How to Invest Money After Retirement

When you retire, you need a steady stream of income. Due to inflation, that income must grow annually to keep up with the cost of living. If you invest in instruments that are too safe, you run the risk that your money won't keep up with inflation. If, however, you go into a variable investment like the stock market, you run the risk that the value of the stock may drop when you need the money most. The answer to the dilemma lies in diversification and asset allocation.

Instructions

1. Adopt an asset-allocation model; it isn't that difficult to understand why. Different types of financial instruments react in opposite ways. When the stock market goes up, usually the Federal Reserve worries about inflation and raises interest rates. If you're holding a bond that has a lower interest rate than those issued, people don't want it because they get more money from newly issued bonds. This makes the bond market drop because the new bonds are higher.

2. Inspect the scenario a little further to understand why the bond market dropped. Just like real estate, if you have two houses the same price and can buy a better house for the same money, you'll buy the better one. The higher interest rate makes the newly issued bond better so people trying to sell the bonds that have lower interest rates have to discount the bonds. This means they sell them for less than face value. If the stock market is crummy, the interest rates go down to stimulate the economy. In this case, the people holding bonds can sell them for more since they have a higher interest rate. Selling a bond for more than face value means you sell it at a premium.

3. Balance investments, but get fixed instruments, too. Many financial advisers recommend putting 40 percent of funds into bonds or other fixed instruments, 30 percent into bank instruments like CDs and 30 percent in the stock market once you retire. Others say that if you subtract your age from 100, that's the amount of money you need in the stock market, while the rest should be divided between bonds and bank instruments.

4. Consider your risk tolerance in the equation. Risk tolerance is how much you worry about your investments losing money. If you understand that the market goes up and down and accept its movement without checking daily on the value of your money, you have a higher risk tolerance, and a blend of 40 percent stock, 40 percent bonds and 20 percent cash and shorter-term CDs is right for you. If you fret over every point the market loses, you need to reduce the amount of stock in your portfolio and put more into investments that don't fluctuate.

5. Look for the cash flow. Even though you invest in stock, it doesn't mean that you look at the investment for its capital appreciation. Some stocks give income in the form of dividends. These are normally value stocks. If you receive a 6 percent return in the form of a dividend every year, you're getting an income from the stock. Bonds also give returns in the form of interest, as do CDs, savings accounts and annuities. When you invest for retirement, you need to look for the income from the investments, even if they fluctuate in price.

6. Diversify within the asset classes. When you invest in stock, you need to have different types of stock. You should have some in all six classes, large-cap growth, large-cap value, mid-cap growth, mid-cap value, small-cap growth and small-cap value. Since most people want an income, the value stocks tend to be their area of focus. You also need international stocks in your portfolio. If you invest in bonds, you need bonds that mature at different lengths of time and those issued by corporations and the government. The pot with investments that don't fluctuate needs CDs with varying maturity dates but also some easily accessed cash.

7. Use individual stocks and bonds or invest in mutual funds. Mutual funds offer the ability to invest in a multitude of stocks and bonds with more limited resources. Remember if you're using an annuity as an investment, you lose the right to your principal if you annuitize. If inflation hits and interest rates rise rapidly, you'll be stuck with the lower return and less buying power.