Aunt’s big losses could be much worse

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Dear Dr. Don,
My aunt, an 80-year-old widow, gets about $38,000 a year in retirement and Social Security benefits. Her expenses are about $40,000 a year. (She is extremely frugal.)

She has $1.4 million invested with Morgan Stanley and $600,000 with UBS. Both firms have about 80 percent of her assets in stocks, with annual fees running about 1.5 percent. She has no desire to increase her wealth, but only seeks to preserve the majority of her principal.

Both brokerage firms have lost close to $60,000 each during the 2008 year. Are they overly risking her assets? Wouldn’t the interest on a 4 percent CD plus her retirement income generate more than enough income?
— Padraic Portfolio

Dear Padraic,
It’s more likely that the financial firms are following the client’s directions concerning the account than overly risking her assets.

It’s been a tough year in the stock market. As I write this, the U.S. market, as measured by the performance of the S&P 500 index, is down 13.5 percent year-to-date.

With 80 percent of a $2 million portfolio invested in stocks, you’d expect a U.S. portfolio invested in large capitalization stocks to be down closer to $216,000, not down $120,000.

I’m not telling you to feel good about her portfolio being down $120,000, just that it wouldn’t be hard for it to be much worse.

If she only needs $2,000 a year from the portfolio to meet her living expenses, keeping it invested mostly in stocks for growth can make perfect sense from an investment management perspective.

That said, it’s easy enough for her to dial down the risk in the portfolio and/or to find less expensive ways to manage her money. By your reckoning, she’s paying about $30,000 a year in asset under management fees on the combined portfolios.

The CD option would easily generate enough income to meet her needs in retirement. The risk is that the purchasing power of the portfolio could decline over time because the returns don’t keep pace with inflation. It’s unlikely that she would ever run out of funds during her lifetime by taking such a conservative approach.

Investing in Treasury inflation-protected securities, or TIPS, could meet her need to protect her principal while keeping pace with inflation. TIPS are a bit complicated when it comes to the tax treatment of the inflation premiums, but she should consider them for her portfolio.

I’d suggest a second opinion on the portfolio. She could hire a fee-only financial planner to review the portfolio in light of her investment goals and tolerance for risk. The National Association of Personal Financial Planners has a listing of fee-only planners.

Bankrate also has a tool to help you search for a Certified Financial Planner.

There can be some big tax considerations when changing how a portfolio is invested. Your aunt needs to consider the tax impact of restructuring the portfolio along with her other concerns.