“How do I make my money earn more for me without taking excessive risk? We are frozen in indecision,” Tom says. “I fear that we are not contributing enough (for college savings).”
They’re also concerned about whether or not they have enough life insurance.
The couple, whose names have changed, have saved $89,200 in 401(k) plans, $194,300 in IRAs, $148,300 in a profit-sharing plan, $45,000 in a brokerage account, $21,000 in mutual funds, $1,500 in savings bonds, $43,500 in savings and $5,500 in checking. They also have $24,000 set aside for college.
The Star-Ledger asked Kim Viscuso, a certified financial planner with Stonegate Wealth Management in Fair Lawn, to help Tom and Gianna create their long-term financial plan.
“Many Americans feel that they are frozen in indecision even if they are fortunate enough to have good jobs,” Viscuso said. “They may feel grateful to have a good job but they are not sure how much savings is enough. They want to know where to invest their savings so it can earn more without taking excessive risk.”
Viscuso says the couple seems to have a good handle on controlling unnecessary spending and as a result, they are able to keep their total monthly expenses to $7,100.
They value life experience over tangible possessions and feel lucky that they have no debt and good savings, but again they feel tied to the uncertainty, she says.
Risk is an issue. They have a moderate tolerance for investment risk, being relatively conservative, and they remain prudent and cautious with their investments.
They have several retirement accounts with savings totaling just under $500,000, and another $70,000 in taxable accounts invested in stocks and bonds.
But first, college, for which they have savings of about $24,000.
“This is not enough to pay for college expenses but they have time to build it up by adding their monthly surplus,” Viscuso says.
Here are the calculations: the estimated cost for private college will be $50,000 per year in today’s money. Assuming a 5 percent annual increase for education costs, it will be $90,000 per year in 12 years when their child attends college, Viscuso says.
“With 5 percent inflation, a 7 percent return on the investment and using time value of money, they need $350,000 by the time their child turns 18,” she says. “To achieve this goal they need to add $1,300 every month for the next 12 years.”
A big nut, indeed.
Tom and Gianna both have universal life insurance policies with a face value of $250,000 each. Tom also has a buy/sell term policy with his business — a 20-year term policy for $1.5 million.
Viscuso says Tom has sufficient coverage, but Gianna needs additional life insurance in case of a premature death. A $1 million term policy for a healthy female of her age should be affordable.
Retirement is the next big concern. Viscuso did a financial analysis using a Monte Carlo simulation, which looks at thousands of variations based on hypothetical market returns and other variables.
It showed the couple will be able to meet their goals of retirement and send their only child to a private college. T
he analysis was performed using the following conservative assumptions: inflation of 4 percent; medical and education inflation of 5 percent; that both spouses will retire in 2036 when Tom is 65 and Gianna is 61 with life expectancy of 100 for both, and long-term investments earn an average of 8 percent.
The projections also assume the couple will stay in their New Jersey home, even in retirement.
“A well-diversified and professionally managed portfolio can earn a reasonable return at lower risk,” she says. “It can also minimize the uncertain feeling most investors are experiencing.”
This can be best explained by an example.
Viscuso says investors trying to be safe may avoid investing in a highly volatile stock market, and instead, may invest in bond funds. However, investors also know that interest rates are at a near all-time low.
“When interest rates begins to rise, investors will lose value in bond funds,” she says. “If you instead buy individual bonds that are laddered and held to maturity you will not lose capital when rates rise.”
Still, the couple should increase their fixed income by allocating more of their assets in the 401(k) plans to bond choices, in particular those with a short-term or medium-term bias, she says.
Interest rates will rise eventually, and that’s why they should avoid those with longer maturities.
“We generally would recommend individual bonds using either government agencies or municipals depending on the account and their tax bracket,” Viscuso says, but the size of their portfolio means they may not be able to do that efficiently.
They should also have an allocation to international bonds but through a bond fund, such as Templeton Global bond fund, she says.
The couple should also use some alternative asset classes, including mutual funds that target long/short, market neutral, convertible arbitrage and merger arbitrage.
“The number of mutual funds offering those traditional hedge fund strategies has exploded in recent years,” she says. “The performance of alternatives is less influenced by the stock market enhancing diversification particularly in bad markets.”