(MONEY Magazine) – Conventional wisdom holds that managing your money in youth and in retirement are as similar as tending a garden of seedlings and one of full-grown plants. Young plants or old, the essential ingredients are still soil, water and sunlight. So too in investing: Small portfolio or large, the building blocks are still stocks, bonds and cash.

Of course, conventional wisdom has also held, at various times, that the world was flat, that members of the British royal family do not get divorced and that the Dow could not top 7000. But the main problem with conventional investing wisdom is not that it's wrong but that it fails to consider the real world of retirees. "Asset allocation is about coming up with an ideal blend for an individual," says Tim Schlindwein, an investment counselor in Chicago. "And the way to do that is by matching up the characteristics of an asset with the needs and preferences of the individual."

The conventional stocks/bonds/cash allocation groups are fine if you're 25 and own no investments outside of your 401(k). But what if you're the average American over the age of 55, which means your house makes up 25% of your total assets? Or you receive Social Security and a corporate pension? How do those income streams figure into your portfolio mix? What's the role of stocks in a portfolio that must produce income as well as growth? And what if you plan to leave some money to your heirs? Does that change how you divvy up the goods? General-issue investing advice doesn't tackle these questions.

Well, we do in this story--and the answers may surprise you. To manage your money properly in retirement, you need to consider as part of your portfolio some holdings you may never before have regarded as assets and to ignore others you may have always thought were indispensable. And it's important to recognize that your investment horizon extends not just through your life span but into your heirs' as well. To see how these truths play out in practice, read on.

--Count your Social Security and pension benefits as fixed-income assets. More 30-year-olds may believe in UFOs than in Social Security, but your close encounter of the federal kind has already begun or is about to. So the idea that Congress would seriously slash benefits for you is more farfetched than the plot of Men in Black. In short, you should consider your claim on the Social Security system at least as solid an asset as a typical corporate bond. Financial planners like James Knaus of Troy, Mich. argue that you ought to treat this entitlement in your portfolio as a fixed-income asset. "Your Social Security checks reduce the amount of income your other assets have to provide," he explains.

If you receive monthly checks from a traditional corporate pension, that too should go into the fixed-income camp of your portfolio. (In the event you took your pension as a lump sum and reinvested it, you should tally the amount as equity or fixed income, depending on what you did with the payout.) In fact, since corporate pensions are guaranteed up to $33,136 in 1997 by Uncle Sam, you can regard your pension up to that amount as the next best thing to a U.S. Government bond. Moreover, the stability of your pension and Social Security "assets" allows you to tilt the remainder of your portfolio comfortably more toward stocks, even in a high-flying market such as today's.

But since there's no market for your claim on Social Security or your company's pension fund, how do you know what value to affix to them? Maria Crawford Scott, editor of the American Association of Individual Investors Journal, says it's simple: Their value is roughly equal to what it would cost to buy an annuity promising the same monthly payments for the rest of your life. The table on the facing page gives you what's known as the annuity factor. If you are 55, for example, your life expectancy is 28.6 years and your annuity factor is 12.4. Multiply the factor by your annual pension, say, $12,000, and you'll get a value of $148,800. Add that sum to the market value of your bonds, CDs and stable-value funds to get the true amount you have allotted to fixed-income assets.

--Don't count your house at all. If you're like most retirees, your casa is either your largest or your second largest asset. Over the past 20 years, house prices have leaped an average of 249%, and you have long been assured that you can use this store of wealth to ensure a comfortable retirement.

Not so fast. Your home is not part of your investment portfolio unless you plan to sell it. "Your house is there to provide shelter, not to generate income, which makes it a nonworking asset," says Wayne Starr, a financial planner in Kansas City, Mo. The same goes--even more so--for your art collection, jewelry, antiques or other collectibles. Are you really planning to part with that 1963 Stingray or the honest-to-god Stickley dining room chairs in order to invest the proceeds? If not, don't count on them as investable assets.

While you could earn some income from a reverse mortgage on your home, selling the house, moving to smaller quarters and investing the difference is preferable by far. For one thing, that way you get to earn interest on the net proceeds from the sale, rather than owing it, as you would on a reverse mortgage. Furthermore, if you are over 55, you can exclude up to $125,000 of your profit on the sale--one of the only real tax shelters you get to enjoy during your lifetime. (Congress and the President may lift the exclusion for all home sales to $500,000 later this year.) And because larger homes tend to have higher utility bills, property taxes and maintenance costs than smaller ones, downsizing will free up money so you can make additional investments. Downsizing has one major strike against it, however: Most retirees like to stay put. In fact, every year, just 5% of them choose to relocate.

If you are dead set against selling your place and are short on cash, then a reverse mortgage may be your only choice. But be aware that it will cost you. A reverse mortgage is essentially a cash advance on which you pay interest against the expected future value of your home when you die. You sign over 80% to 90% of your home's value to the lender in return for a stream of monthly payments that last as long as you live. You never have to vacate your house, but the price of that privilege can be absurdly high, depending on how long you live and how much your home appreciates.

Take the example of a 75-year-old woman living in a $150,000 house who receives a mortgage payment equivalent to $564 a month. If she stays in her house for 17 years and it appreciates at an annual rate of 4%, the loan's effective interest rate works out to be just 6.5%. But if after taking out the loan she lives in the house for just two years, she'll end up paying an effective interest rate of 46%.

Obviously, a well-executed retirement plan should not force you to take that risk. "A reverse mortgage is an option of last resort," says Peggy Ruhlin, a financial planner in Columbus, Ohio and president of the International Association for Financial Planning. "If you are reduced to it to keep your home, then you really haven't saved enough for retirement."

--You can touch your principal. If you needed $100, would it matter whether you took it from your checking account or from your savings account? Of course not. And yet too many retirees persist in defining potential income as only the money that will come exclusively from their fixed-income investments, namely bonds or Social Security. Principal, they reckon, is off limits.

But proceeds from the sale of a stock can pay a month's rent just as easily as the 6.1% payout from your three-year Treasury notes. "When we're talking about income, what we're really talking about is your cash flow," says Ruhlin. "That can mean capital gains, dividends and principal, as well as interest from bonds."

Say, for example, that you retire this year with a $300,000 portfolio and need to take out $20,000 a year to meet living expenses. You could invest your money in 30-year bonds at 6.7%; that would be enough to let you meet expenses without touching principal. By 2017 you'd still have $300,000 in your nest egg, as well as your $20,000 of income--although 3% inflation would have reduced the purchasing power on that sum to just $10,876--not to mention its effects on your principal.

Suppose, instead, that you put the money into a portfolio heavily weighted with stock funds and it returned 9% a year, nearly two percentage points below the average for the S&P 500 since 1926. Because the yield on such a portfolio would likely be less than 2%, you would have to sell securities every year to meet your income needs. Even so, in 20 years, your portfolio would have grown to $697,000, even if you took $20,000 a year from the kitty in living expenses. Alternatively, you could have raised your withdrawals by 3% a year to keep pace with inflation, and your nest egg would still have grown to $416,000 by 2017. And that doesn't account for the fact that if you're in the 31% tax bracket, you save on taxes by taking your income out of capital gains (currently taxed at 28%) rather than interest (dunned at your maximum bracket).

Obviously, no stock-oriented portfolio will earn 9% each and every year. But losing years are only paper losses until you have to liquidate your portfolio. "In a year when you're winning, you're tucking away for the down years," Ruhlin says. "So you really have to focus on how it averages out." Your best bet for minimizing losses: Stick with conservative blue-chip stocks that pay dividends, as opposed to riskier, small-size companies.

--You should invest for both yourself and your heirs. There's another reason to weight your portfolio more toward stocks than the conventional wisdom advises: It's better for your heirs.

Suppose you invest mainly in bonds and bequeath your portfolio to your daughter. For the reasons explained above, you will probably have a smaller legacy than you would have had if you had invested in stocks. Moreover, presuming that your daughter prefers stocks to bonds for her own portfolio, bequeathing her bonds leaves her with two unattractive options: She can hold on to the bonds and pay ordinary income taxes on the interest; or she can sell them, incur unnecessary transaction costs of up to 3.5% or so and reinvest the remainder in stocks.

When you bequeath stocks, on the other hand, you take much greater advantage of a huge tax break. At your death, any capital-gains tax liability on your profits is wiped out. For tax purposes, your heirs' cost in inherited stock becomes the value of the shares as of the day of your death, not as of the day you bought them. So if your daughter sells the stocks right away, she'll owe no capital-gains taxes; if she waits to sell them, she'll owe taxes only on gains incurred since the inheritance. "Appreciated assets are one of the best things you can leave your heirs," says Ellen Fairbanks, a certified financial planner in Pittsburgh.

And be sure you keep those assets separate from the ones you plan on investing for your own retirement. After all, your heirs will have their whole lifetime to ride out the ups and downs of the stock market and they can afford to be more aggressively invested. Which brings us back to where we started: Asset allocation is not a one-size-fits-all strategy. Your heirs won't want to wear the same kind of portfolio you do