Post by Zoinkers on Aug 25, 2006 21:00:10 GMT -5
Morningstar.com
Portfolio Makeover: Getting Ready for Retirement
Thursday August 24, 7:00 am ET
By Sue Stevens, CFA, CFP, CPA
Morningstar Practical Finance is a monthly newsletter devoted to helping you improve every aspect of your financial life. Because so many of my readers are in or near retirement, I spend a lot of time discussing how best to position your portfolio to grow and deliver a healthy income stream during your golden years.
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This week's column, devoted to shaping up a soon-to-be-retiree's portfolio, is representative of the type of guidance you'll find in Practical Finance. For a free trial subscription, click here.
I recently received a letter from "Jeannie," a 62-year-old widow who not only lost her beloved husband last year but who is also shifting gears into retirement mode. That's a lot of change happening all at once.
Jeannie writes: "I'm trying to figure out the best way to make my money last for 30 years. I have many questions: Should I pay off my mortgage of $190,000 at 5.375% or invest that money? Is my asset allocation correct since my only source of income is Social Security? Do I need a financial advisor or can I do this myself?"
Transitioning into retirement is probably one of the most vulnerable times in anyone's financial life (and perhaps emotional life, too). I will start by assessing a personal balance sheet. Then I'll take a look at Jeannie's portfolio with an eye toward income. Finally I'll run a retirement projection that will help answer many of Jeannie's questions.
Net Worth
I always like to start with a quick snapshot of an investor's personal balance sheet. It's like taking a picture of her finances at a single point in time. Jeannie has made this process easy for us because she uses a software package to track her finances. She has more than enough liquidity and a solid nest egg for retirement. Click here for an overview of her financial picture.
Portfolio Design
Although Jeannie has a healthy nest egg, she will need to make significant changes to her portfolio in part to invest the life insurance benefits and in part to help transition into retirement. I spoke to her about her risk tolerance, and she is somewhere between conservative and moderate. She and I discussed using either a balanced mix of stocks and bonds (50% fixed income, 50% equity) or a more growth-oriented mix (40% fixed income, 60% equity). We both agreed the growth mix would be better for her.
Next, I used our model Growth Portfolio for retirees to rebalance Jeannie's portfolio. To see tables listing Jeannie's current and proposed asset allocation and individual holdings, click here.
Let me highlight a few of the issues I came across in Jeannie's portfolio.
1. Jeannie knew she had too much stashed in cash. I left her a comfortable balance of $10,000 in her checking account and another $40,000 in her money market. That total of $50,000 will cover approximately one year of her expenses.
2. We decided to hold another $100,000 or so in short-term bond funds. This adds an additional layer of liquidity to her portfolio and could potentially cover another two years of expenses.
3. Because bonds soak up a fairly large piece of her portfolio, I paid as much attention to diversification among bond choices as I did stock choices. You'll notice that her bond holdings include short- to intermediate-term bonds, inflation-indexed bonds, high-yield bonds, multisector bonds, and foreign bonds. Overall, her proposed portfolio will generate about $14,400 in annual income.
4. I recommended that Jeannie sell a number of individual stocks in her portfolio. Although Morningstar rates many of these stocks highly, I thought there were other investment opportunities that better fit her goals. She holds the stocks in taxable accounts, so I first calculated what the capital gain or loss would be to sell these securities. The effect of making these trades was a net loss of $4,420. That means she won't owe any capital gains tax, plus she'll be able to use $3,000 of those losses to reduce her taxable income on this year's tax return.
5. Jeannie's Simple IRA holds a variable annuity, which means that she's holding one tax-advantaged vehicle inside another. There are two questions to ask: First, will she incur a surrender charge to get out of the annuity, and, second, can Jeannie roll this plan into her traditional IRA? In talking with Jeannie, I learned that she has held this annuity for six years and there is a seven-year surrender period. She will find out how much of a penalty there is for moving this money out of the annuity now. Regarding the second issue, Jeannie can roll over a Simple IRA into a traditional IRA because she has held it for at least two years. Otherwise, rollovers can only be from one Simple IRA to another Simple IRA.
Retirement Projection
A retirement projection can be one of the most important tools to use when you are trying to make important decisions such as paying off the mortgage or determining how much is reasonable to spend in retirement.
I entered Jeannie's proposed portfolio mix and her Social Security benefits in our retirement-projection software. To be conservative, I used single-digit rates of return on all asset classes and a life expectancy of 97 years. Jeannie would have to start taking required minimum distributions from her traditional IRAs at age 70 1/2.
Her total expenses are about $50,000 to $55,000 per year including mortgage payments. The mortgage will be completely paid off in 15 years. She can meet these expenses in part through Social Security benefits and portfolio income. Part will need to come from withdrawals from her cash-equivalent pools. I assumed that Jeannie would draw from her taxable assets first and let the retirement assets continue to grow tax-deferred as long as possible.
Using a Monte Carlo probability analysis, I determined there would be a 92% probability that Jeannie would have enough assets to last through age 97. Based on this probability, she would also be able to leave her daughter a nice inheritance.
I ran a second case to test the feasibility of paying off the mortgage now and found that it made the probability of having enough capital increase slightly. So, Jeannie should feel confident in doing that.
Summary
Retirement planning is a complex process that encompasses portfolio planning, tax planning, and cash-flow planning. Each situation is unique to some degree--in part because of personal preference and current portfolio holdings. Jeannie wanted to know if she could manage her nest egg herself or if she should hire an advisor. In this particular case, much of her portfolio could be self-managed. Perhaps the best plan would be to hire an "investment coach" who would look over the portfolio periodically or be available for shorter questions as they arise.
This article should not be taken or relied upon as investment advice. It is written for educational purposes only to illustrate sound portfolio principles. A version of this article appeared in the April 2005 issue of Morningstar Practical Finance.
Get Morningstar's portfolio tools, data, and editorial insight, plus Analyst Reports on 1,450 stocks and 2,000 funds. Start your free 14-day trial today.
Portfolio Makeover: Getting Ready for Retirement
Thursday August 24, 7:00 am ET
By Sue Stevens, CFA, CFP, CPA
Morningstar Practical Finance is a monthly newsletter devoted to helping you improve every aspect of your financial life. Because so many of my readers are in or near retirement, I spend a lot of time discussing how best to position your portfolio to grow and deliver a healthy income stream during your golden years.
ADVERTISEMENT
This week's column, devoted to shaping up a soon-to-be-retiree's portfolio, is representative of the type of guidance you'll find in Practical Finance. For a free trial subscription, click here.
I recently received a letter from "Jeannie," a 62-year-old widow who not only lost her beloved husband last year but who is also shifting gears into retirement mode. That's a lot of change happening all at once.
Jeannie writes: "I'm trying to figure out the best way to make my money last for 30 years. I have many questions: Should I pay off my mortgage of $190,000 at 5.375% or invest that money? Is my asset allocation correct since my only source of income is Social Security? Do I need a financial advisor or can I do this myself?"
Transitioning into retirement is probably one of the most vulnerable times in anyone's financial life (and perhaps emotional life, too). I will start by assessing a personal balance sheet. Then I'll take a look at Jeannie's portfolio with an eye toward income. Finally I'll run a retirement projection that will help answer many of Jeannie's questions.
Net Worth
I always like to start with a quick snapshot of an investor's personal balance sheet. It's like taking a picture of her finances at a single point in time. Jeannie has made this process easy for us because she uses a software package to track her finances. She has more than enough liquidity and a solid nest egg for retirement. Click here for an overview of her financial picture.
Portfolio Design
Although Jeannie has a healthy nest egg, she will need to make significant changes to her portfolio in part to invest the life insurance benefits and in part to help transition into retirement. I spoke to her about her risk tolerance, and she is somewhere between conservative and moderate. She and I discussed using either a balanced mix of stocks and bonds (50% fixed income, 50% equity) or a more growth-oriented mix (40% fixed income, 60% equity). We both agreed the growth mix would be better for her.
Next, I used our model Growth Portfolio for retirees to rebalance Jeannie's portfolio. To see tables listing Jeannie's current and proposed asset allocation and individual holdings, click here.
Let me highlight a few of the issues I came across in Jeannie's portfolio.
1. Jeannie knew she had too much stashed in cash. I left her a comfortable balance of $10,000 in her checking account and another $40,000 in her money market. That total of $50,000 will cover approximately one year of her expenses.
2. We decided to hold another $100,000 or so in short-term bond funds. This adds an additional layer of liquidity to her portfolio and could potentially cover another two years of expenses.
3. Because bonds soak up a fairly large piece of her portfolio, I paid as much attention to diversification among bond choices as I did stock choices. You'll notice that her bond holdings include short- to intermediate-term bonds, inflation-indexed bonds, high-yield bonds, multisector bonds, and foreign bonds. Overall, her proposed portfolio will generate about $14,400 in annual income.
4. I recommended that Jeannie sell a number of individual stocks in her portfolio. Although Morningstar rates many of these stocks highly, I thought there were other investment opportunities that better fit her goals. She holds the stocks in taxable accounts, so I first calculated what the capital gain or loss would be to sell these securities. The effect of making these trades was a net loss of $4,420. That means she won't owe any capital gains tax, plus she'll be able to use $3,000 of those losses to reduce her taxable income on this year's tax return.
5. Jeannie's Simple IRA holds a variable annuity, which means that she's holding one tax-advantaged vehicle inside another. There are two questions to ask: First, will she incur a surrender charge to get out of the annuity, and, second, can Jeannie roll this plan into her traditional IRA? In talking with Jeannie, I learned that she has held this annuity for six years and there is a seven-year surrender period. She will find out how much of a penalty there is for moving this money out of the annuity now. Regarding the second issue, Jeannie can roll over a Simple IRA into a traditional IRA because she has held it for at least two years. Otherwise, rollovers can only be from one Simple IRA to another Simple IRA.
Retirement Projection
A retirement projection can be one of the most important tools to use when you are trying to make important decisions such as paying off the mortgage or determining how much is reasonable to spend in retirement.
I entered Jeannie's proposed portfolio mix and her Social Security benefits in our retirement-projection software. To be conservative, I used single-digit rates of return on all asset classes and a life expectancy of 97 years. Jeannie would have to start taking required minimum distributions from her traditional IRAs at age 70 1/2.
Her total expenses are about $50,000 to $55,000 per year including mortgage payments. The mortgage will be completely paid off in 15 years. She can meet these expenses in part through Social Security benefits and portfolio income. Part will need to come from withdrawals from her cash-equivalent pools. I assumed that Jeannie would draw from her taxable assets first and let the retirement assets continue to grow tax-deferred as long as possible.
Using a Monte Carlo probability analysis, I determined there would be a 92% probability that Jeannie would have enough assets to last through age 97. Based on this probability, she would also be able to leave her daughter a nice inheritance.
I ran a second case to test the feasibility of paying off the mortgage now and found that it made the probability of having enough capital increase slightly. So, Jeannie should feel confident in doing that.
Summary
Retirement planning is a complex process that encompasses portfolio planning, tax planning, and cash-flow planning. Each situation is unique to some degree--in part because of personal preference and current portfolio holdings. Jeannie wanted to know if she could manage her nest egg herself or if she should hire an advisor. In this particular case, much of her portfolio could be self-managed. Perhaps the best plan would be to hire an "investment coach" who would look over the portfolio periodically or be available for shorter questions as they arise.
This article should not be taken or relied upon as investment advice. It is written for educational purposes only to illustrate sound portfolio principles. A version of this article appeared in the April 2005 issue of Morningstar Practical Finance.
Get Morningstar's portfolio tools, data, and editorial insight, plus Analyst Reports on 1,450 stocks and 2,000 funds. Start your free 14-day trial today.