When the Mix Is the Biggest Challenge

Bruce and Beverly Cosper of Arroyo Grande came late to the stock market. The couple started seriously investing in equities only seven years ago, when Bruce was 68 and Beverly was 60.

The Cospers now have half their nest egg in stocks, the other half in bonds. Yet despite double-digit losses on some of their stock funds this year--and increasing talk that the nearly 8-year-old bull market may have ended--the couple have no plans to change their portfolio mix.

In fact, they plan to rebalance their portfolio later this year with the help of their financial planner and will buy more stocks if necessary to keep their 50-50 mix.

“People are panicking over this,” scoffs Beverly, 67. “We have some faith in the American system. We’re going to continue on with our investing.”

By contrast, Phil and Blanca Ross of Fullerton trimmed their stocks from 75% of their portfolio to less than 33% in recent weeks, and Phil, 68, wishes they had bailed out sooner.

“I’m erring on the side of caution, since I’m retired,” he says.

Although the stock market’s gyrations have rattled many individual investors--most of whom have never experienced a true bear market--retirement-age investors face a unique set of needs and challenges in coping with the turmoil.

In fact, the decisions these older investors make now could determine whether their last years are comfortable or comfortless, financial advisors say.

The good news is that today’s retirees have significant buffers against stock market swoons. Most have Social Security to fall back on, and many have pensions and significant home equity as well.

Still, financial missteps by retirees--including losing a significant sum in the stock market--can have serious consequences. Whereas working people can save more, put off retirement or pick up a second job if their investment plans falter, options are often more limited for retirees.

“When you’re younger, you can take bigger risks, because if you do lose, you can make it up with your income,” said Earl Gross, a retired insurance broker from West Hollywood. “But I’ll be 74 this month, and I don’t want to go back to work.”

Memories of ’29 Crash

Current retirees and older investors also know just how far stocks can fall. Many remember the Depression-era bear market that slashed the value of the Dow Jones industrial average by nearly 90%; the Dow took 25 years to recover its former high.

While subsequent bear markets have been shorter and recoveries quicker, the damage the 1929 crash inflicted is never far from many retirees’ minds.

“I remember what it was like even though I was small,” said Lonell Spencer, 69, a retired machinist who keeps the bulk of his retirement funds in bank certificates of deposit. “You don’t ever forget what people went through.”

Some simple math speaks volumes about stock market risk: An investment that falls 50% in value must then rise 100% just to get back to even.

Even so, most financial planners argue that retirees need to keep at least part of their nest egg in stocks at all times, because historically stocks’ returns have outpaced the inflation and tax bites that steadily erode retirees’ buying power.

“There’s nothing magical about turning 65 except that you’re one day older,” said Joel Framson, a financial planner where and past president of the California Society of Certified Public Accountants. “You still need growth. You have 20 or 30 years of retirement to get through.”

Although inflation has been in the 2% range in recent years, there’s no guarantee it will stay there. An annual inflation rate of just 3% would cut the buying power of today’s dollar to 50 cents in about 23 years. At 5% inflation, prices would double in 13 years.

Stocks, meanwhile, have historically returned about 11% annually on average, despite regular bear markets. That is well above the historical returns on long-term government bonds (5.2%) and short-term money market securities (3.8%).

What’s more, because long-term capital gains are taxed at a maximum of 20%, whereas interest income is fully taxable as income, stocks’ long-term returns are more substantial on an after-tax basis.

Nevertheless, lower-returning bonds, money market investments and bank CDs offer retirees something that stocks can’t guarantee in the short term: capital preservation.

What Dictates the Mix

The challenge for retirees, perhaps much more so than for younger investors, is coming up with the proper mix of stocks, bonds and “cash” accounts.

For some, the mix is dictated by the amount of money they feel they’ll need in order to live comfortably in later years.

Jerry Olsen of Irvine feels he has little choice but to stay heavily invested in stocks. The 70-year-old engineer started saving for retirement just 10 years ago, and by his calculations he needs a 10% annual return to retire in five years.

So Olsen expects to keep about 90% of his 401(k) plan in equities; his investments will eventually supplement his company pension and the Social Security checks he already receives.

“I’m running more risk, but I have to,” Olsen said.

Helen Berger of Newport Beach is at the opposite end of the scale. The retired homemaker lives comfortably on her bond investments, which consist almost entirely of Treasury securities, some of which now pay less than 6% interest.

Berger said her savings are sufficient that she doesn’t have to invest in stocks.

“I didn’t make a killing in the stock market like my friends did, but I have a pretty good income,” she said.

An investor’s asset allocation should also take into account his or her emotional ability to tolerate stock market swings.

Robert Wacker, a San Luis Obispo financial planner, suspects many investors who thought they were prepared for a stock market drop found out they weren’t amid Wall Street’s harrowing August decline.

“Before, it was still all hypothetical. And now they’re there,” Wacker said.

One of Wacker’s retired clients, who is in his early 60s, insisted on selling all his stocks two weeks ago despite Wacker’s efforts to dissuade him. Wacker, past president of the fee-only National Assn. of Personal Financial Advisors, had already reduced the client’s stock assets to 55% of his total portfolio--lower than the 60% to 70% Wacker typically recommends--but the investor panicked at the six-figure losses his $1.2-million portfolio sustained.

Planners say such sudden moves, driven by emotion, are usually ill-advised. Investors risk being out of the market just when stocks turn around; then investors have to buy back in at higher prices, missing some of the growth they may need long-term.

Weighing Risk, Need for Returns

Experts advise that older investors who now feel overexposed to stocks--perhaps because the long bull market has swelled their holdings--should instead gradually trim their stock assets, selling into interim rallies that are likely to occur even if the overall trend is lower in coming months.

But retirees must understand that taking less risk most likely will mean settling for lower returns--and less money to spend--in later years, Framson said.

Common wisdom has long been that retirees should lower their percentage of assets in stocks--and raise the percentage in fixed-income assets--as they age. One rule of thumb has been that your fixed-income asset weighting should equal your age.

Some financial advisors, however, use a different formula in setting older clients’ asset allocations.

Coral Gables, Fla., planner Harold Evensky helps keep his retired clients calm in rough markets by insisting they have at least two years’ expenses in cash investments and three years’ worth in bonds. The remainder of the portfolio stays invested in stocks.

That mix should allow retired investors of any age to ride out most stock market cycles, he said.

But that also means that retirees must be mindful about rebalancing their portfolios. Investors should rebalance at least once a year to return to their target mix, planners say.

That means selling some stock, and buying more fixed-income assets after the stock market has risen, and selling fixed-income assets in favor of stocks after the market has fallen.

In addition, retirees should resist the urge to splurge in their spending during good market years, to avoid having to cut back when the market drops, Wacker said.

“The excess [return] is there to offset the poor returns in other years,” Wacker said.

At the same time, retirees with a solid financial plan and properly diversified investments shouldn’t worry themselves into a Scrooge-like mentality, experts say.

If worse came to worst, many retirees could tap substantial equity built up in their homes.

Lonell Spencer and his wife, Marguerite, for example, paid $10,500 for their Arcadia home in 1953; similar houses in the neighborhood have sold for nearly $300,000. That’s an asset most younger investors can only dream about.

Fear of Tapping Principal

Finally, financial advisors note that there is a time when tapping principal--including stock assets--to live becomes almost inevitable.

Retirees who are at that stage may have to admit that selling some stock now may be the logical course--perhaps better now than in six months, at what could be much lower prices if a bear market is indeed underway.

Although some retirees have a deeply held aversion to tapping their principal, few investors are so rich that they can afford to leave their capital alone forever.

“You can start being afraid to spend anything,” Bruce Cosper said. “We want to enjoy ourselves. That’s what all the saving was for.”