Many retirees experience an emotional roller-coaster ride. On the one hand, they fear that the money they’ve saved is inadequate to sustain their current lifestyle and on the other hand, they are apprehensive that they won’t live long enough to enjoy the money for which they’ve worked and saved. As a Financial Consultant, I help my clients address this emotional disparity by using an investment approach that not only brings peace of mind to the retiree, but also enables them to stay with their plan.

My approach stems from the theory that consistent positive returns produce superior long-term investment results. For example, $1,000 invested at only 7% will grow to a larger value in five years than the same $1,000 invested with the following five year performance:

Year 1: +10%

Year 2: +20%

Year 3: +30%

Year 4: -25%

Year 5: +8%.

The results: after 5 years, $1000 at 7% grew to $1,402 while $1000 invested at the above returns grew to $1,389. To help produce consistent positive returns, use the three fundamental principles of investing - asset allocation, diversification and money management.

Asset allocation involves dividing your total investments into three broad asset categories: equities (or stocks), bonds, and cash. Once you have decided on a percentage for each of these three categories, then apply the principle of diversification. Diversify your equities between large and small cap stocks, value and growth styles of investing, and U.S. and international stocks. Diversify your bonds by varying the maturity of each bond and by the type of bond (i.e., corporate vs. government). Finally and most importantly, apply the principle of money management by reviewing your holdings on a regular basis and reallocating back to your original allocation percentage. For example, if you started with 50% in equities, 45% in bonds and 5% in cash, upon review, move your portfolio back to this allocation.

To research the effectiveness of this approach, I commissioned a study on 46 years worth of financial data (1950 through 1995). The study was designed as follows: beginning with $1,000,000, I placed 5% of the total in cash, 45% in a one through ten year laddered maturity Government bond portfolio, and 50% in equities. The equities were diversified by placing 30% in a large-cap US stock fund and 20% into five Dow Jones stocks chosen each January using the “Dogs of the Dow” theory. I reviewed the value of the total portfolio every four months and reallocated to the original starting percentages. For the period January 1950 through December 1995 the study produced a 10.2% annual compound return while the S&P 500 Index produced a 12.5% annual compound return and the Dow Jones Industrial Average produced 12% (Source: The American Funds Group Hypo). Considering that the study’s portfolio was adjusted every four months to no more then 50% of its assets invested in the equity market, the 10.2% return is quite impressive.

A recent study by Reinhardt Werba & Bowen, a national management firm, produced similar results. This study compared a portfolio that was invested 100% in the S&P 500 with one invested in a more conservative diversified global portfolio. The global portfolio contained 50% money market investments and short-term bonds and 50% stocks. They then diversified the global portfolio within each asset category. The study covered the time span from 1972 through 1997. They reallocated the assets back to the original percentages every quarter.

The results were for every dollar invested the S&P 500 grew to $25.45, while the global portfolio grew to $25.60. In other words, the diversified global portfolio kept pace with the S&P but with less volatility. (The above referenced examples have been provided for illustrative purposes only. Past performance does not guarantee future results.)

For those of you who are experiencing the emotional roller-coaster ride as a retiree, my advice to you is develop an investment approach for your retirement savings that allows you to preserve and consistently increase those assets by utilizing the asset allocation, diversification and money management principles.

Posted by Michael Chapman at 11:49 AM PST