A friend is retiring (at age 62), he put most of his money in CDs and wonder if there are better ways. He is active and in good health and plans to live to mid-80s or even 90s. They have sufficient income for day-to-day expenses for the next 3 to 5 years. After several rounds of drinks and lots of back and forth, we came up with a formula:
First, sock away money for minimally 6-month’s living expenses, assuming no income. Next make sure medical insurance is taken care of (they should receive medicare or Obamacare soon).
Divide the remain into two pots: one for risk-free investment in US Treasury bonds. Buy equal amount of 5-, 10-, and 15-year bonds and hold them until maturity. After 5 years, re-invest the proceeds for 15-year bonds. This is the “guaranteed income” part of the investment.
I recommend 30% for the safety pot, but everyone’s risk appetite is different. For people younger than 40, the first pot should be near zero. My friend decided for 20%. That means he will put 80% in stocks.
For the stock pot, first take 10% off the table. Those are “working capital” reserved for short-term maneuvering.
For the remaining (90% of the stock pile), divide it into two parts: one for the US market and the other for international. I recommended 60/40 and he went for 80/20. For the international, simply pick a good low-fee mutual fund.
The rest (80% of the 90% of the stock pile), divide it into roughly 20 parts and buy stocks of 20 companies of different industries. (I actually recommended 30 companies, but that was over-whelming for my friend.) Use one yard-stick, “win after at least one year.” It is relatively easy to predict if a stock will grow in a year or longer. It is essentially impossible to predict stock’s short-term behavior. This is the difficult and fun step. There is no need to invest all the money in one day. Take time to research and choose. Set a “loss target” (I recommend 75% of the purchase price and he agreed). If the stock fell below this number, accept your lost and dump it. Otherwise, no selling in less than a year.
If this pile is not big enough to divide, buy one, and only one, index fund (for the US stock market).
Inevitably, that 30 parts become different in sizes and hopefully the whole pile grows. Adjust to divide the big part into two companies, either still in the same industry or venture into a new one. After a year, re-evaluate the industry and switch companies if necessary. Yes, this means keeping track of about 20 industries.
Yes, this is a full-time job.