Building a Happy Retirement - Part 2
How to make your investments work harder for you

By Norm Coe, farm business consultant, First Pioneer Farm Credit, Claverack, N.Y

NOTE: This is the second of a two-part series. Click here for part one.

Folks are constantly looking for effective ways to build a nest egg for retirement. They often ask me questions like, “Where should I put my money so it works as hard as I worked to earn it?” This article explores four golden rules that help you answer that question:

• Put some money in fixed investments.
• Also invest in equities.
  
• Base your ratio of fixed investments to equities on several things: Your tolerance for risk is number one.
• Monitor the performance of your equities quarterly.
  

#1: Put some money in fixed investments.
One way to accomplish your retirement goals is to purchase certificates of deposit (CDs). CDs are a popular nonfarm investment that provide interest for a specified period of time, such as six months, one year, two years, etc. They are easy to buy at banks, and they come with no fees.

In addition, CDs are a very safe investment because the Federal Deposit Insurance Corporation (FDIC) insures your principal for up to $100,000.

While CDs or other fixed investments should be part of your investment portfolio, remember that even safe investments have risk associated with them. Two types of risk that you may not consider when purchasing a CD are:

• Changing interest rates due to the market. To reduce this risk, don’t put all your eggs in one basket. Instead, invest in several CDs so you can stagger their maturity dates. For example, say you plan to invest $100,000. Invest $20,000 in a one-year CD, $20,000 in a two-year CD, $20,000 in a three-year CD and so forth. Then when each CD matures, roll the principal and interest for that CD into a new five-year CD.
• Loss of purchasing power. An example of lost purchasing power is the car that you bought for $12,000 in 1990 cost $18,000 in 1999. And the $100,000 that you invest in a CD today will not have the same purchasing power when the CD matures. While CDs offer some growth if you reinvest the income, you actually lose purchasing power (and growth) if you use the interest for living expenses. To maintain your purchasing power, you need to follow golden rule #2: Invest some of your money in the stock market (equities).
  

#2: Invest in the stock market — More Risk for More Potential Reward.
By investing in the stock market, you can earn more money over time for retirement than if you put money into fixed investments alone. Even though your risk is greater than investing in CDs, your potential rewards are also greater. Whether you’re starting from scratch or have a few thousand dollars saved, the following basics will help get you going on the road to financial well being.

To invest in equities, you can buy stock of individual companies or you can invest in a group of companies through a mutual fund. A mutual fund is a collection of stocks, bonds and other investments, which the fund’s professional manager chooses to meet its investment objective. By reading a fund’s prospectus, you can find a fund whose investment objective matches your own.

Mutual funds reduce your market risk by spreading your risk across many different companies. That way, if the value of one company drops, the performance of the others helps to protect you against volatile changes.

History shows us that total return is on our side in the stock market if we just let time and patience work for us. This buy-and-hold strategy is important since an investment plan for retirement is by definition a long-term plan. You can be assured that your risk will decrease the longer you keep your money in equities. In addition, you can also be assured that on average your investment in the stock market will bring greater returns than if you invested the same amount in fixed vehicles over any five-year period.

The following chart shows average returns for different investment vehicles between 1925 and 1997. You can see that investments in equities far exceed investments in fixed vehicles. For example, the return for large company stock at 11.2 percent is about twice the long-term government bond rate of 5.2 percent, and both are higher than inflation at 3.1 percent.

Source: Ibbotson Associates

As a long-term investor in the stock market, you will be rewarded when your retirement funds increase in value and you are able to maintain your purchasing power.


#3: Base your ratio on your tolerance for risk.
Volatility in stock prices is a market characteristic that’s difficult to predict. From 1925 to 1997, small company stocks, for example, experienced real volatility, but they also enjoyed some of the highest price increases. Large company stock prices also experienced volatility, but they saw less dramatic drops and lower (but still very respectable) returns.

You need to assess your feelings about volatility in the stock market, and how you will feel when your investment drops. Give as much attention to this important characteristic of the market as you give to your potential higher rate of return.

When you invest in the stock market, your goal is to focus on long-term results and ignore short-term gyrations. If you will lose sleep in the downturns, then start by making smaller, more cautious investments in the market.

By the way, you also want to consider your age in this decision. Your ratio of fixed investments to equities may need to be adjusted based on your age, and how close you are to retirement. Talk to your financial adviser about a smart ratio for your risk tolerance, your goals and your age.

#4: Monitor performance quarterly.
Most important of all to the long-term success of your investment portfolio is paying attention. You need to check up on your investments regularly to see if they are matching or beating the market.

Just as the sports section of your newspaper carries the latest scores to help you follow your favorite sports team, most business sections carry stock information to help you follow the performance of your long-term investment portfolio.

Unlike sports, however, you need to check stock performance quarterly rather than every day. Set aside time to review your portfolio at least once every three months. While you shouldn’t be glued to the newspaper or computer screen tracking your investments on a minute-by- minute basis, tossing them in a drawer and forgetting them is not a great idea either.

The stock market has many different indexes to help you track your mutual fund’s performance. Here are the most frequently talked about indexes:

• Dow Jones Industrials. An index of 30 large U.S. companies, such as Proctor and Gamble and Coca-Cola.
• Standard & Poor’s 500. 500 of the most widely held U.S.-based common stocks, chosen by S&P for market size, liquidity and sector representation, such as General Electric and Exxon Mobil.
• NASDAQ. Includes a large number of technology-oriented growth companies, such as Cisco, Intel and Dell Computer as well as many smaller and less well-known companies.

The right index for you depends on your portfolio mix. To check the record of your funds, compare an individual fund’s year-to-date rate of return to the performance of the appropriate index for the same period. You can find this information in the business section of your major area newspaper under “Stock Market Indexes” and on many financial Web sites.

While we aim to hold on to our investments for the long term, we also know that sometimes a good buy goes bad. When you assess your fund’s performance, you want to know that nothing has changed in the business and that your original investment is still correct. Sometimes you may need to adjust your strategy, but be sure to discuss your thoughts with your financial and tax advisers first.

Flexibility

Call your local First Pioneer office for help planning for your financial future. We are happy to help you develop a retirement savings plan, analyze the best choices for your retirement or help you develop estate or business plans. You can also contact us at info@firstpioneer.com for more information.

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