Get With The Plan: December 1, 2013

12113William, 66, and Maye, 63, have raised three children. Now that the kids are independent, they’re looking toward their goal of being retired — together. William has already stopped work, and Maye hopes she can stop in two years.

“If necessary, I can continue to work to 66 or 70, but would prefer not to,” Maye says. “We would also like to arrange our finances in such a way as to leave as much inheritance as possible for our children and grandchildren when the time comes.”

The Middlesex County couple, whose names have changed, have saved $443,700 in 401(k) plans, $7,000 in a money market, $4,700 in savings and $500 in checking. William receives a healthy pension worth nearly $70,000 a year, and when Maye retires, she expects a pension of about $23,000 a year.

The Star-Ledger asked Douglas Buchan, a certified financial planner with Main Street Financial Solutions in Pennington, to help William and Maye determine the best way to position their finances for a long retirement.

For this couple, the correct asset allocation and mix will help accomplish their goals and leave a cushion for “just in case,” Buchan says.

“The way their assets are currently allocated, however, there is not a whole lot of room for error, and not a whole lot for goal No. 2: the inheritance,” he says. “In other words, they could be in much better shape to accomplish both goals if they change their asset allocation.”

Buchan says changing their asset allocation is easy, but in order to do that, they may need to change some long-held views, which may prove to be much more difficult.

He says the primary reason why many folks in their 60s will run out of money — or will have to significantly downgrade their lifestyle — is because they define certain investment terms incorrectly. These faulty definitions lead to investment portfolios that are doomed as costs inevitably rise, he says.

For example, William and Maye’s current portfolio is about 25 percent stocks and 75 percent bonds/cash. Most would describe that as a “conservative” portfolio.

Buchan says conventional wisdom says this would be in line with the couple’s risk tolerance as “extremely conservative.”

“Humbly, I disagree with the premise,” he says. “I believe we, as a society, use investing words like conservative, aggressive, risky, safe and money — we define all of these words incorrectly. It all stems from how we define the word ‘money.’ ”

Buchan says most people think a dollar bill is money, but it’s not. It’s just currency. He says investors need to think of the word “money” as “purchasing power,” or your ability to buy the things you want and need. Defining it this way, he says, investors see that a dollar bill loses some of its money every day as costs slowly, but insidiously, rise.

“Even if you perfectly preserve your dollar, when your costs double — as they surely will over time — you’ll have lost half your money,” he says. “By this definition, you see that one of the worst ways to protect your money over long periods is by having it sit in cash.”

Buchan says to him, a proper way to use the word “conservative” in financial planning would be, “I think I’ll spend $7,500 per month for the rest of my life, but let’s build a portfolio assuming I’ll spend $8,000, just to be conservative.”

“Most people, as they walk into retirement, end up spending a bit more than anticipated, as every day for them becomes a Saturday,” Buchan says.

He says this couple will probably need to downgrade their lifestyle in their later years if they end up spending a bit more than anticipated in the early years — unless they earn slightly better investment returns. They also should be able to leave a significantly higher amount to their children and grandchildren if they earn slightly better investment returns.

Buchan says his projections show that they are far better off if they change their asset allocation to 50 percent stocks and 50 percent bonds.

“In order to earn slightly better investment returns, they need to increase their equity exposure. In order to increase their equity exposure, they need to be able to withstand the greater volatility of their portfolio,” he says. “It’s really as simple and as difficult as that. I say difficult because there is only one issue with implementing this strategy: that is maintaining this strategy through thick and thin.”

Buchan says one of the biggest misconceptions people have with investing is that they think selection — which stocks or funds to own — is a critical component in a successful investing experience. It is not, he says. Rather, the two primary determinants in investment success are one’s asset allocation — percentage of stocks to bonds — and one’s investor behavior.

“Many people will run out of money in their lifetime because they take too many fixed income assets into a rising cost world,” he says. “No one will run out of money because they picked the wrong large-cap growth fund.”

But the key is that building an appropriate asset allocation does you no good if you panic out of it, like back in March of 2009 or in the next garden variety market correction, Buchan says.

“You need an appropriate asset allocation, and you need to make sure you stick to it regardless of the constant media noise and the day-to-day iterations of the market,” he says. “You may want to look in the mirror and decide if you are capable of maintaining the necessary discipline on your own or if it makes sense to hire someone that will keep you on track.”

Buchan says if they decide they’re not comfortable increasing their stock allocation, he highly recommends they delay taking Social Security until age 70, and tapping their 401(k) to supplement their income until that age.

“It makes sense to wait either way, but most definitely if your portfolio is tilted more towards bonds and cash,” he says. “You essentially get an 8 percent raise every year you wait (to take Social Security) and that raise will be there for the rest of your life. Tough to beat 8 percent guaranteed.”