Dan and Barbara Hoffa felt a lot wealthier in 2007 than they do today. The market's plunge vaporized half of the Hoffas' portfolio, reducing their total liquid assets to about $900,000, a little more than half of which is arrayed in 401(k)s and a Roth IRA. The summer rally has restored a portion of those losses, but the Hoffas may never get their portfolio back to where it was at the market peak. Although the money is invested with five different mutual fund companies, almost all of it is in one type of asset class: growth-and-income funds with an 80/20 split between stocks and bonds. Dan had thought that by investing through different fund companies, he had diversified, but it turned out that all the fund managers had bet their chips on the same hand.
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The couple has an additional $400,000 in savings held in CDs, bank accounts and securities. That’s more money than many couples have saved, but Dan and Barbara fear that their losses could crimp their plans. The Portland, Ore., couple had planned to celebrate Dan’s 65th birthday in August by taking a trip to Portugal, Spain and Greece, but decided not to spend the money. “We substituted by taking three days and playing golf, went from a 10- or 15-thousand-dollar vacation, to $250.” They’ve sold two cars (including one used by their son, who recently moved out of the house), and have just one. He had been looking forward to what he calls a “normal retirement”: no more work after age 66. “Now,” Dan says, “I would push out retirement up until 68 or even 70, as long I was able to be productive. But I may be ‘recession-retired,’ for all I know.”
The Hoffa’s house, once appraised at over $1 million, is now likely worth closer to $800,000, according to real estate agents in their area. And Dan recently lost his $125,000-a-year job. Worse yet, Dan’s father is seriously ill, and may need the couple’s support. The Hoffas, who are both avid gardeners, feel like they’ve recently reaped a crop of financial weeds.
Here’s how they can regroup:
Create a Cash Cushion for the Next Five Years
With Dan’s employment uncertain, it’s especially important to lock down an emergency fund. They can take a two-pronged approach, says Marilyn Bergen, a Portland financial planner. First, they should segregate about two years’ worth of living expenses, (the money they need in addition to Social Security), about $50,000, and invest it in “laddered” certificates of deposit.
How to ladder? “Ideally, you buy one or more CDs at three, nine, and 12 months, so there is always something coming due in the future,” explains Bergen. “You typically will earn slightly more with a CD than with a money market fund, and if interest rates move higher, you haven’t locked yourself in for a long period of time if you have a ladder. Right now, our concern is more with the 18-month-to-24-month outlook, where it’s possible for inflation to return, with a corresponding return to higher interest rates.” The ladder allows you to reinvest your money at a higher rate. Second, the Hoffas should invest another two to three years’ worth of living expenses — about $75,000 — in a short-term bond fund with a maturity of two to three years. Such a fund, Bergen asserts, would allow the Hoffas to earn more than they would with CDs or a money market fund but without taking on much more risk. Yes, there is some risk. Even a solid standby, like the Vanguard Short-Term Investment-Grade Bond Fund (VFSTX), had a -4.67 percent return for 2008, but it’s up nearly 12 percent this year. And, as Bergen points out, “2008 was bad for everything.”
Allocate Assets for the Long Term
The Hoffas face two different — even contradictory — risks, a classic dilemma for people at their point in life. On the one hand, they don’t have the prospect of building their nest egg through future income, so they have to protect what they’ve got; they can’t take on too much market risk. But on the other hand, they need to support themselves for another 20 or 30 years, which means they are vulnerable to inflation risk.; they can’t just stuff their money in the mattress. So they’ll need a portfolio that is heavy on safe bonds, for principal protection, but also has a big enough stock component to keep up with inflation.
For starters, Bergen notes the Hoffas could simplify their financial life by consolidating the various 401(k) accounts into an IRA at a low-cost brokerage. Then, they can start tweaking their investment mix. “Simply spreading money among different fund companies or brokerage firms won’t achieve true diversification,” says Bergen. “One of the biggest mistakes we’ve seen when prospective clients come in is that they own eight different mutual fund company names, but they are all purchasing U.S. equities.” She urges Hoffa to diversify across a wide range of investment classes, capping the equity portion at no more than 50 percent. “Based on their age and lack of current predictable income, they don’t have the time frame to be much more aggressive than that,” she explains.
“Whether stocks go down 10 percent or 40 percent in any given year, they need to take less market risk with their overall portfolio until they are in a position to have a larger and more-predictable income stream.” She acknowledges that, depending on the exact allocation, even this type of portfolio may have fallen as much as 20 percent in the crash. “Typically the bond side of a portfolio would have helped to mitigate the downside, which it did last year, but not as much as normally.”
As the Hoffas age, they’ll want to reduce their exposure to equities, with this caveat: “If there is any way that they can have some decent earnings for a few years, they may want to invest in equities with a monthly dollar-cost-averaging structure for helping to meet long-term needs,“ Bergen says.
“We think the laddering concept for savings is good, and we plan to do that,” Hoffa offers. The Hoffas have begun consolidating their retirement funds by moving some accounts to a brokerage and have allocated that rollover money to an intermediate bond fund. At this point, they’re still considering the proper allocation for the rest of the retirement funds: “I realize now that just growth-and-income alone wasn’t enough of a diversification strategy, but looking at the [planner’s] allocation, I’m not able to be that precise right now about what we’ll do next. It’s going to be what I consider conservative.”
|Short-term bond funds||$75,000|
|Short-term U.S. bonds||8%|
|Intermediate U.S. bonds||26%|
|Emerging markets bonds||4%|
|Large-company U.S. stocks||26%|
|Small-company U.S. stocks||5%|
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