The recent recession battered Americans' investment portfolios, hurt their home values and cut into their incomes. Some unlucky people suffered severely from all three.
Bloomberg.com asked leading financial advisers how they'd handle a client hit by such severe setbacks. We constructed a fictional, but realistic, scenario and then asked: What does it take to get these people's retirement dreams back on track?
We imagined a married couple, age 55. Coming out of the recession, the couple has a combined annual income of $200,000; a $390,000 mortgage and $20,000 in parent college loans; and an investment portfolio of $1 million, with 55 percent in actively managed stock funds and 45 percent in bond funds. In the past few years, their annual pay fell $100,000 after a job change and shrinking bonuses. Their investments have lost 40 percent, hurt by poorly timed stock sales to pay college tuition. Finally, their home has lost a third of its value, wiping out almost all the home equity on their now-$400,000 home.
Below are edited excerpts of advisers' reactions and suggestions:
Refinance, check costs, add stocks
1. Karen Altfest, executive vice-president at Altfest Personal Wealth Management
If they were my clients, I'd be very concerned about their habits. There are many, many things they have to get in shape. They're not prepared for their retirement. They have to live somewhere, and yet they have just about zero equity in their home. They are in big trouble in their spending patterns. They don't have an emergency fund.
I'd like to see them plan to retire at 70. Many people live well into their 90s. If they retire at 65, $1 million to last 30 years is not as much as it sounds.
I'd like to know if there is any opportunity to refinance their mortgage. Since rates are so favorable right now, can they do better? The lack of equity in their home would be a problem for a mortgage lender, but not insurmountable.
They need to contain their costs. I hear so often: “I don't know where it goes.” They need to keep track of their spending for six months, see where the money goes, and revise their spending patterns if needed. Sometimes just pointing out what somebody is spending will cause a wake-up call.
This is a good time to increase the stocks they own. There are some good values out there. Everybody should have a modest portion in Europe, where some of the stock markets are cheap and are going to rally over time.
The 4 Percent Solution
2. Kevin M. Peters, financial adviser at Morgan Stanley Smith Barney
First, we'd have to get an understanding of their plans. How much income do they think they need when they retire? We would work backwards from whatever income number they need. Let's assume inflation and interest rates stay fairly benign over the next several years. If so, you need to plan on pulling out about 4 percent of retirement savings annually in order not to dilute principal. In other words, if you have $1 million, you would be able to pull $40,000 a year from the portfolio while still allowing it to grow 1 percent to 2 percent a year to make up for inflation.
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If their mortgage rate is high, refinance and potentially roll the college loan into the mortgage. Mortgage loans are tax deductible, while consumer loans are not. If this couple plans on staying in that house for only seven years, they could potentially go into a 7-year, interest-only mortgage at 3.25 percent. They don't have much equity in the house, so why pay down principal? Conserve cash flow today and invest it. They can earn more than 3 percent on their portfolio, so why not use that leverage to their advantage? As their house recovers in price, pay off the mortgage.
If their investments are down 40 percent, they were much too aggressive. You want them to be able to sit through tough markets, without making ill-timed stock sales. So you may not be able to give them an 8 percent return over the next five years. You might have to model a 6 percent return because they can't stand the volatility.
Direct deposit -- into savings
3. Diahann Lassus, president of wealth management firm Lassus Wherley
They really need to totally regroup. What is it they're trying to accomplish? Is it more important to them that they have the higher dollars, which means they work longer? Or is it more important to have free time with their family, in which case they need to cut back and spend less?
Even though they've lost money, they are still in a pretty good place in terms of overall assets. For retirement, there is no magic number you need. There is no scientific way to figure that out. Instead, you save the maximum you can save without killing your current lifestyle, and you develop a diversified investment portfolio.
You start with making sure they're maximizing 401(k)s, especially if there is employer matching. Also, have dollars go directly into a savings account, not a checking account. If you have cash reserves and a safety net, you don't have to sell investments at the worst possible time.
In terms of asset allocation, they should have a broad diversification that includes U.S. large-cap, U.S. small-cap and international stock mutual funds and bond funds, along with real estate and commodities. It's the consistent, boring funds -- the index funds and passive investment funds -- that do well over a long period of time. It's not trying to pick the next hot fund.
People say, “I want an aggressive portfolio because I want to make a lot of money fast.” But they aren't willing to accept the super losses they'll get if they're very aggressive when the market tanks. They're better off doing something more moderate and middle-of-the-road. That portfolio today would be 60 percent to 70 percent in equity and 30 percent or 40 percent in bonds.