MONEY Ask the Expert

Investing in TIPS: Can Retirees Beat Inflation?

Q. Are TIPS a good investment for a retiree? — Rich Sherman

A. If your goal is to protect the value of your assets and your income from inflation over the course of a long retirement, then you should certainly consider TIPS, or Treasury Inflation Protected Securities.

But before you go stuffing your retirement portfolio with them — or more likely, TIPS funds — you first need to understand the type of the inflation risks you face in retirement. You’ll also want to keep in mind that you already have a very powerful inflation buffer in Social Security, as its payments are pegged to the inflation rate.

So as important as hedging your retirement portfolio against inflation is, you don’t want to overdo it.

Essentially, you need to guard against two forms of inflation during retirement. The first is what economists call expected inflation, or the steady rise in the price level that takes place over many years.

Hedging against this version of inflation is relatively straightforward: Keep a portion of your savings in investments that have the potential to generate returns several percentage points or more above the inflation rate over the long term.

Stocks are clearly one such investment, although mutual funds that invest in REITS and other real estate-related investments can also provide long-term inflation-beating returns. (Don’t forget that if you own a truly diversified portfolio of stocks, such as a total stock market index fund, you already have REITs in the mix.)

Related: Long-term investing — keep it simple

The second type of inflation you need to protect against is unexpected inflation. This is the kind that can flare up suddenly, like the oil-price shocks of the mid-1970s and early 1980s.

These spikes are usually relatively short-lived, so they’re not a major issue for people still investing for a retirement that’s decades down the road. But if you’re a retiree relying on your investments for current spending cash, even short spurts of inflation can make it more difficult to maintain your standard of living.

The issue is how to deal with this second inflation threat. Many advisers recommend investments like commodities or gold, which have the potential to generate lofty returns when unanticipated inflation takes off.

But Vanguard Investment Counseling and Research principal John Ameriks points out that these outsized returns aren’t a given. “There are many historical instances where you see high inflation and low commodity returns,” says Ameriks. Indeed, research shows that there’s roughly a 30% chance that commodities could post negative returns if inflation goes up.

TIPS, on the other hand, are uniquely suited for handling unexpected inflation. Unlike commodities or gold, which may be statistically likely to climb in value if inflation spikes, TIPS have been specifically designed to rise along with increases in the consumer price index.

Related: Are emerging market bond funds a safe haven?

That said, TIPS also have some drawbacks. They are bonds, so their value can fall if real interest rates rise. What’s more, demand for TIPS from investors seeking shelter from inflation has pushed their real yield, or their payout after inflation, close to or even below zero. Recently, for example, the real yield on 10-year TIPS was -0.53%.

Many advisers have pointed to TIPS’ negative real yields as a reason not to own them. But while investing in TIPS when their real yield is negative does mean you’ll earn less than the inflation rate, the principal value of the TIPS and the income they throw off will still rise if inflation picks up. Thus, by owning them you are still protecting yourself should inflation climb in the future or spike unexpectedly in the short-run.

Besides, it’s not as if regular Treasuries or other bonds will thrive if inflation heats up. Quite the opposite. Conventional 10-year Treasuries recently yielded about 2.03%. So if inflation exceeds that level over the next 10 years, regular 10-year Treasuries would generate a loss. And if inflation exceeds 2.56% — the recent difference between the -0.53% yield for 10-year TIPS and the 2.03% yield for 10-year nominal Treasuries — then TIPS will outperform regular, or nominal, Treasuries.

That’s why you really want to own both TIPS and regular Treasuries and other bonds. If inflation rises over time or just spikes for a shorter period at some point in the future, then TIPS could be the better performer. If inflation stays tame or becomes even more docile, then conventional bonds will generate better returns. By owning both, you’re hedging your bets.

You can argue about how much of a retiree’s bond stake should go to TIPS vs. nominal bonds. But if your retirement portfolio already includes some stocks to protect against expected inflation over the longer term, then devoting, say, 25% to 30% of your bond holdings to TIPS seems a reasonable way to guard against both expected and unexpected inflation.

Bottom line: Investing in TIPS is a reasonable way for you to protect your purchasing power in retirement. But do it in moderation. Because the more you focus your investing strategy toward dealing with one risk, the more vulnerable you are to others.

MONEY

A Couple’s 5-Year Plan to Pay off $93,600 in Debt

Larry and Lynn Mantanona, 56 and 54, Fairview, Ore. photo: miller mobley

When it comes to family, Lynn and Larry Mantanona believe in sparing no expense. That means frequent travels to Larry’s native Guam for weddings, funerals, and other big family events.

They had no qualms about taking a $12,000 loan for college tuition for Savanah, 22, and borrowing $20,000 for wedding expenses for Chanelle, 28.

“We want to do for our daughters what our parents couldn’t do for us,” says Lynn.

Now the couple find themselves in a difficult situation. The Mantanonas owe over $90,000 on various credit cards and personal loans and can’t seem to whittle the debt down.

“We aggressively make payments, but then something comes up, and we have no savings to fall back on,” says Lynn. They also owe more on their house than it’s worth.

On the upside: The couple have a decent amount of retirement savings, thanks to Lynn’s longtime habit of putting 5% of her salary in her 401(k). She’ll also qualify for a monthly pension of $1,300 at age 62.

Still, the couple feel behind. “Lynn deserves to retire in 10 years,” says Larry. “I’ll keep working if I have to.”

Occupations: Catering manager,IT manager

Goals: Pay off debt, retire in 10 years

Total income: $152,000

Retirement savings: $330,000

THE PROBLEM

The Mantanonas clearly need to axe the debt, says Marc Russell, an adviser with Convergent Wealth Advisors in Los Angeles. Still, they need to keep saving for retirement. “It’s about weighing competing priorities,” Russell says. With the right plan, they can get there.

THE ADVICE

Make a repayment plan. In early 2013, Lynn will receive a $14,000 tax-free gift from her mother. That money can nearly wipe out their credit card debt.

By temporarily cutting Lynn’s retirement contributions to 3% — enough to still get the full company match — they’ll free enough cash to make a big dent in their highest-rate debt within a year. Then they can focus on other loans.

Check for money leaks. After closely examining the Mantanonas’ budget, Russell thinks they can carve out $200 a month to save in a money-market account earmarked for emergencies and future expenses.

As they pay their debts, they should aim to build the emergency fund to six months’ worth of living expenses and save more aggressively for retirement.

Move into a target-date fund. Right now Lynn’s retirement plan is mostly low-yielding government bonds.

Russell suggests she shift into the low-fee 2020 target-date fund in her plan, which would bring her fixed-income allocation to about 46%, or half what it is now.

Assuming the couple save an additional $12,000 a year for retirement beginning in 2018, they should hit $600,000 in savings in 10 years — not what they need to fully retire, but not far off.

Says Lynn: “At least that will bring us to a manageable situation.”

Would you like a free financial makeover in Money magazine? E-mail makeover@moneymail.com for more information.

MONEY Ask the Expert

Long-Term Investing: Keep It Simple

Q. I have $12,000 that I’m ready to invest for a long term. But I’m not sure whether to buy regular mutual funds, index funds or a mix of both. What do you suggest? — Daniel, Sugarland, Texas

A. I believe that investors are generally better off when they keep things simple. So for that reason alone, I’d go with index funds.

You can make a very nice diversified portfolio for yourself by combining just two funds: a total stock market index fund and a total bond market index fund VANGUARD BD IDX FD COM NPV VBMFX -0.277% . That would give you a portfolio that covers all sectors of the U.S. stock market — large and small caps, value and growth shares, virtually every industry — as well as the entire investment-grade taxable bond market, including government and corporate bonds.

You would do just fine if you stopped there.

But if you want to add some exposure to foreign markets — which over the long run can reduce the volatility of your portfolio overall — you could also throw in a total international stock index fund VANGUARD STAR FUND TOTAL INTL STOCK INDEX FD VGTSX 0.1143% . For guidance on how to divvy up your holdings between stocks and bonds, you can check out our Fix Your Mix asset allocation tool.

Simplicity aside, this approach offers another huge benefit: low annual expenses.

By sticking to diversified stock and bond index funds, you’ll likely pay yearly fees of less than 0.25% of the amount invested, in some cases less than half that figure. Regular, or actively managed, mutual funds on the other hand, often charge 1% of assets or more. And while there’s no guarantee that lower expenses leads to better performance, there’s plenty of evidence that’s the case, including this 2010 Morningstar study.

Oh, and there’s one more reason I prefer index funds: You know exactly what you’re getting. As their name implies, index funds track a particular index or stock market benchmark. The fund holds all, or in some cases a representative sample, of the stocks in the index and nothing more (except, perhaps, a smidgen of cash to accommodate redeeming shareholders).

Managers of actively managed funds, by contrast, have lots of wiggle room when it comes to investing.

So even though a fund may purport to specialize in, say, domestic large-cap value stocks, it’s not unusual to find a manager making forays into small-caps, growth stocks or even foreign shares in an attempt to juice returns. This sort of “adventurism” makes it harder to use actively managed funds as building blocks for a diversified portfolio in which you’re counting on each fund to play a specific role.

But as much as I believe index funds are the better choice, I don’t think you’d be jeopardizing your financial future by devoting a portion of your investing stash to actively managed funds. And if that’s the way you want to roll, you should have no trouble finding funds run by smart managers with solid long-term records who can do a credible job of investing your money.

In that case, you might employ a version of what’s known as a “core and explore” strategy: put most of your money into index funds and then round out your portfolio with some well-chosen actively managed funds.

Related: Mutual funds – a simple way to diversify your portfolio

How much of your dough goes into the core vs. explore is up to you. But to prevent any bad picks from undermining your portfolio’s overall performance, I’d recommend keeping the active portion of your holdings pretty small, say, 10% to 15%.

There’s one other thing you’ll want to be careful about if you decide to take this hybrid approach. Some advisers suggest using index funds in “efficient” markets like those for U.S. and developed country large-cap stocks and recommend actively managed funds for “inefficient” markets like those for small-caps and emerging market stocks. But identifying efficient vs. inefficient markets isn’t quite so simple, and finding active managers who consistently outperform is difficult in almost any market.

So I’d recommend that you get exposure to all markets with index funds and then add the actively managed funds you like even if it means you’ll have a bit of overlap in some areas.

I also suggest that as much as possible you go with actively managed funds that have reasonable expenses, as that should give those funds a better shot at competitive performance. You can find such funds, as well as all the index funds you’ll need, on our MONEY 50 list of recommended funds.

To sum up, I think most investors would be best served if they just stick with a straightforward portfolio of broad index funds.

Human nature being what it is, however, many people will give in to the urge to venture beyond the indexes for the thrill (even if only fleeting) of finding a fund that beats the market. If you’re one of those people, fine. Just don’t let yielding to that urge undermine your investing results.

MONEY Ask the Expert

Your Future Self Thinks You Should Save More for Retirement

From: faceretirement.merrilledge.com/

Q. How do I convince my spender husband that it makes sense to contribute more to his 401(k)? — G.L.

A. You’ve got a bit of an uphill battle for the simple reason that it’s a lot more fun to spend than save. Still, I have a suggestion that may be able to help you convince your hubby to rein in his free-spending ways and throw a few more bucks into the old retirement account: Introduce your husband to his future self.

How, you may ask, can you do that? Before I tell you, you first need to know why such a meeting might spur your husband to save more.

Ultimately, saving comes down to foregoing spending money today so you can spend it (plus however much it earns) later in life.

Problem is, research shows that the present day you doesn’t identify particularly well with the older you. Given that disconnect, you don’t have much of an incentive to abstain from spending and the pleasure it can bring today to make life better for this stranger in the future.

But apparently there’s a way to bridge the gap between our current and future selves.

Researchers at Stanford University conducted experiments in which they put two groups of students into virtual reality headgear and had them interact with realistic computer renderings of themselves. But one group was shown only images of themselves at their current age, while the other also saw age-morphed versions of how they may look in retirement.

When each group was later asked how much they would save for retirement, the ones who saw their older selves said they would save twice as much on average as the other group. Apparently they felt more of a bond with their future self and thus were more disposed to do something today to help that person.

You can do a somewhat similar experiment with your hubby. Just have him go to Merrill Edge Face Retirement and click on “Meet the Future You.” After entering his age and gender, he’ll be able to snap an online photo of himself (assuming his computer has a built-in camera) to which the site applies facial-aging software. He’ll then see a series of photos simulating what he might look like at different ages late in life.

The idea is that seeing a version of himself at, say 77, may make him think more seriously about the fact that he’ll still be around at that age and have to support himself in retirement.

The little factoids that accompany the photos at different ages — Cost of a new car in 2034: $62,000; Cost of living increase from 2012 to 2054: 307% — may also help drive home the point that he’ll need a sizable nest egg if he hopes to maintain his lifestyle in retirement.

Related: Take control of your spending

I’m not saying that going through this exercise — which, if only for kicks, you may want to try, too — will lead your husband to immediately boost his 401(k) contribution by 50%. But it could get you both talking about retirement and whether you’re adequately preparing for it.

Ideally, that discussion will lead you and your husband to take some other steps to advance your retirement planning. To get a sense of how you might actually live in retirement, you could check out Ready-2-Retire, a tool that allows you to sort through photos of different retirement activities (traveling, going back to school, etc.) and prioritize them based on how likely you are to engage in them. Once you have a decent idea of what kind of retirement lifestyle you aspire to, you can then go to a tool like our Retirement Planner to see how much you should be saving to achieve that goal.

See whether you’re saving enough

If after checking out these tools you find that your husband is actually putting away enough to assure you’ll both have a secure retirement, that’s great. You can both feel reassured about that.

But if it turns out that your husband really does need to save more, then having him meet a digital version of his future self maybe just the motivation he needs.

MONEY Ask the Expert

Reasons to Cut Back on Stocks in Retirement

Q. Why is the recommended mix of stocks and bonds any different at the beginning of my career than at the start of retirement? I don’t understand why I should reduce my exposure to stocks when I retire, as I’ll still have 30 years of investing ahead of me. — Gordon Groff, Lancaster, Pa.

A. You’re right. You should be investing for the long term — both during your career and after you retire. Still, there are some key differences between those two stages of life that argue for gradually scaling back on equities after you retire.

The single biggest difference is that you have a lot more flexibility during your career when it comes to retirement planning. For example, if you have the bulk of your retirement accounts in stocks and the market tanks, you’ve got plenty of options for rebuilding the value of those accounts.

With years of work still ahead of you, you can simply sit back and wait for the market to rebound and eventually climb to higher ground. Or you can pump up the amount you contribute to your retirement accounts, which will hasten the recovery of your balances.

If worse comes to worse, you can always postpone retirement for a year or two, which will give your nest egg a chance to grow through a combination of additional savings and a few extra years of investment returns.

But if your savings are heavily invested in stocks in retirement and the market takes a dive, you don’t have nearly as much wiggle room.

Unlike during your career when you’re still putting money into your 401(k), IRA or other accounts, you’ll be pulling money out of your nest egg once you retire. And that creates a very different dynamic.

Related: Retirement checkup for the new year

Specifically, the combination of investment losses from a market downturn, plus withdrawals from your account for retirement living expenses creates a double-whammy effect that can decimate the value of your portfolio and dramatically increase your chances of outliving your dough.

As a result, the same market meltdown that may be very unsettling during your career can be absolutely devastating after you’ve retired, perhaps even forcing you to radically scale back your standard of living to avoid running through your money too soon.

Here’s an example. Let’s say you retire at 65 with $500,000 in savings from which you plan to withdraw an initial 4%, or $20,000, that you will increase annually by the inflation rate to maintain your purchasing power. And let’s further assume that you would like your savings to support you at least 30 years.

If you plug that scenario into a good online retirement calculator, you’ll find that the chances of your nest egg lasting 30 years are roughly the same — just under 80% — whether you invest 80% of your savings in stocks and 20% in bonds or split it 50-50 between the two.

And although the calculator doesn’t show this, it’s also true that if all goes well and there are no major blowups in the market, the higher returns stocks can deliver might allow you to draw even more from your nest egg than had you gone with the 50-50 mix.

Related: Market timing — Not a good retirement strategy

The problem is what happens to those odds if things go badly. For example, if you had retired at the beginning of 2008 with 80% of your savings in stocks and 20% in bonds and embarked on the withdrawal scenario above, at the end of the first year of retirement the combination of a $20,000 withdrawal and a 30% investment loss would have left you with a nest egg worth roughly $340,000 — a 32% decline in a single year.

If you continued to withdraw $20,000 and increased annually for inflation of, say 3%, the chances of your savings lasting the next 29 years to age 95 would plummet from a little less than 80% to just under 40%.

By contrast, had you invested half your savings in stocks and half in bonds, the combination of your initial withdrawal and the market downturn would have left you with a nest egg worth a bit more than $400,000.

The probability of your money lasting to age 95 would decline. But since your nest egg wasn’t whacked as hard, the chances would drop to just over 50%.

Clearly, in both cases you would have to make some adjustments — going without an inflation increase for a few years, reducing your withdrawals outright or perhaps even taking on part-time work.

The difference is that with the more conservative portfolio, the compromises you would have to make to your retirement lifestyle wouldn’t have to be as severe. And you wouldn’t be as vulnerable to potential market setbacks in the future.

Now, does that mean that it can never make sense to invest somewhat aggressively in retirement? Of course not.

Related: Emergency funds: Risk versus returns

If income from Social Security and a traditional company pension covered all or nearly all of your annual expenses, then theoretically you may be able to invest quite heavily in stocks.

After all, if your retirement accounts suffered serious losses, you would still have enough income apart from savings withdrawals to maintain your lifestyle (although even then you would have to consider whether you would be emotionally okay watching your nest egg’s value decline by 30% or more).

Bottom line: If you’ll have lots of income flowing in throughout retirement from guaranteed sources — or your nest egg is so large or withdrawal rate so small that your chances of depleting it are truly minimal — then I suppose you could invest the same way late in life as you did at the beginning of your career. But if that’s not the case — and I suspect it’s not for most of us — the more prudent approach is to scale back your stock exposure as you near and enter retirement.

MONEY Ask the Expert

Retirement Savings Checkup for the New Year

Q. I save 15% of my salary each year in my 401(k), my company matches another 4.5% and I contribute the max to a Roth IRA. Am I doing enough to safely retire? — Dave K., Jacksonville Beach, Fla.

A. If you continue at the rate you’re saving, it’s hard to imagine you’ll come up short at retirement time. After all, you’re socking away money at more than double the rate of most 401(k) participants, plus you’re funding that Roth IRA.

But as important as diligent saving is, your savings rate alone can’t tell you whether you’re on track for a secure retirement. To know for sure, you’ve got to undertake a more comprehensive review of your retirement planning efforts.

You can do that by performing what I call my annual New Year’s Retirement-Planning Checkup. It consists of just three simple steps:

1. Figure the odds. There are so many unknowns and potential detours along the road to retirement — market setbacks, spates of unemployment, emergencies that drain savings — that you can never say that a secure retirement is a given.

Related: Take control of your spending

But by taking a look at where you stand now as well as the strategy you’re currently employing,you can get an estimate of the probability that you’ll be able to maintain an acceptable standard of living once you retire.

The easiest way to do such an assessment is to go to a robust online tool like our Retirement Planner or T. Rowe Price’s Retirement Income Calculator. You just plug in such information as how much you’ve already got tucked away in retirement accounts, the percentage of salary you’re saving now, how those savings are invested and the age at which you intend to retire, and you’ll get an immediate forecast of your chances of being able to retire on, say, 75% of your pre-retirement salary.

Aside from the obvious benefit of letting you know whether the path you’re on has a decent chance of leading to a comfy post-career life, this sort of evaluation has another advantage: by changing a few variables — your savings rate, how you invest, the age at which you retire, whether you work part-time in retirement — you can see how you might be able to increase your shot at a secure retirement.

This type of exercise is essential if you really want to know whether you’re making progress toward retirement. If you don’t feel confident doing this sort of number crunching on your own, then consider hiring a pro to guide you through the process. Just be sure to vet that adviser carefully.

2. Evaluate your portfolio. Although I’ve long noted that diligent saving is more crucial to retirement success than savvy investing, you nonetheless want to be sure you’re not undermining your savings effort with an inferior investment strategy.

Your first task on the investingfront is to makesure you’ve got a mix of stocks and bonds that’s appropriate given your age and risk tolerance.

Generally, the younger you are, the more of your retirement savings you’ll want to invest in stocks. As retirement nears and preserving your nest egg becomes a bigger priority than growing it, you’ll want to shift more toward bonds. There’s no single stocks-bonds blend that’s right for everyone.

As a starting point, you can check out the mix for a target-date retirement fund designed for someone your age. You can then see how such a blend might actually perform by going to Morningstar’s Asset Allocator tool. If you find that the mix you’re considering is too aggressive or too conservative, you can then adjust it.

You also want to be sure that your respective stock and bond holdings are properly diversified. In the case of stocks, for example, that means owning shares of both large and small companies as well as a broad range of industries. To gauge whether your portfolio is reasonably balanced compared with market benchmarks, plug your holdings into Morningstar’s Portfolio X-Ray tool.

Finally, take a hard look at what you’re shelling out in annual expenses.

Reducing the portion of your return that’s siphoned off by investment costs can have a big payoff. Lowering expenses from, say, 1.5% a year to 0.5% can increase the eventual size of your nest egg by roughly 20%. Fortunately, federal rules that went into effect in August make it much easier for 401(k) participants to see what they’re actually paying in fees and thus home in on the low-cost options in their plan’s investment roster.

3. Schedule updates. Once you’ve completed this checkup, you don’t need to fiddle with your retirement strategy every waking moment. Still, it is a good idea to check in occasionally just to be sure the plan you’ve put in place is working as expected.

So take a moment now to schedule a few specific times during the coming year — the end of a quarter, a birthday, wedding anniversary, whatever — when you can do quick re-assessment of where you stand and make tweaks if needed.

If you experience a significant change in your circumstances — say, moving to a new job or taking on a big new financial commitment — then you may very well want to perform a full-blown review.

Bottom line: There’s no way to eliminate uncertainty when it comes to retirement planning. But if you combine this sort of annual checkup with periodic monitoring throughout the year, you’ll dramatically improve your chances of getting, and staying, on the path to a secure retirement.

MONEY

Reverse Mortgage: Is It Too Risky?

Considering a reverse mortgage to drum up retirement cash? Don't tap your home's equity too hard. photo: adam voorhes

If you’re 62 or older, you’ve probably started getting reverse-mortgage solicitations in the mail, and it’s hard to miss the aging actors singing the loans’ praises on TV (hey, it’s the Fonz!).

The pitch may sound appealing, especially if you’re among the 83% of boomers who plan to stay in their home through retirement: Tap your home’s equity now and receive a monthly payment, line of credit, or lump sum, regardless of your credit score or income.

The mortgage will start accruing interest immediately, but you won’t need to pay back a dime until you move out or die — at which point you or your heirs must repay the bank in full.

Indeed, reverse mortgages can be a good option for seniors age 70 or older who are committed to staying in their homes and don’t have the savings to cover their expenses, says elder-law attorney Janet Colliton of West Chester, Pa.

However, she adds that recent trends are making the loans a riskier proposition. For one, borrowers are younger: Last year 47% were in their sixties, more than double the percentage from 2001. A growing number (69%) are also taking their payout in a lump sum rather than a steady stream. And reports say predatory lenders have been pushing these mortgages on folks who can’t afford them.

The result: Borrowers who take the loan too soon, or spend the payout too quickly, could end up without a source of equity to fall back on — and might even lose their homes.

If you or someone you love is thinking about a reverse mortgage, consider these questions. If you answer yes to even one, this type of loan is probably the wrong option for you.

Are you in your sixties?

You want to put off a reverse mortgage as long as possible. The amount you can borrow is based on the current interest rate (you can borrow more when it’s lower), your home equity, and the age of the younger spouse. The older he or she is, the more you get.

On a $300,000 house with a $100,000 mortgage, for instance, a 75-year-old might receive a $574 monthly payment, while a 65-year-old would get just $411. (See reversemortgage.org for a calculator.)

Related: Your Pension: Lump Sum or Lifetime Payments?

Younger borrowers also face more years of compound interest, which can quickly ratchet up the amount you owe.

There’s also a greater chance that you’ll run into unexpected medical bills or other expenses as you age, sapping your payout more quickly than you anticipated.

Will the costs be more than you can afford?

Reverse mortgages are a notoriously expensive way to tap equity.

For that borrower with the $300,000 home, fees would include $6,000 in upfront mortgage insurance, a $2,500 origination fee, and about $3,400 in traditional closing costs — and that’s before you get to the monthly mortgage insurance premium of 1.25% of the loan balance.

Plus, you’ll still need to cover regular housing expenses such as taxes and maintenance.

Don’t commit to the loan until you’ve met with an independent financial adviser to go over the total cost and discuss alternatives, says Steve Weisman, author of A Guide to Elder Planning.

Is there a better option?

Before turning to a reverse mortgage, homeowners should explore bolstering their finances by downsizing or working longer.

Those with good credit might also consider a traditional refinance or a home-equity line of credit (HELOC), where you draw only the funds you need and pay off interest as you go, says Waterford, Conn., financial planner Nancy Butler.

It’s also a good idea to get your heirs involved — particularly since they’ll be responsible for paying off (or selling your house to pay off) the loan after your death. They may be able to provide a private reverse mortgage or become a part owner of the house now.

Ultimately, people should think very carefully before draining their home equity, says Margot Saunders, counsel at the National Consumer Law Center: “Once it’s gone, it’s gone.”

MONEY

Retirement Investing in Uncertain Times

I’m 37, make $52,000 a year and have just begun putting money into a 401(k). With thirty years until retirement, I’m inclined to believe that a somewhat aggressive investing strategy will pay off in the long run. But given the immediate uncertainty in the economy and the market, am I better off investing in less risky funds in the short term? — Erik, Brooklyn, N.Y.

If you’re waiting for uncertainty, immediate or otherwise, to die down before you embark on your long-term investing strategy, you’re going to have a long wait. Things are never certain in the economy and the market.

Whether it’s concerns about the ability of a new Congress and a second Obama administration to get a handle on our massive budget deficit, worries about the effect Superstorm Sandy might have on future job growth, trepidation over the approaching fiscal cliff or anxiety stemming from the European debt crisis, uncertainty is a constant.

Or, to borrow a phrase from Gilda Radner’s classic Roseanne Roseannadanna character from the early days of Saturday Night Live: “It’s always something — if it ain’t one thing, it’s another.”

So the more important question you should be asking yourself is this: What kind of investor do you want to be, given that you’ll always have to deal with uncertainty? As I see it, you have two choices: you can be a reactive investor or a systematic investor.

Reactive investors spend most of their time figuring how to rejigger their investments to take advantage of new developments on the investing scene or to prevent those developments from hurting them.

Related: Worried about the Fiscal Cliff: Should I Sell?

If they see that inflation is ticking up or interest rates are starting to climb, they may shift money out of bonds and into gold or commodities. If they believe economic growth is weakening and the economy may be slipping into recession, they might get into defensive stocks or buy long-term bonds.

If you like making lots of moves with your investments, this is the right camp for you — for the reactive investor, investing is a never-ending guessing game. There will always be something going on in the economy or the markets that will catch your attention and require action.

The downside is that it’s tough — I would say virtually impossible — to make the right call consistently. Very often what seems like the obvious isn’t. Back in early 2009, for example, the last place most investors wanted to be was in stocks, which had just plummeted nearly 60% from their 2007 high. Moving to bonds or cash seemed a more prudent bet. Of course, we now know that since that low, stock prices have climbed more than 100%, while bonds gained about 28% and cash returned less than 1%.

A systematic investor, by contrast, starts with the premise that you can’t outguess the markets. The best you can do is set a strategy that will allow you to participate in the long-term upswing of stock prices, while hedging against the inevitable downturns by also holding some bonds and cash.

This type of investor doesn’t feel compelled to act every time a new piece of economic data flickers across his computer screen or a headline warns of impending doom.

Related: Retirement Savings: Quick Guide to How Much You’ll Need

Rather, the systematic investor realizes that one decision is key: determining the mix of stocks, bonds and cash that will give him a shot at reasonable returns while holding the risk of short-term setbacks to an acceptable level. Once he sets that mix, the systematic investor pretty much leaves it alone, except to rebalance periodically to bring the mix back to its original proportions.

If you prefer to be a reactive investor, I can’t offer you much advice. I don’t believe investors can consistently make the right moves in order to take advantage of market fluctuations. I think they’re more likely to end up hurting themselves.

No worries, though. There are plenty of brokers and other advisers out there all too willing to cater to the reactive investor’s need to act. In fact, the standard pitch from most of Wall Street and much of the financial services industry is that they know what moves to make, and for a price they’re willing to help you make the unending series of decisions you’ll face as a reactive investor.

If you want to join the systematic camp, however, then I suggest you stop obsessing about uncertainty and instead focus on creating a portfolio that makes sense for the long haul, in your case for someone with thirty or so years until retirement.

Related: Why There’s No Such Thing as Risk-Free Investing

Typically, retirement investors with that sort of time horizon invest between 70% and 90% of their savings in stocks with the rest in bonds, although the blend you choose should reflect how much you’re willing to see your account balance dip during market downturns. (To get a feel for the tradeoff between risk and return for different stocks-bonds mixes, you can check out Morningstar’s Asset Allocator tool.)

Of course, just because you arrive at the right mix doesn’t mean uncertainty will go away. It will always be there. But if you take the systematic approach, then at least you won’t have to react to it day after day after day.

MONEY

Protect Your Retirement from Inflation

How can I protect myself against inflation in retirement? — Roger Grebel, Candler, N.C.

In a recent survey by the Society of Actuaries, retirees named inflation the No. 1 retirement risk. Even though prices have been tame lately, that anxiety is understandable. Inflation of just 2% a year can reduce your purchasing power by roughly a third over 20 years.

While shielding yourself from rising prices is certainly crucial, don’t overdo it. After all, Social Security payments are pegged to the Consumer Price Index. And when you tilt your investment strategy too far toward protecting from inflation and price spikes don’t materialize, you can face subpar returns.

To hedge against the inexorable rise in prices over the years, keep a portion of your savings in investments that can generate inflation-beating returns. Stocks fit the bill; REITs and other real estate–related investments do too.

Related: What are the advantages of stocks for retirement?

You also need to guard against inflation that can erupt with little warning, like the oil-price shocks of the 1970s and ’80s.

To deal with this threat, many advisers tout commodities or gold. “But you’re talking about a general tendency for a payoff here,” says Vanguard Investment Counseling and Research principal John Ameriks. “It’s not insurance.”

Vanguard’s research shows that there’s roughly a one-in-three chance that commodities will post negative returns if inflation goes up.

Instead, go with Treasury Inflation-Protected Securities (TIPS), whose principal value rises along with inflation. TIPS are expensive today because of high investor demand.

Related: Retirement Savings: Quick Guide to How Much You’ll Need

So keep TIPS to 25% to 30% of your overall bond stake, with the rest in government and corporate bonds. The TIPS are more likely to fare well if prices spike, while the regular bonds will do better if inflation remains tame.

MONEY Health Care

4 Medicare Enrollment Mistakes to Avoid

Enrolling in Medicare? Don't get tangled up up in mistakes that are easily avoided. Photo: Massimo Gammacurta

Signing up for the health program isn't as straightforward as you might think. These common missteps will cost you.

When Houston attorney Barbara Quackenbush retired at age 67, she decided to stay on her company health plan through COBRA rather than sign up for Medicare. But as her COBRA coverage neared expiration, she learned that this choice will saddle her with a Medicare penalty requiring her to pay 20% higher premiums.

Even scarier, she’ll be left without coverage for 10 months. When Quackenbush found out, she says, “I was so upset I nearly dropped the phone.”

Reaching the big six-five is your ticket to guaranteed, affordable insurance via the Medicare system—provided you comply with a byzantine set of rules.

Getting the sign-up process right can be tricky for anyone, but it’s become a major headache for the growing number of folks working past 65, say advocates, particularly now that Medicare enrollment no longer comes at the same time people start collecting full Social Security.

“There are pitfalls you must watch out for,” says David Lipschutz, a policy attorney at the Center for Medicare Advocacy. Here are four big ones to avoid.

Mistake no. 1: Not enrolling because you’re employed.

If you’re still working, and have coverage from your job, you don’t have to sign up at 65. Many workers, though, benefit from enrolling, especially when you consider that you can take parts A and B at different times.

Who should sign up?

Part A, which covers hospitals, is a no-brainer for most people. It’s usually free and may pick up costs your job does not.

If you work for a small company, your firm may require that you take Part B, which covers doctor visits, so that Medicare can start paying most of your expenses. Anyone with a high-deductible plan can also benefit from Part B, since it often picks up costs before you’ve met the deductible.

A caveat: If you have a health savings account, you must stop making deposits.

Who should hold off on Part B?

Workers at large companies. The plan costs at least $100 a month and often provides little benefit beyond what their job covers.

Mistake no. 2: Failing to sign up when you or your spouse retires.

You must enroll in Part B eight months from your last month of work, even if you have retiree benefits or COBRA. Miss that date and your coverage won’t kick in for three to 15 months. You’ll also face a 10% premium penalty for every 12 months you delay.

For Quackenbush, going on COBRA for 18 months without enrolling in Part B triggered a penalty and waiting period.

If you’re 65 or older and get benefits from your spouse’s job, remember that the same rules apply when she retires, says Frederic Riccardi of the Medicare Rights Center: You must sign up within eight months of her final month.

Mistake no. 3: Accidentally voiding retiree coverage.

Signing up for an Advantage plan, which offers coverage as an alternative to parts A and B, could prompt your former employer to kick you off its insurance.

Going with a private Part D plan, which covers drugs, may have the same effect. The reason, says John Grosso, a consultant at Aon Hewitt, is that most retiree coverage is designed to work with traditional Medicare and isn’t compatible with private plans.

Mistake no. 4: Not considering Medigap early on.

The first six months after you enroll in Part B is usually the cheapest time to buy a Medigap plan, which covers deductibles and other costs not picked up by Medicare.

People still covered by their job may not need Medigap right away, but if you buy after this six-month period, your monthly premium could jump by $50 or more, especially if you have a health problem. Worse, you could end up being denied.

 

For more information about the Medicare program, see the Ultimate Guide to Retirement.

 

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