Decision Time


Freeman recommends the following:

Build up retirement savings. While contributing the $15,000 maximum allowed on a pre-tax basis can only help, Reddic should use the 401(k) catch-up provision that allows individuals over age 50 to contribute an additional $5,000 each year. With early retirement only five years away, she needs to make some changes to her 401(k). Freeman suggests reallocating future balances to the following types of investments: common stock index fund, 25%; value equity fund, 40%; small-cap stock fund, 15%; international equity fund, 10%; emerging markets equity fund, 10%; and company stock 5%. He says this asset mix should allow for a little more growth without exposure to significantly more risk.

Freeman notes a potential problem is that the vast majority of Reddic’s wealth is in qualified accounts, which have some restrictions on accessing the money prior to age 59 1/2. As a result, Reddic needs to accumulate money for retirement outside of her 401(k) and IRA. In order to maintain her current lifestyle in retirement at age 55, her investment portfolio should be valued at between $650,000 and $750,000. What’s more, because she is a widow, the earliest Reddic will be able to draw Social Security is age 60. Assuming a 7% average rate of return, Freeman suggests she save and invest $1,500 to $2,500 a month.

Invest for income and minimize taxes. Reddic should invest in income-generating investments, which provide an additional income stream in the form of dividends or interest. She should consider tax-free investments such as municipal bonds and municipal bond funds, which generate interest that is exempt from federal taxes and, in some cases, state taxes too. Freeman also recommends the Vanguard High-Yield Tax Exempt Fund (VWAHX), a low-cost municipal bond fund with a yield of 4.55%, and the BlackRock Debt Strategies Fund II (DSU), a high-yield bond fund that sports a yield of about 8.70%.

Diversify holdings. A possible weakness in Reddic’s portfolio is the lack of a broad exposure to real estate. While it is great that she owns a home free and clear, price appreciation for residential real estate has slowed. However, commercial real estate has been doing well and global commercial real estate has started to take off. Freeman advises that she gain additional exposure by adding more Real Estate Investment Trusts (REITs) to her portfolio. He recommends the Cohen & Steers International Realty A fund (IRFAX), a specialty real estate mutual fund that holds a variety of REITS and has a dividend yield of 2.69%.
Increase college savings. Reddic currently has $3,000 in an Education IRA that she opened more than a year ago. Obviously, this is not enough. Freeman suggests she take the $2,000 contest winnings and add it to Veronica’s college savings. However, because college is around the corner, putting the money in the Education IRA or a section 529 plan wouldn’t be very beneficial. Instead, Reddic should open a brokerage account in her name and invest in a fund such as the Fidelity Floating Rate High Income Fund (FFRHX).


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