Q. I am 71 years old with no debts. Basically, I only have my monthly living expenses and those, by and large, are covered by Social Security. Where can I invest $100,000 to produce a very modest, low-risk return? —D.H., by email
A. At last! A reader seeking a "very modest" return! If that is what you seek, the world is your oyster. Today, modest, even extremely modest, returns are available in abundance. (Sorry, I couldn't resist.)
One of the best low-risk/low-reward deals available in the current market is investing in relatively short-term Treasury Inflation-Protected Securities (TIPs). An index fund of these securities can be purchased as an exchange traded fund on any discount brokerage platform. The benefit of these securities is that you get the guarantee of adjustment for inflation and the bizarre upside that it provides if inflation comes back. Basically, these funds are a good "parking place" for modest risk with a return that is likely to be greater than cash and somewhat less than the rate of inflation.
There are now three exchange-traded funds indexed to zero-to-Five-Year Treasury Inflation-Protected Securities. They are:
- iShares 0-5 Year TIPS bond fund (ticker: STIP, expense ratio 0.20 percent),
- PIMCO 1-5 Year U.S. Tips Index fund (ticker: STPZ, expense ratio 0.20 percent)
- and Vanguard Short-Term 0-5 Year Inflation Protected Securities fund (ticker: VTIP, expense ratio 0.10 percent),
Q. Perhaps this has been addressed by the financial community in the past, but I do not recall seeing it if they did. The question is: How do you factor in the impact of a pension or life annuity on your philosophy of asset allocation for retirement? Here’s a specific example: At retirement, my pension plan offers a lump sum or a life annuity with monthly payments. Let's say my lump sum choice would be $400,000, but I choose to take a monthly pension. If I take the lump sum and invest it in bonds, that adds a lot to the "bond piece" of my asset allocation pie chart. However, there is no impact on the same pie chart if I choose the pension option.
My logical brain wants to think that the monthly pension should receive some sort of credit in the "low risk" category over all. But it doesn't, unless I try to do something like calculate the net present value, or something convoluted like that.
Bottom line, if I'm aiming for a 60/40 asset allocation, does that mean I should aim for that with "what's left" (ignoring the annuity) - or should I take into consideration the pension and somehow rationalize more risk in my remaining portfolio? —J.W., Dallas, TX
A. It would be nice if this question had a nicely calculated and universally accepted answer, but it does not. Academic researchers like Laurence J. Kotlikoff at Boston University and Wade D. Pfau at the American College of Financial Services, however, both conclude that the higher your guaranteed income from Social Security, pensions or life annuities relative to your basic living expenses, the more risk you can afford with your savings. The reason for this is simple: If your investments are only providing 10 percent of the income you need to pay your bills, a major investment loss will be a much smaller problem than if they are providing 90 percent of your income.
Since optimal asset allocations based on investment assets generally range from 50 percent equities to 75 percent equities, it is argued that high-income professionals who will derive most of their retirement income from investments should be closer to a 50 percent allocation to equities.
On the other hand, workers with Social Security and pensions that will replace a large portion of their pre-retirement income should feel free to have 75 percent of their retirement savings invested in equities. Both figures, of course, would be subject to your personal "sleep well at night factor."
These questions are now moving out of academic research into retirement planning in the field. Multiple firms are developing broad household balance sheet analysis tools for financial planners specializing in retirement income planning. While only a handful of planners (about 100) have earned the designation to date, this thinking is at the core of the RMA (Retirement Management Analyst) certification. Stay tuned.