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{"s" : "dba,de,djp,dodix,fcntx,prwbx,rbfax,rerax,rgaax,rio,rlbax,rpmgx,rslax,vbmfx,vfiix,vgenx,vipsx,vtsmx,vwelx","k" : "a00,a50,b00,b60,c10,g00,h00,l10,p20,t10,v00","o" : "dodix,fcntx,prwbx,rbfax,rerax,rgaax,rlbax,rpmgx,rslax,vbmfx,vfiix,vgenx,vipsx,vtsmx,vwelx","j" : ""} Christine Benz, On Friday May 20, 2011, 7:00 am EDT
In the final installment of Morningstar's Portfolio Makeover Week, we wanted to discuss a common investor profile: people who are getting close to retirement but are concerned they haven't saved enough. We didn't hear from any real-life users who are in this predicament, but we know it's a big demographic. Today's Portfolio Makeover is, therefore, a composite profile of several users we've heard from over the years.
If they could do it over, Jack and Marion wouldn't change a thing.
At ages 56 and 57, respectively, they've raised three children, now in their mid- to late 20s. They've helped pay for college, taken memorable family vacations, and paid off the house they've lived in since the mid-1980s. They also recently helped foot the bill for a wedding for their son and his new wife. They feel rich in the truest sense of the word.
But as they hurtle toward their retirement years, they're also a little nervous about what the future holds. Jack is a sales manager for an industrial-manufacturing firm, and Marion works 30 hours a week in a medical office. Although both enjoy their jobs, they'd like to start thinking about their retirement: when, where, and how. They're also concerned about the sustainability of what they've managed to set aside. As part of the first wave of baby boomers who are retiring without pensions, they'll be relying on their own assets and Social Security to cover their living expenses once they stop working.
They want to make sure they can draw a livable level of income from their investments during retirement without running out of money prematurely. They acknowledge that their retirement plan may entail some compromises, such as continuing to work longer than they expected to, downsizing to a smaller home, or scaling back their planned in-retirement expenses. Jack and Marion would also like help in maximizing their investments right now while they're still accumulating, so they can be well-positioned for retirement.
The Before Portfolio
Like many people at this life stage, Jack and Marion have a grab-bag of different investments stashed in different accounts: 401(k)s at both of their employers, a rollover IRA, and some taxable savings. Across all accounts, their current asset allocation is roughly 45% stocks, 30% bonds, and the rest in cash.
Marion and Jack's Portfolio (Before)--Market Value ($)
Marion 401(k): Am Fnd Am Bal (NASDAQ:RLBAX - News)--33,000
Marion 401(k): Am Fnd Bnd Fnd of Am (NASDAQ:RBFAX - News)--43,000
Marion 401(k): Am Fnd EuroPacific Gr (NASDAQ:RERAX - News)--27,000
Marion 401(k): Am Fnd Gr Fnd of Am (NASDAQ:RGAAX - News)--24,000
Marion 401(k): Am Fnd SMALLCAP Wld (NASDAQ:RSLAX - News)--19,000
Subtotal--146,000
Jack 401(k): Company Stock--70,000
Jack 401(k): Dodge & Cox Income (NASDAQ:DODIX - News)--95,000
Jack 401(k): Fidelity Contrafund (NASDAQ:FCNTX - News)--105,000
Jack 401(k): Stable Value Fund--70,000
Jack 401(k): T. Rowe Mid-Cap Gr (NASDAQ:RPMGX - News)--50,000
Jack 401(k): Morgan Stanley Intl (Clctv Trst)--75,000
Subtotal--465,000
Taxable: Deere (NYSE:DE - News)--62,000
Taxable: iPath DJ-UBS Cmd Idx (NYSEArca:DJP - News)--22,000
Taxable: PowerShares DB Ag (NYSEArca:DBA - News)--15,000
Taxable: Rio Tinto (NYSE:RIO - News)--33,000
Taxable: Cash--122,000
Subotal--254,000
Rollover IRA: Vngrd Energy (NASDAQ:VGENX - News)--22,000
Rollover IRA: Vngrd GNMA (NASDAQ:VFIIX - News)--25,000
Rollover IRA: Vngrd Tot Bond Mkt Idx (NASDAQ:VBMFX - News)--22,000
Rollover IRA: Vngrd Wellington (NASDAQ:VWELX - News)--25,000
Subtotal--94,000
Total--959,000
Jack's 401(k) is the largest share of this couple's retirement nest egg. His employer is a large firm, so he has been able to take advantage of a broad selection of high-quality, low-cost investment options. His biggest 401(k) holding for many years has been Fidelity Contrafund , but he also holds positions in Dodge & Cox Income , T. Rowe Price Mid Cap Growth , and an international equity collective investment trust (essentially a private-label mutual fund) managed by Morgan Stanley. Jack also has a large share of his portfolio in the stable-value option, which delivers a higher yield than a money market fund but also provides a stable net asset value. Finally, he holds a large stake in the stock of his employer. He acknowledges that it's a larger position than it should be, but his company has been on a hot streak since the market trough two years ago, and he hasn't wanted to peel back.
American Funds is the investment provider for Marion's 401(k) plan, and her assets are well-diversified across the lineup. Unfortunately, however, her investment options aren't the low-cost choices that one normally associates with the firm. Rather, the share classes in her plan are costly, encompassing the administrative costs of the 401(k) plan as well as the costs of fund management. That means that core funds such as Growth Fund of America , normally a bargain, cost nearly 1.5% per year.
The pair has another slice of money in an IRA rollover account held at Vanguard. Finally, in their taxable account, the couple has a sizable cash position. Jack has also dabbled in individual stocks, including several companies in his own industry. Recently, he has embraced exchange-traded funds as a way to gain exposure to entire industries whose prospects he thinks are bright. Powershares DB Agriculture was a relatively recent addition, and the couple also holds a commodity tracker, iPath DJ UBS Commodity Index , an exchange-traded note.
The After Portfolio
Based on their current portfolio, Jack and Marion's current monthly savings target of $3,000 per month, and a possible retirement date of 2019, Morningstar's Asset Allocator tool calculates that there's an 80% probability that they'll be able to achieve their goal of withdrawing $70,000 from their portfolio for 25 years.
If the couple would like to achieve an even higher probability (and I think 90% or more is a good target, particularly given Asset Allocator's fairly rosy return projections for stock and bond returns), one starting point would be deploying at least part of their sizable cash holdings. They currently have nearly $200,000 in low-returning cash and cashlike vehicles, including the money they hold in their brokerage account, checking and savings, and Jack's stable-value fund. Jack and Marion only need half that much for an emergency fund (two years' worth of living expenses), and that money is best held where they can have ready access to it. (In their taxable account, they can build the two-part emergency fund I've discussed in other makeovers--true cash combined with a high-quality short-term bond.) While Jack's stable-value option provides a slightly higher-yielding alternative to what they can earn via certificates of deposit or money market funds, the money in his 401(k) could be working even harder if it were invested in long-term stocks and bonds. Given that the couple's overall bond exposure is a bit light, Dodge & Cox Income is a worthy receptacle for those additional assets.
Marion and Jack's Portfolio (After)--Market Value ($)
Marion 401(k): Am Fnd Am Bal--51,000
Marion 401(k): Am Fnd Bnd Fnd of Am--25,000
Marion 401(k): Am Fnd EuroPacific Gr--27,000
Marion 401(k): Am Fnd Gr Fnd of Am--24,000
Marion 401(k): Am Fnd SMALLCAP Wld--19,000
Subtotal--146,000
Jack 401(k): Company Stock--40,000
Jack 401(k): Dodge & Cox Income--245,000
Jack 401(k): Fidelity Contrafund--105,000
Jack 401(k): Morgan Stanley Intl (Clctv Trst)--75,000
Subtotal--465,000
Taxable: Vngrd Tot Stock Mkt Idx (NASDAQ:VTSMX - News)--75,000
Taxable: Deere--25,000
Taxable: iPath DJ-UBS Cmd Idx--22,000
Taxable: T. Rowe Price ST Bond (NASDAQ:PRWBX - News)--50,000
Taxable: Rio Tinto--10,000
Taxable: Cash--72,000
Subotal--254,000
Rollover IRA: Vngrd Infla-Prot Secs (NASDAQ:VIPSX - News)--25,000
Rollover IRA: Vngrd Energy--22,000
Rollover IRA: Vngrd Tot Bond Mkt Idx--22,000
Rollover IRA: Vngrd Wellington--25,000
Subtotal--94,000
Total--959,000
In addition, Jack would do well to reduce his company stock holdings, given that his current stake accounts for about 7% of his and Marion's overall assets and that so much of this couple's livelihood already depends on his employer. Given their life stage, a position no higher than 5% is plenty. Even with that change, their portfolio has a very large stake in the industrial sector and relatively little in the industries that Morningstar classifies as "defensive"--consumer defensive, health care, and utilities. Adding a position in a total stock market index fund while also scaling back on economically sensitive winners, such as Deere and Rio Tinto , will help address the imbalance.
In terms of future allocations, Marion would do well to invest only as much in her 401(k) as she needs to in order to earn her employer's matching contributions. Beyond that, she should consider saving inside of an IRA or in tax-efficient mutual funds held in a taxable account, where she will have her choice of more cost-effective options than are available on her 401(k) menu.
Forward-Looking Moves
While those changes help improve the quality and diversification of the portfolio, they don't substantially improve the likelihood that it will be able to sustain itself for another 25 years with $70,000 in annual withdrawals. Given that, Jack and Marion will have to mull other, nonportfolio options, including working longer than they had anticipated, finding a way to save even more before they retire, spending less in retirement, or downsizing from their current home. The latter may be the most logical option, particularly because the couple acknowledges that their current home is too large for their needs. By selling it and purchasing a smaller townhome, they estimate they'd bring another $100,000 into their retirement kitty and lower their property tax bills to boot. In addition, it's not too soon for Jack and Marion to start mulling a Social Security strategy to maximize their payouts during their lifetimes. This article delves into some of the key variables to consider.
Data as of May 19, 2011.
Please note that the information above is not intended to be personalized portfolio advice for the makeover subject or any other investor. It is meant to illustrate a common investor dilemma and offer general portfolio ideas for consideration by investors in similar circumstances. Every investor’s situation is distinctive and may include several important variables not accounted for in this makeover.
Christine Benz will show you how to "Do Your Own Portfolio Makeover" in a live web seminar at 12 p.m. Central Time on Monday, May 23.
http://www.morningstar.com/BenzPortfolioMakeover
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Note: The articles above, including before and after portfolios, are meant for educational purposes only, and to illustrate common investor quandaries and possible solutions. These articles should not be construed as specific investment advice. Please read Morningstar.com's Terms of Use for more information.
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