Markets & Finance

A Peak Earning Years Portfolio


BusinessWeek taps several pros for their best strategies for restoring your nest egg and keeping it secure

When it comes to building, or rebuilding, your retirement nest egg during your peak salary years, from age 40 to 55, the investing choices most people make to achieve growth in their portfolios may be substantially less aggressive in the future than they were before the financial debacle of 2008-09.

And long-held beliefs, such as that you can minimize portfolio risk with diversified bets across a range of noncorrelated or minimally correlated asset classes, have been turned on their head by the collapse, which sent all asset classes except Treasury bonds reeling in the closing months of last year. That, along with heightened fears of job losses, have made it extremely tough to persuade some people to stay invested and keep investing in the markets, say financial advisers.

"It would be a mistake to view the last six months as a template for how asset classes work relative to each other," says Jeffrey Layman, chief investment officer at BKD Wealth Advisors in Springfield, Mo. He concedes that there's a strong correlation between emerging-market stocks and commodity prices but sees the increased correlation among other assets as a temporary phenomenon, the result of massive deleveraging and forced selling.

The 50% to 60% drop in major stock indexes arguably makes it much less risky to put your faith in stocks in the future, just as investors seem to be well-compensated right now for taking added risk in the bond market by investing in investment-grade corporate and junk bonds, which are paying much higher yields than Treasuries with comparable maturities, in contrast to a couple of years ago.

New Respect for Annuities

The massacre on Wall Street has convinced many financial advisers of the need to put a portion of clients' investment portfolios in some kind of annuity product to ensure annual income on top of their Social Security checks.

Clifford Michaels, president of New York's Institutional Investment Advisors and president of the Financial Planners Assn., recommends you put as much as 10% of your portfolio into either a fixed or variable annuity. You pay a fee to the insurance company only on variable annuities.

"At the end of the day, investors want to know they can withdraw X amount of dollars [a year] for life. That's why it makes a little more sense than it ever has before," he says. "Don't you think there are millions of investors who wish they had a guarantee on their income at retirement [after all the market carnage]?"

His one caveat: Stick with the bigger insurers such as John Hancock Income Securities Trust (JHS) and MetLife (MET) since you can't be sure the smaller providers will survive until you retire.

At the very least, you need to put a few serious questions to your financial adviser to make sure he or she isn't just following a plan developed for a bygone era.

Lower Your Expectations

It's become clear through daily discussions with clients over the past several months that their risk tolerance is much lower than they believed it was, says Michael Sangirardi, a senior financial adviser at Ameriprise Financial Services (AMP) in New York. And for many of his clients who either worked in financial services or professions such as accounting and consulting that get much of their work from that industry, newfound fear of losing their jobs and a lack of income stability has also reduced their appetite for risk, he says.

That means investors need to plan on less portfolio growth. That's something Tom Orecchio, a principal at Modera Wealth Management in Old Tappan, N.J., has long tried to convey, especially to people who began investing in the 1980s and '90s and have experienced mostly upward-trending markets.

"Investors need to reduce their expectations because stocks have dramatically outperformed their historical averages," he says. He sees the negative returns of the past decade as simply a reversion to the mean. Since the stock market performs in cycles, he believes that if the current downturn continues for an extended time, we can expect a period where long-term average returns rise thereafter. But if this downturn ends too soon, before the down cycle has been fully exhausted, investors should temper any positive expectations for stock returns, he believes.

Patricia Raskob, president of Raskob Kambourian Financial Advisors in Tucson, Ariz., says she makes it a point to reexamine each client's risk tolerance every spring based on big-ticket purchases and other major expenditures they expect to make over the next year. She works with each client to create a unique portfolio based on his or her circumstances. Even for clients in the middle of their peak accumulation years, she distinguishes between short-term money, which needs to be available to cover major expenses over the next three to five years, and longer-range investments. She uses individual bonds with laddered maturities, certificates of deposit, and bond mutual funds to generate short-term money.

Do You Love Your Work?

How much exposure to stocks you should have will depend on your investment time horizon, income level, and whether you love your work, says Raskob. A person who enjoys what he or she does and can continue working past retirement age can afford to have a bigger portion in stocks than someone who's eager to stop working. Raskob says she tries to help clients who don't like their jobs transition into something they do like so they can continue to earn income.

For people with less than $500,000 in their portfolios, she suggests a balanced portfolio, starting with an actively managed balanced fund that can skew toward value or growth-oriented stocks and can also invest in fixed-income products. Vanguard, Wellesley Investment Advisers, and Wellington Management offer them. Raskob likes Oakmark Equity & Income Fund (OAKBX), a mostly large-cap fund that pays a relatively high dividend and had a return of -16.2% in 2008, according to Morningstar (MORN). That's a smaller loss than most index funds had during the same period, she says.

"It's an additional assist to our oversight. It offers some stability and potential for growth," she says. "For clients who are not scared to death [by the market declines], taking that balanced position makes good sense for a 5- to 10-year period."

Small-cap value stocks had been the best performing U.S. equity sector for the past 40 to 50 years and, while they, like all stocks, have been hurt in the current maelstrom, they should generally benefit from smaller firms' greater agility, ability to move on decisions more quickly and ability to largely escape the increased regulatory scrutiny that lies ahead for bigger firms, says Michaels at Institutional Investment Advisors. At the opposite end of the spectrum, large-cap stocks that continue to pay big dividends are probably a good bet, whether as single stocks or in a mutual fund, he says.

Safety Vs. Growth

To round out a diversified asset-allocation strategy, you could take a position in alternative assets such as commodities, emerging-market stocks, international real estate, and, for more aggressive high-net-worth investors, absolute value plays such as hedge funds that can make long or short bets on various assets. The Absolute Strategies Fund (ASFIX) and Hussman Strategic Growth (HSGFX) provide exposure beyond stock and bond markets and are likely generate returns over the next several years somewhere between stocks and bonds, but with volatility well below stocks, says Daniel Roe, a principal at Budros Ruhlin Roe in Columbus, Ohio.

Zvi Bodie, a finance professor at Boston University School of Management, believes people make a dangerous mistake by thinking about investing in retirement in speculative terms rather than as insurance to protect their standard of living.

He suggests you start by assuming you'll invest 100% of your savings in Treasury inflation-protected securities, or TIPS, with a range of maturities to fund your retirement. If you assume a zero interest rate, then investing in TIPS allows you to keep pace with inflation. "That is much safer than putting your money in a money market account [where] you don't know what interest rate you're going to earn," he says. "Whereas with TIPS, I can get 2.5% real interest rate over 20 years, so I'm beating inflation by 2.5%."

Raskob isn't a fan of TIPS, recalling an old adage that says you should try to beat inflation by 3% annually just to maintain the same standard of living. In addition, not everyone uses the same inflation factor. Investors with children in college experience a higher rate of inflation than people who are single or older with independent children, though the latter group is likely to be hit more by rapidly rising health-care costs, she says. In general, she thinks you're losing future buying power by being invested in fixed-income products beyond a certain weight in your portfolio.

Getting TIPS into 401(k)s

Still, Bodie believes a 401(k) plan should contain mostly TIPS, with a certain portion of the extra return you're willing to sacrifice set aside to buy a portion of a call option on the S&P 500-stock index, through a financial adviser who can get a cheaper price for it. That would increase your potential to earn upside beyond the returns on TIPS while locking in the downside risk. "That's my idea of what a 401(k) accumulation product should look like—and then you wouldn't have what happened to people in 2008," he says.

Boston University has formed a task source on employee benefits that is trying to persuade providers of structured retirement products to introduce this into the 403(b) plan available to university employees. With management fees attached, Bodie believes you'll be able to get roughly 50% of the upside from exposure to indexed options.

The timing couldn't be better. On Mar. 10, Service Employees International Union, the Economic Policy Institute, and the Pension Rights Center launched a campaign to overhaul the retirement system by seeking proposals for new plan structures that would provide universal access to all working Americans and sufficient lifetime income for retirees.

The Trouble with Target Dates

Bodie advises people to stay away from target-date funds, which employers automatically enroll employees in when they don't choose a plan. Many of those funds have you invested as much as 50% or more in equities in the year you retire, which is a ridiculously high level of risk to be exposed to, says Bodie. (A study by Watson Wyatt Worldwide found that equity allocations range from 20% to 65% in the year of an investor's retirement.

While the majority of financial advisers continue to promote stocks as providing much higher average annual returns than other asset classes over the long run, some suggest taking it slow over the next six months to two years, using dollar-cost averaging to reduce your risk to further downside and to avoid missing a recovery. However, says BKD Wealth Advisors' Layman, if you have a 20-year time horizon, it makes absolutely no difference when you jump back into stocks.

"Investors can really do themselves more harm than good trying to guess where this thing's going to bottom," he says. "We have an opportunity to buy stocks here and around the world at 55% to 60% discounts. That's what's important now, not whether we come down another 10%."

Perhaps, but getting people to shift back to long-term planning is tough when they've suffered so much short-term pain.


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