When should you crack your nest egg?

by Don Kuehn

Talk about a double-edged sword. In 2001, the Federal Reserve cut interest rates 11 times. It was an effort to stimulate the U.S. economy and pull corporate earnings, and thus the swooning stock markets, out of the recession that officially began in March 2001.

For a large segment of the public, it was good news. Money was cheap. Mortgage interest rates fell to near-historic lows. Cars were cheaper to buy; financing almost anything was easy. The exception was interest on credit card debt, which hardly moved.

For older Americans, the sight of falling interest rates isn't pretty. Declining rates choke off the supply of income on which many seniors depend to augment state retirement, Social Security or private pension payouts.

It takes a lot of sacrifice and "deferred gratification" to save enough to ensure a secure retirement. A retiree counting on interest income from, say, $100,000 saved over a lifetime and parked in CDs lost more than $3,000 due to last year's rate cuts. That probably meant a significant adjustment in lifestyle, or at least a diminished capacity to enjoy such extras as travel, entertainment or social functions.

Maybe it's time to stop deferring that gratification and enjoy the fruits of your labor.

Is it time to break into that nest egg? Time to draw down some principal to make up for the decline in buying power? There's an old saying that you've got to break a few eggs to make an omelet--or a soufflé.

That may sound like blasphemy to a generation taught to protect principal at all costs. But the caveat of drawing only the interest on investments may need to be "re-thunk" in light of today's dismal rates of return on fixed-income investments.

A check of recent yields on popular CDs and money funds revealed that 2 percent to 2.3 percent was the average being paid on short-term CDs and money funds. One- and two-year certificates were paying slightly more. If you shop around, it's possible to bump that up by less than 0.75 percent. Big deal.

Interest rates, like the stock market, fluctuate. Because there isn't much room for rates to go down any further, the next moves are likely to be up.

In the meantime, what's a person to do? Sit back and "reap" the reward of 2 percent returns in savings accounts? Sure. If that's the hand we're all being dealt. Think how much better off you would be with a 2 percent positive gain when compared to the double-digit losses many of us have experienced in the past two years.

Many people have learned to "ladder" their CDs. For example, if they have $20,000 to invest, they put $5,000 in a three-month certificate, and equal $5,000 amounts in each of six-month and nine-month and one-year CDs. As each one matures, they simply strip the interest off of the balance and reinvest the original $5,000 for one year. The result is that every quarter these people have a certificate of deposit maturing and extra cash coming in.

Today's question: Is it time to think about dismantling the ladder? Rather than tying up a large chunk of cash for a year at minimal interest rates, why not redeem the certificate and park the proceeds in your money-market fund. There, you will benefit from the fluctuating rates of interest over the year and when you want to dip into the principal, there is no penalty for early withdrawal.

There is no single right answer for everyone, but it's worth taking a look at the issue of cracking into that nest egg. Drawing a few hundred dollars a month to offset the loss of income attributable to lower savings rates may not be such a bad thing.

If you have $100,000 socked away in a "fixed-income" account, it would take many years to put a sizable dent in your nest egg if you drew $300 or $400 per month from your account. But, for some, that money may well be the difference between enjoying retirement and surviving it.

Ideally, a balanced retirement portfolio would include several features: your retirement fund from the state, Social Security for those who are eligible, perhaps a 403(b) and personal investments.

Let's review: Your personal portfolio should include a portion invested in stocks--either through mutual funds or individually--to provide growth; an emergency reserve in an easily accessible money fund; and a fixed-income component in short-term bond funds, CDs or, perhaps, inflation-adjusted U.S. Savings Bonds (I-Bonds).

The two-year slide in equity (stock) markets also presents an opportunity to reposition oneself for a future recovery in stocks. Stocks typically rise three to six months before the general economy, so investors who buy the right stocks (or stock mutual funds) while prices are depressed could reap hefty returns when the reversal comes. The trick is to buy selectively, diversify and balance your portfolio.

The goal is not to make up for all of your past losses in a few months. A well-positioned portfolio is one that captures gains, but just as important, protects against steep losses.

I'm no math teacher, but I know that if you lose 10 percent it takes more than 11 percent to recover to the break-even point. If you lost half the value of your stock holdings, you have to make 100 percent on what's left to break even.

Once you have put the essential building blocks in place to secure your future, the only reason to have money is so you can do the things you have always dreamed of doing. And hey, don't feel guilty about it. If you need to tap some principal in your nest egg to get the job done, go ahead.

As I wrote a few years ago, author Stephen A. Pollan embraced that philosophy in his book Die Broke. Wealth, he said, is to be spent while you are still alive, either on yourself or on your loved ones. Forget about leaving an inheritance to your relatives. If you want to take care of them, give gifts while you are around to share their enjoyment. Plan to leave behind just enough money to settle your estate, then get about the business of living your own life to the fullest.

If that means breaking a few eggs, go ahead, make an omelet! I'll have the soufflé.