Your Freedom Portfolio - investing for early retirement

Kiplinger's Personal Finance Magazine, March, 2001 by Manuel Schiffres

COVER | A sound strategy and sturdy investments will put wind into your EARLY-RETIREMENT sails.

A SELF-DESCRIBED "crazy sailor," Elizabeth Sugg has been racing dinghies and other boats since high school. She dreams of retiring in 15 years, spending her leisure time sailing and traveling the world. To achieve her goals, Sugg, a 42-year-old executive editor for book publisher Prentice Hall, figures she'll need a nest egg of $2 million.

The White Plains, N.Y., woman is counting on appreciation of her stock-packed, six-figure portfolio to make her dream come true. But if the stock market continues to buffet investors with gale-force winds, as it did last year, it could sink her retirement plans. Given that the overall market fell in 2000--the first time that's happened in a decade--Sugg isn't panicking because her retirement accounts lost 12%.

To varying degrees, millions of others who are saving for early retirement are--pardon the expression--in the same boat as Sugg. They are coming off a year in which it felt good to see their investment portfolios nudge barely into the black--forget those glorious, if gaudy, 30% gains that were SOP in the late 1990s. And investors who entered 2000 laden with the kinds of stocks that had worked best the previous year or two--and who stuck with them throughout the year--got soaked.

Whether your portfolio was drowned or merely waterlogged, this is a good time to reexamine your investment blueprint for early retirement and, if necessary, make mid-course corrections. The aftermath of a turbulent year is the perfect time to determine whether your retirement investments are properly diversified. Consider last year--during which the Nasdaq Composite plunged 39%--a vivid reminder that some of the verities of investing were only blurred, not obliterated, during the Internet boom of the late '90s. Stocks sometimes lose value; a company's profits (or lack thereof) do ultimately matter; diversification isn't just for hopelessly old-fashioned fuddy-duddies; those who take the biggest risks are apt to experience the biggest falls.

Retirement savers could do a lot worse than follow Sugg's lead. Despite her soggy results last year, she is sticking with her investment program. That includes contributing 10% of her salary and 10% of her bonus annually to her company's 401(k) retirement plan (the rest of the bonus goes into a taxable account). She is keeping her portfolio heavily tilted toward stocks, which over the next 15 years are most likely to generate the returns Sugg needs to achieve her goals. In Sugg's case, that means holding on to good, high-quality stocks, even if they've fallen in value--and, in some instances, buying even more shares of battered names.

The building block

OWNING STOCKS is crucial to building a bundle for retirement. "The biggest risk over the long term is inflation," says Bill Starkey, director of retirement planning at Prudential Securities. "You have to be in stocks, something that's tied to the growth of the economy, to protect yourself from inflation." True, 2000 reminded us that in any given year stocks as a group can fall in value. But over long periods, stocks rarely lose money. Since 1926, the U.S. market, as measured by Standard & Poor's 500-stock index, has returned 11% per year, says Ibbotson Associates, a Chicago consulting firm. In only two ten-year periods, both encompassing the Great Depression, did the S&P 500 fail to generate positive results. Moreover, over long periods, stocks have always performed better than alternative investments, such as bonds and Treasury bills. With interest rates as low as they are--benchmark ten-year Treasury notes yield 5.2%--it's likely that that relationship will persist.

The other keys to successful long-term wealth-building are to start early and invest regularly. Given the large number of employers that allow workers to contribute to 401(k) and 403(b) retirement plans, it's easier than ever. If you save through an IRA, many mutual fund companies will allow you to make regular contributions by shifting funds automatically from your checking account to the fund.

Another benefit of putting contributions to your retirement kitty on autopilot is that it takes much of the emotion out of investment decisions. By in effect practicing dollar-cost averaging--that is, investing a fixed amount of money at regular intervals--you're not tempted to increase your investments after stocks have soared to possibly unsustainable levels. On the other hand, if stocks fall for a while, averaging forces you to buy shares when bargains abound but you're feeling gun-shy.

Beyond conservative instruments such as Treasury notes and bank certificates of deposit, few investments come with a guaranteed return. One that does come with an assured return--and it's usually a substantial one--is your employer's match for your 401 (k) contribution. Many employers fork over 50 cents for each $1 you contribute. In essence, you receive a 50% return for each dollar you contribute to your account up to the company's match limit, usually 6% of your salary. As the now-discredited dot-com mania underscored, you otherwise need to take extraordinary risks to achieve such lofty gains. "Contribute at least enough to get the maximum match," says Lindsey Wilkins, head of retirement marketing at the Edward Jones brokerage. "Don't leave money lying on the table."