|
 Revisit
Your Asset Allocation
No one
enjoys the recent market fluctuations. But if these fluctuations have
caused you extreme discomfort, then it's probably time to reassess your
asset allocation. To do so, follow these steps:
1.
Review your desired asset allocation percentages.
When designing your investment strategy, you
probably decided what percentage of your portfolio to allocate to
different investments. Review those percentages to see if they still
make sense for your situation. Over time, how much you want to allocate
to different asset classes will probably change as your personal
circumstances change. However, don't make significant changes as a
result of discomfort over market fluctuations. First, reevaluate these
factors:
 |
Risk
tolerance -
Carefully assess your tolerance for risk so that you invest in
assets you are comfortable with. While the recent stock market
fluctuations have made many investors more risk averse, don't
overreact to these fluctuations.
|
Return
expectations - You need to set
realistic return expectations for various investments to help assure
that you meet your investment goals. While past performance is not a
guarantee of future results, reviewing historical rates of return
can help you assess whether your return expectations are reasonable.
Keep in mind that higher returns are generally accompanied by higher
risk.
|
Time
horizon - The longer your investment
period, the more risk you can typically tolerate. Investing for long
periods through different market cycles generally reduces the risk
of receiving a lower return than expected, especially with
investments that can fluctuate significantly over the short term.
|
Investment
preferences -
With such a wide variety of investments to choose from, you should
understand the basics of each to decide which are appropriate for
you. |
| | |
In
general, you should consider a more conservative allocation if you are
older, have short-term needs for your funds, have low earnings, or are
uncomfortable with investing. A more aggressive allocation may be
appropriate if you have high earnings, are younger, do not need your
funds for many years, or are an experienced investor.
2.
Determine your portfolio's current allocation.
You should consider all of your investments,
including taxable accounts, individual retirement accounts, and
retirement plans at work. Some investments may not fit totally in one
category - for instance, an investment may invest in both stocks and
bonds or in both domestic and international stocks. In those cases,
allocate a percentage of the market value to each of the categories it
is invested in. You don't have to be exact, since many investments'
allocations will change over time.
3.
Determine how much variation you are willing to tolerate in your asset
allocation. It's unlikely that your actual
asset allocation will equal your desired asset allocation, due to
varying market values and rates of return. Since it is difficult to
maintain precise asset allocation percentages, decide how much variation
you will tolerate. For example, you may monitor your portfolio more
closely if an asset class varies by 5% of your desired allocation and
rebalance when it varies by 10%.
4.
Decide how to move your portfolio closer to your desired asset
allocation. If
you have not reassessed your asset allocation for a while, you may find
that significant changes are needed to get your allocation back in line.
However, you may not want to make drastic changes all at once. Instead,
you may want to take a more gradual approach to shifting your asset
allocation. For instance, you can make new investments in assets that
are underweighted in your portfolio. Periodic interest, dividends, or
capital gains distributions can be redirected to other asset classes
rather than reinvested in the same asset. Any withdrawals can come from
overweighted asset classes.
Back
to topics.
 Is
10% Enough?
A common
rule of thumb when planning for retirement is to save 10% of your gross
income during your working years. Since this rule of thumb has been
around for a long time, it's logical to question whether it's still an
appropriate guideline. Several trends suggest that it is probably on the
low side:
|
Fewer
individuals are covered by defined-benefit plans.
The 10% guideline anticipated that a
retiree would receive a defined-benefit pension as well as Social
Security benefits. But a substantial portion of the work force is no
longer covered by a defined-benefit pension.
|
The
Social Security system will face increasing pressure in the future.
Due to the unprecedented number of baby
boomers that will be retiring in the near future, there will be
fewer workers to pay the benefits for each retiree. By 2037, unless
changes are made to the system, benefits will need to be reduced by
approximately 25% to equal revenues collected (Source: Social
Security Administration, 2009).
|
Life
expectancies are continuing to increase.
Average retirement ages have been
decreasing, while life expectancies have been increasing. Currently,
at age 65, the average life expectancy is 82 years for a man and 85
years for a woman, compared to 78 years for a man and 81 years for a
woman in 1950 (Source: Journal of Financial Planning, August
2008).
|
Plans
for retirement have changed.
Another common retirement planning rule of
thumb is that you'll need 70% of preretirement income during
retirement. However, that guideline assumed a relatively inactive
retirement lifestyle. Increasingly, retirees view retirement as a
time to travel extensively or engage in expensive new hobbies. Thus,
more and more retirees are finding little change in their income
needs after retirement. |
| | |
All
these trends point to the fact that future retirees will be responsible
for providing more of their income for a longer period of time. Thus,
you should consider higher, not lower, savings rates. While 10% of
income may sound like a lot of money, consider how many years you expect
to work compared to how many years will be spent in retirement. Assume
you start working at age 22, work until age 62, and then die at age 82.
Thus, you work 40 years and are retired for 20 years - for every two
years you work, you need to support yourself for one year in retirement.
If your retirement expenses don't go down and you don't have a
defined-benefit pension, you'll need to save significant sums to support
yourself for that length of time.
Contrast
the current situation with a typical scenario in 1950. At that time, the
average retiree worked 47 years before retiring for nine years. Thus,
that person worked over five years to support one year of retirement.
For many
people, then, the answer may be to extend their working years. In the
above example, if you wait until age 70 instead of age 62 to retire, you
will work for 48 years and be retired for 12 years. Thus, you will work
four years for every year of retirement. While preretirees may not have
the mathematics down, many realize that working longer, rather than
retiring earlier, may be the only way to ensure that they don't run out
of retirement funds. Almost all recent surveys of baby boomers indicate
that the majority expect to work at least part-time during retirement.
These
stark realities don't mean that you can't retire, just that you need to
plan carefully. Thus, you should start saving as much as possible, as
soon as possible, for your retirement. Waiting even a few years to start
saving can substantially increase the annual amount you need to save.
Trying
to gauge whether your retirement savings are on track? While there's
nothing like going through a thorough analysis, you can take a quick
look by adding up all your retirement assets and multiplying that
balance by 3% or 4%. These withdrawal percentages should ensure that
your retirement assets last for several decades.
Back
to topics.
 Caught
in the Middle
At a
time when baby boomer couples should be saving for their own
retirements, many feel squeezed by competing financial needs. Having
started families later than past generations, their children may just
now be entering college or still living at home. At the same time, aging
parents may need financial assistance. It is a dilemma that is likely to
become more common.
Caring
for Parents
As life
expectancies continue to rise, it becomes increasingly likely that you
may need to help an aging parent. Some financial precautions you should
consider now include:
|
Investigate
long-term-care insurance for your parents. If they can't afford the
insurance, you may want to purchase it.
|
Have
your parents prepare a listing of their assets, liabilities, and
income sources, including the location of important documents. This
can save time if you need to take over their finances.
|
Make
sure your parents have legal documents in place so someone can take
over their financial affairs if they become incapacitated. They may
also want to delegate health care decisions.
|
Understand
the tax laws if you provide financial support to your parents. You
may be able to claim them as dependents if you provide more than
half their support. Additionally, you may be able to deduct medical
expenses paid on their behalf.
|
Find
out if your employer offers a flexible spending account for elder
care. This may allow you to set aside pretax dollars to pay for up
to $5,000 of elder-care expenses for a dependent parent. |
| | | |
Assisting
Your Children
For many
families, college is a significant financial cost. While you may want to
pay all college costs for your children, it may not be feasible. Some
strategies to consider include:
|
Shift
some of the burden to your children, requiring them to work
part-time during college or to take out student loans.
|
Understand
the financial aid system, investigating all financial aid sources.
Search for scholarships that are not based on need. Apply to several
different colleges, looking for the best financial aid package.
|
Look
for ways to reduce the costs of college. Your child can start at a
community college, which is often cheaper than a four-year college.
Or consider a public university in your state. |
| |
Once
your child graduates from college, don't assume your financial
responsibilities are over. Adult children may return home for a variety
of reasons. If your child returns home, realize there are increased
costs. Consider charging rent and imposing a deadline on how long he/she
can stay.
Don't
Forget Yourself
When
faced with the needs of children and aging parents, it's easy to neglect
your own need to save for retirement. But don't feel guilty about your
retirement needs. One of the best gifts you can give your children is
the knowledge that you will be financially independent during
retirement. Consider these tips:
|
Calculate
how much you need for retirement and how much to save on an annual
basis to reach that goal. Don't give up if that amount is beyond
what you're able to save now. Start out saving what you can,
resolving to significantly increase your saving once your parents'
or children's needs have passed. Also consider changing your
retirement plans, perhaps delaying your retirement or reducing your
financial needs.
|
Take
advantage of all retirement plans. Enroll in your company's 401(k),
403(b), or other defined-contribution plan as soon as you're
eligible. Also consider investing in individual retirement accounts.
|
Reconsider
your views about retirement. Instead of a time of total leisure,
consider working at a less stressful job, starting your own
business, or turning hobbies into paying jobs. |
| |
Back
to topics.
 The
Problem with Average Returns
When
setting up an investment program, the assumed rate of return is
typically an average return for some historical period. While that is
generally viewed as a conservative approach, there are some problems
with using an average return:
|
Average
returns are an average of past returns and do not indicate what will
happen in the future. Economic and market events may or may not
replicate past events.
|
The
average annual return can vary substantially depending on the
historical period used. For instance, from 1926 to 2008, the
Standard & Poor's 500 (S&P 500) had an average annual return
of 9.6%. From 1984 to 2008 (25 years), the average return was 9.2%
and 6.4% from 1999 to 2008 (10 years).* Those differences in average
return would project a substantially different portfolio value over
an extended time.
|
The
average return does not reveal the pattern of returns over that
period. Some years will experience higher returns, while other years
will experience lower or even negative returns. Even if you select
an average return that is exactly right, your portfolio's ultimate
balance will depend on the pattern of returns over that period. For
instance, if you experience high returns in the early years when
your portfolio's balance is low and then lower returns in the later
years when your portfolio's balance is higher, you will have a lower
value than if the opposite occurred.
|
Most
people don't just allow a lump sum to grow, but make deposits and
withdrawals over the years. Since your actual return fluctuates from
year to year, your pattern of additions and withdrawals can also
significantly impact your portfolio's ultimate value. |
| | |
While it
is instructive to consider average returns when developing an investment
program, you can't simply project that return into the future and hope
for the best. Instead, consider these steps when deciding on an
estimated rate of return:
|
Evaluate
your expectations for future returns against historical averages.
It may be prudent to assume lower returns in the future. It is
easier to save less if you obtain higher returns than to try to save
more over a short period of time if your actual return is lower.
|
Consider
a range of possible returns for your portfolio. What
would happen to your portfolio's balance if you earned your expected
return, 1% less, 2% less, etc.? This analysis can help you determine
what adjustments would need to be made to compensate for lower
returns.
|
Review
your progress every year.
This will allow you to make adjustments
along the way. If your return is lower than expected, you may need
to increase savings or change investment allocations. |
| |
*
Source: Stocks, Bonds, Bills, and Inflation 2009 Yearbook,
Ibbotson Associates. The S&P 500 is an unmanaged index generally
considered representative of the U.S. stock market. Investors cannot
invest directly in an index. Past performance is not a guarantee of
future results. Returns are presented for illustrative purposes only and
are not intended to project the performance of a specific investment.
Back
to topics.
 Time
to Reassess Your Risk Tolerance
Typically,
before deciding how much to allocate to different investment categories,
you answer several questions about your tolerance for risk. While it can
be difficult to judge how you will react to different scenarios, the
recent stock market fluctuations have provided a real-world test of
theoretical answers. Many people have been surprised to find out that
their tolerance for risk is not as high as they thought. That's not
unusual. When the markets are performing well, it's easy to think you
have a high tolerance for risk. But when the markets start to decline,
our tolerance for losing money is not very high.
Thus,
you should now have a better understanding of your comfort level with
risk, making this a good time to reassess your risk tolerance. There are
at least two components to your risk tolerance. One is the appropriate
level of investment risk based on your personal situation. Factors such
as your time horizon for investing, income level, total assets, debt
levels, liquidity, and family responsibilities will affect that aspect.
The
other element is your emotional tolerance for risk. Even if your
personal situation indicates a high level of risk, that may not be
prudent if you don't feel emotionally comfortable with that risk. How
you have handled the recent stock market fluctuations should provide a
good indication of your emotional comfort level with risk. How have you
reacted during this volatile period? Have you taken the fluctuations in
stride, or have you been anxious about your portfolio's value? Have you
frequently calculated your portfolio's value or only occasionally
checked? Have you been tempted to sell all your stock investments, or
did you realize that this is a normal part of the investing process?
What would you do if the market continued to decline? How long could you
withstand a declining market before feeling compelled to sell?
One
approach to develop an investment portfolio that reflects your
individual risk tolerance is to consider your investment income needs
and your attitude about the potential changes in investment values. If
your standard of living is dependent on investment income, your
portfolio should be concentrated in investments that provide stable and
predictable income. However, if your living needs are covered through
employment income, it makes more sense to take a little more risk with
your investments, choosing investments with greater growth potential
over the long run.
By
knowing yourself and understanding your financial needs and goals, you
will be better able to gauge how you may react to market fluctuations.
In turn, this will help you determine what levels of risk to assume in
your portfolio to help meet your financial goals.
Back
to topics.
Copyright
© 2010. Some information provided in this newsletter was prepared by
Integrated Concepts. This newsletter intends to offer factual and
up-to-date information on the subjects discussed, but should not be
regarded as a complete analysis of these subjects. The appropriate
professional advisers should be consulted before implementing any
options presented. No party assumes liability for any loss or damage
resulting from errors or omissions or reliance on or use of this
material.
FR2009-1124-0116
|