Last Updated: May 25, 2009
If you're in your 50s, and certainly if you're in your 60s, it might not seem as if you have much time to make up all that you've lost in your retirement accounts since last year. After all, when your portfolio declines 50 percent, it means that it has to rise 100 percent just to get back to even.
Those kinds of statistics are pause for concern. But it's not cause for inertia, say financial planners.
Here's what FPA member, Jerry A. Miccolis, CFA®, CFP®, of Brinton Eaton Wealth Advisors and co-author of Asset Allocation For Dummies suggests thinking about if you're 10 to 15 years away from retirement.
What's your time horizon?
Many people assume that their investment horizon — the time over which they need their portfolio to work for them — extends only to their retirement date, says Miccolis. "But, unless you're under 40, it's a good bet that the time until your retirement will represent less than half of your investment horizon. So, if you're a 45-year-old and expect to work another 20 years, you'd better expect to live — and therefore need your portfolio to work for you — at least another 20 years after you retire, "Miccolis said.
If you're married, Miccolis notes that the joint life expectancy of you and your spouse is even longer. Additionally, if you have children and/or grandchildren, you're probably thinking about bequests, about shepherding at least a part of your portfolio for their ultimate benefit, which makes your investment horizon even longer. "The longer your investment horizon, the more aggressive, the more equity-heavy, a portfolio you can afford to have, since there will be more opportunities for the good years to outweigh the bad," Miccolis said. "More aggressive portfolios lead to higher expected returns. And the times following significant market declines have been historically good times to be buying the securities, equities, that constitute an aggressive portfolio. So, if you're within 10-15 years of retirement, this is a time for some optimism, " said Miccolis.
Think tax efficiency
When building a portfolio, it's critical to allocate your investment into appropriate accounts. Some investments are best suited for tax-deferred accounts while other investments are best suited for taxable accounts. "Tax efficiency is an integral part of portfolio construction and management. This takes several forms," he said.
One form is something called asset location, which is quite different from asset allocation. Asset location involves locating tax inefficient assets, such as real estate investment trusts, which produce "ordinary income" that is taxable at your highest rate in tax-deferred accounts such as Individual Retirement Accounts (IRAs), where the income can be sheltered from taxation for many years.
After locating assets that produce ordinary income in your tax deferred accounts, Miccolis recommends identifying those assets that generate little or no ordinary income, such as growth stocks, in our taxable accounts.
"Another form of managing your portfolio in a tax-efficient way is to be alert to "tax loss harvesting" opportunities as they arise. Say you own an equity mutual fund or ETF that covers the health-care sector, and that the fund is showing a material unrealized tax loss at the moment. You can opportunistically sell that fund and immediately buy any one of a number of other funds that cover the same sector. You haven't changed your asset allocation one bit, but you've captured, or "harvested," a tax loss that you can use to offset taxable gains in the current or future tax years, lowering your tax bill." Miccolis said.
What is an asset?
When contemplating your retirement plan, it's important to think not only of your financial capital but your human capital. After all what is an asset other than something with the potential to generate income? "Clearly those individuals with earnings capacity, from a job, should consider themselves an asset," Miccolis said. "This is called human capital."
Increasingly, financial planners say your human capital should be considered when designing your investment strategy and asset allocation. "And the most effective and comprehensive way to do so is to do a lifetime cash flow projection," Miccolis said. "This projection should include all your anticipated expense items — both one-time, college and weddings for instance, and ongoing — and reflect future inflation in those expenses. It also should include your anticipated annual wages, bonuses, deferred compensation, stock options, stock awards, pensions, Social Security payments, and the like in addition to your expected investment returns.
"Of course, your investment returns are dependent on your investment strategy and asset allocation. And the more aggressive your allocation, the higher both your expected return and your risk, typically measured by the volatility in your expected return stream.
"The best asset allocation for you — the one that results in the best trade-off between risk and return in your particular circumstances — is the one that maximizes the probability that your assets will always be sufficient to cover your expenses, that is to support your lifestyle for the rest of your life. The lifetime cash flow projection is how to incorporate human capital into the investment strategy decision in a natural, comprehensive, coherent way," Miccolis said.
If you need help rebuilding your retirement portfolio or want to learn more about incorporating your human capital into your financial plan, consider hiring a financial planner. Find a financial planner.