Get With The Plan: November 4, 2012

Justin, 47, and Taylor, 46, have two financial goals they consider to be equally important: saving for retirement and paying for college for their three children, 14, 12 and 9. They say they live a modest lifestyle, but given the high cost of living in the state, they don’t see how they can stay in New Jersey when they retire at age 65.

“We do not have pensions and don’t see a way to ever save enough money to afford retirement expenses such as medical, long-term care and living expenses,” Justin said.

Adding to their challenges is that Taylor was laid off in June, and she still doesn’t have a new job. She plans to go back to school for a program that will cost more than $11,000.

To date, the couple, whose names have been changed, has saved $463,500 in 401(k) plans, $132,000 in IRAs, $62,300 in mutual funds, $2,300 in a brokerage account, $22,600 in bonds, $17,000 in a money market, $90,000 in savings and $11,000 in checking. They’ve also saved $101,200 for college expenses.

The Star-Ledger asked Brian Power, a certified financial planner with Gateway Advisory in Westfield, to help the couple balance their big-ticket goals.

“Fortunately, because they are modest people, they look to be in good shape to be able to accomplish both goals without one having to suffer for the other,” Power says.

“This assumes Taylor can go back to work by mid-2013 and earn approximately $40,000 a year and put the majority of her net paycheck toward college and additional retirement savings once the kids are done with college.”

Power says the couple has managed their spending well. They have a $400,000 home in a neighborhood that Power calls a “high-rent district.”

“They could have easily gotten themselves caught up in the real estate craze during the mid-2000s by buying a bigger, more expensive home as their family grew, but did not and now have a very manageable mortgage, hence allowing for more flexibility with their finances,” Power said.

Consistent saving will allow Justin and Taylor to reach their goal of fully funding college for their three children at an average cost of $40,000 a year in today’s dollars, and assuming 6 percent inflation.

To get there, they can use their current college savings, their personal savings and add an additional amount per month for this goal. When Taylor starts working again, they should earmark $25,000 of her salary for college expenses.

To determine what the couple should expect for college, Power assumed a modest after-tax retirement lifestyle of $80,000 per year that increases 2 percent each year for inflation. This was based on a budget that Justin and Taylor had created.

Power said they’ve done a terrific job of accumulating a nice retirement nest egg. If they can stay on track, saving through Justin’s 401(k) at his current savings level of 10 percent of compensation, plus his generous company match of 4 percent, they will be on the right track. Then once college costs are gone, Taylor can reallocate the $25,000 of her salary toward retirement savings, giving them a very high probability of reaching that goal, 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. This method varies the rates of return and inflation to simulate the fluctuations that can be experienced in the marketplace, and Power says it provides a more accurate reflection of the real life ups and downs of the investment environment.

In order to create a Monte Carlo simulation model, he says, historical performance of the securities market must be analyzed. The analysis does not use historical dates for any specific securities, but instead uses historical data for broad asset classes such as “small-cap equities,” “long-term bonds” and the like.

The modeling involves the movement of yields through time and then layers on various equity risk to derive returns, he says.

This couple’s risk tolerance is moderate.

“From a high level view, when you look at their overall portfolio, they are in line with our recommendation since they are 46 percent equities and 54 percent fixed income and money market,” Power says. “My recommended allocation for moderate clients in their pre-retirement years is 50 percent equities and 50 percent fixed income/money market.

“If you dig a bit deeper to see what kinds of equities they own and what kinds of bonds they own, I would recommend additional asset classes that they do not currently have exposure to, such as emerging market equity, REITs, international bonds, long-term bonds and commodities,’ he says.

Power says that when back-testing portfolios, by combining certain asset classes together and using the proper percentages in each, over time, one can lower the volatility of a portfolio and at the same time enhance returns — essentially making the portfolio more efficient.

Looking at life insurance, Power says both Justin and Taylor have sufficient coverage.

“If survivor protection was inadequate, I would typically recommend putting money toward that goal first before college and retirement since an underfunded death or disability could turn over a young family’s apple cart completely,” Power says.