A soon-to-be-retiree deploys her sizable cash stake.
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By Christine Benz | 01-25-11 | 06:00 AM | Email Article

"I would really be delighted if you considered me in light of the fact that I represent so many single women with no pension but a few assets and no debt who are just closing in on retirement."

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz and on Facebook.

So ended an e-mail I received from Emily Booth (not her real name), who wrote me requesting a portfolio makeover in the summer of 2009. At 64, she was looking back in satisfaction on her successful career in real estate. But she was also thinking about the next phase in her life--retirement--and whether her portfolio will afford her the financial stability she's seeking. With the real estate market in the doldrums during the past few years, Emily's income had slowed to a trickle, and she was considering retiring within the next few months.

Before she did, however, she wanted to reposition her investment portfolio. With more than 60% of her assets in cash, she was rightfully concerned about her portfolio's limited upside potential. At the same time, she was worried about moving a lot of money into the market given that stocks went on a tear for much of 2009. Incurring big portfolio losses early in one's retirement years can be catastrophic, so Emily was seeking guidance not just on what to buy but when and how to buy it.

The Before Portfolio
Emily's portfolio, at roughly $750,000, is a tribute to her careful financial management. She obviously has too much cash, but I like nearly all of her stock and bond holdings.  Dodge & Cox Income  and  T. Rowe Price New Income , both solid core funds, are the linchpins of her bond portfolio. She also has several fine funds that combine stock and bond holdings, including  Dodge & Cox Balanced ,  Vanguard LifeStrategy Growth , and  Oakmark Equity & Income . Her pure equity holdings include some of Morningstar's favorite active funds-- Fairholme ,  Third Avenue Value , and  Mairs & Power Growth --as well as a smattering of index funds.

Emily's Portfolio: Before
Star Rating
Category/Industry
Holding Value ($)
T. Rowe Price New Income PRCIX
Intermediate Bond
38,560
Dodge & Cox Income DODIX
Intermediate Bond
33,035
Fidelity Asset Manager 20% FASIX
Conservative Alloc
31,215
Dodge & Cox Balanced DODBX
Moderate Alloc
28,414
Oakmark Equity & Income OAKBX
Moderate Alloc
27,844
Fidelity Balanced FBALX
Moderate Alloc
26,247
Vanguard LifeStrategy Growth VASGX
Large Blend
26,113
ExxonMobil Corp XOM
Energy
18,406
Vanguard Int-Tm Tax-Exempt VWITX
Intermediate Muni
16,945
Vanguard Total Stk Mkt Idx VTSMX
Large Blend
10,323
Vanguard GNMA VFIIX
Intermediate Gov't
10,093
Dodge & Cox Int'l Stock DODFX
Foreign Lg Val
8,469
T. Rowe Price Health Sciences PRHSX
Health
7,288
Third Avenue Value TAVFX
World Stock
7,275
Cash
N/A
N/A
463,599
Total (incl. 5 holdings not shown)
 
 
769,612

 
In addition to the careful homework she had done on investment selection, Emily had also gotten the big picture right. She owned her own home outright and her expenses were manageable, both of which are huge pluses given her proximity to retirement. Emily estimated that she'll need $25,000-$30,000 a year--in addition to Social Security--to maintain her standard of living in retirement. That's an income level that her current portfolio should be able to support. She also had purchased a long-term care policy with generous benefits from a highly rated insurance company. The policy premiums are not cheap, at $2,400 a year, but having this type of insurance afforded Emily valuable peace of mind.

The After Portfolio
As much as Emily had done right, however, there were still a few areas where she could improve. Given her proximity to retirement and the threat that rising costs can pose to a retiree's purchasing power, Emily's portfolio lacked inflation protection, so allocating a portion of her fixed-income portfolio to Treasury Inflation-Protected Securities is a good start. Inflation isn't a near-term worry, but it may well be a bigger risk factor later in Emily's life. (To avoid buying into the asset class at an inopportune time, she might consider dollar-cost-averaging into the asset class over the space of one or two years.) She could pick up a more robust total return without taking on a lot of additional risk by investing some of her cash war chest in high-quality bonds and even lower-risk stock funds. Finally, some of her stock holdings overlap with one another. She can prune some of her redundant holdings but still maintain diversification that's more than adequate.

Emily's Portfolio: After
Star Rating
Category/Industry
Holding Value ($)
Oakmark Equity & Income OAKBX
Moderate Allocatioan
150,000
Dodge & Cox Inc DODIX
Intermediate Bond
100,000
T. Rowe Price Sh-Tm Bond PRWBX
Short-Term Bond
100,000
Vanguard Infl-Protect Sec VIPSX
Inflat-Protect Bond
50,000
ExxonMobil XOM
Energy
18,406
Vanguard Total Stk Mkt Idx VTSMX
Large Blend
50,000
Fairholme FAIRX
Large Blend
50,000
Mairs & Power Growth MPGFX
Large Blend
50,000
Dodge & Cox Int'l Stock DODFX
Foreign Large Value
50,000
Third Avenue Value TAVFX
World Stock
25,000
Harbor International Growth HIIGX
Foreign Large Growth
25,000
Harbor Commodity HACMX
N/A
Commodities
25,000
Cash
N/A
N/A
76,205
Total
 
 
769,612

 
One starting point for someone like Emily is to determine cash needs over the near and long term and allocate assets accordingly. For example, Emily could start by determining her cash needs for the next two years--$50,000-$60,000, based on her projections. She can then leave that money, and a little more, in her various cash accounts.

After that, she can think about "laddering" the portfolio based on when she expects to need the assets. For example, for assets she expects to tap in years 3 to 5 of her retirement, she can park them in a short-term bond fund such as  T. Rowe Price Short-Term Bond  or even a conservative intermediate-term bond fund like Dodge & Cox Income. She might also consider a combination of the two.

Assets for years 6 through 10 can go in an intermediate-term bond fund and, at least in part, conservative wide-moat stock funds. Emily's several stock/bond combination funds would also work well in this sleeve of her portfolio. I'm a big fan of Dodge & Cox Balanced and Oakmark Equity & Income. I'd favor the latter, largely because Emily has plenty of exposure to Dodge & Cox elsewhere in her portfolio. I would also cut her position in  Fidelity Balanced .

For the long-term portion of Emily's portfolio (10-year time horizon and longer), many of her current holdings provide a solid foundation. I also like that Emily's portfolio mixes index and active funds. However, holding both  Vanguard 500 Index  and  Vanguard Total Stock Market Index  creates redundancies. I'd recommend cutting the 500 fund and enlarging the position in Total Stock Market Index, which has somewhat broader reach. Emily should also consider adding to her portfolio's foreign-stock exposure, as she's currently quite light in this area.  Dodge & Cox International Stock  is a great building block, but she might also consider a complementary growth-oriented fund such as  Harbor International Growth .

Morningstar Ratings as of Jan. 21, 2011.

A version of this article was published August 5, 2010.

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Morningstar - 2011/01/25 - Preparing a Portfolio for Retirement - <a href="http://www.morningstar.com/articles/author/30-christine-benz.aspx">Christine Benz</a>
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