within her "other" group, Altfest is shifting away from real estate investment trusts, which are pricey now, and toward oil and gas partnerships and merger-arbitrage funds. Such investments are great for countering extreme moves in the stock market. But they can be volatile on their own, so she keeps them around 3% for clients this age, compared with 7% for people in their 40s.
Like the other planners, Altfest has been backing away from long-term bonds, which had a good run in the past two years. Buying them now would mean unwisely locking in today's low yields. If long-term rates rise with a pickup in the economy and increasing demand for capital, the bonds will lose value. To reduce that risk, Altfest would invest nearly one-quarter of the portfolio in short- and intermediate-terms bonds, and only 8% in long-term issues.
She has no particular preference between Treasuries and high-grade corporates, which offer higher yields but carry the risk of credit downgrades from mergers or a business downturn. She also throws in a smattering of high-yield bonds, which are yielding 12.92% on average and stand to appreciate if the economy improves. She rounds out the mix with 3% in money-market instruments.
DELIVERING INCOME. Among retired couples age 75, Wade finds people want to have money left over when they die for heirs and charities. For them, he aims for a portfolio that retains the appreciation potential of stocks but still delivers income. Key to his strategy is allocating 17% to balanced funds that hold both bonds and equities, particularly stocks with high dividend payouts. Then he recommends putting 36% of the portfolio in stocks and 47% in bonds and cash.
In essence, he says, the portfolio is about 40% stocks and 60% bonds. The balanced fund has another advantage, says Wade: The hybrid should hold up well if uncertainty rises over future terrorist strikes. With bonds, Wade is also picking up income by putting 15% into high-yield issues. They're also cheap right now, he contends. The investment-grade bond holdings of 13% should be light on long-term issues, he says. And, Wade, too likes inflation-indexed bonds for 10% of the portfolio.
His portfolio has a special allocation of 5% for a health-care sector fund. Those stocks should hold up better in a troubled economy, he says.
But Wade hastens to add that no portfolio, no matter how young or old the investor, should be concentrated in anything. What's key to reducing risk and still building your assets is setting up and maintaining a diversified portfolio. "Stick with your game plan," says Wade. "When the market is hot or cold, don't jump off the train." That's steady advice for all times. By David Henry