Five allocation options, from preservation to aggressive growth.
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By Sue Stevens, CFA, CFP, CPA | 06-02-05 | 06:00 AM | Email Article

Many of you who have been loyal Morningstar readers for some time are at least somewhat comfortable with choosing funds. What you need more help with is creating an appropriate portfolio that incorporates your fund choices. 

Sue Stevens, CPA, CFP, MBA, and CFA Charterholder, runs her own financial planning firm, Stevens Portfolio Design, and manages over $100 million in assets.

We're going to take a closer look at five model portfolios specifically designed for retirees. What makes them different from portfolios appropriate for those of you who are still employed is that preservation of principal plays a key role in the investment strategy. So you'll see a heavier allocation to cash and fixed income.

Each person's retirement situation is unique. One size really doesn't fit all when it comes to retirement investing. You need to consider all sources of income--Social Security, pensions, dividend income, annuity payouts, etc. You also need to think carefully about how much risk you can tolerate. Use the following model portfolios to jump-start your investing strategy for retirement. But make sure you tailor these portfolios to fit your own individual circumstances. 
 
Preservation Portfolio
If you are having trouble sleeping at night and you constantly worry about losing money in the stock market, then the Preservation Portfolio may be for you. This portfolio may be appropriate for those of you with shorter time horizons--say, less than 10 years. (By "time horizon," I generally mean life expectancy, not years until you retire.) If you don't have any other sources of income, then this portfolio may help you preserve your nest egg. Of course, even this very conservative portfolio has some risk. For example, when interest rates go up, you may lose principal if you are invested in bond mutual funds. If that's a concern, you can always use CDs (certificates of deposit) or individual bonds (holding them to maturity) instead of a bond fund.

 Preservation Portfolio
Allocation
%
Stock Total
20
Large Value or Large Blend
10
Foreign
5
Real Estate
5
Bond Total
55
Short to Intermediate Term
35
Inflation Indexed
15
Foreign
5
Cash and Cash Equivalents
25

For your stock exposure, consider using  T. Rowe Price Capital Appreciation , Vanguard Total Stock Market VIPERs , or  iShares Russell 1000 Value Index . The last two recommendations are exchange-traded funds (ETFs). They act like funds, but trade like stocks.

If you're looking for a real estate fund, consider using  Third Avenue Real Estate Value  or  Vanguard REIT Index . If you want to add international exposure, consider  Dodge & Cox International Stock .

If you want to hold funds that combine stocks and bonds, consider  T. Rowe Price Personal Strategy Balanced  or  Vanguard Wellesley Income . T. Rowe Price Capital Appreciation (mentioned above) also holds some bonds, but I would consider it more of a large-cap value fund than a balanced fund.

For your core bond holding, put most of your money in high-quality short- to intermediate-term bonds or bond funds. When interest rates go up, in general you'll preserve more principal if you're invested in shorter-term bond funds. Consider  Vanguard Short-Term Bond Index  or  Vanguard Short-Term Investment Grade . If you want a tax-exempt fund, consider  Vanguard Limited-Term Tax- Exempt  or  Fidelity Spartan Short-Intermediate Municipal Income .

To add further diversification, consider holding a portion of your fixed-income holdings in inflation-indexed bonds. These bonds have longer maturities, so keep in mind their values may drop further than shorter-term bonds as interest rates rise. That aside, inflation-linked bonds offer a terrific diversification value. A component of their total return increases with inflation, which could be particularly valuable if inflation edges up over the coming months and years.

In taxable accounts, I'd use I-Bonds (a type of U.S. savings bond) for inflation protection. For more information, check out TreasuryDirect.gov on the Web. For tax-deferred accounts, you can buy individual Treasury Inflation Protected Securities (TIPS) or a fund like  Vanguard Inflation-Protected Securities . You may also benefit from a small amount of foreign bonds in your portfolio. Consider a fund like  T. Rowe Price International Bond .

Finally, make sure you have a comfortable liquidity cushion. You should have enough in cash and cash equivalents (money markets, savings accounts, CDs, and very short-term bond funds) to cover two to five years' expenses.

Conservative Portfolio
If your life expectancy is at least 10 more years, you don't like taking a lot of risk, and you want modest growth over inflation, the Conservative Portfolio may be for you.

 Conservative Portfolio
Allocation
%
Stock Total
35
Large Value or Large Blend
15
Mid/Small Cap
8
Foreign
8
Real Estate
4
Bond Total
55
Short to Intermediate Term
30
Inflation Indexed
20
Foreign
5
Cash and Cash Equivalents
10

Investments that might be appropriate for the conservative crowd include any of the funds listed under the Preservation Portfolio and mid- to small-cap funds like  Vanguard Selected Value  or  Royce Premier .

Balanced Portfolio
Is your life expectancy at least 15 more years? Do you want to beat inflation by at least three percentage points per year? Could you tolerate it if your portfolio value declined in some years? Will you have other sources of retirement income, like a pension? If this describes your situation, a Balanced Portfolio might be right for you.

 Balanced Portfolio
Allocation
%
Stock Total
50
Large Value
10
Large Blend
7
Large Growth
10
Mid/Small Cap
10
Foreign
8
Real Estate
5
Bond Total
45
Short to Intermediate Term
20
Inflation Indexed
15
High Yield or Multisector
5
Foreign
5
Cash and Cash Equivalents
5

Any of the funds mentioned above in either the Preservation Portfolio or the Conservative Portfolio will also work well here--you'll just hold different proportions. For large-cap growth funds, consider  Fidelity Contrafund  or  T. Rowe Price Growth Stock .

For greater diversification within the bond portion of your portfolio, consider adding just a touch of high-yield exposure. Understand that these are junk-bond funds and they are riskier. But in smaller proportions, they can add diversification value. Consider  Vanguard High-Yield Corporate . If you want a tax-exempt fund, consider  T. Rowe Price Tax-Free High-Yield . You might also want to add a small stake in a multisector-bond fund such as  Loomis Sayles Bond .

Growth Portfolio
Like the Balanced Portfolio, this mix is appropriate for people with a life expectancy of at least 15 years. Ask yourself if you want to beat inflation by at least 4% per year. Could you tolerate it if your portfolio lost money for a year or more? Will you have other sources of retirement income, like a pension? Younger retirees or retirees with considerable wealth might find the Growth Portfolio appropriate for their goals.

 Growth Portfolio
Allocation
%
Stock Total
60
Large Value
10
Large Blend
8
Large Growth
12
Mid/Small Cap
15
Foreign
10
Real Estate
5
Bond Total
35
Short to Intermediate Term
15
Inflation Indexed
10
High Yield or Multisector
5
Foreign
5
Cash and Cash Equivalents
5

With more of your portfolio allocated to stocks, you can afford to branch out a little in your security selection. Besides the funds listed in the above portfolios, you might also consider  PIMCO All Asset . This is a fund of funds, but with a unique twist: It invests in hedging types of asset classes such as TIPS, commodities, and real estate.

Aggressive Growth Portfolio
Do you expect to live for at least 20 more years? Could you tolerate it if your portfolio declined for at least two consecutive years? Will you have other sources of retirement income, like a pension? If you answered yes to these questions, you may be a candidate for the Aggressive Growth Portfolio.

 Aggressive Growth Portfolio
Allocation
%
Stock Total
75
Large Value
7
Large Blend
5
Large Growth
15
Mid/Small Cap
25
Foreign
15
Real Estate
8
Bond Total
20
Short to Intermediate Term
5
Inflation Indexed
5
High Yield or Multisector
5
Foreign
5
Cash and Cash Equivalents
5

You'll notice that even the most aggressive retirement portfolio does not include 100% stocks. Although this may not apply to all cases, the vast majority of retirees should not be risking their entire nest eggs in the stock market.

Any of these portfolios may also hold a small percentage in a precious-metals fund such as  Vanguard Precious Metals and Mining . This can broaden your diversification. It may also help protect you against unexpected geopolitical events.

A version of this article appeared in the March 2005 issue ofMorningstar Practical Finance.

Securities mentioned in this article

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Sue Stevens, CFA, CFP, CPA has a position in the following securities mentioned above: VIPSX VIPSX DODFX PRWCX VASVX Find out about Morningstar's editorial policies.
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