Assessing risk, diversifying portfolio keys to investing
January 23, 2011
Q: Dear Rick: I just had a $100,000 Certificate of Deposit come due. I am a conservative investor, so I was just going to buy another CD, but the rate is very low so I decided not to do anything. What should I do with the money? I am in my early 50s with a decent job. I plan to retire in about 15 years. I am conservative and don't like volatile investments. The money from the CD is the money I have saved for retirement. Any ideas?
A:The first issue to explore is risk. You are a conservative investor and that is why you like investing in CDs. However, in your situation, CDs are not conservative. My reasoning has nothing to do with where interest rates are today, but rather, where interest rates are historically. For short-term needs, CDs are a very good investment. However, they don't keep up when you look long term.
When looking at risk, most people only consider principal fluctuation. I suggest that a risk too many investors forget about, and one that is just as important as principal risk, is the risk of not keeping up with the increased cost of living.In regards to your $100,000 CD, the key is to make it grow in real dollar terms. After all, we know $100,000 today is not worth $100,000 five years from now. Therefore, in establishing a portfolio, the key is to factor in a variety of risks such as purchasing power risk, and risk of principal.
There are a number of different investment options. The first is to set up a conservative growth portfolio. My recommendation is to initially allocate 55-60 percent in equities, the rest in bonds. The 55-60 percent in equities does not get invested in one fund or one investment, but rather is spread out into a variety of different investment vehicles. At the same time, the remaining 40-45 percent of the portfolio would be invested in fixed-income investments such as U.S. Treasuries and investment-grade corporate bonds.
If you have a portfolio that is investing in equities, there will be principal fluctuations. Stock funds go up and down. However, don't look day to day, or even year to year — focus on 15 years down the road. I have no doubt that equities will be higher in the future.
In addition, the only way to have a rising income throughout your lifetime is to have a portion of the portfolio invested in stocks.
I don't have the space to list all the funds I would use. However, there are probably 10-15 different funds and, of course, they would all be commission-free.
In making your decision, keep in mind that the goal in saving for retirement is to make sure that the purchasing power of your money grows into the future. When you factor taxes and increased costs of living into the mix, the very low rates of return you receive at a bank just don't make it. Purchasing power risk is important to consider. Investors that play it too close to the vest, particularly long-term investors who fail to take purchasing power risk into consideration, generally get burned.
Good luck!
Rick Bloom is a fee-only financial adviser. Observer & Eccentric readers can submit questions at moneymatters@hometownlife.com. For more information, visit Rick's Web site at www.bloomassetmanagement.com.
