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By Jason Stipp | 09-22-2011 02:30 PM

Weathering Volatile Markets in Retirement

With the right allocation plan, retired investors can avoid making big--and potentially costly--portfolio shifts during turbulent times.

Jason Stipp: I'm Jason Stipp for Morningstar.

Volatility can make us all uneasy, but it's of particular concern to retirees, who are depending on their portfolios to fund those living expenses.

Here with me to offer some tips on how retirees can concur that volatility is Morningstar's Christine Benz, director of personal finance.

Thanks for joining me, Christine.

Christine Benz: Jason, great to be here.

Stipp: So we have seen a lot of volatility in the markets over the last few weeks for various reasons. I know especially retirees are apt to be checking in on their portfolios because they are depending on those investments. What are some tips for how you can get the right mind set to weather this volatility? I think your first one has to do with how the portfolio is constructed.

Benz: It does, and it gets back to that central point about asset allocation and the importance of giving due attention to asset allocation--so making sure that you have saved stuff in your portfolio, intermediate-term securities in your portfolio maybe bonds or hybrid mutual funds, and then a long-term piece.

And if you have adequate cash reserves set aside in that "safe" component, so this is maybe CDs, money market funds, possibly a very high-quality short-term bond. If you have that liquidity set aside to fund the next one or two years, ideally, in living expenses, you can really let those other parts fluctuate a little bit, particularly that long-term part that is doing the most fluctuation, you can actually live with that as long as that you know you have your near-term cash needs covered.

Stipp: So I know a lot of investors are apt to want to become more conservative when the market is very uncertain and when the economic environment is very uncertain.

What's wrong with really pulling a lot of that portfolio and making sure that it's stable and not going to lose value?

Benz: Well, a couple of things. First of all, if you do that, then you are sort of left with this nagging sense of, "how do I get back in?" "When do I know whether it's the right time to get back in?" I am guessing that people who got out or reduced their equity exposure during late summer when things were really bad have been probably looking over the past weeks and saying, "Now is this the time?" "Did I miss it?" So you are left with those nagging concerns. That's reason number one.

Then long term, if you sit tight with a very conservative portfolio, the big risk is that inflation is going to gobble up the earnings power of your savings, and so to me there is a huge opportunity cost, particularly given how low yields are on the safe stuff right now. The opportunity cost of staying too conservative is very great for retirees, particularly when you consider how long people are living. So, many people can expect to live until 85-90 or even beyond. That means that your portfolio has to last that many years. You have to have an awful lot of wealth to be able to make due on that very low yield that you are getting from safe stuff right now.

Stipp: So it seems to me you are saying resist the urge to make huge overhauls if you've already set a logical asset allocation in place.

Another reason I think to resist the urge to do that is some of these investments that you might make could be difficult to unwind should the market improve or the situation change?

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