For retirement, how to invest beyond stocks and bonds

Helen H. Richardson Denver Post — Getty Images

When you think about your portfolio and it’s components, what items come to mind? Your stocks, bonds and mutual funds, naturally, whether they’re in a 401(k) or a discretionary account. No doubt you think about company stock if you have it (a new piece of research from Fidelity says 10% of employees who have this benefit consider it more important than their 401(k).)  And perhaps you consider investments that you’ve made – angel style – in start-up companies, or rental properties that provide you with ancillary income.  These all fall under the uber-heading of “Investments,” with a capital I.

David Blanchett, head of retirement research at Morningstar Investment Management, wants you to think bigger. In a new white paper entitled “No Portfolio Is An Island” (thank you, John Donne), he argues that your home, job and pensions (including Social Security) are an important – and often overlooked – part of the picture. “The vast majority of investors take an island perspective on their wealth,” he said. “They say, ‘Ok, I’m going to buy this stock or make this change to my portfolio,’ while totally ignoring other risk factors. All of these other things should, to some extent, come into play when figuring out what is the optimal portfolio for individuals who are investing.”

To get a better sense of what he’s talking about, consider company stock.  We’re used to the notion that there’s a high correlation between the risks of your job and the risks of company stock you own. If the company does poorly, you could lose your job at the same time your holdings take a dive – and suffer doubly.  Blanchett and his co-author Philip Straehl, also of Morningstar, are essentially saying that there are other things that work similarly and that you should take them into account when deciding how much or how little investment risk you want to take. For example:

Do you live in a one company town? 

If so, it’s important to consider what happens if that company falls on tough times, or goes under. You could lose your job, but you could also lose significant value in your home because if that company is not hiring, fewer people will want homes in the area. Similarly, the town could lose its tax base, which could send the burden on homeowners up.  “The less diversified, economically, your town is, the less risk you want to be taking in your portfolio,” Blanchett says. And if you suspect the company is headed for tough times renting a place to live rather than buying one may be a smart move.

Do you live in a one-industry city? 

If your city has many businesses all focused on a single industry, you should take similar considerations. Take San Francisco, he suggests. It’s a very large city but if, for some reason, tech stalled and there was little innovation for the next five years, there would be a dramatic, negative impact on the entire city. In that case, you want to be sure your portfolio is invested in things other than technology and things that could act as buffers, if technology falters. Similarly, if you work for a bank, for example, your job and any company stock you own are tied up in large value so your portfolio shouldn’t be.  It’s a means of diversifying overall.

Is your job secure or volatile? 

Do you work in an industry currently going through consolidation or a company that, for whatever reason, is having a rough go of it?  Or, do you have a history of being in and out of the job market (some people seem to suffer more periods of unemployment than others). If that’s the case, the traditional three-to-six month emergency cash cushion is probably not sufficient for you.  Consider doubling up.

How much equity do you have in your home?  

For many people, Blanchett explains, your house is your most leveraged asset. If you put 20% down, you have a five-times leverage factor. So if the value of the place increases by 5%, your realized return (on your equity) is 25%. On the flip-side, for people who have really large mortgage balances, even a small drop in housing can wipe your equity out.  “When you’re thinking about how risky your home is, first think about where you are in respect to your neighborhood and region,” he says.  “But also think about how much leverage you have.”

How much of your income comes from Social Security and pensions? 

This, of course, applies to folks already in retirement – but it’s also something to think about as you get close. The bigger percentage of your income that comes from guaranteed sources, like Social Security, pensions and other annuities, the more risk you can take in your portfolio. “Social Security is really just like a bond if you think about it,” says Blanchett. “That’s how you have to think about it when determining the asset allocation for your overall wealth.”

And if you find all of these factors a little, well, squishy?  Well, so did I. These questions are meant to encourage you to take a high-level perspective, says Blanchett.  “For most people the best approach is to ask yourself: ‘Do I think my job is riskier than average? What are the different unique risks I have that should affect my portfolio?’ The key is to say, how can I make my overall portfolio best accomplish my total wealth goals.”

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