A Road Map Out of This Retirement Mess

Hit by the long bear market in stocks, many recent retirees now have to wonder if their money will last. Here's why they need more, not less, in stocks -- and smart ways to hedge those bets.

From their house 15 miles outside Honolulu, Curt Schryer and his wife, Jeannie, look out the windows and see both mountains and the Pacific Ocean. Schryer, 58, an inveterate golfer and traveler who retired six years ago from the U.S. Department of Energy, is enjoying the good life, thanks largely to consistent saving and astute investing. Although the severity of the bear market surprised him (along with the rest of us), his portfolio of stock mutual funds has held up remarkably well. And a stash of U.S. savings bonds is tiding him over until the market recovers.

Schryer, a slight, loquacious man, golfs two or three times a week and recently hiked around Greece and bicycled through Portugal. He stands as an example for investors who want to live out their dreams in retirement.

Unfortunately, not all retirees survived the bear market so successfully. Enter John Nobis, a lanky man with a white beard and a toothy smile who also loves to travel. Nobis took a buyout in September 2000 from McLennan Community College, in Waco, Texas, where he had been a career counselor for 31 years. Annuities, invested largely in stock accounts with TIAA-CREF, initially provided Nobis, 65, and his wife, Joyce, 52, with $40,000 in annual income. But last year Nobis's annuity income slipped to $25,000 because of the market implosion. "We don't buy new clothes -- we go to thrift stores," he says. "We used to eat out two or three times a week. Now it's once a week."

Welcome to the worst-case scenario for retirees: a major market hit in the early years of retirement. "Such an event leaves you with a smaller pie, just as you're beginning to slice into it," says William Bengen, a financial planner in El Cajon, Calif.

For Nobis and other retirees who are living the nightmare of the worst bear market since 1937-38, the questions are: What can I do to stop my savings from hemorrhaging? How can I invest more wisely? What other steps can I take in retirement so that I don't have to worry and scrimp -- or end up relying on my children?

This article lays out a road map, a path you can follow for righting your retirement.

Stocks Will Rise Again

First, the good news. This bear market, if it didn't end last Oct. 9, is on its last legs. While you can't expect to get the 20%-plus annual returns of the late 1990s, it's reasonable to count on long-term annualized growth of 10% or so in the years ahead, while bonds should return about 4%.

As the market continued to fall last year, Nobis retreated to the warm blanket of bonds. While most of his money was in stock accounts when he retired, today only 28% is in equities. "We all had on rose-colored glasses," Nobis says of the late 1990s, with a bitter laugh. But the worst thing for investors in retirement to do now is forsake stocks. "In early 2000, investors didn't understand risk," says Tobias Levkovich, chief market strategist for Smith Barney. "Now they're unwilling to take any risk."

The first step for savvy investors may sound downright frightening: Put more of your money into stocks and stock funds than usual.

If you'd normally put 50% in stocks, now is the time to invest 60%. If you'd ordinarily have 40% in stocks, go to 50%. Why? Stocks tend to do better than average in the first years after devastating bear markets.

Too much risk for you to stomach? Then at least rebalance your assets. For example, if you started 2000 with 50% in stocks and 50% in bonds, the brutal winnowing of stocks may mean you now have 65% in bonds and 35% in stocks. Rebalancing forces you to do the intellectually simple but emotionally difficult thing: Sell high and buy low. At this point, that means sell bonds and buy stocks.

The Right Asset Allocation

You need stocks because your money needs to last for many years. The life expectancy for retirees is long -- and growing longer with medical advances. Take a couple, both age 65. The odds are that one of them will live to be 91, reports Ron Gebhardtsbauer, senior pension fellow at the American Academy of Actuaries.

The probability that you'll still be drawing on your nest egg 25 years after age 65 is the reason stocks -- with their proven ability to stay ahead of inflation over the long term -- are essential. During the early years of retirement, you'll want to keep 50% of your investments in stocks. The rest belongs in bonds and cash investments, such as bank CDs and money-market funds. If you're a reasonably aggressive investor -- and the past three years have certainly shown you how much risk you can tolerate -- you'll want to put 60% in stocks. If you're more conservative, invest 40% in stocks. "When you go below 40% in stocks, you run into inflation risk," says Todd Cleary, chief financial planner at T. Rowe Price. In the later years of retirement -- say, after age 75 -- investors should reduce the allocation to stocks by about ten percentage points.

A happy complication to the asset-allocation issue is how to count guaranteed income from Social Security, pensions or fixed annuities. To the extent such income covers your financial needs, it frees you to invest other assets more aggressively by hiking your stock allocation.

Regardless of your overall asset allocation, keep a life preserver of cash -- enough to cover two or three years' worth of expenses -- in short-term bond funds, money markets or bank CDs. That way, during the next bear market, you can spend your "safe" money rather than sell your decimated stocks. When the stock market goes up, though, plan on selling mostly stocks to support yourself. If bonds do well, plan on selling mainly bonds. That will help keep your portfolio in balance.

The Role of the Annuity

The next step is deploying your money, keeping in mind the painful lessons learned (or relearned) over the past few years. Don't invest too much into any one industry sector or type of stock fund (for a sample portfolio, see below).

The final ingredient in your portfolio may be immediate fixed annuities, which are winning increased attention and applause from retirement specialists. Money you invest in annuities should come from the bond portion of your asset allocation.

Sold by insurance companies, annuities may be thought of as the reverse of life insurance, says John Ameriks, a research economist at TIAA-CREF. You pay a lump sum to an insurance company, which pays you a fixed monthly income for the rest of your life (or for the rest of yours and your spouse's). What's attractive about these annuities is their relatively high guaranteed rates of return. Planners generally suggest that you can spend only 4% to 5% of your retirement portfolio each year -- more, and you'll risk running out of money. But today's annuities will provide a 70-year-old California couple, for instance, 7.6% of their initial investment each year -- for as long as either of them lives. In other words, a $100,000 investment can translate to $7,600 a year in payments. A single 70-year-old man could get $9,340 a year; a woman (who is expected to live longer), $8,640 a year.

Before you decide to dump all your money into annuities, recognize a huge drawback: You become a prisoner of inflation because the payments are fixed. Sure, you can buy a $100,000 annuity now that allows a couple to spend $7,600 a year of their initial investment. That's 50% more than the 5% withdrawal rate recommended by some planners. But 20 years of 3% inflation would squeeze the real value of that payout to just $4,200.

For that reason, you should never invest more than half of your money in annuities. "But some level of annuitization makes sense for the vast majority of investors," says Mike Henkel, president of Ibbotson Associates.

Don't buy an annuity if you're in poor health, of course, because once you shell out the money, it's gone. Insurers will add a guarantee that your heirs receive benefits if you die early, but such guarantees cut monthly income.

You don't need to invest everything that you intend to put in annuities at one time. In fact, you should buy in increments. With interest rates at 40-year lows, this is not the time to put too much into annuities. If interest rates go up, buying a second annuity a few years down the road gives a double boost to your payments: one because of the higher rates, the second because you'll receive fewer, larger payments. Web sites such as WebAnnuities.com (see the link at left under "Related Sites") are a great help in shopping for the best deals. To be on the safe side, buy from several insurance companies and check the financial strength of each one of them with a rating service, such as A.M. Best. "An annuity is just a substitute for a pension," says Moshe Milevsky, a finance professor at York University, in Toronto. "If you don't have a pension, buy yourself one."

Rescue plans

For retirees like Nobis, who have been savaged by the bear market, here are other ways to right your retirement:

• Take out a reverse mortgage to tap the equity in your home with regular monthly checks. The loan isn't repaid until you move or die.
• Sell your home to cash in on today's high prices, move to a smaller place, and invest your profits in your retirement portfolio.
• Face the music. Cut back on your spending until the stock market inevitably climbs out of its hole. "It's just like running a business," says Jack Brod, Vanguard's chief financial planner. "When business is down, you have to tighten your belt."
• Work. Nobis has picked up extra money proctoring exams and working part-time at his old job. His wife, a registered nurse, is considering going back to work. Schryer doesn't need the money but works part-time as a starter at the golf course where he plays.