“I’m carrying $343,115 in prior losses when I was investing in individual stocks,” he says. “My job is very stable and I would like to work well past retirement, but I still would like to have the financial security to retire when I want to.”
So now he’s looking for diversification and low risk.
Ziggy, whose name has been changed, has saved $130,611 in a 401(k), $161,963 in IRAs, $628,168 in mutual funds, $54,124 in a brokerage account, $31,057 in a money market and $6,683 in a checking account.
The Star-Ledger asked Vince Pallitto, a certified financial planner and certified public accountant with Summit Asset Management in Florham Park, to see if Ziggy’s current saving and investing plan will get him to his goals.
“Ziggy already has a nest egg that can sustain his retirement needs. The trick is not to lose it,” Pallitto says.
His current investment allocation is extremely risky for a 53-year-old and more suited to someone who is 35, Pallitto says. Excluding Ziggy’s money market and checking account, 100 percent of the remaining assets are invested in the equities.
Pallitto says Ziggy’s portfolio outperformed the S&P 500 in 2010, but that can quickly reverse—as Ziggy learned the hard way when his portfolio suffered the more than $343,000 in capital losses a few years back.
He’s unlikely to ever use all those losses from a tax standpoint.
Pallitto says based on Ziggy’s age and risk tolerance, he should completely overhaul his current investment allocation to achieve a 60 percent equity and 40 percent fixed income allocation.
That’s for the long term. Pallitto says the short term has a different outlook.
Pallitto recommends Ziggy take his recent gains from the stock market, and park about 80 percent of his assets in short-term fixed income securities.
“The markets are extremely overbought and poised for a significant pullback,” Pallitto says. “There is no question that the economy is better than it was a year or two ago but the stock market is valued at a level that would suggest that we are in a much stronger recovery.”
Pallitto says investors like Ziggy would fare well with a managed investment account rather than a self-guided, no-load mutual fund program.
He says no-load mutual funds tend to attract investors who buy and sell using two investment philosophies: fear and greed.
“They sell at the wrong time due to fear and buy because they don’t want to miss the boat — greed,” Pallitto says.
Rather, he says a separately managed account or accounts can act as your own professionally managed mutual fund. The performance is based on the manager’s investment choices and not the cash flows of a mutual fund.
“More importantly for Ziggy, all capital gains and losses pass through to the owner, not just the distributable amount determined by the mutual fund’s board,” Pallitto says. “In addition, short-term gains within a mutual fund are distributed as dividends which cannot utilize Ziggy’s capital losses.”
As the manager of a managed account recognizes gains and short-term profits, they can be offset for federal tax purposes by Ziggy’s capital loss, which can be carried forward.
Pallitto says a separately managed account charges one flat fee based on the value of the account and there are no other transaction charges. Depending on the managed account Ziggy chooses, the fees may be higher than the mutual funds, but not by much. Pallitto says managed accounts generally range from 1 percent to 2.5 percent, while mutual funds will usually charge a 0.25 percent to 1.75 percent management fee, with occasional additional costs such as 12-b-1 fees (used by the fund company to market the fund to new investors).
On the fixed income side, Pallitto recommends structured certificates of deposit, which are FDIC-insured CDs that offer varying interest rates which are often tied to a stock market index or basket of stocks. If the index or stocks go up, investors receive an interest rate based on the upside. If they go down, no interest is paid, but with current bank CDs offering less than 1 percent, there isn’t much to lose, Pallitto says.
Ziggy contributes 6 percent of his salary to his 401(k), plus the extra $5,500 catch-up contribution for those over age 50. Pallitto says he should increase his contributions to the max.
If Ziggy works nine more years to age 62, adjusts his current aggressive investment allocation to be more conservative and saves the maximum in his 401(k), Pallitto says he will enjoy a very comfortable retirement.
“The real hole in his financial plan is that he does not have long-term care insurance,” Pallitto says. “Ziggy is very healthy and works out every day, so I strongly recommend that he obtain long-term care insurance while he is healthy to ensure that he can live comfortably in the event of a prolonged illness.”