Equities Are Part of a Balanced Financial Diet

When the Dow Jones industrial index drops 10% in a single month, as it did in August, it can be tough to persuade people to invest in stocks or stock funds.

It can be especially difficult trying to persuade anybody who’s nearing retirement age. Most retirees live on a fixed income, so they can’t afford losses. Besides, folks in their early 60s or older remember the stock market crash of 1929 and the economic devastation that followed. This explains why a lot of people in these age groups have a natural bias against equity investments.

Yet despite the risks, most people planning for retirement should have some stock market holdings, financial experts say. And the reason can be summed up in one word: inflation. “Most people ignore the inflation risk,” says Brian Roehl, an academic consultant at Educational Technologies Inc., a Troy, Mich., firm that conducts retirement-planning seminars for corporations.

Of course, inflation diminishes the purchasing power of everybody, not just retirees. But anyone on a fixed income will likely feel the impact severely. “People benefit from inflation in that their salaries increase over the years,” notes Bruce Grenke, a principal at Asset Allocation Advisors in Walnut Creek, Calif. “When you retire, that advantage ends.”

Certainly, Social Security and company pension plans go a long ways toward fulfilling retirement needs. But most people can’t depend on these sources to meet all their financial requirements. “As a general rule, pension plans and Social Security will pay 50% of the retirement needs for a typical person,” Roehl estimates.

While that percentage will vary according to individual circumstances, most people need to tap their savings and investments to defray at least part of their living expenses upon retirement. To build up an adequate nest egg, stock market holdings are your best long-term choice.

That’s because fixed-income instruments such as bonds, money market accounts and certificates of deposit have historically returned just slightly more than the inflation rate. From 1965 through 1989, for example, long-term government bonds returned about 6.7% a year, compounded, but only about 0.9% annually when inflation is factored in, according to Ibbotson Associates of Chicago. During much of the ‘60s and ‘70s, bonds were unable to keep up with inflation, as the accompanying chart shows.

By contrast, common stocks, as measured by the Standard & Poor’s 500, returned 10.2% annually (4.3% a year when adjusted for inflation) the last 25 years. Even if you exclude the high-flying ‘80s, stocks have averaged about a 9% nominal and 6% real annual return dating back to the 1920s.

Though there’s no guarantee that similar results will be seen in the ‘90s and beyond, the more time you have to invest, the better your odds of succeeding with an equity strategy. Many people nearing retirement feel that they have to play it safe because they don’t have much time to make up any losses. However, a person turning 60 today can expect to live to 85 or so, Roehl points out. “That means he has 25 more years to be invested in the market.”

Some investment advisers pursue an aggressive, equity-oriented strategy for all of their clients, young and old alike. Norman L. Yu, a Newport Beach money manager, restricts his purchases to high-growth stocks, many of which show above-average volatility. “Our clients range in age from the low 40s to the 70s, and they’re all in the same type of program,” he says.

Like many money managers, Yu generally accepts accounts of $100,000 or more. For people with less to invest, he suggests sticking with a well-managed growth stock fund. And rather than worry about volatility, he urges investors to exploit periods of market weakness by purchasing additional shares. In fact, he believes that, following the heavy selling in August, stocks are positioned for a strong rally later this year and in 1991--an upswing he thinks will take the Dow past 3,000.

Grenke isn’t so optimistic. Nevertheless, he recommends at least some equity holdings for just about everybody, at all times. For a person in or approaching retirement, he suggests placing even amounts of money in four areas: stocks, bonds, cash and real estate.

Grenke likes the Evergreen Total Return Fund (no load; 800-235-0064) for the stock portion, and either Vanguard’s Short-Term Corporate Bond portfolio (no load; 800-662-7447) or Fidelity’s Intermediate Bond fund (no load; 800-544-6666) in the fixed-income category. Money-market funds, certificates of deposit or Treasury bills all can work for the cash component, he says.

If you own a home, Grenke suggests that you don’t need any more real estate holdings. Otherwise, you could purchase a real estate mutual fund or real estate investment trusts (REITs), a type of stock market investment. At the moment, he’s not making such recommendations since the real estate industry has been hurting so much lately.

Roehl advocates a similar asset-allocation strategy. For investors within a few years of retirement, he suggests an equal mix among stocks, bonds and cash. For those planning to keep working several more years, he recommends 50% in equities and 25% in the other two categories. Only for retired people past 70 does he advise forsaking stocks in favor of a 50-50 mix of bonds and cash.

Roehl further suggests that you readjust your portfolio once a year to bring it back to its original composition. For example, if the bond market has rallied the past year while stock prices have fallen, you would sell some of your bond fund shares and add money to the equity fund. This is an automatic buy-low, sell-high strategy, he says, and an approach that does a bit better than a simple buy-and-hold discipline.

Certainly, no investment approach makes sense it if causes you to lose sleep at night. Unless you have an unwavering tolerance for risk, you probably would have trouble handling an all-equity strategy. But a retirement-oriented allocation that includes perhaps a 25% to 33% weighting in stocks or stock funds can provide growth potential without exposing your entire portfolio to excessive risk.

Grenke sees a parallel between a well-rounded portfolio and a balanced diet. An asset mix that includes equities, bonds, cash and real estate meets all the nutritional minimums. “It’s like the four basic food groups,” he says. “You need a bit of each.”

STOCKS AND BONDS: THE REAL STORY It’s not what you make that counts but what you keep. That axiom is often used to describe the tax bite, but it also says plenty about the impact of inflation. The following chart shows the after-inflation, or “real,” returns for common stocks, as measured by the Standard & Poor’s 500 index, and for bonds (long-term U.S. governments) from 1965 through 1989. All results are compounded and include reinvested dividends and interest, as compiled by Ibbotson Associates of Chicago. Note that stocks fared much better against inflation than bonds over this period.,