Get With The Plan: June 30, 2013

63013Elena, 36, and Jared, 39, have concerns about their investments. They hope to retire when Jared is 60, so they want to make sure their retirement accounts are invested wisely for the long term.

“A main concern now is how to invest and use our savings well, given that current savings rates are so low,” Elena said. “We have an income surplus each month and are wondering if we should just keep adding to our balanced fund, or if it would make more sense to invest it in other ways.”

The couple doesn’t plan to have children, and they would eventually like to “live simply in a warmer, less stressful climate than New Jersey.”

Elena and Jared, whose names have been changed, have saved $466,000 in 401(k) plans, $92,600 in IRAs, $84,000 in a cash balance pension, $1,295 in a brokerage account, $52,000 in a mutual fund, $15,000 in certificates of deposit, $1,300 in a money market, $25,500 in savings and $11,600 in checking.

The Star-Ledger asked Matthew Mozer, a certified financial planner with RegentAtlantic Capital in Morristown, to help the couple make smart decisions to last them through their senior years.

“Jared and Elena have a significant amount of cash savings,” Mozer said. “A strong emergency fund would require only six months’ worth of expenses, or $25,000 for them. I would recommend investing a portion of the cash savings as they have no debt besides their mortgage and have two reliable sources of income.”

The couple’s largest investment is Jared’s 401(k) plan. Mozer said Jared is doing a good job in terms of diversification by investing in multiple asset classes and allocating the majority of his account to equity investments. Given his age, Jared has a long investment horizon before withdrawals so he can benefit from the higher expected return of equity investments.

Still, Mozer has some changes to recommend.

First, Jared’s intermediate-term bond fund.

“I would recommend he exchange this allocation to the short-term bond fund because of the inverse relationship between interest rates and bond prices,” Mozer said.

For example, as interest rates rise, bond prices will fall. Furthermore, Mozer said, longer-term bonds with longer maturities are more sensitive to interest rate changes than short-term bonds. If interest rates rise, his intermediate-term bond fund will be more volatile than a short-term bond fund and experience more price depreciation, Mozer said.

A few of Jared’s funds are in equity growth that invest primarily in growth companies versus value companies. Mozer said growth companies are typically more expensive than value companies when comparing a company’s stock price to some fundamental measure of its worth. Common valuation metrics include price-to-earnings, price-to-book or price-to-sales ratios.

“These valuation metrics help compare how expensive one company’s stock is relative to another or an index,” he said. “A value company will tend to have lower valuation ratios and be less expensive.”

Mozer said research shows that over a long-term period, value companies have outperformed growth companies — something Jared should take advantage of.
Finally, Mozer recommends larger exposure to emerging markets.

“Emerging market investments have a higher expected return and higher volatility than investments in developed market funds,” Mozer said. “Jared can afford to experience this higher volatility due to his longer investment time horizon and eventual need for the assets.”

Looking at their Roth IRAs, both hold intermediate-bond funds, but Mozer suggested they get rid of all fixed income in these accounts.

“I would prefer to invest these accounts in equity investments that provide the greatest expected return over the long term,” he said. “This is because these assets have already paid taxes and none of their future growth will be subject to tax. These accounts could benefit from increased growth exposure.”

For their after-tax savings, the couple uses a balanced fund. Mozer thinks it’s a good strategy, but not the right fund.

“The equity investments only have allocations to U.S. large- and small-cap companies,” he said. “By adding more asset classes with lower correlations to each other — such as international large and small cap companies, emerging markets companies, infrastructure investments, etc. — they could help lower fund volatility and increase expected return.”

Mozer suggests they both make the maximum contributions to their Roth IRAs each year.

As long as their adjusted gross income is below $188,000 (for a married couple filing jointly), they have the ability to make contributions to a Roth IRA. If their AGI surpasses this level, then they will no longer be eligible to make these contributions. The maximum contribution for individuals under age 50 in 2013 is $5,500.

Jared participates in his employer’s high deductible health plan that includes a Health Savings Account, which allows pre-tax contributions and tax-free withdrawals for medical expenses. Mozer recommends Jared max it out with $3,250 a year — but not use the money.

Instead, he suggests Jared pay medical expenses with his after-tax assets.

“This strategy would allow his contributions to accumulate in the HSA and let him withdraw those funds in retirement — including any earnings and appreciation — tax-free for medical expenses such as Medicare premiums,” he said. “If he keeps track of the medical expenses he pays out of pocket, in retirement, he can make a tax-free withdrawal from the HSA for unreimbursed qualified medical expenses that he incurred in the past.”

So the HSA can provide him with a tax-free distribution, and an additional asset in retirement.

Mozer said the couple is charitably motivated, having given more than $6,000 in cash donations over the past two years. Instead of donating cash, they could benefit more from a tax perspective by gifting highly appreciated securities to the charities, Mozer said.

“Similar to gifting cash, they would receive a tax deduction equal to the fair market value of the security on the day it was donated. This strategy allows them to avoid paying capital gains tax while still benefiting from the tax deduction,” he said. “The end charity would receive the security and sell it, and due to their nonprofit tax status would avoid paying any taxes on the gains.”

The couple doesn’t have any estate-planning documents, but they need wills, powers of attorney, health care proxies and living wills. They should also check their beneficiary designations on their retirement plans because those assets don’t pass through a will.