Navigating a 'No-Pension' Retirement
This retiree looks to get more fully invested and determine whether the stable-value option merits staying put in an old 401(k).
Investing Specialists
Portfolio Makeover Profile
Investor: Sandra | Age: 73
Assets: $428,386 | Key Financial Goals: Portfolio Cleanup, Withdrawal Sequencing
"I have all the typical issues of the first generation of retirees depending on a 401(k) and not a pension," wrote Sandra, now 73 and already retired.
Sandra can look back on a varied and interesting life thus far. She spent 20 years working in Europe before returning to the United States and embarking on a new career in marketing at age 50. She has no regrets, save one. "I didn't start saving for retirement until I was 50! Today I tell young people to start earlier."
An avid Morningstar.com user, Sandra says she has worked to educate herself about investing and has some ideas about how her investment program could be better. But she needs confirmation that she's on the right track. "I lack confidence, and I have been very slow to make the changes I need to make."
Specifically, Sandra fears she's holding too much cash and too little in equities. Her stable-value fund in her 401(k) plan is her largest position in that account, while a money market fund is her top position in her Traditional IRA. Moreover, even more cash is piling up in her taxable account, as she's taking required minimum distributions from her IRA and 401(k) but not spending the entire amount. "I was too conservative for too long, and I know I lost earnings for it," she wrote. "Now I know I have to find the right balance."
With multiple accounts at multiple institutions, Sandra says she'd also like help with "portfolio cleanup," in her words. Apart from her large cash holdings, she has many small positions in both her IRA and her 401(k). She is also paying for a portfolio-advisory service for a portion of her portfolio, but she has concluded she's not getting her money's worth--in this case, 1% of her assets, plus any fees associated with the investment choices.
Finally, because Sandra is in drawdown mode and must take required minimum distributions from her IRAs and 401(k)s, she is also looking for guidance on asset location and sequencing her withdrawals.
The Before Portfolio
Sandra's correct--her portfolio is extremely conservative. Morningstar's X-Ray tool shows that she currently has about one fourth of her assets in stocks, 15% in bonds, and the rest--a whopping 61% of assets--in cash and cashlike investments. (Her stable-value fund counts as "cashlike"; while not technically cash, cash is the most similar asset class.) Her equity portfolio is well-distributed across the Morningstar Style Box
Sandra holds her accounts in three main silos: a 401(k) with her former employer (her largest account), a Traditional IRA, and a taxable brokerage account consisting exclusively of cash instruments. She also has a tiny Roth IRA position in a single holding, Vanguard STAR (VGSTX).
Within the 401(k), Sandra's largest position is the stable-value offering. The rest of the portfolio is spread across a smattering of high-quality equity-fund holdings, both active and passive, from firms such as T. Rowe Price Group (TROW), Fidelity, and American Funds.
Cash is Sandra's largest position in her Traditional IRA, but she holds a mix of bond and equity holdings here, all from Vanguard. Sandra is also using the portfolio-advisory service within the confines of her IRA. That account employs a 30% equity/70% bond allocation.
Holding Market Value ($) Weight (%) Star Rating Taxable: Cash 79,616 18.59 N/A 401(k): Wells Fargo Stable Value Return E 152,454 35.59 N/A 401(k): Am Funds Growth Fund of America R4 (RGAEX) 4,828 1.13
The After Portfolio
One of the first decisions Sandra needs to make is whether to maintain two primary accounts: her 401(k) and her Traditional IRA. Sandra's main rationale for staying put in her 401(k) is to take advantage of the stable-value fund. Stable-value funds aren't found outside of 401(k) plans, and such offerings typically offer higher yields than cash while buying insurance contracts to help them maintain stable net asset values. Stable-value fund yields, like the yields on almost everything else these days, are miserly; Sandra notes that she has gained just 0.52% in her stable-value account thus far this year. But when bond yields trend up, so will the payouts on these investments. Moreover, the expense ratios on Sandra's other 401(k) funds are generally quite low, and Sandra is able to use the brokerage window to invest in a massive range of securities.
That said, I'm unconvinced that the benefits of the stable-value offering outweigh the drawbacks of staying put in the old 401(k). First, her 401(k) lineup's bond choices are limited. She'd need to use the brokerage window--and potentially incur additional administrative and transaction costs--to obtain fixed-income exposure that goes beyond a total bond market index tracker. Just as important, keeping the 401(k) means that Sandra will have to maintain, rebalance, and take RMDs from two separate accounts, and she may find these added duties increasingly cumbersome as she advances in retirement. (The ideal compromise would be to continue to invest in the stable-value fund alone in her 401(k), while investing the rest of the portfolio in her Traditional IRA. But Sandra checked and reported that her 401(k) doesn't allow partial rollovers.) Thus, I'm inclined to roll over her 401(k) into her IRA.
Apart from the "which wrappers?" question, the bigger issue with Sandra's portfolio is its too conservative positioning. Given the very low yields available on cash currently, a big chunk of Sandra's portfolio runs the risk of losing money once one includes the effects of inflation. And with such low growth potential in her portfolio, even her current withdrawal rate of about 3.5% could be too high. The bucket system for retirement portfolio management can help retirees like Sandra visualize what their asset allocations should look like based on their anticipated cash needs. Near-term disbursements, such as RMDs, are held in cash, while intermediate-term assets can go into bonds. Longer-term assets can go into stocks. (This article includes more detail on the bucket strategy, as well as links to related articles.)
That framework results in a much higher equity allocation than Sandra had before, as well as a higher weighting in bonds. As with my model bucket portfolios, I've stair-stepped each of Sandra's buckets by risk level. Bucket 2, for example, starts with short-term bonds, then segues into core fixed-income exposure and Treasury Inflation-Protected Securities. At the tail end, it includes a conservative-allocation vehicle. The idea is that if Sandra's bucket 1 (cash) runs dry and longer-term holdings like stocks and/or intermediate-term bonds are in the dumps (and therefore not good candidates for selling), she can use the short-term bond fund as her next-line reserves.
Sandra's makeover will require her to think through a few logistical issues. First, if she uses the bucket approach, it's important she'll need a strategy for bucket maintenance--filling up bucket 1 as she depletes it for RMDs. My bias is to reinvest her dividend, income, and capital gain distributions and then rebalance annually, trimming her most highly appreciated positions and sending the proceeds into her cash account. (My bucket stress tests show how this would work in practice.)
Just as important, she'll have to get a plan for implementing higher bond and equity weightings in her portfolio. Bond yields are quite low, and rising yields could spell trouble for bond funds. Moreover, while stocks aren't especially expensive, we're five-plus years into a bull market, so they're not cheap, either. To avoid plowing her cash into long-term assets at what, in hindsight, is the worst possible time, she could move the money into those holdings in smaller increments during the next year (or even more). That way she'll obtain a range of prices for her newly purchased assets. However, she should not move all of her 401(k) assets into cash when she rolls them over to the IRA; instead, she should aim to maintain at least as much equity and bond exposure as she has today.
Sandra should keep her taxable portfolio simple. Because she's not actively drawing upon that piece of her portfolio, she can use a simple balanced or allocation fund to hold any assets that she doesn't need for near-term living expenses. If she does eventually begin drawing on her taxable portfolio, she'll want to hold separate stock and bond funds to give her control over where she goes for distributions.
Finally, I'd like to see Sandra identify a financial advisor--or even a trusted, financially savvy relative or friend--to whom she can turn to when she needs hand-holding or if she decides she no longer wants to manage her assets on her own. Paying such an advisor on an hourly or per-engagement basis will allow her to get advice when she needs it without paying more than necessary.
Holding Market Value ($) Weight (%) Star Rating Taxable: Cash 54,616 12.75 N/A Taxable: Vanguard Wellington (VWELX) 25,000 5.84
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