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Financial Literacy - Securing retirement Click Here
MONEY MAKEOVER
Taking protective measures
A sound financial plan consists of ample savings, insurance and an asset allocation plan, among other things.
Securing retirement
  Money makeover: The plan
The plan: Fine-tuning the financials
Key issues
Review disability insurance policy.
Beef up emergency reserve.
Maximize retirement contributions.
Adjust asset allocation.
Rebalance investments periodically.
Consult elder care planning attorney.
Consider buying personal residence.

These are Alice's current asset holdings:
Old 401(k) -- 26 percent of assets
Hartford Midcap (26%)
Dodge & Cox International Stock (19%)
Pimco Total Return (16%)
Vanguard Primecap (16%)
Vanguard Windsor (12%)
First Eagle Overseas (11 %)

Current 401(k) -- 5 percent of assets
Vanguard Target Retirement 2025 (100%)

Certificate of deposit -- 5 percent of assets

Bank account -- 3 percent of assets

Traditional IRA -- 7 percent of assets
Vanguard Target 2015 (100%)

Roth IRA -- 34 percent of assets
Vanguard Energy Fund (10%)
Vanguard REIT (9%)
Vanguard Target Retirement 2030 (81%)

Roth IRA -- 5 percent of assets
USAA Precious Metals and Minerals (100%)

Assess the asset allocation
Target date funds are a great tool for those investors who don't want to monitor their investments and would rather just set it and forget it. These funds tend to decrease the equity exposure and increase bond exposure as you get closer to the target date.

Although in one breath I call them a great tool, I have to say that the primary problem I have with many target-style funds is that they view every investor with the same target date as investors with identical risk tolerance. Another problem is that these funds tend to move to a higher level of bond exposure than might be appropriate, given how long the money must grow into retirement to keep up with inflation.

For securities licensing compliance reasons, I am unable to make specific fund recommendations. However, I can certainly comment on asset allocation, and I think Alice should make some adjustments here. For example, she has no small-cap exposure, and too much exposure to midcaps. She has exposure to both the value-style of investing (Vanguard Windsor) and growth (Vanguard Primecap), but both are large-cap funds. She should probably whittle down her large-cap exposure to 25 percent altogether.

In general, for someone Alice's age, I recommend this moderately aggressive portfolio mix as a guideline. The proportions should be followed with respect to all her various accounts, excluding CDs and bank savings.

Asset allocation recommendation
10% midcap.
10% small-cap.
25% large-cap.
25% international (5% emerging market).
20% bonds.
10% alternatives (real estate, energy, commodities).

Notice that even at her young age, Alice should have 20 percent invested in a diversified bond fund. This will provide stability to her portfolio in very volatile periods, such as the one we're in now. For tax efficiency, the bonds should be tucked away in tax-deferred retirement accounts such as her IRAs or 401(k) since bonds produce income and are otherwise taxed at the highest tax bracket. If she opts to sell her target-date funds, she could choose low-cost index funds or exchange-traded funds that fulfill the asset allocation recommendations. Her portfolio would then be diverse enough to weather all market conditions.

While I am pleased to see some energy and real estate in her portfolio, she should reduce that exposure to 10 percent altogether. The performance of these asset classes has been very good in recent years and has perhaps pushed those allocations into larger positions than Alice originally intended. Now might be the time to rebalance and reduce down to 5 percent each her REIT and energy positions.

A common mistake many investors make is that they tend not to periodically rebalance their portfolios back to their original allocation amounts as certain asset classes increase in size and change the risk profile of the original portfolio over time. The natural inclination is to overload the portfolio with the best past performers, and this strategy tends to hurt investors. It would be a good idea to enlist the help of a qualified financial adviser since it's nearly impossible for individual investors to do this on their own. Selling good-performing assets and buying underperforming assets is difficult and counterintuitive.

With the goal of retiring early and the chance that it may not be voluntary, Alice should add additional investments to her individual taxable account to the degree she can afford after maximizing her retirement plan investments. If she were to be forced to retire early, she does have access to her retirement funds prior to age 59, provided she follows the IRS guidelines with regard to equal and regular payments for a minimum of five years.

Some final considerations
Alice has to plan for the possibility of taking care of her parents, perhaps financially. The first thing I would recommend is a visit to an elder care planning attorney. This will allow her to better understand what needs to be done and how to plan for any assistance available for care and financial aid. There are many programs that her parents might be eligible for, provided the estate is planned properly.

The last area of planning is personal real estate investment in a primary residence. Alice says that she may not stay in Virginia long because her jobs have taken her to quite a few locations over time. Even if she doesn't move to another area, she wants to avoid long commutes by moving if she changes jobs locally. Her decision not to purchase near Washington, D.C., where she moved for work recently, was based partly because of the seemingly overpriced housing market. This decision turned out to benefit her as the market has been correcting over the last couple years.

This in my opinion should give her reason to rethink housing. Along with tax savings on the interest payment that comes from homeownership, she can benefit from price appreciation in a passive investment of a personal residence. This will allow for additional wealth creation that can be used in her retirement years through sale or a reverse mortgage. But I am sympathetic to her buying concerns. And of course if she expects to move soon, she should hold off on such an investment.

Alice has made terrific progress saving toward retirement, considering her relatively young age. She may need extra money for health care needs, and she is doing a great job of saving for this possibility. I hope that she will enjoy good health going forward and that she will have the opportunity to choose her own retirement date when she's ready to do so.

This report was prepared by Bryan Beatty, a Certified Financial Planner with Egan, Berger & Weiner of Vienna, Va.
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