Never too old for stocks

Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005)

Ultimate Guide to Retirement

• Getting started
• 401(k)s & company plans
• Investing
• Annuities
• IRAs
• Self-employment plans
• Pensions and benefit plans
• Social Security
• Insurance
• Estate planning
• Living in retirement
• Getting help

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NEW YORK (Money) -- Question: I'm nearing retirement, but would like to continue investing in stocks and bonds. My question: Should retirees continue to put money into the markets even after they have retired? --Lee Benge, Charlotte, North Carolina

Answer: I think most advisers would say that most retirees should have at least some of their money in the stock and bond markets after they retire. And I agree.

After all, even though inflation has been tame lately, you have to wonder how long that's going to be the case considering how much money the boys and girls down in D.C. are throwing around these days. I don't think it's rash to assume that, over the course of a long retirement, the price you and other retirees will pay for all manner of goods and services is likely to rise.

And if you're depending on your investments for spending cash in retirement -- and you don't want your spending power to fall behind inflation -- then you want your portfolio to have the potential for capital growth over the long term.

Getting enough growth to maintain your purchasing power throughout a lengthy retirement is difficult if you invest only in cash equivalents like money-market funds and CDs. Although there are no guarantees, investing a diversified portfolio of stocks and bonds (or, more likely, stock and bond mutual funds and ETFs) gives you a much better shot at getting the long-term gains you need.

The question, though, is how much of your retirement savings should go into the markets, and how should you divvy up the portion you decide to put there?

Clearly, once you retire, you want to have enough set aside in money-market funds, money-market accounts, short-term CDs and the like to provide cash for current expenses and everyday spending as well as for any emergencies that might arise. People can quibble about exactly how large that cash fund should be, but I'd say a reserve of 12 to 24 months' worth of projected living expenses makes sense.

As far as the rest of your portfolio is concerned -- what I'd call the investing portion -- you're essentially talking about a balancing act. If you put too much of your money into equities and the stock market gets hammered as badly as it did in 2008, your savings stash can take such a big hit from which it could take a long, long time to recover.

Remember, to the extent you're also pulling money out of your savings each year for income, your portfolio is experiencing a double-whammy during market setbacks. Both withdrawals and investment losses are pushing its value down. That means you have less capital left to participate in market rebounds, making it harder to restore your portfolio's health.

On the other hand, if you wimp out and put virtually nothing in stocks, you may not earn returns large enough to assure that your money will last 30 or more years. You could run out of dough while you've still got a lot of living to do.

I should add, by the way, that although bonds tend to be more stable and less prone to blow ups than stocks, they can have their wild side too.

Both investment-grade and high-yield corporate bonds got whacked last year, while long-term Treasuries sustained damage this year.

So as I see it, the issue comes down to how retirees should divvy up the investing portion of their portfolio between stocks and bonds.

Alas, there's no single correct answer. For example, all else equal, a retiree who is collecting a generous company pension and is sitting on large balances in IRAs and other retirement accounts can likely afford to keep a higher percentage of his or her portfolio in stocks than a retiree with a much smaller portfolio who will be relying heavily on Social Security for living expenses.

Similarly, the more other resources you have to draw on -- home equity, cash value insurance policies, income from part-time work -- the more likely you'll be able to weather the larger loss a more stock-heavy portfolio might suffer.

Don't forget to take your gut, or emotions, into account too. If you've got sizeable pension checks coming in each month but you still know that a 20% decline in the value of your portfolio will have you reaching for the Pepto Bismol, then you've got to factor your weak stomach into the size of your stock stake.

If you'd like to get an idea of how different mixes of stocks, bonds and cash might perform, you can check out the Asset Allocator tool in the Morningstar Tools section of T. Rowe Price's site. By using the sliders to create different blends of large-cap, mid/small-cap and foreign stocks, as well as bonds and cash, you can see what sort of projected annual returns and possible three-month losses different portfolios might generate.

The point of going through this exercise isn't to find out exactly what returns you'll get. No tool can predict that. But you can come away with a sense of how the tradeoff between risk and return changes as you go from more aggressive to more conservative mixes.

One final note: Assuming you'll be relying on your investments for regular income after you retire, you may want to consider diversifying beyond traditional financial assets like stocks and bonds into investments that can generate reliable income, such as annuities.

Annuities often get a bad rap, justifiably so in many cases. But if you use the right type of annuity in the right way along with a portfolio of stocks and bonds, you may be able to get a better balance of stable income, protection from downturns and long-term upside potential than you would by limiting yourself only to stocks and bonds.

So my advice is that if you're comfortable continuing to invest in stocks and bonds in retirement, by all means do it. Just be careful you don't overdo it.