Batten Down the Hatches

Balance and variety can help your portfolio weather the whims of the market.

The downturn in the stock market has hurt many investors, but it's been particularly tough on retirees who depend heavily on their investment income. It's forced many to either move back into the workplace or cut expenses, while those close to retirement are postponing or altering their plans. If their portfolios had been properly weatherproofed, however, many might have avoided or mitigated this problem.

To overcome the whims of the market, the best mix of investments for retirees or those nearing retirement depends on age, needs, other sources of retirement income, and tolerance for risk. For example, despite the market's current weak conditions, retirees should remain in long-term stocks to some extent, because they usually stay ahead of inflation better than alternative investments.

So, how much should you have in stocks? It depends on your goals and risk tolerance. Forget the adage "100 minus your age"; this ignores factors such as other income from pensions and Social Security. Instead, focus on longer time horizons; this money will have to last the rest of your life, so if you're 65 you might need funds to last as long as 30 years or more. True, you won't have the cushion of a steady income to replenish your portfolio if you sustain losses, but you still have time to recover. A flight entirely to the stock market isn't an appropriate response, but neither is a flight entirely out of equity markets. That can lead to a well-defined program of "going broke safely."

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Whatever percentage is right for you, keep it well-diversified. Many investors mistakenly loaded up on tech stocks in the late 1990s. Since then, they've watched in agony as their tech-heavy portfolios have plummeted in value. As a result, many investors fled the market completely, in essence selling out at the worst time.

Even with today's difficult market, many well-diversified stock portfolios are down only 10 percent to 15 percent — some even less. For example, while tech stocks and large-company stocks have declined, small-company stocks, value stocks, and real estate mutual funds have done well.

Another key to weatherproofing your portfolio is to keep a couple of years' (preferably four to five) worth of needed income in cash and fixed-income investments. This prevents having to sell losing stocks just to cover basic expenses. This portion of your portfolio might include money market funds, certificates of deposit (cds), individual bonds, or bond mutual funds of different maturities. When the stock market recovers, you can sell some of your stock winners to replenish this safety buffer.

Unfortunately for retirees, interest rates are at their lowest levels in years. Cash payouts from such fixed-income vehicles as cds and money market funds have been sliced in half in many cases. Be sure to shop around — there's a wide range of cd rates (especially online). Alternatives to these vehicles include real estate investment trusts, which typically kick off strong dividends, and short-term bond funds.

After selecting the right mix, the final key is to keep it balanced regardless of what the market does. One of the mistakes many investors made in recent years was allowing the booming stock portion of their portfolio to dominate their investments. Once a category in your mix drops 5 percent to 10 percent, rebalance by selling winners and investing the profits in lower-returning segments. This is especially important for retirees because they generally don't have outside income to invest in lower-performing portions of their portfolio.

Finally, be comfortable with whatever mix you select. Retirees who worry about their portfolios, or near-retirees who've found themselves postponing their retirement, don't have the right mix.