The Motley Fool : Retirees can’t afford to play it too safe

Just because you’re retired doesn’t mean your investing days are over. Retirees rightly wonder, though, where they can relatively safely invest their money.

The traditional answer has been to invest retirement money in utilities, preferred stocks, REITs, bonds and other dividend-producing, interest-paying securities. You would take the interest and dividends as income for the year and let the principal ride. The emphasis was on income, not growing the base of the investment. Investing for growth meant taking more risk, and risk was to be avoided at all costs — or at least so said the retirement advisers.

Times have changed, and the approach that once seemed so sensible is no longer right for many people. Fewer companies promising dividend growth, the deregulation of utilities, volatile bond markets, low interest rates, inflation and increasing life spans have all undermined the security of a “low-risk, income-only” investment strategy for retirees. Many experts believe this strategy may actually endanger retirees — you may run out of money before you run out of time to spend it. Not taking enough risk with your retirement money may represent the greatest risk of all.

For example, an all-bond portfolio with an average return of 6 percent might throw off enough income for a retiree today. But with a modest annual inflation rate of, say, 3 percent, every $1,000 produced by that portfolio will be worth only $554 in 20 years. Worse, the principal available then for reinvestment wouldn’t have grown through the years. As purchasing power declines, a retiree using such a strategy almost certainly will have to dip into principal to sustain her lifestyle, and the use of that principal will shorten the life of her portfolio. Conversely, while an all-stock portfolio may produce growth from which one may take income, stocks can be quite volatile, and they can drop and stay down for five years or longer. That, too, can be a devastating result.

The solution to this quandary is asset allocation. Tune in for more on that next week.

In the meantime, learn more about retirement investing at www.fool.com/retirement.htm and http://money.cnn.com/retirement.

Ask the Fool

Q: What’s the “accrual” method in accounting? —G.K., Tucson, Ariz.

A: It’s an important accounting concept to understand, because with the accrual accounting system, the “revenues” (sales) on a company’s income statement may not have actually been received by the company.

Revenues don’t necessarily represent the receipt of cash in a sale. Many firms “accrue” revenues, booking sales when goods are shipped, when services are rendered, or as a long-term contract proceeds through stages of completion.

Imagine the Porcine Aviation Co. (ticker: PGFLY). With the accrual method, if it has shipped off a thousand flying pigs but hasn’t yet received payment for them, those sales still appear on the income statement. The checks “in the mail,” not all of which may ever arrive, are reported as “accounts receivable” on the balance sheet.

Make sure a company’s receivables are not growing faster than sales.

Q: Is it OK that a stock I own is planning a reverse stock split? — H.R., Beverly Hills, Calif.

A: Yikes. Generally, it’s just companies in trouble that execute reverse splits. The splits are often done to avoid getting de-listed from a stock exchange that has minimum stock-price requirements. They also prop up stock prices so they look less embarrassing. For example, imagine a stock trading at $1 per share. If you own 200 shares and the company announces a 1-for-10 reverse split, then you’ll suddenly have one share for each 10 that you owned. You’ll now hold 20 shares, priced around $10 each. Note that before and after the split, the value of your shares is the same: $200. All that really happened is the company increased its stock price by decreasing its number of shares. Be wary of companies announcing reverse splits.

My dumbest investment

A friend told me he’d found a “completely legitimate” forex (foreign currency exchange) fund that was making between 4 percent and 12 percent a month, every month. He had taken a mortgage on his house, met with the founders and was convinced this was a good thing. Over a year and half, I invested about $4,000 in it. One day my friend called and said: “The money is gone. The trader made a bad trade and lost 97 percent of the money in one day.” It turned out to be a scam. My friend was devastated to know that not only had he lost well over $100,000, but he had convinced many friends and family members to do the same. I was warned by countless people that it would end this way, but my faith in my friend was too strong.

— R. Wagner, Vancouver, Wash.

The Fool Responds: Always remember: Investments that seem too good to be true usually are.