In one respect, Maureen Erwin-Motley’s predicament is similar to that of almost every other senior citizen. As treasurer of her condo association in Sun City Center, Fla., the 68-year-old retired real estate agent is in charge of investing the association’s reserves in a stable interest-bearing CD account. “The yields are dreadful,” she says. “I’m trying to move money around from CDs with yields of 0.0-something to 0.01-something to get an extra $25 in yield for the account. You are not even hedging inflation with that. You’re watching the money go nowhere.”
Unlike many of her fellow retirees, though, Erwin-Motley has opted for a riskier strategy with her own portfolio. Her financial adviser, Debbie Levenson of Braver Wealth Management in Needham, Mass., keeps about 20 percent of Erwin-Motley’s account in equities, with the rest in a variety of tactical asset allocation strategies that shift in and out of stocks, high-yield bonds and cash. Levenson analyzes the stock market’s price momentum and keeps clients invested when it’s rallying, and then moves to cash when it’s not. (She uses mutual funds and exchange-traded funds with no transaction fees.) Erwin-Motley’s portfolio lost 8 percent during the 2008 credit crash, and it has delivered double-digit returns during the stock market's comeback.
In a schizophrenic environment in which retirees can’t live off their bond income yet are afraid of getting burned in stocks, this unorthodox approach is becoming a hot topic. “It’s a conversation coming up with clients more and more,” says financial adviser Gary Schatsky, president of ObjectiveAdvice.com in New York City. “People who are incredibly risk averse seem willing to throw risk out the window because they’re not getting high rates of return on conservative investments. I have people who’ve been comfortable with 30 percent in equities. All of a sudden they want to put 60 percent and 70 percent in equities. I’m looking at them asking if this is the same person I’m dealing with. Their response isn’t that there’s a great opportunity in equities markets -- it's that there are no other opportunities.”
Although Schatsky is unwilling to play the tactical game of shifting in and out of stocks, he acknowledges that he's largely not buying conventional bond funds with long durations anymore. He's opting for short-term bond funds and cash substitutes, such as 5-year CDs that have only a six-month penalty in case he needs to withdraw assets and reinvest them when interest rates rise. He may increase stock allocations 5 percent or 10 percent if clients want to take more risk, but mostly he’s trying to encourage them to stick with existing allocations.
Are there other solutions? “If clients have flexibility in spending, they can ride out times of low returns without taking on too much risk,” says financial planner Alan Dossett of Waypoint Financial Planning in Southborough, Mass. “Often investors focus on rate of return and income, but flexibility in spending can be a powerful counteracting force. Preparation before retirement is the key to flexibility -- get your level of essential spending as low as possible. When returns are good, spend more; when returns are low, you can still pay the electric bill and have peace of mind.”
Most Americans can’t afford that kind of flexibility. According to the Employee Benefits Research Institute, the median 401(k) balance in America at the end of 2010 was $17,686. Just under 40 percent of 401(k) accounts hold less than $10,000, and only 7.6 percent had in excess of $200,000. Although estimates vary as to how much people need to retire comfortably, the number is usually well above $200,000. For those still working, saving more and spending less makes sense. For those already retired, most won’t be able to wait out the low-rate environment without risking more in the stock market or eating into principal.
One possible compromise: increase one’s equity allocation but invest only in high-quality, dividend-paying stocks that provide a reliable income stream. “We see our current investment environment for retirees not as one where ‘cash is king,' but rather 'cash flow is king,’" says chartered financial consultant Margaret McDowell of Arbor Wealth Management in Miramar Beach, Fla. “The stock markets will rise and fall -- we can't control that. We can control elements of a portfolio that deliver a tangible, spendable reward to shareholders in the form of regular dividends.” McDowell is buying multinational consumer stocks such as Clorox, Heinz, Unilever and Coca-Cola that pay stable dividends and tap into burgeoning middle-class demand in Latin American and Asian emerging markets.
No matter how high or stable the dividend a stock pays, it's important to remember that the income stream isn't locked in. “Stocks don’t come due,” says Stan Richelson, co-founder of Scarsdale Investment Group, a financial advisory firm in Blue Bell, Pa. “Bonds come due. At some point you get your money back when the bond matures. With dividend stocks, every quarter the dividend must be declared or it’s not paid. You get to hard times when companies need cash, they reduce dividends. Bond interest must be paid or the company is in default.”
Richelson sees values in high-quality, long-term municipal bonds for wealthy investors. “We can get 3.5 percent yield-to-maturity on the highest-quality, 20-year, tax-free muni bonds,” he says. “This is a pretax equivalent return of about 5.2 percent [for investors in the highest tax bracket].” Richelson designs portfolios of bonds of different maturities so that when the ones with the shortest maturities expire, perhaps rates will be higher and he can reinvest in higher-yielding bonds.
Investors who aren't in the highest income bracket won't benefit much from the tax-saving advantage of munis -- and not everyone can afford to wait 20 years for a bond to mature. Richelson acknowledges that the interest rate risk for investors who can’t buy individual munis and hold them until maturity could be high. For those without the wherewithal for a 20-year muni, he recommends I-savings bonds sold by the government at Treasurydirect.gov. The bonds increase payouts with inflation and have only 90-day penalties on interest if you withdraw your money before five years. That inflation-adjustment feature should protect people against interest rate risk.
As for Erwin-Motley, she says Braver Wealth’s tactical strategy lets her take on some market risk while helping her sleep at night. “I know that as soon as they see signs that the market is dropping, they get me out and put me in cash,” she says. “I may not be making a lot, but I’m not losing.” While her planner Debbie Levenson says the strategy isn't right for everyone, and still believes in a buy-and-hold strategy for a portion of portfolios, she thinks the need to take that risk while having some downside protection is essential for seniors to survive. “You picture the old woman who is trying to live off her CDs now -- that is the saddest character,” she says. Unfortunately, it is a character that will become increasingly familiar as time goes on if rates remain low.
(Lewis Braham is a freelance writer based in Pittsburgh.)