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Putting retirement tips into practice
Part II of Jeff Francis’s retirement tips, continued from last week’s issue.

What place should stocks have in my portfolio?

Traditionally, many investors consider retirement a time to pull back from the market as they retire and seek a reliable, stable source of income. Recent market volatility, too, may lead some to reduce the portion of their portfolios allocated to stocks and move to what they consider to be safer territory. But is that the right course of action?

“This time is different” is a common phrase right now. But, even so, taking a historical perspective suggests that abandoning the market completely can mean lost opportunities. The S&P 500 was down 38.5 percent for 2008. But investors saw similar drops on at least two previous occasions: from January 1973 to October 1974 (-48.2 percent) and from March 2000 to October 2002 (-49.2 percent).

Yet stock market rallies can come quickly and unexpectedly. After the 1973-1974 bear market, the S&P rose 37 percent in 1975 and after the 2000-02 market, 28.7 percent in 2003. When an investor is out of the market, he or she loses the chance of taking advantage of what might prove to be a significant run up.

Then, too, market indices only tell part of the story. Although stock and mutual funds showed losses across the board in 2008, the damage wasn’t uniform for all of them. Certain sectors fared better than others. Some sectors may be poised for a quicker recovery in 2009.

What fixed-income investments should I be considering?

Typically, a retiree who seeks a regular source of income at a relatively low risk turns to bonds. But today the right choices may not be as clear-cut as they once were.

Because of a rush to “safe” investments, yields on Treasury bonds and notes have fallen dramatically. Maturities of under three years were coming in at less than 1 percent in December and even 30-year bonds were under 3 percent. These low yields pose a problem when the market recovery begins. As yields rise, the market value of existing bonds will fall. Retirees who need to sell lower-yield Treasuries will face losses.

Although inflation has slowed (with talk of deflation in the air), rates are bound to rise at some point. Buying bonds at their current yields offer little protection. Treasury Inflation-Protected Securities may be the solution for some investors. At the end of 2008, TIPS yields ranged from 1.81 percent for five-year TIPS to 2.36 percent for those with a 20-year maturity. But unlike regular Treasuries, prices and payouts of TIPS are adjusted twice a year to compensate for any inflation. Tax alert: Payments of interest are taxable, as is any increase in the value of principal, even though an investor has not actually received a payout that would cover the tax on the latter amount.

Corporate bonds are offering more attractive yields. But in the current economy, with the chance of bankruptcy for even corporate giants, investors are exposed to greater risk.

By comparison, municipal bonds historically have been considered to offer minimum risk because state and local governments have much lower default rates than corporate bond issuers. Generally, because state and local governments pay income that is exempt from federal tax, yields on tax-exempt municipal bonds have been lower than those for Treasuries. Yet, because some investors have been shying away from them in recent months, munis have been yielding as much or even more than taxable Treasuries.

One reason is that munis may no longer give investors the sense of security that they once did. The high ratings by credit agencies have been called into question after the subprime mortgage crisis. Another factor is the growing fear that financially strapped cities and states may have trouble meeting scheduled interest payments on their bonds. There is also fear that cities, hospitals and transportation systems could default on their obligations. And add in the call risk factor, too: If munis become more popular (a strong possibility if taxes go up), a municipality may buy back its bonds in order to reissue new ones at lower rates. One solution may be to stay with state general obligation bonds rather than local issuers that might not be as creditworthy and to seek out municipalities that are standing on firm financial ground.

*References to market indices are for illustration only. Investors cannot invest directly in any index.

Jeff Francis is vice president and senior investment officer for First Tennessee Brokerage. For more information about this and other personal finance issues, call 865-971-2321.


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