You must determine whether you can maintain your current lifestyle after your spouse’s death. In all likelihood, even without planning, you’ll be fine for the time being. The question is whether you will continue to enjoy the same lifestyle for the rest of your life. Answering the question of whether you can get there from here requires a detailed analysis of your current assets, your sources of income, your spending habits, the anticipated rate of return on your investments and a projected inflation rate.

Short of going to work (or to continue working), your plan should call for you to “not touch principal.” Although the exact definition of “principal” is open to debate, the concept is clear. If you spend more than you take in, you erode your nest egg. Once you start spending savings, you begin a descent that ends with your running out of money. Like a downhill skier, you pick up speed as you go. Less principal means less income. The lower your income, the more you erode principal, and so on and so forth.

Despite your best-laid plans, some factors like inflation, stock market fluctuations, and unforeseen emergencies are outside of your control. The key is to minimize these risks with a diversified investment strategy and adequate insurance.

Diversification, described more fully below, is the process of investing in different investment vehicles (guaranteed investments, stocks, bonds, mutual funds, and real estate), in various sectors of the economy (drugs, industrials, high tech, banking, municipal, utilities) in such a way as to minimize the risk that any one sector will suffer a significant downturn. One only has to remember the fall of high tech stocks in 2000-2001 to be reminded that having all of your eggs in one basket can be a risky practice.

Clients often hold stock of their current or former employer. Whether out of company loyalty or as a result of a company-matching program, these clients may have a significant portion of their net worth invested in a single company. Although they may feel safe, in reality they are exposing themselves to substantial risk. They could be wiped out if their company experiences a severe downturn.

In addition to being diversified among a variety of investment types, sound investing dictates that you monitor the amount of your investment in each category. A tried and true paradigm of investing is the “investment pyramid” shown below. Basically, start at the bottom. Only when you have fulfilled your need at a given level should you move up to the next level.

Insurance is at the base of the pyramid because you must first protect yourself from unforeseen events (such as death, disability, illness and an extended nursing home stay) that could threaten your financial security. Estate planning must also be in place to assure your family’s well being in the event of your permanent disability or death.

Once your insurance and estate planning needs have been satisfied, you should have sufficient liquid investments and cash reserves to cover your short-term needs in the event of an interruption of your income. The amount of your readily accessible cash will depend on your other sources of income including Social Security, pension, and IRA minimum distributions (see Chapter Six, “IRA and Retirement Distributions”).

Next are mutual funds, stocks and bonds owned outside of your IRAs and 401(k)s. Assets in this category are less accessible than cash and passbook savings, and may result in capital gains when liquidated, but are subject to a lower tax rate than distributions from IRAs, 401(k)s and annuities that generate “ordinary” income.

Annuities, IRAs, and 401(k)s follow. With twenty years of IRA and 401(k) savings, this category is the fastest growing category of assets in the United States. Special planning is necessary since distributions from these assets are subject to income tax. We have seen over-saving in this area, with clients afraid to touch their vast retirement savings for fear of paying tax on the distributions.

Two important points need to be made about retirement savings: First, retirement savings should be used!

They’re intended to supplement your Social Security and pensions, so work out a systematic withdrawal program and add the distributions to your monthly income. You’ll have to start taking it anyway when you turn age 70 ½ (see Chapter Six). Next, integrate retirement accounts into your overall investment strategy.

It’s all your money! Make sure that your assets as a whole satisfy your needs.

Once your financial house is in order with insurance, liquid investments and your long-term growth portfolio, you then have the luxury to invest in more speculative investments if you are so inclined. Naturally, speculative investments such as oil and gas, limited partnerships and commodities should constitute a very small portion of your portfolio and should only be invested with money you can afford to lose.

Again, the key is diversification. To protect against inflation (see below), you shouldn’t hold only low-risk, low yield investments. Nor should you hold only high-risk investments. The proper mix depends on your risk tolerance, your age and your income needs.