Portfolio Planning: A Case Study

The market meltdown unmoored many a financial plan. With the portfolios of countless baby boomers a shadow of what they once were, BusinessWeek asked five top investment advisers to draft a plan that would enable a hypothetical couple to meet all of their financial obligations.

To create the profile of our couple, we picked a scenario that describes at least a portion of our readership: a husband and wife, ages 51 and 49 respectively, with two kids in college and a third headed that way. The pair earn a seemingly comfortable $210,000, but college costs and high state taxes claim a large share of their income. Making matters worse, their taxable and retirement investment accounts were ravaged in the downturn. So they're worried about having enough money when they're ready for retirement—and they're wondering whether they'll have to endure sharp cutbacks in their lifestyle.

The five investment advisers represent different cross-sections of the financial advisory business, from a discount brokerage to a pair of high-end wealth management firms. Our experts, who agree that our couple has little margin for error, believe they can achieve their goals. "If everything falls right, they can make it," says Andrew Sharp, director of client services and research for Paul Comstock Partners, a Houston-based firm with $1.14 billion under management. Here's what the five advisers suggest:


Christopher McDermott, vice-president of retirement and financial planning at mutual fund giant Fidelity, ran our numbers and came back with a 44-page preliminary report ("just the starting point of many conversations," he noted). His conclusion: The couple should aim for a nest egg of $2.26 million by retirement, which should be sufficient to provide them with an annual income of $121,200, or 75% of their pre-retirement income after adjusting for inflation. Running simulations that assumed the markets would deliver "below-average" and "average" returns over the next two decades, McDermott said that on their current course, our couple will have the savings to draw down between $7,585 (assuming "below- average" annual returns of 4.5%) and $11,506 a month ("average" returns of 8% a year) in retirement—equal to 56% to 85% of their pre-retirement income.

To buy them more time to reach the target, Fidelity recommends our couple delay retirement (as well as their start date for drawing Social Security) to age 68, given that the life expectancy of a couple who make it to 65 is now 82 for men and 85 for women. To ensure they hit that $2.26 million target, Fidelity says the couple needs to be saving $3,196 a month, or roughly $38,000 a year. And while they have been raiding their 401(k) to help cover college expenses, McDermott says that must end. "We realize they feel an obligation to put their kids through college, but they can't rob their retirement," he says. "There are scholarships, work study, student loans, and even home equity loans."

McDermott recommends an identical asset mix for both their 401(k) and taxable accounts: 60% U.S. stocks, 10% international stocks, 25% bonds, and 5% cash. Alone among all the investment advisers we surveyed, Fidelity recommended specific funds that fit that mix—and perhaps surprisingly, the suggested portfolio included no Fidelity stock funds and only two Fidelity fixed-income funds constituting just 15% of the total asset mix. "There's no in-house bias," says McDermott. Among the recommendations: roughly equal stakes (between 8% and 10%) in the Touchstone Sands Capital Select Growth Fund (CFSIX), Janus Perkins Mid Cap Value Investor (JMCVX), MainStay International Equity Fund, Nicholas II Fund, and two large-cap value funds from American Century Investments.


Jeff Holzbach, a financial planning manager at discount brokerage Schwab (SCH), built a plan for our couple based on the conservative assumption that the markets would generate a 6% return between now and when our couple hits 65, and 5.1% afterward—a refreshing move, given the hyped returns that Wall Street firms usually promise. "Some advisers have been overly optimistic about what the market can do for you, and that's an area where Wall Street has let its clients down," says Holzbach.

If Holzbach's assumptions prove true, Mr. and Mrs. Hypothetical will have just $1.3 million in savings come retirement, based on their current savings rate. That would be fine if they live only to age 79, but using roughly the same life expectancy assumptions as Fidelity, Holzbach estimates they'll need a nest egg of $2.6 million, or enough to provide an annual income stream of $115,000, including Social Security. Schwab's plan suggests that's doable if the couple defers retirement to age 67 and saves an average $40,000 a year between now and then (a little less while their kids are still in college; more afterward). Holzbach recommends pumping as much of that savings as possible into their tax-deferred 401(k) account. To do so, he suggests the husband check whether his employer allows workers to make larger, "catch-up" 401(k) contributions.

If saving $40,000 a year isn't feasible, Holzbach offers two alternatives: The husband delays his retirement to 76 (allowing their portfolio time to grow to $2.26 million, if he can stay employed that long), or they figure out how to make do with a retirement income of just $74,600 a year. Schwab's recommended portfolio is a little less aggressive than Fidelity's: 60% stock, 35% bonds, and 5% cash. Holzbach suggests the couple purchase long-term care insurance, as well as life insurance to provide income replacement or pay off debts if one spouse dies. He adds that the wife should consider putting a side business she runs in an S Corp (or limited liability corporation) for tax and liability reasons, and setting up a corporate defined-benefit retirement plan.


This 23-year-old Wellesley (Mass.) investment firm manages $2.4 billion and caters mostly to executives and entrepreneurs with net worth of $1 million to $20 million. Still, Steven Keirn, a counselor in GW & Wade's Palo Alto (Calif.) office, says the plight of our couple isn't so different from what he and his colleagues are seeing, even among their wealthier clients. "They're very typical," says Keirn. "All up and down the ladder of personal wealth, everybody has their gallows humor about what their retirement portfolios are worth, no matter how much money they make." Keirn estimates that the couple needs to save an average of $30,000 a year between now and 2025. With his assumptions of 8% returns now and 7% in retirement, "they could probably keep a $90,000 lifestyle into their late 80s or 90s," says Keirn. He recommends a portfolio that's 65% to 70% in stocks, with an emphasis on mutual funds that invest in dividend-paying stocks that are managed in a way to minimize the tax consequences, and one that is also invested in tax-free municipal bonds and high-grade corporate debt.

Keirn also suggests the wife start a self-employed retirement plan, which would both increase the couple's savings and reduce their taxable income. He recommends tapping just the taxable brokerage account to pay their kids' college expenses. With that account down 30%, the couple can apply the capital losses they incur when selling to offset any other capital gains. Lastly, Keirn suggests the couple look into refinancing their mortgage as a way of paying off their home equity loan and credit cards—all of which presumably carry higher, and variable, interest rates. If they have the stomach, he also suggests they consider borrowing even more in the refinancing and using the extra funds to boost their contributions to a 529 college savings plan for the child who's still in high school.


Like GW & Wade, Comstock Partners' clientele isn't without means: Most of its customers have $10 million or more in assets. But Andrew Sharp, the firm's director of client services and research, says that Comstock's advisers have been having "tough love" meetings with a number of clients about trimming their spending to match their shrunken portfolios. "We're focusing hard on spending habits," he says.

Sharp recommends our couple cut their spending to increase their savings, but his advice doesn't stop there. Without knowing more about the capital needs of the wife's small business, he says it's worth asking whether the couple should consider selling that business if they can turn a healthy profit. "Why keep that on your books when you're struggling to save?" he asks. He also suggests the couple examine their portfolio to make sure they aren't too heavily invested in companies in the same industry in which the husband works, a common mistake he sees among many professionals. "People in the medical profession are big into the health-care sector," he notes. "Being that concentrated in one sector doesn't pay off."

Given the current market volatility and the couple's growing outlays for their kids' college tuitions, Sharp recommends an asset mix that's overweight in cash and short-term, high-quality bonds and other fixed-income securities. But as their college outlays taper off, Sharp recommends the couple hold a portfolio that's 34% in U.S. stocks, 18% in international equities, 20% in fixed income, 10% in cash, and 18% in an array of alternative assets, like mutual funds or exchange-traded funds holding higher-yield mortgages. "Plenty of people think there's opportunity in Alt-A mortgages, which are trading at 40 cents on the dollar," he says.


Jim Hansberger, a top Smith Barney broker who heads his own wealth management group in Atlanta and oversees $2 billion in assets, wouldn't mince words if he met the Hypotheticals in real life. "I am a very big believer that a couple like you described should have very little debt," he says. "There's no reason for them to maintain the [home equity] debt or credit-card debt." Hansberger also believes the Hypothetical household needs to take less risk in their portfolio. "The assumption that their 401(k) is down 50% and their personal account is down 30% suggests they were all in equities. A couple like that should have been more conservative—and if they were, would have been down 30% rather than 50%." He believes the couple should consider deferring retirement into their 70s. With Americans living much longer, "The idea of retiring today at 65 is equivalent to yesterday's 55 or even 45. I wouldn't fixate on this couple retiring at 65."

Hansberger recommends the couple put 20% of their assets in Treasury's inflation-indexed bonds, and suggests they diversify their equity holdings so that 20% are in assets that can provide a hedge if inflation climbs as he fears in coming years. That includes gold, energy, and agricultural commodities, but in all instances he recommends positions in stocks or exchange-traded funds that are liquid and easily tradable. "There's a valid argument that some of the current policies could cause inflation and higher interest rates down the road, which could very well lead to a decline in the dollar," he says. That said, Hansberger is still bullish on the prospects for U.S. stocks. While the financial plan he drafted models a 7% return for stocks, the Smith Barney adviser says there's potential for higher returns. "Given the prospects for inflation, the ability of companies to increase prices if there's inflation, and the strength of corporate balance sheets outside of the banks, I wouldn't be surprised to see stocks return 10% [annually] over the next decade," he says.

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