Get With The Plan: March 6, 2011

3611Eileen has put herself on a five-year plan. The Essex County woman, 65, wants to make sure her portfolio can keep up with her lifestyle if she retires at age 70.

“I envision my retirement remaining in my current residence and devoting time to my hobbies, visiting family out of the area and occasional travel including cruises and international ventures,” she says.

The divorced woman, whose name has been changed, has accumulated $157,000 in IRAs, $54,200 in 401(k)s, $42,200 in mutual funds, $15,300 in a brokerage account, $1,000 in a Certificate of Deposit, $69,000 in savings and $200 in checking. She’s also set aside $6,880 to help with college costs for her grandchild. She will also see some early spousal Social Security benefits this summer. At age 66, she’ll receive $933 per month, and she can allow her personal benefit to grow about 8 percent a year until she retires. By then, she expects a monthly Social Security benefit of about $2,400 per month.

The Star-Ledger asked Taylor Thomas, a certified financial planner with Highland Financial Advisors in Riverdale, to help Eileen determine her future financial health.

“Overall, Eileen is on track to meeting her retirement goal at the age of 70 with some adjustments to her investment portfolio, some additional savings in her 401(k) and a reduction in spending,” Taylor says. “Compliance with these recommendations will increase the probability of meeting the goals she has set for retirement.”

Taylor examined Eileen’s current asset allocation, which is 30 percent cash, 20 percent bonds and 50 percent equities — the majority of which is invested in large-cap stocks.

“Eileen’s current portfolio is like many new clients we take on,” he says, noting most investors seem to be overweighted in large-cap domestic stocks. “Large-cap equities are good investments for a portion of the overall portfolio but we usually find the position to be too substantial and thereby creating unnecessary risk, which can be minimized by diversification.”

Taylor recommends Eileen have only 2 percent of assets in cash, and that she increase her equity stake to 70 percent, but have a smaller overall percentage in large-cap domestic stocks.

Taylor saw some other asset allocation problems. Eileen’s international securities are underweighted. Given that the market capitalization of the United States is about only 42 percent of the world’s total market cap, he says a portfolio of investments should hold between 30 and 40 percent of the overall equity investments in international securities.

The last noticeable portfolio discrepancy was the lack of investment in a commodity fund, Taylor says.

“Investments in this type of security are readily available at low cost to an investor and help to lower the risk and variability of a portfolio,” he says. “Furthermore, a fully diversified portfolio, if used in conjunction with a regular portfolio rebalance, can even provide excess returns.”

Taylor says Eileen has $70,000 in a savings account, plus some cash in her IRA annuity, which brings her overall cash position to about 30 percent of her total portfolio. Too much.

He recommends she leave only about three to six months of fixed expenses in a savings account, or between $10,000 and $20,000. He suggests she take the remainder and open a brokerage account, fully diversifying the monies in no-load mutual funds and exchange traded funds to go with her new asset allocation. Having so much in cash today actually increases the risk to Eileen meeting her goals, Taylor says.

“When we change her portfolio to the 30/70 portfolio, her probability of meeting her retirement goals is substantially increased,” he says. “Furthermore, the return on her portfolio increases from 6.96 percent to 8.63 percent annualized per year before inflation with only a slight increase in the risk of the portfolio.”

Variable items in Eileen’s budget will also play an important role, Taylor says. Lowering discretionary spending by 20 percent a month will make a big difference in Eileen’s long-term bottom line.

Following a new asset allocation plan and instituting some expense reductions means instead of running out of money in her early 80s, her savings will take her well into her 90s.

While Eileen considers her overall plan, she should take a closer look at the annuities she holds within IRAs.

As long as there are no early withdrawal fees or distribution taxes, Taylor recommends she consider consolidating these to an IRA so she can mange her retirement money from one account — and she may want to bail from the annuity part altogether.

Taylor says annuities can be good for investors who have fully funded every other tax-deferred savings allowed, but they’re not for everyone.

“Annuities usually carry substantial annual mortality and expense fees, administrative fees, as well as additional fees associated with the individual investment selections,” Taylor says. “These fees can reach about 3 percent per year and eat away at investment returns within the annuity.”