My Money Makeover

What you can learn from expert makeovers of real-life investment portfolios

If you blink, you may miss the next major stock market move. For anyone who follows the financial markets, 2010 has been topsy-turvy. In the first three months of the year, stocks maintained the pace of 2009’s rebound and moved up nicely. But spring turned out to be a disaster as Greece’s debt woes threatened Europe’s financial stability, and slow job growth in the U.S. raised concerns about economic recovery. At the halfway point of 2010, U.S. and foreign stocks were down sharply. Those ups and downs are likely to continue in the months ahead.

In times like these, it’s important for all of us to return to the fundamentals of investing. That is, properly spreading risk by diversifying your portfolio of holdings among various sectors of the global economy and efficiently allocating assets among stocks, bonds, cash, and commodities.

The financial headlines are littered with reasons to apply these tried-and-true principles. Many categories of mutual funds were losers in the first seven months of 2010. Foreign stock funds lost ground, especially those with European holdings. Other poor performers included funds with heavy exposure to commodities, especially oil, and healthcare funds. The bottom line? We seem to be in a market without clear trends.

To protect yourself from future market turbulence, it’s wise to hold a mix of various funds that own different types of stocks. And don’t forget bond funds, which can deliver lower risk to your portfolio. So, how do you gauge whether your portfolio is equally balanced in terms of the investments it contains—and the amount of your nest egg divided among various types of assets? In this article, you’ll read about investors who, while serious about securing their financial future, are in need of some help when it comes to balancing and properly allocating their holdings in a way that fits with their goals. black enterprise asked financial advisers to evaluate each of these investors’ strategies and suggest ways to navigate today’s uncertain markets.

The Rehab Specialist
Kandria Daniels, 35, Chicago
Value of invested assets: $40,000
Current savings strategy: As a certified rehabilitation counselor, working for a company that processes disability claims, Daniels specializes in helping people get back to work. Now she wants to find out if she should rehab her investment strategy.

Daniels’ strategy has been to balance the types of mutual funds in her 401(k). She has a stock fund, a bond fund, and a stable value fund. (Stable value funds generally invest in short-term, high-quality bonds that have low risks and low returns.) Within those funds, she has invested 77% in bonds, 15% in domestic stocks, 3% in foreign stocks, and roughly 5% in cash equivalents.  She’s now contributing 5% of her income to her 401(k), even though her company matches up to 6%.

Outside of her 401(k), Daniels has been contributing to a 529 college savings plan for her 11-year-old child, where she invests in a stock fund. She also has modest amounts in a Roth IRA—mainly invested in a bond fund—and in a tax-exempt bond fund.

Daniels also holds down a part-time job at a local retailer to help her build her investment accounts. She also pulls in cash as a landlord too. “I own a duplex,” she says, “where I live on the second floor. My parents live on the first floor and my grandmother lives in the basement.” The rent she collects allows Daniels to bring her monthly mortgage from more than $2,000 down to less than $1,000. “I would like to invest in rental property,” says Daniels, “perhaps a multiunit complex. I have also flirted with the idea of starting a mentoring program for teenage girls.” Those desires, though, come in second to her financial goals: saving for her child’s college fund and for her own retirement.

The makeover: “Assuming an 8% investment return and 3% inflation, Kandria will have an annual retirement income from her portfolio of about $24,000—$26,000 in today’s dollars,” says Chris Long, a fee-only financial adviser in Chicago. “It’s a good start but with a couple of changes she could boost her retirement income from $35,000 to $39,000 a year.”

For starters, Daniels should increase her 401(k) plan contribution from 5% to 6% to get the full employer match, which is 66.67 cents on the dollar. “This is the one of the few ‘free lunches’ around and she should not leave it on the table,” says Long. What’s more, Long finds that Daniels’ investment portfolio is very conservative for a 35-year-old, with more than 80% in bonds and cash.

Once Daniels has increased her 401(k) contributions to 6% of her income and rearranged her investments there, Long suggests that her next $5,000 of annual investment dollars go into her Roth IRA, rather than into the 401(k) plan. “Some of the investment choices in her 401(k) have high fees or commissions,” he says. “She can shop for lower-cost options in her Roth IRA.”

For now, Daniels has a relatively small amount in her Roth IRA, so Long indicates that she should hold a single fund there: a target date fund. Such funds, offered by many mutual fund families, are heavy on stocks while the target date is far away and shift assets into bonds as that date approaches. “Considering that Kandria is a relatively conservative investor,” says Long, “she might be comfortable with a fund with a 2025 target date. However, she should look closely at the fund’s holdings before investing because target date funds vary from one company to another.”

The Professors
Adam, 36, and Anna, 32, Bradley, Boulder, CO
Value of invested assets: $95,000
Current savings strategy: The Bradleys teach at the University of Colorado. Married for four years, they’re expecting their first child in January. Anna, an associate professor of law and a founding member of Mediators Beyond Borders, intends to keep working so they can both continue investing for their family’s future.

After buying a house recently, Adam and Anna have seen their cash reserves reduced below their comfort level. As a result, one of their near-term goals is to rebuild their emergency fund, which most financial experts believe should equal six to nine months’ of living expenses. “We’ve been putting $2,000 a month into savings,” says Adam. “Our goal is $60,000, and we’re more than halfway there.”

The bulk of the Bradleys’ assets are in various retirement savings accounts from their current employer, former employer, and IRAs. Within those plans, they hold multiple mutual funds. Anna’s largest holding is in the University of Colorado’s plan, where more than three quarters of her assets are in one foreign stock fund.  “I put the money in that fund two years ago on the advice of an adviser working with a family member,” Anna explains. “Now I’d like to know if that’s a sensible allocation.”

Adam is a tenured associate professor of English who has published books on hip-hop music and culture. He is co-editor of Three Days Before the Shooting, Ralph Ellison’s second novel, published posthumously this year. Adam has most of his retirement money in a TIAA-CREF 401(k) account that holds contributions from two universities, one where he was formerly employed. More than 60% of that account is invested in mutual funds made up of stocks, with the balance in various types of fixed income.

The makeover: “Anna and Adam seem to be doing a lot of things right,” says Richard J. Peace, a financial planner with FSC Securities Corp. in Colorado Springs, Colorado. “I think they can make some improvements, though.”

For starters, Peace suggests building up an even larger cash reserve. With a newly purchased home and a child on the way, unexpected expenses are inevitable. “Rather than hold cash in a bank account or a money market that pays almost nothing,” says Peace, “they can use a mutual fund that holds high-quality tax-exempt municipal bonds.”
Once Peace turned his attention to the Bradleys’ investments, he immediately fixated on Anna’s portfolio, where more than three-quarters of her University of Colorado plan is in one foreign fund. “That’s a large risk,” says Peace. “I’m a fan of international investing but I think Anna might cut that back to around 40%.”

The other money in her Colorado plan might be divided into three 20% chunks to be split among a growth-and-income stock fund; a small-cap fund; and a balanced fund. “At her age,” says Peace, “Anna can invest largely in stock funds, which are likely to have superior long-term returns.”

Peace adds that “Four good funds with different investment strategies should be sufficient.” In her other investments, Peace suggests that Anna maintain the 40-20-20-20 strategy: international funds, domestic growth-and-income funds, small-cap funds, and balanced funds.

As for Adam, Peace finds that a similar asset allocation would be appropriate. “Now, Adam has nearly 30% of his investments in some form of fixed income. That’s too much for a 36-year-old with good financial prospects. If Adam is concerned about recent stock market volatility, which is understandable, he can focus on funds that hold dividend-paying stocks. Such stocks offer more income and less downside risk.”

The Supervisor
Corey Thompson, 41, Washington, D.C.
Value of invested assets: $100,000
Current savings strategy: Thompson is a supervisor in the district’s court system. Although he has worked there for 16 years, he doesn’t see himself staying put until retirement. Instead, Thompson, who is single, is looking to start an entrepreneurial venture, perhaps sometime in the next few years. He is weighing whether it makes sense to start a business in the U.S. or in Jamaica, where his parents live. To accumulate capital for his future venture, Thompson participates in the Thrift Savings Plan, a federal retirement plan that’s similar to a 401(k). He contributes enough to get a full employer match.

Thompson also puts $1,000 a year into a Roth IRA and some other money periodically into individual stocks via a Scottrade  Inc. discount broker account. Altogether, Thompson invests 10% to 15% of his income—all of which goes into stocks and stock funds. “Especially after how the market has dropped in the last few years,” Thompson says, “I think I can get better returns in stocks than I can get from bank accounts or other low-yielding investments.”

Besides his stock investments, Thompson recently took advantage of depressed real estate prices and bought a condo in Broward County, Florida (near Fort Lauderdale). Instead of taking out a mortgage from a third-party lender, he borrowed from his TSP account. “That way, I’m paying back money to myself, into my retirement account,” he says. “I’m using the condo myself, but I might rent it out for short-term stays.” And, if the local housing market improves, Thompson could have a valuable asset he can sell to help finance his dream.

The makeover: “If Corey wants to pursue an entrepreneurial endeavor, he should have at least one year’s worth of living expenses in the bank,” says Ivory Johnson, director of financial planning at Scarborough Group Inc., an investment advisory firm in Annapolis, Maryland. “Most small businesses fail because they have limited access to capital.

On a positive note, Johnson says that Thompson’s savings rate is good. “Also,” Johnson notes, “the Roth IRA makes sense because tax rates won’t remain this low forever.” That is, if Thompson has a traditional IRA he’ll owe tax on future withdrawals, possibly at higher rates, while a Roth IRA offers tax-free withdrawals.

What about Thompson’s investments? “I would recommend that he diversify his portfolio with alternative assets,” says Johnson. “When the market corrected, large-, mid-, and small-cap stocks all declined, as did international companies. Therefore, a portfolio with 100% stocks may not really be diversified.” Among alternative assets, Johnson singles out gold, which is “an incorruptible form of wealth” that is not correlated with the stock market. Other alternative assets that Thompson might consider are managed futures funds and long/short funds. Both types can make money if prices go down so they offer protection when market volatility increases.

Johnson suggests that Thompson reallocate his portfolio by putting 30% in gold funds, 25% in U.S. stock funds, 25% in foreign stock funds, 10% in managed futures fund, and another 10% in a long/short fund.

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