March 8, 1998

I will retire at 65 this summer. We will require $60,000 before taxes for income, of which $24,000 will come from Social Security. Thus we need to generate an additional $36,000 a year. We don't own our home, have no debt, and plan to rent for the rest of our lives in towns throughout the South, where housing is cheaper. We have a nest egg of $900,000, and so need a return of only 4 percent to generate the $36,000. We wonder if you could design a sample portfolio. We are old enough to remember the Depression, and don't want to risk rolling the dice and losing sleep trying for 10 to 15 percent per year.

C.M., Wellesley

A. My approach would be to divide the portfolio into two segments, one designed to produce your income stream, the other to give you capital growth, which you'll want as a hedge against inflation, to enable you to purchase any extras that might appeal to you, and to provide for emergencies.

You can do this neatly by putting two-thirds into a fixed-income portfolio and the remaining third into a diversified stock-oriented portfolio.

I am going to suggest a portfolio based on Vanguard funds, which I tend to favor because of their low expenses and disciplined approach to fulfilling their missions. One of the missing elements here is the question of taxes -- if most of your savings is tax-deferred, such as with IRA, 401(k), or 403(b) accounts, you can proceed as I outline below. If not, you will probably want to substitute in a significant position in a municipal bond fund -- probably one free of not only federal taxes but also taxes of the state where you decide to live.

If this is tax-deferred money, I suggest for the fixed-income side $200,000 in Vanguard's GNMA fund, which currently provides a yield of 7.29 percent.

Another $200,000 might go into two jumbo CDs, which would bring you a 6.05 percent yield at this week's best rate, offered by Atlanta Internet Bank in Georgia. I suggest CDs at two different institutions, thus giving you federal insurance on your entire principal at each bank. Finally, I suggest $100,000 each in Vanguard Short-Term Bond Index, currently yielding 5.5 percent, and in Vanguard High-Yield Corporate, which has a current yield of 7.97 percent.

The effect of all these investments would bring you an average yield of 6.75 percent from this part of the portfolio -- working out to $40,150. This would allow you to withdraw the $34,000 you need while the balance of the yield can build up in the accounts to offset potential vagaries of the bond markets.

As for the remaining $300,000, I suggest you begin a dollar-cost averaging program, designed to get you fully invested in three target funds over 36 months. I would do this by initially investing a total of $9,000 in the three funds, putting the balance of $291,000 in Vanguard's Prime Money Market fund with instructions that $8,975 be directed into each target fund on a monthly basis.

As for the target investments, I suggest 50 percent into Vanguard Balanced Index, which holds 60 percent of its assets in a stock index and the balance in a bond index. Next I would allot one-third of the money to Vanguard Index Value, which holds about two-thirds of the Standard & Poor's 500 stocks, representing those with the lowest price-to-book value ratios. Finally, I would add the wild card -- 16.67 percent of the portfolio, or $50,000 -- in Vanguard Specialized Health Care Portfolio, which I regard as a sector with terrific long-term prospects.

You could build a comparable portfolio at most major mutual fund families.

Finally, if you find that some tax-exempt investments are appropriate to your situation, I would make those investments by drawing evenly from the amounts I allotted to the GNMA and CD accounts.