Playing Catch-Up in the Retirement-Plan Game
Virginia and Fred Johnson have cut it close--very, very close.
With less than a year remaining before Fred, a $49,000-a-year aerospace machinist, is scheduled to retire, the Whittier couple have decided to seek professional retirement planning assistance--for the first time.
“We have no idea what to do with my husband’s 401(k) and the other moneys we have in our IRAs and certificate of deposit accounts,” wrote Virginia, a 64-year-old homemaker who has managed the couple’s finances during their 41-year marriage, in seeking advice. “We need some kind of plan so that we don’t run out of money before our time is up on this earth.”
The key lesson here is this: Don’t wait until you’re on the brink of retirement to begin planning for it.
It may be too late for the Johnsons to profit from that bit of wisdom, but the fortunate news, says San Francisco Bay Area investment advisor Stephen Janachowski, is that the couple ought to be able to achieve the two goals they have set for their retirement: to maintain their current standard of living and to be able to enjoy some travel each year.
However, he said, the Johnsons should break with their ultraconservative investing practices and, for the first time in their lives, invest in stock and bond mutual funds, to increase their nest egg and potential retirement income.
That’s right, with the exception of about $6,000 in Boeing stock that Fred has accumulated as an employee of the aerospace giant, the Johnsons have never invested in securities of any kind. Instead, the rest of their $117,500 life savings, including individual retirement accounts and Fred’s 401 (k), is held in credit union accounts, money market accounts and short-term bank certificates of deposit.
“We have always wanted everything to be safe,” explains Virginia, who says that she and 61-year-old Fred, like so many others of their generation, were influenced by the stock market Crash of 1929 and the Great Depression that followed. “We were willing not to get as much in exchange for the safety of our savings.”
The irony, however, is that such a “safety first” strategy isn’t as safe as it may seem. Why? Because the money put in bank CDs to be “safe” has returned just a tiny fraction of what it would have generated had it been invested--even conservatively--in the stock market years ago and left there while the couple had the time to ride out the market’s inevitable booms and busts.
Worse yet, if the Johnsons hope to make a significant addition to their nest egg in the next few years, then they’ll be investing at a point when they can least afford to lose anything, since they need the income from their investments for a secure retirement.
Even the couple’s frugal lifestyle costs about $22,000 per year, just slightly less than the $23,000 annual income they can expect from their Social Security benefits and Fred’s pension.
The mutual fund portfolio of 30% stock and 70% bond investments proposed by Janachowski should generate an additional $4,000 a year at first and, as their savings grow, eventually $11,000 a year, assuming the markets’ performances are in line with his estimates.
That’s an additional 17% to 47% above what the Johnsons are counting on receiving in pension and Social Security payments. If the markets perform well, the Johnsons’ total savings could grow from $117,500 today to nearly $295,000 in 25 years. (Janachowski is assuming a 5% average annual return on the $78,000 to be invested in bond funds and a 10% average annual appreciation of the $34,500 to be invested in equity funds.)
Janachowski’s plan could give the couple the wherewithal for the extras they want during retirement, as well as a cushion against unexpected problems. But it will require a leap of faith from the couple.
“The sad thing is that the Johnsons now have to make up for their strategy by taking on risk at a time when they need all the money they have; they don’t have the time to recoup major losses,” says Janachowski, co-author with partner Kurt Brouwer of the book “Mutual Fund Mastery,” published earlier this year. “The longer perspective you can take with investing in the market,” the more time you have to ride out the bumps.
Consider the difference an investing strategy can make over four decades’ time. According to Janachowski, $1,000 invested in stocks in 1956, the year the Johnsons married, and that produced returns matching the performance of the Standard & Poor’s 500-stock index (a common benchmark of average stock market performance) would have grown to $94,596 by the end of September 1997. That same $1,000 put into short-term Treasury bills, investments that would have produced a total yield similar to the Johnsons’ savings accounts, would have grown to just $9,782 over the same period.
However illuminating such examples might be for younger investors, they can’t do much for anyone in the Johnsons’ position. But, Janachowski says, the couple should be able to get greater leverage out of their savings without taking on extraordinary risk.
To simplify tracking their investments, Janachowski strongly advised the couple to transfer their savings to an account at a one-stop financial “supermarket” such as those operated by Charles Schwab or Fidelity Investments, both of which offer an extensive and varied selection of investments beyond their own brands of funds. (The IRA and, after retirement, the 401[k] account would have to be transferred to separate accounts that will preserve their tax-favored status; the remainder of the savings can be combined into a single investment account.)
From here, he recommends setting aside $5,000 for emergencies in an easily accessible interest-generating account such as Schwab’s U.S. Treasury Money Market Fund. For the remainder, Janachowski recommends the following:
From Fred’s holdings: $10,600 IRA and $25,500 from 401(k) plan to the Harbor Bond Fund, $3,500 from 401(k) to Third Avenue Value Fund, $7,000 from 401(k) to Harbor International Fund II; $12,000 from 401(k) to Selected American Shares Fund, $12,000 from 401(k) to the Dodge & Cox Stock Fund. From Virginia’s holdings: $3,900 IRA to the Harbor Bond Fund. For $38,000 of the couple’s certificates of deposit, current money market and passbook savings accounts, Janachowski recommends investing in the Vanguard Fixed-Income Securities Fund Short-Term U.S. Treasury Portfolio.
The overall strategy for the Johnsons relies on bonds or bond funds for income and as a hedge against lower interest rates. The job of the stock funds is to increase the Johnsons’ nest egg.
He says the couple should aim to maintain the 30%-70% split between stock and bonds over the projected 25-year life of the portfolio, buying additional bond funds as their capital grows in the stock funds.
“You have to make your money last for a long time, because you have a long life ahead,” Janachowski told the couple.
The Harbor International and Third Avenue Value funds were selected to provide portfolio growth. Janachowski says that although Harbor’s International Fund II is less than 2 years old, it brings a time-tested management style to its current “small and nimble portfolio.” The fund invests primarily in Europe, but is diversified in other established and emerging markets. Janachowski calls Third Avenue Value Fund (five-year average annual return: 21.2%) an “opportunistic” fund that invests primarily in smaller undervalued stocks and other, unloved securities selling at distressed prices. Two funds were selected to provide current dividend income as well as portfolio growth. Selected American Shares (five-year average annual return: 20.4%) is a Janachowski favorite. He says it invests in large and well-established companies that tend to be undervalued by the market, and he noted that if he himself “could own only one thing, this is it.”
Dodge & Cox Stock Fund (five-year average annual return: 21.8%) was selected as a “classic high-quality stock portfolio” that has a “sterling long-term track record.”
Of his choices to provide the Johnsons with income, Janachowski says Harbor Bond Fund (five-year average annual return: 8.2%) is “one of the steadiest and most consistent performers of intermediate-term taxable bond funds.” It invests primarily in high-quality government and corporate bonds and has an average maturity of about 10 years. It should provide the Johnsons high current income with only modest volatility, he said.
The Vanguard Fixed-Income Securities Fund Short-Term U.S. Treasury Portfolio (five-year average annual return: 5.7%) invests primarily in U.S. Treasury securities, and the bonds in it have an average maturity of about two years. It, too, has a very modest volatility.
Janachowski says that if the Johnsons prefer, they can purchase U.S. Treasury bonds and notes directly rather than invest in the mutual funds that hold those securities. Such a move would increase their sense of safety, since they can lock in a specific yield until the bond’s maturity. Buying directly also reduces the risk, albeit a small one, of lower returns should the fund have to sell a large portion of its holdings at an inopportune time--such as a selling panic among some investors. However, buying directly and choosing maturities requires some homework and allows for less flexibility in the amounts invested.
Janachowski said the bond fund investments could be made in single transactions, but he suggested phasing in purchases into the four stock funds over a year, roughly at a rate of $3,000 per month. Dividends from the equity funds should be reinvested, he said, whereas income from the bond funds is to become a part of the Johnsons budget and used primarily to pay for their travels.
The stock market’s recent bout of bungee jumping isn’t cause for worry, Janachowski says. In fact, he says that if the market should suddenly drop 25% or more, the Johnsons should quickly complete whatever purchases remain to be made to take advantage of the bargains.
Richard Goldstein, a San Francisco-area financial planner who participated in the Johnsons’ make-over, urges the couple to prepare wills, something they’ve been putting off for years. He also advised that they be sure to attach a signed addendum to each will stating that all marital assets were purchased with community property funds, to ensure that their holdings are given full step-up in value upon death of one spouse to protect surviving spouse from a tax bite in the event of sale of those assets.
The couple could also write living wills, whose chief purpose is to establish guidelines for medical treatment should the person become incapacitated--if only to make their desires clear to their two adult children.
Finally, he urges the couple to start thinking about their future health insurance needs. Fred will have to buy private health insurance to bridge the gap between the expiration of his employment coverage 18 months after his retirement and his eligibility for Medicare. Goldstein also recommends that the couple buy long-term care insurance to cover nursing home or in-home care in the event of a disabling illness or accident. Because making a choice is so complex, he gave the Johnsons a copy of an evaluation form his office uses to help clients compare and contrast the features of various policies.
(Goldstein has offered to send readers a copy also. To get one, send a self-addressed stamped business envelope to GoldsteinEnright Financial Advisers Inc., 4 Crow Canyon Court, Suite 200, San Ramon, CA 94583. Allow at least three weeks for it to arrive.)
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Carla Lazzareschi is The Times’ Money Talk columnist. To participate in Money Make-Over, send your name, age, phone number, income, assets and financial goals to Money Make-Over, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053.
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This Week’s Make-Over
* Investors: Virginia Johnson, 64, and Fred Johnson, 61
* Occupations: Virginia, homemaker; Fred, machinist
* Gross annual income: $49,000
* Financial goals: Maintain their current standard of living after Fred retires in March, be able to afford travel.
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Current Portfolio
* Fred: $10,600 in a credit union individual retirement account; in 401(k) plan, $54,000 invested in a money market account and $6,000 in Boeing stock
* Virginia: $3,900 IRA in a credit union account
* Jointly: $140,000 in home equity, $35,000 in certificates of deposit, $8,000 in money market accounts and passbook savings accounts
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Recommendations
* Address health insurance needs for both spouses. Fred will need coverage after his workplace coverage expires and until he becomes eligible for Medicare. Both should consider buying long-term care insurance.
* Have a will and durable power of attorney prepared immediately for each spouse.
* Revamp investments so that 30% of holdings are in stock mutual funds and 70% are in bond mutual funds; maintain that mix after Fred retires.
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Recommended Mutual Funds
* Vanguard Fixed-Income Securities Fund
Short-Term U.S. Treasury Portfolio: (800) 662-2739
* Harbor Bond Fund: (800) 422-1050
* Harbor International Fund II
* Third Avenue Value Fund: (800) 443-1021
* Selected American Shares Fund: (800) 243-1575
* Dodge & Cox Stock Fund: (800) 621-3979
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Meet the Planners
Stephen Janachowski is a co-founder of Brouwer & Janachowski Inc., a Tiburon-based investment advisory firm specializing in no-load mutual funds. Janachowski and Kurt Brouwer are co-authors of “Mutual Fund Mastery,” published this year by Times Books.
Richard Goldstein is president of GoldsteinEnright Financial Advisers Inc., a San Ramon, Calif.-based wealth-management firm that assists clients with setting financial goals, planning to achieve those goals and implementation of the plan.
