Investing in Retirement: A Modular Approach to Building a Portfolio

By Christopher L. Hudson, Financial Advisor, CIMA

Your retirement distribution will most likely represent the single largest amount of cash and/or stock that you receive in your lifetime and upon its distribution, you as the recipient, will have to make several key financial decisions. The first decision is a tax decision: What is the best way to actually take this money given the options that are available and your own personal situation. The second, and equally important, decision concerns the management, or investment, of these funds.

Assuming you have decided to retire and take a lump-sum distribution, you must now look for investments that have the attributes, or characteristics, that can help you meet your objectives.

As life expectancies increase, the duration of your retirement might very well exceed that of your employment. During such a lengthy period, interest rates and inflation levels could fluctuate greatly, and the economic environment will constantly change. If you look back 20 or 25 years, you will find that some types of investments performed well within some portions of that time frame, while others performed well in different portions. This phenomenon obliges us to seek diversification in the portfolio - to accommodate the unknown changes that will inevitably affect your retirement investments.

When considering investments for the portfolio, you must remember that different investments have different attributes such as preservation of capital, income, growth, and liquidity. Outside of an IRA account, you might also consider whether an investment has tax advantages as well. Optimally, you would invest in vehicles that have the potential to maximize income, have good growth potential, are completely liquid, and have minimal risk. Unfortunately, there is no single investment that has every one of these characteristics, so trade-offs are necessary.

If you want to emphasize one attribute, let’s say income, you will, in many cases, have to subordinate growth and possibly even preservation of capital. If on the other hand, you want to maximize growth potential, you could very well limit your ability to generate income. For these reasons, diversification is needed in the portfolio.

All clients differ with respects to how much risk, or volatility, they are willing to accommodate in retirement as well as their definition of “preservation.” Similarly, clients vary in their need for growth and liquidity. One common need at retirement, is, of course, income. Whether from distributions or from other sources. To address these needs and concerns, we construct an investment portfolio that is modular in its approach. Through diversification, and a variety of different types of investments, our investment strategy provides growth, income, preservation, and liquidity.

Since a significant portion of the portfolio is devoted to FDIC insured CDs, AAA rated U.S. Government obligations and other, individually held, high quality fixed income investments, much of your principal will be invested for preservation and income. The remaining portion is allocated to inflation sensitive, growth oriented, investments like dividend paying stocks.

Since current cash flow is needed, most of the investments selected are designed to produce current or deferred income. The return of current interest and dividends, whether monthly, quarterly, or semi-annually, is used to provide current income.

Thus far we have invested for preservation, income, and growth. We must now provide for liquidity. This is accomplished by using fixed income investments with a staggered, or laddered, maturity schedule. Most of the investments are self-liquidating (maturing), therefore, we have largely eliminated the need to ask, “Is this the best time to sell”? The interest from these laddered investments would provide added liquidity as well.

To summarize, our investment philosophy is based on the acceptance of the following beliefs:

1. You most likely do not wish to re-enter the job market to generate your post- retirement income.
2. There is no one ideal investment, that is, there is no “one” investment that provides maximum income, preservation of principle, growth, liquidity, and performs well under all economic conditions. Hence, there is a need for diversification.
3. During your retirement, the economy will undergo changes, and interest rates and inflation will fluctuate unpredictably.
4. No one can accurately predict, over a 20–25-year period, when interest rates and inflation will fluctuate nor to what degree.

Therefore, we construct a cohesive, well-balanced, modular strategy designed to:

1. Provide income potential with preservation of capital.
2. Provide for potential long-term growth by investing in inflation sensitive, growth oriented, investments such as diversified equities.
3. Include short-term investments with staggered, or laddered, maturities that upon maturity can be used to satisfy all, or a portion, of your income needs or, be reinvested in five-year maturities to accommodate changes in interest rates and help increase the average overall yield of the portfolio.

Any opinions are those of Christopher Hudson and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including asset allocation and diversification.

Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.