As investors begin nearing retirement, the focus of their portfolio should turn to capital preservation. Riskier investments should be pared back in favor of investments designed to provide a safer risk/return profile and an income component to support retirement expenses.
At this point you don't want to abandon equities altogether, as you'll still need that growth component to keep ahead of inflation. The guideline figure of 40% stocks and 60% bonds is probably a good starting point and you'll largely want to consider large caps to fill that equity position.
There is only so much diversification you'll be able to get from just five stocks, but for the purpose of this exercise I'll choose one company from five different sectors that is a major player in its particular space, maintains broad economic exposure and provides either a good value, a substantial income component or both.
Energy - Duke Energy (DUK)
Utilities are a staple of conservative portfolios due to their slow steady growth and high dividend payouts. Plus, there's constant demand for utility services because despite how good or how poor the economy is performing people will always need electricity and water.
Duke is one of the biggest energy providers in the central United States. It has a 28 year history of paying dividends and has a current yield of over 4.5%, which beats the Utilities Select Sector SPDR (XLU) yield of 3.8%.
It's not a risk free investment though. Utilities tend to struggle in a rising interest rate environment like what we've seen in 2013. Consequently, utilities have managed only about half the gain of the S&P 500 this year. But for someone who's in retirement a big utility with a rich income component is an ideal choice for your portfolio.
Consumer Goods - Procter & Gamble (PG)
If you've ever walked through a grocery store, odds are you've seen many Procter & Gamble products. The maker of toothpaste, laundry detergent, soap, shampoo, paper towels, diapers and cosmetics is perhaps the king of the consumer goods space and, like Duke Energy, produces a product that people will always need.
The current dividend yield of around 3% is higher than the 2.6% yield of the Consumer Staples Select Sector SPDR (XLP) and has a 43 year history of steadily raising the dividend. A current beta of 0.38 shows that this stock doesn't fluctuate wildly at a time when retirees need less volatility in their portfolios.
The stock is currently a bit richly valued (a price/earnings ratio of 20 and a price/sales ratio of 2.6 are both above sector averages) but the company's steady revenue growth and low volatility make P&G a solid core building block in any portfolio.
Healthcare - Pfizer (PFE)
As most people have seen, health care costs continue to rise. As the American population continues to age and the Affordable Care Act goes into effect at the beginning of 2014, health care costs figure to be a sizeable portion of people's budgets. So why not try to profit from it?
The maker of drugs like Lipitor, Celebrex and Lyrica continues to record billions of dollars in revenue on the heels of its big name drugs. It boasts a dividend yield of 3.2% which doubles that of the Health Care Select Sector SPDR (XLV) and it's currently producing margins that are above the sector as a whole.
The concern with health care companies is the patent cliff. Companies need to develop drugs to replace the ones whose patent expires. Pfizer looks to be well positioned as it has roughly two dozen drugs in later phase trials. Keep an eye on revenue growth though. Revenue growth has been negative for the last few quarters and will need to turn around if the stock price is to move up.
Services - McDonald's (MCD)
McDonald's has been the biggest fast food chain for decades and has recently taken steps to keep things that way with the expansion of its menu into healthier fare and value options. Despite the emergence of new competitors like Panera Bread (PNRA) and Red Robin (RRGB), McDonald's remains the sales leader. Its current price/earnings ratio of 17 positions it as a potential value play and the 3.4% dividend yield helps provide some downside cushion.
McDonald's has had trouble keeping up with market performance lately (a 7% YTD return vs. 36% for the Consumer Discretionary Select Sector SPDR (XLY)) as the company has reported lackluster sales growth, so that's something to keep an eye on, but the company exists virtually everywhere in the world so as a long-term holding it should still remain in a diversified portfolio.
Technology - Google (GOOG)
Technology is constantly changing and user preferences are changing even faster, so it might make sense to choose a broad technology sector ETF like the Technology Select Sector SPDR (XLK), but I'm instead going to go with the megacap internet search and advertising giant.
Google currently generates more than $50 billion a year in revenue through advertising via a variety of products like Google Search, Google+, Google Chrome, Android, Google Maps, the Chromebook and YouTube, as well as ventures into hardware products like the Nexus mobile device, Google glass and its recent foray into the world of robotics. Its place in the consumer marketplace has been established.
Investors may be intimidated by its $1,000 share price but a look at the fundamentals shows a company that is fairly valued. Its price/earnings ratio is 20, which is reasonable for a company growing as rapidly as Google is. Its PEG ratio - a measure of a stock's valuation given its growth expectations - is currently at 1.54, which is lower than the S&P 500's 1.82. And don't forget that it's sitting on $54 billion in cash. That makes for a great core holding in your portfolio.
Centering your retirement portfolio on large cap stocks that are leaders within their respective industries is a wise decision. Selecting companies like the ones above, which deliver significant revenue and dominant market positions, should be ideal in keeping ahead of inflation in your later years. Plus, the associated dividend yields should provide regular ongoing income to fund your retirement plans.