Retirees Can Take More Risk Diversification Will Take Sting From Stock Market Fluctuations

Financial advisers have told us over and over not to be too conservative with the money we invest for retirement, and to put at least some of it in stocks.

Yes, stocks are riskier in the short run, but over time they deliver the biggest return.

Millions of Baby Boomers have taken this advice to heart. The numbers show these investors are buying on market dips, presumably because they figure they have ample time to recover from any temporary setback in stock prices. That may work out fine for Baby Boomers, who are still years away from retirement, the oldest turning just 50 this year. But how about the people who are already retired? How much risk should they take?

The answer, according to the people who run an investment program for the American Association of Retired Persons, is that retirees should reduce risk - but that they can’t afford to abandon stocks just because they are older.

“Age as a definition for taking on risk is inappropriate,” said Benjamin W. Thorndike, a managing director of Scudder, Stevens & Clark. The Boston firm manages a family of mutual funds designed specifically for members of the AARP, an organization open only to people 50 or over, whether retired or not.

Far more important than age in choosing investments, Thorndike said, is each person’s tolerance for risk, and his or her objectives. But even in the most conservative portfolio - income being the main objective - there is a place for stocks.

“Everyone should have some money in equities,” said Thorndike, co-manager of the AARP Growth and Income Fund, which invests in conservative, higher-yielding stocks.

The Growth and Income Fund is one of nine no-load mutual funds that Scudder manages for AARP members. The funds are open to anyone but sell primarily to members of the AARP, which selected Scudder to create the funds in 1985.

The AARP funds tend to be conservative, beginning with taxable and tax-free money funds that invest only in high-quality, short-term securities, a fund that invests in Ginnie Maes and U.S. Treasury securities, a high-quality bond fund and an insured tax-free bond fund.

But four funds invest at least partially in stocks, including a Global Growth Fund added this year based on surveys of AARP members.

“If you ignore international investments, you ignore two-thirds of the world’s investment opportunities,” Thorndike said. “Investors who limit themselves to the U.S. market miss out on the 10 largest banks, seven of the 10 largest auto companies and eight of the 10 largest machinery companies in the world.”

In addition to international stocks, other of what Thorndike called “alternative” investments - small U.S. company stocks, foreign bonds and securities from emerging markets - have historically outperformed the more “comfortable” choices, such as Treasury securities, U.S. bonds or even blue chip stocks. But the tradeoff, he said, is increasing volatility, with prices bouncing up and down more sharply.

“The solution relies on the power of diversification,” Thorndike said, suggesting that investors in retirement divide their money among different types of assets.

Thorndike suggested three sample portfolios for retirees, based on whether their main objective is income, a mixture of income and growth, or growth.

For income investors, a possible mix is 60 percent bonds, 30 percent stocks and 10 percent cash. For growth investors, the mix would be 75 percent stocks, 20 percent bonds and 5 percent cash. And for the “balanced” portfolio, he suggested 55 percent stocks, 35 percent bonds and 10 percent cash.

Thorndike also divided each portfolio into subcategories with “alternative” asset classes in each.

In the income portfolio, for example, 3 percent of the money was invested in small-company stocks and 5 percent in international stocks; 5 percent in international bonds and 5 percent in fixed-income securities from emerging markets.

In the balanced portfolio, 30 percent of the money was allocated to “alternative” investments: 10 percent international stocks, 10 percent small U.S. stocks, 5 percent international bonds and 5 percent from emerging markets. The percentage went up to 40 percent in the growth portfolio: 15 percent international stocks, 15 percent small U.S. companies, 5 percent international bonds, and 5 percent from emerging markets.