Last Updated May 16, 2011 3:15 PM EDT
While the answer is not the same for everyone, the decisions you have to make regarding asset allocation for those investments are. You'll need to determine the appropriate mix of investments (such as stocks, bonds, annuities, and real estate) for your situation, You'll also need to choose specific investment products and services.
Welcome to Week Seven of my series 12 Weeks to Plan Your Retirement. It's time to discuss the considerations you'll need to take into account when choosing investment vehicles for your retirement savings. You'll also need to decide which of the three methods I discussed in my previous post to use to generate retirement income. If you haven't read that post, you may want to review it first to best understand this post. Ready? Then let's get started.
Method #1: Invest your retirement savings, and use just interest and dividends to generate retirement income.
For this purpose, I like using low-cost, no-load, broad-based mutual funds balanced between stocks and bonds. Consider a fund that invests at least one-third but no more than two-thirds in stocks, with the remainder invested in bonds. This gives you the potential for growth to keep up with inflation, with protection against stock market declines. In today's market, these types of investments will generate investment earnings of 2 to nearly 4 percent per year, depending on the specific asset allocation you've selected, with a potential for future growth in both principal and dividend amounts. One good fund along these lines is the Vanguard Wellesley Fund (VWIAX).
Target date funds that have reached their target retirement year may also fit the above goals. And, a reasonable alternative for some of your investments might be mutual fund REITs (real estate investment trusts), since this type of investment can also give you income with the potential for growth.
If you'd followed such a strategy for the first decade of the century, you would have ended the decade with more money than you started with, and you would have enjoyed a steady flow of investment earnings that only had mild fluctuations. You would have survived one of the worst decades for investing!
If you want to live on your investment earnings, I'd avoid using CDs or cash equivalents -- interest rates are just too low right now. And even if interest rates rise in the future, I'd be very cautious about a future repeat of the past few years.
On the other hand, I wouldn't seek the highest-yielding stocks or bonds either, as these assets often have underlying risks and the high yields can evaporate.
You can use www.morningstar.com to help you evaluate and shop for the types of mutual funds mentioned here.
Method #2: Invest your retirement savings and withdraw principal cautiously.
If this is the method you've decided to select, then the same kinds of investments I mentioned above work well here, too -- with a caveat. Here's one scenario you want to avoid: exhausting your savings because you invested well above 50 percent of your assets in stocks, withdrew too aggressively (well over 4 percent of your account balances), and experienced a stock market decline in the first 10 years of your retirement.
To protect against this possibility, either invest conservatively -- with under 50 percent of your assets in stocks -- or withdraw conservatively -- 4 percent or less. Frankly, I'd rather see you hold back your withdrawals in your early years of retirement and only increase your withdrawals if you experience positive returns for 10 years or more to make sure you don't outlive your money. T. Rowe Price has a good online calculator to help estimate failure rates of different combinations of asset allocations and withdrawal rates. You should use it to help you figure out an allocation/withdrawal plan that works best for you.
Method #3: Buy an immediate annuity.
When it comes to immediate annuities, you have three choices. If you buy a fixed immediate annuity or an inflation-indexed immediate annuity, you're done with your investment decisions. Your payout is now locked in, and you'll have no ability to change your mind.
With a variable immediate annuity, your monthly payout will fluctuate according to an underlying portfolio of stocks and bonds. You can even change the underlying portfolio after your payments start. These types of annuities offer the potential for future growth in your monthly income, with the accompanying risk that your monthly payment could decrease if the market drops. For these annuities, just as with Method #1, I prefer keeping your allocation to stocks between one-third and two-thirds for the reasons I mentioned earlier.
My favorite way to buy immediate annuities is through an online shopping service such as www.immediateannuities.com or Vanguard's Annuity Access program. These services shop your annuity for the best price among a panel of insurance companies, and they strive to minimize transaction fees.
As with all the steps in this series, it might take you more than one week of homework to decide on the investments that will work best for you in your retirement years. And it might be a good idea to enlist the help of a professional advisor who doesn't have a stake in your decisions -- an advisor whom you'd pay by the hour or with a flat fee and who does not accept commissions.
Since you're building a paycheck that might last 10, 20, or 30 years, it's well worth many hours of studying and analyzing the right moves for you. You won't regret it many years from now, when you've still got a reliable retirement income that has weathered future recessions.
Image from iStockphoto contributor Marlee90
More on MoneyWatch:
- 12 Weeks to Get Your Retirement Plan in Order
- Planning Your Retirement: The Best Ways to Generate Lifetime Income
- Recession-Proof Your Retirement Savings
- The Best Target Date Funds
- How to Pick a Target Date Fund
- IRA and 401k Retirement Income: Increase Security With an Inflation-Adjusted Annuity
- Using a Variable Immediate Annuity to Increase Your Retirement Income