Managing Investments

Managing Investments

Today, many Americans over age 65 rely to some extent on investment income to meet their expenses. High net worth seniors have inherited or built their wealth through investments; middle and lower-income seniors’ primary sources of income are often employer-sponsored retirement plans that required them to make investment choices.

  • High net worth individuals probably have the most potential for investment diversification. Someone in this category might invest in income-producing commercial real estate along with owning a number of individual stocks and bonds. High net worth individuals often also have the opportunity to invest more speculatively in fine arts and other collectibles. Most high net worth individuals are likely to invest with growth as their primary goal.
  • Middle-income investors may own some rental property, and may also own some nice art, but their primary investment vehicles are going to be stocks and bonds. Many middle-income individuals will do their investing through mutual funds rather than owning the individual stocks and bonds. Middle-income investors will invest for both growth and income, with the balance between the two shifting toward income as retirement lengthens.
  • Lower-income individuals probably won’t do much investing in the true sense of the word-at least outside of company retirement plans. Within those plans, they may invest in a number of mutual funds. Other investments probably will be more in the category of money market funds, passbook savings, and certificates of deposit. Annuities may also offer potential for both growth and income investing.

The purpose of having investments is to increase income and the value of the assets. However, the profitable return on the cost of the investment is subject to the ups and downs of the marketplace, which is influenced by numerous factors, such as the international marketplace, new technologies, and politics.

The best ways for individual investors to manage the market risk to their investments is to choose the right financial advisor and the investment approaches that match their risk tolerance, financial concerns and goals, and available assets.

Obtaining Professional Financial Advice

Seniors can benefit from expert financial advice in many situations-for example, implementing Medicaid spend downs, choosing the right mix of investments in their employer-sponsored retirement plans, deciding whether to invest in an employee stock ownership or stock purchase plan, determining how to properly use their Social Security retirement benefits, or calculating the best time to retire.

Not only can a qualified financial advisors offer seniors investment strategies and options they may not be aware of to help them beat inflation’s erosion on retirement dollars, such an expert can teach your clients the fundamental concepts of investing and guide them through the steps of the financial planning process that are appropriate for their financial resources and goals.

Unfortunately, it’s all too easy to make some significant investment mistakes-one of the most significant being the choice of an advisor. Seniors who have a pressing need to supplement income lost from lower interest rates can be susceptible to promises of higher returns without understanding the risks involved and the various sales charges. Senior investors should be especially mindful of common investment problems.

The following sections examine in depth the factors that go into choosing the investment strategies and vehicles that best serve the individual seniors’ financial and retirement needs.

Selecting an Investment Approach

Deciding which investment is most appropriate depends on your clients’ available assets as well as their risk tolerance and time horizon, including their life expectancy and amount of time the investment can grow in value or produce income.

Risk Tolerance

If you bought a stock that declined in value by 20 to 25 percent would you sell it? Do nothing? Buy more?

Often financial advisors ask these kinds of questions to help their clients express their tolerance for investment risk. The client who would sell seems relatively risk averse, whereas the client who would buy more appears to be an above-average risk taker. Risk tolerance is one of the key factors that determine which investment strategies are most appropriate for seniors.

Below is a list of investment approach characteristics:

Risk Tolerance Level

Investment Approach

Type of Investment



  • Aggressive growth (small cap)
  • High-income bond funds
  • Real estate investment trust or real estate limited partnership



  • Moderate growth (mid cap)
  • Growth and income funds
  • Value funds



  • Conservative growth (large cap)
  • Fixed-income (government and high-grade corporate bonds)



  • Best for pre-retirement wealth accumulation due to longer time horizons
  • Highest potential for capital appreciation, but also for loss
  • May also be appropriate for early stages of retirement
  • Focused almost entirely on growth and capital appreciation


  • best for early and middle stages of retirement
  • decreased potential for gain, but not as much downside either
  • adapting a moderate strategy early (i.e., in pre-retirement) will probably reduce potential gains, but should also produce less volatility
  • look for a balance between growth and income


  • best for later stages of retirement
  • low potential for gain, but also little potential for loss
  • probably focused on income production rather than capital appreciation

As a general rule, the fewer the assets, the more conservative the investor should be. This means that for those individuals who have few assets or low income, aggressive investing is probably inappropriate. High net worth individuals, on the other hand, have the discretionary income and asset base to invest more aggressively. Yes, it is true that the rich get richer, because they have more to work with. However, appropriate investment strategy can help the poor from getting poorer. We will cover investments later in more depth.

Longer retirements and the continuous erosion of inflation on retirement income will likely to require investment strategies that go beyond reliance on putting money into certificates of deposit. While safe from market risk, certificates of deposit are vulnerable to other risks, such as inflation. Conversely, when work is no longer a source of income, retirees feel quite protective of their nest eggs and are resistant to exposure to market risk, believing that they cannot make up substantial losses. Wise equity investing (whether are individual stocks or using mutual funds) is one of the most effective ways to create growth in a retirement portfolio. Postretirement investment management seeks to provide individuals with growth and income, along with reasonable preservation of principal and tax advantages. Seniors drawn toward highly conservative investments that focus entirely on safety of principal often find their portfolios eroded by inflation risk (i.e., purchasing power risk). Even seniors with a relatively low (conservative) tolerance for investment risk should consider incorporating a small portion of growth-oriented investments such as common stock.

No one wants to lose money they have invested. Unfortunately, people frequently do just that. There are few guarantees with investing, but there are some ways to minimize potential losses. One of the primary ways to minimize potential losses is to match investments to a client’s time horizon.

Time Horizon

A key component of protection against market risk is the time horizon. The time horizon is the period of time between making the investment and when that investment needs to be withdrawn to meet goals or other financial needs. Generally, the longer the time horizon, the greater potential of investment growth using investments that would be considered too risky with a shorter time horizon. As the investment time lengthens, the average annual compound return that can be earned in a particular investment class (e.g., stocks or bonds) becomes more predictable. The primary goal of investing for retirement is to accumulate as much money as possible in order to meet financial needs during retirement.

The goal of accumulating money actually continues into retirement due to the increased life expectancy most people are experiencing. Poor investment results prior to, or early in, retirement, can have a significant impact on a client’s lifestyle as the retirement year’s increase. Investment results are dependent on many factors, with one of the key factors being matching time horizons with appropriate investment vehicles. For example, it normally would not be wise to invest money that is going to be needed in a year in growth stocks. There is too much possibility or significant market fluctuations during such a short period, without the ability to allow time to even out those fluctuations. A better short-term investment would be a money market fund, or perhaps a high-quality short-term bond mutual fund. Over the long term, a diversified stock portfolio (whether holding individual stocks or in mutual funds) will normally produce the best return.

Look for long-term performance. Poor returns in the stock market during the early 2000s made investors more averse to risk than during the bull market of the 1990s. Poor investment returns cannot be ignored, but investing for retirement over a period of 25 or 30 years or making long-term investments during retirement makes the stock market’s return over the short run relatively less important. Historically, performance in exceptionally good years has offset performance in exceptionally bad years for long-term investments. Ernst and Young’s retirement planning guide advises that “over any period of 10 years, stock owners can expect to receive a higher average annual rate of return than do lenders who invest in cash and bonds” (Armone et al., 2002).

Managing Market Risk: Diversification

Burt, 69, has thousands of dollars in his company’s stock that he purchased through its employee stock purchase plan over his 20-year career. Burt counted on the stock appreciating in market value, so he could cash it out in periodic payments for retirement income. But the company suffered severe market losses. Today Burt’s stock is essentially worth just pennies. By the time the company might recover and its stock might increase over the price Burt paid for it, Burt could be dead.

What else could Burt have done? Obviously, rather than putting all his eggs in one basket, Burt could have used a number of other investment vehicles to diversify the way he allocated his assets and protect his investments against changes in the market.

Asset allocations should be consistent with an older investor’s goals, financial constraints, and time horizon. The goal of asset allocation is to achieve the highest return given an acceptable level of risk or the lowest risk for a needed rate of return.

Asset Classes

By combining assets with different characteristics in an investment portfolio, an investor may achieve higher returns with lower risk over the long term.

Diversifying funds across a variety of asset classes may be crucial to managing market risk and increasing the return on investments. Assets are classified in broad terms as:

  • Stocks: large-cap and small-cap, value income and growth, international and combinations of each; common and preferred
  • Bonds: short, intermediate, and long-term; tax-free; high-yield; convertible; and international classifications
  • Cash

Two of the most common types of investments are stocks and bonds. Generally, stocks provide the potential for growth whereas bonds provide income (of course, stocks can also provide income, and bonds may offer some growth potential).

Equity Investing through Common Stock

Common stock belongs in most investment portfolios because, in the past 50 years, it has generally outperformed inflation and has dramatically outperformed other investments. Common stock is a form of equity investment. In investing, equity refers to ownership. The best recognized unit of investment ownership is common stock, which implies ownership in a corporation. Such ownership entails limited liability for the shareholder, who can lose no more than the amount paid to acquire the stock (plus costs).

Investing in Debt for Income: Bonds

In investing, debt generally describes bonds, notes, mortgages, and other arrangements involving monies owed and payable. Issuers of debt include federal governments such as the United States Treasury; municipalities, such as states, cities, and counties; and also corporations. An investor who buys a debt instrument is lending money to its issuer with the promise that at some point in time the money must be returned to the lender. Clearly, the investor who holds a debt security has no ownership. Instead, the bond or note holder’s position is that of the issuer’s creditor, because the face amount of the bond or note must be returned to that bondholder.

Not everyone has the resources available to invest directly in stocks or bonds. Prudent investing requires diversification among various types of investments, different industries, and different companies. This helps to reduce market risk. For example, a well-diversified stock portfolio requires at least 12 to 15 different stocks (and perhaps more). Mutual funds were created to provide many people with the opportunity to have well-diversified portfolios, even when they might not have the funds to create such an individual portfolio of stocks or bonds.

 Key Terms and Definitions

Investment portfolio: a group of investments, which may include stocks, bonds, real estate, money markets, and/or mutual funds. A portfolio may be managed professionally or by the individual investor.

Capitalization: the market value of a company’s stock.

Large-cap stocks: stocks of companies with a market capitalization between $ 10 billion and $ 200 billion. Usually large, well-established companies or blue chips (Note: Exact dollar amounts may vary. For example, some sources suggest that the upper number should be $ 300 billion or even more. However, the general guidelines will serve.)

Mild-cap stocks: stocks of companies with a market capitalization between $ 2 billion and $ 10 billion. Usually mid-sized companies with some growth potential along with some of the stability of larger companies.

Small-cap stocks: stocks of companies with a market capitalization between $ 300 million to $ 2 billion. Usually small, new companies with good growth potential. However, these stocks frequently have high volatility.

Value investing: process of selecting stocks that trade for less than their intrinsic value. A value investor usually looks for stocks of companies that are financially sound but currently undervalued by the market.

Income investing: process of selecting stocks or bonds that produce regular income payments. Payments may be in the form of stock dividends or income (coupon) payments from bonds. Income investors are less concerned with capital appreciation (growth) than with regular income.

Growth investing: process of selecting stocks of companies that seem ready to have strong growth and expansion. These may be established companies, but more often are young companies with a good product and not too much competition (yet). Where income investing looks for periodic income (dividends), growth investing looks for capital appreciation.

Common stock: represents ownership of a company. Owning common stock gives equity in the company, usually along with voting rights, and provides the opportunity to share in the company’s growth or income, or both.

Preferred stock: represents ownership of a company, but usually without voting rights. Preferred stock pays a fixed dividend before any common stock dividends are paid. Preferred stock investors are senior to common stock investors and have a greater claim on company assets than common shareholders.

High-yield bonds: typically bonds with a lower credit rating that offer increased returns. While they may offer more income potential, they also have a greater default potential, and conservative investors should be cautious.

Convertible bonds: corporate bond that may be exchanged for a specified number of shares of stock in the same company. Convertible bonds are sold at a premium over the price of the stock. They pay interest and may also offer the opportunity for capital appreciation.

Mutual Funds

Mutual funds are managed investment companies that offer an investor not only professional management, but also liquidity, diversification, and other important services that would otherwise be unavailable to small or inexperienced investors. There is little wonder that roughly 16,000 managed investment companies operated in the United States in 2007, according to the Investment Company Institute and Strategic Insight Simfund. Despite the popularity of managed mutual funds, the decision as to when an older investor should buy or sell them should take into account the economy; the state of stock and bond market interest rates; and, of course, the client’s needs, objectives, and risk tolerances.

Mutual funds invest the pooled money of many small investors in portfolios of securities matching an investment objective state for that portfolio. Mutual funds charge management or administrative feeds for the services they provide, and many impose sales charges upon purchase or sale of the funds. Mutual fund sales charges (commissions) are often referred to as loads. There are several different types of commissions for different types of investors.

Open-end mutual funds are among the most liquid of investments because an issuing company must redeem shares on demand. This operates in contrast to nonredeemable securities, where an investor (or a broker) wishing to sell must located a buyer. Shares are redeemed at net asset value, although back-end loads or redemption fees may be charged.

Mutual funds are available in many varieties. Some invest aggressively in the stock market for growth, while other funds invest more conservatively for income. You need to understand the risk tolerance and total portfolio components before recommending a particular mutual fund.

Mutual Funds

Growth-Type Funds

  • Growth funds invest in common stocks for appreciation
  • Aggressive growth funds hold common stocks of rapidly growing corporations.
  • Specialized funds, often called sector funds, concentrate in one industry (or one geographic region).
  • Index funds operate portfolios mirroring those of recognized broad-based indices and averages, such as the Down Jones Industrial Average or the S & P 500.
  • Growth and income funds seek appreciation as well as dividend income.

Income-Type Funds

  • Equity income funds hold high-dividend-paying stocks in industries such as utilities.
  • Corporate bond funds invest in corporate bonds of many issues for income.
  • High-grade (investment-grade) bond funds invest in bonds rated AAA or AA by recognized rating services, such as Moody’s and Standard and Poor’s.
  • High-yield bond funds, sometimes called junk bond funds, invest in corporate debt with ratings of BB or lower.
  • Municipal bond funds hold tax-exempt bonds issued by states, cities, and other municipal entities.
  • Intermediate-term municipal bond funds, called muni bond funds, feature bonds with intermediate-term maturities between 10 and 30 years.
  • High-yield municipal bond funds seek higher tax-exempt yields by investing in lower-ranked municipal securities carrying higher yields.
  • Government-guaranteed funds invest in debt securities, mainly Treasury securities, with no default risk.
  • Government securities funds invest in both Treasury and agency securities. The return is somewhat higher than that of government-guaranteed funds.
  • Government National Mortgage Association (GNMA) funds invest in mortgage-backed securities with interest and principal guaranteed by the U.S. government.
  • Money market funds invest in short-term or soon-to-mature debt. Money market funds are designed to maintain a constant $ 1-per-share value regardless of interest rate changes.
  • Tax-exempt money market funds invest in short-term municipal notes and soon-to-mature municipal bonds.

Balanced-Type Funds

  • Asset allocation funds switch portfolio assets among stocks, bonds, and money market securities.
  • Balanced funds are overseen by managers who buy common and preferred stocks as well as bonds, seeking to blend growth from stocks with a more defensive bond strategy.

Global Funds

  • Global or international funds invest in stocks or bonds issued throughout the world. Global funds contain both American and foreign-issued securities.
  • Foreign funds invest to foreign-issued, non-American securities, seeking profit opportunities in markets currently offering the highest potential return.

Computer Modeling to Plan Asset Allocation

Today’s financial professionals generally employ sophisticated computer programs that analyze historic returns and risk of asset categories to identify the ideal mix of stocks, bonds, and international investments. These programs are called optimizers because they create portfolios that aim for maximum return with the lowest possible volatility. Sample asset allocation models and projected returns should be reviewed with senior clients, who can select the investment strategies that best fit their risk tolerance and financial goals. Exploring various portfolio models allow a senior to consider the impact of different investment strategies.

Marginal Tax Rate

Seniors should examine investment vehicles that reduce their exposure to income taxes. The higher a senior’s tax bracket (as determined by annual income), the more significant tax-advantaged investments such as public-purpose municipal bonds become. A fully taxable investment must earn a higher rate of return to provide an equivalent rate of return to a tax-free investment. Understanding the impact of marginal tax rate and becoming familiar with a tax-advantaged investment could offer significant benefits to seniors.

The information above is reprinted from Working with Seniors: Health, Financial and Social Issues with permission from Society of Certified Senior Advisors® . Copyright © 2009. All rights reserved.