Story first appeared in on WSJ.com.
Generating the most income in the safest fashion from a nest egg is the holy grail of retirement income planning. You obviously want your dollars to stretch as far as possible without taking on much risk.
The proper mix of stocks and bonds and cash is the mix that allows you and your parents to sleep at night. That may sound trite, but it is the only true gauge that works. Mom and Dad can look at all the charts and all the probabilities, but if at the end of the day the mix of assets has them paranoid that a market correction will wipe them out or leave them unable to afford their cost of living, then it is clearly the wrong mix. Thus, telling you what an appropriate mix might be for your parent is largely impossible. But there are a couple of generalities and rules of thumb around which you should begin helping your parent structure a nest egg.
Do not put all the money into CDs, savings accounts and bonds. Inflation will decimate those assets over time and that will not help a parent maintain financial security later in life.
Depending on a parent's age, put between 20% and 60% of the nest egg into high-quality, dividend-paying U.S. and global stocks to provide the necessary growth as well as income. Where your parent should be on that spectrum between 20% and 60% largely depends on age.
And remember: While we're focusing on managing the finances of elderly parents, many of the issues apply to your own retirement planning as well.
U.S. Stocks
Too many retirees tend to shy away from stocks for fear of losing their principal. Better to be ultrasafe than devastated by a dramatic downturn in the financial markets. However, given the potential length of time a retiree will spend in retirement these days, a nest egg really demands some exposure to stocks in order to survive for as long as a retiree does.
This is not an argument for investing in high-growth Internet stocks or biotechnology companies with unproven medications. No retiree needs exposure to the market's riskiest stocks.
However, it is an argument for owning stable, blue-chip companies, particularly those that pay dividends. These are big, brand-name firms that have a long history of growing their business year after year and that in many cases have an equally long history of spinning out a healthy stream of dividends -- companies like Pfizer, McDonald's, Wal-Mart Stores, Johnson & Johnson, Exxon Mobil and Coca-Cola. Mind you, those aren't recommendations of stocks you should go buy for your parent's portfolio. Rather, they're examples of the kinds of companies that make for relatively stable, dividend-earning investments.
Indeed, the best advice for the bulk of retirees is to own blue-chip stocks through a mutual fund, where the portfolio manager's aim isn't to shoot out the lights in the quest for capital appreciation but, rather, to own investments that along with modest growth prospects pay out a stream of dividends or other forms of income.
Foreign Stocks
A retirement portfolio should have a small exposure to overseas stock markets, particularly for retirees early into their retirement. While foreign stocks are often considered riskier assets than U.S. stocks, when you narrow your focus to developed markets like Japan, Australia and Western Europe, those shares are, statistically speaking, no more risky than what you find in America.
But they offer retirees some advantages. First, they typically pay meatier dividends (as a percentage of the stock's price). And they offer exposure to the growth happening in other economies, which can offset weakness in the U.S. economy. And potentially more important, putting some money to work in foreign markets exposes a portfolio to other currencies -- especially important when the U.S. dollar is weakening against other currencies.
Bonds
Even more than with stocks, you'll largely want your parent's bond portfolio in a mutual fund; bonds can be much more challenging to research individually because there are just so many of them. In general, stick to a broad-based, intermediate-term bond index fund (intermediate-term because bonds of between five and 10 years in maturity tend to deliver decent rates with only moderate risk).
You also should give some consideration to municipal bonds sold by the various counties, cities and agencies within your parent's home state. Most of these are tax-free at all levels, meaning parents owe no income taxes at a city, state or federal level on the interest income received.
One caveat you should understand about bonds and bond funds is that, generally speaking, owning individual bonds tailored to a parent's specific situation is preferable to owning a bond mutual fund.
But building a portfolio of individual bonds typically requires at least $100,000 in cash to adequately diversify across at least 20 different bonds in various sectors of the economy. Such a sum implies a much larger overall portfolio when you consider that your parent still needs exposure to stocks and cash. As such, individual bonds are out of the question for most retirees.
Certificates of Deposit
A CD ladder is essentially a series of certificates of deposit, each maturing at a different point in time. CDs are standard fare for retirees, and with good reason. The cash is in a rock-solid institution and will never accrue losses.
You don't need a specific amount of money to ladder CDs. You could, for instance, put $100 in three CDs, maturing respectively in one, three and five years. In practical terms, however, laddered CDs tend to make the most sense when a parent has several thousand dollars to spread out. That's where you'll see the biggest impact in terms of income.
With a $50,000 lump sum of cash, a parent has the option to put all of it in a one-year CD so that the money is available fairly readily, or the cash can go into five $10,000 CDs laddered across one-, two-, three-, four- and five-year periods, with some of the cash fairly readily available, and some of the cash locked up for a number of years.
