Get With The Plan: March 3, 2013

3313Lisa, 53, was widowed two years ago. She has one child in college and the other is expected to start at a county college in two years, then move to a private university. She wants to know, now that her husband is gone, if she’s on track for retirement.

“I want to know whether my portfolio is set to meet my needs and whether I need to sell my house,” she says. “I plan to pay for my kids’ tuition with no loans, and I want to have enough money to help my kids when they’re grown, do some travel and have a nice house.”

Lisa receives a child survivor benefit of $1,800 per month for her youngest child, and she’s also set $69,000 aside for college. She has $704,400 in IRAs, $517,000 in mutual funds, $70,300 in a brokerage account, $235,000 in savings and $80,000 in savings.

Additionally, she will receive $900 per month starting in 2012 from her late husband’s pension.

The Star-Ledger asked Brian Power, a certified financial planner with Gateway Advisory in Westfield, to help Lisa determine her working and retirement future.

“Lisa’s main concerns are being able to continue to live in their current home, keep up with their current lifestyle and pay for college for both children without them graduating with any debt,” he says.

For the analysis, Power used an after-tax lifestyle of $70,000 per year, increasing every year for inflation, based on the budget Lisa worked up. He said he kept the lifestyle dollar figures consistent throughout Lisa’s life, although it’s very likely her lifestyle expenses would go down once her children are grown and out of the house.

“Considering such an awful situation, losing your husband to a battle with cancer with two kids, Lisa and her children are in excellent financial shape,” he says. “With Lisa continuing to work through age 65 and supplementing their lifestyle with their portfolio, they have an acceptable probability of success for Lisa’s assets to stay intact until she is age 92.”

Power said if she waits to take her Social Security until age 65 instead of starting early at age 62, her probability of success increases by approximately 5 percent — and that includes funding two years of a private college costing $48,000 for her older child, and paying for a two-year stint at a community college at $8,000 for her youngest, followed by two years at a private college costing $48,000.

A pretty big accomplishment, Power said.

“Their modest lifestyle and having children willing to go to community college for two years before committing to a full-cost college option has a lot to do with their success,” he says.

Looking at Lisa’s portfolio, Power says instead of assuming a constant rate of return on their assets, he used a Monte Carlo simulation to evaluate the outcome of their portfolio over time. By varying the rates of return and inflation to simulate the fluctuations that can be experienced in the marketplace, a more accurate reflection of the real-life ups and downs of the investment environment is presented, he says.

Power said the Monte Carlo uses the historical data for broad asset classes such as “small-cap equities,” “long-term bonds,” and more. The modeling involves the movement of yields through time and then layers on various equity risk to derive returns, he says.

Lisa’s risk tolerance is moderate.

“From a high level view, when you look at her overall portfolio, she is in line with my recommended asset allocation,” Power says of Lisa’s 49 percent equities, 28 percent fixed income and 23 percent cash allocation.

But when you dig a bit deeper, she is heavily weighted in U.S. large-cap equities at 32 percent versus Power’s suggestion of 13 percent. Her long-term bond allocation is 15 percent, compared with his recommendation of 2 percent.

And there’s more.

“Lisa is missing some asset classes all together, such as REITs, mid-cap U.S. stocks and commodities,” he says.

Making sure Lisa’s portfolio has as many asset classes represented as possible would help with controlling the volatility of her portfolio, he says, by having asset classes that complement each other well.

Also, shortening up the maturities of her bond portfolio would be wise with the inevitability of interest rates rising, Power says.

“Bond prices move in opposite directions to interest rates and the longer your bonds are to maturity, the bigger potential impact on the principal of the bonds,” he says.

Lisa’s intermediate-term and long-term bond exposure may surprise her on the downside if and when interest rates start to rise, Power says.

For example, a bond that matures in five years (intermediate-term) could be down in value approximately 5 percent with a 1 percent increase in interest rates. At the same time, a bond that matures in 15 years (long-term) could be down in value as much as 15 percent with a 1 percent increase in interest rates.

“Most investors that have been investing in bonds since the early to mid 1980s — when this current bull bond market began — have not experienced major depreciation in their bonds,” Power says. “Having more of those bonds re-allocated towards short-term could help protect their principal against rising rates, keeping Lisa’s overall portfolio performance much more consistent.”

Power says one other investment suggestion would be to put $150,000 of her savings and checking to work into her investments.

“Keeping $170,000 in readily available cash will be plenty to cover her older child’s next two years of private college tuition, her younger child’s first two years of community college and some extra cash for an emergency,” he says.