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A Young Power Couple's Kickstart Portfolio

With "massive" student debt loads receding in the rearview mirror, a young professional couple fires up their investment plan.

Portfolio Makeover Profile
Matt and Jenny | Ages: Mid-30s
Assets: $269,003 | Key Financial Goals: Buying a Home, Saving for College and Retirement, Paying Off Debt

"HELP!!!" was the subject line in Matt and Jenny's request for a portfolio makeover.

In their mid-30s, this couple wouldn't seem to need help at all; in fact, they have everything going for them, including robust salaries as a medical doctor (Jenny) and as an attorney (Matt). But they've amassed little in savings thus far because they've been concentrating on paying down student loan burdens that were, in Jenny's words, "massive." They also live in a high-cost part of the country where it's not unusual to pay $2,000 a month for a modest rental. In addition, they have some big expensive goals, including buying a home in a pricey real estate market, saving for college for the children they hope to have, and retiring with comfortable incomes in their 60s.

Now that their salaries are ramping up and their debt loads are receding, Matt and Jenny are ready to get serious about saving. They'd like help figuring the best use of their household's financial capital--the right investment wrappers as well as the best investments to put within them. "Neither of us is business-savvy," wrote Jenny. The couple also has some student debt left and would like some guidance about how to prioritize their competing financial goals.

The Before Portfolio
Matt and Jenny's Before Portfolio looks a bit uneven. The bulk of their assets are parked in cash in a taxable account, set aside for their home down payment. They still have a ways to go on that front: Jenny says that she and Matt think they will need to spend $1 million to get into a home they can grow into, and they'd like to put 20% down.

Both have just started their full-time professional jobs, so their retirement savings are pretty small. Matt, whose employer offers a pension as well as a 401(k) plan, has stuck with his 401(k) plan's custom target-date option. He has split his contributions between the 2040 and 2045 options because he expects to retire within that time frame. Companies hire investment managers to design custom target-date funds to meet the needs of their employee populations; for example, a company that also offers a pension, as Matt's does, might offer an equity-heavy target-date lineup to serve as a complement.

Jenny has a profit-sharing plan with her relatively new employer, to which her employer contributes the maximum allowable amount annually, $52,000 in 2014. (A profit-sharing plan is similar to a 401(k) plan, but the employer makes contributions on behalf of the employees, and has the discretion to forgo contributions as business conditions dictate.) Jenny owns a target-date fund in her profit-sharing plan-- Fidelity Freedom 2040 (FFFFX)--but the bulk of her plan is parked in cash. In addition, she owns two fine equity funds, the Silver-rated  T. Rowe Price Dividend Growth (PRDGX) and  Primecap Odyssey Stock (POSKX). She also has picked up a small slice of  Facebook (FB) stock. 

Jenny and Matt each have Roth IRAs, which they've acquired using the so-called backdoor IRA maneuver. Because they earn too much to contribute to Roths directly and neither has any rollover IRA assets from previous employers, they're perfect candidates for this tactic. Getting into a Roth through the backdoor simply means you fund a nondeductible Traditional IRA, which has no income limits, then convert to a Roth shortly thereafter. They used an advisor to help them choose their investments, and his choices are quirky--tiny positions in individual stocks, mainly biotechs, and larger stakes in equity closed-end funds.

On the other side of the ledger, Matt and Jenny still have some debt to contend with. They have about $75,000 in loans with an interest rate of more than 6.0%, and another $140,000 in loans with an interest rate of either 2.5% or 2.75%.

Holding Market Value ($) Weight (%) Star Rating Matt's Roth IRA: Cash 5,263 1.96 N/A Matt's Roth IRA: Abiomed 184 0.07 N/A Matt's Roth IRA: Alpine Dynamic Dividend (AOD) 1,134 0.42 Matt's Roth IRA: Biomarin Pharmaceuticals (BMRN) 185 0.07 Matt's Roth IRA: Corcept Therapeutics (CORT) 108 0.04 N/A Matt's Roth IRA: Cyberonics (CYBX) $179 0.07 N/A Matt's Roth IRA: Jazz Pharmaceuticals (JAZZ) 144 0.05 N/A Matt's Roth IRA: JPMorgan Chase (JPM) 167 0.06 Matt's Roth IRA: Liberty All Star Equity USA 1,084 0.40 Matt's Roth IRA: Royce Micro Cap (RMT) 1,061 0.39 N/A Matt's Roth IRA: Royce Value Trust (RVT) 1,073 0.40 N/A Matt's Roth IRA: United Therapeutics (UTHR) 191 0.07 N/A Jenny's Roth IRA: Mirrors holdings in Matt's 10,805 4.02 N/A Matt's 401(k): Custom Target-Date Fund 2045 25,792 9.59 N/A Matt's 401(k): Custom Target-Date Fund 2040 46,784 17.39 N/A Jenny's Profit-Sharing: Facebook (FB) 943 0.35 Jenny's Profit-Sharing: Fidelity Freedom 2040 (FFFFX) 3,080 1.14 Jenny's Profit-Sharing: Primecap Odyssey Stock (POSKX) 1,002 0.37 Jenny's Profit-Sharing: T. Rowe Dividend Growth (PRDGX) 1,003 0.37 Jenny's Profit-Sharing: Cash 18,821 7.00 N/A Taxable: Cash 150,000 55.76 N/A Total 269,003 100

The After Portfolio
Creating a financial plan means minding the details, but it helps to first step back and think big-picture rather than risk getting caught in the weeds. The big-picture takeaways for this couple? They have long time horizons, so they will want to ensure their long-term investments are parked mainly in stocks. They also have high incomes and a high savings rate, meaning that savvy tax management will be important for them, both now and in the future. 

Finally, and not insignificantly, Matt and Jenny are exceptionally busy and could become even more so if they have children. Thus, they need to create a straightforward, low-maintenance plan that they can invest in to get going. Down the road, as their portfolio grows and their financial situation becomes more complicated, they'll likely benefit from having a financial advisor to rely upon for ongoing guidance.

This couple's total portfolio still skews heavily toward cash, but that's because of their house down payment fund. I've oriented their retirement accounts toward equities, in keeping with their very long time horizon. Jenny says she and Matt have about $100,000-$125,000 to invest across all asset pools each year--an extremely high savings rate, especially given that their employers are also saving on their behalf, Jenny's via her profit-sharing plan and Matt through his pension. 

Within Jenny's profit-sharing plan, I like her two core equity-fund picks, but I have added a core international fund into the mix,  Dodge & Cox International Stock (DODFX). I deployed her cash holdings across these positions and also cut her stake in Facebook, which Morningstar analyst Rick Summer thinks looks pricey relative to his estimate of its fair value.

Matt's custom target-date fund, charging 0.54%, is on the pricey side relative to some of the very cheap index funds in his 401(k) plan raising the question of whether he might not be better off creating his own asset mix. But the fund includes some high-quality active fund managers, as well as index products. I also like the fact that it's customized for employees at Matt's organization. The target-date vehicle also wins points for letting Matt be hands-off about his 401(k); he won't need to rebalance or make his asset allocation more conservative over time.

Matt and Jenny should also continue to contribute the maximum to their IRAs each year and convert those sums to Roth. With their savings rate as high as it is, it's likely they're going to benefit from the tax break even more in the future than they will today. But I'd rather see them focus on core-type investments rather than holding a lot of niche investments as they do now. I employed basic index funds for this portion of the portfolio. Because their Roths are the longest-term portions of their portfolios, sticking exclusively with equities makes sense for now.

Once they've built up their down payment and have also set aside money for emergency expenses, they'll need to begin buying long-term securities in their taxable account in addition to funding their IRAs and company retirement plans. I'd keep it simple and tax-efficient, focusing on index mutual funds or exchange-traded funds on the equity side, as well as municipal bonds for shorter-term goals.

Regarding debt paydown, Matt and Jenny should obviously prioritize the higher-rate student debt (the loans that carry a rate of 6% or more), as it would be impossible to earn a guaranteed return anywhere close to 6% on their investments. But over time they won't have too difficult a time outearning their lower-rate debt by investing in the markets, so they can take their time paying off those loans and concentrate on building up their house fund instead.

Holding Market Value ($) Weight (%) Star Rating Matt's Roth IRA: Vanguard Total Stock Mkt Idx (VTSAX) 5,773 2.15 Matt's Roth IRA: Vanguard FTSE All-World ex-US (VFWAX) 5,000 1.86 N/A Jenny's Roth IRA: Vanguard Total Stock Mkt Idx (VTSAX) 5,805 2.16 Jenny's Roth IRA: Vanguard All-Wld ex-US (VFWAX) 5,000 1.86 N/A Matt's 401(k): Custom Target-Date Fund 2045 72,576 26.98 N/A Jenny's Profit-Sharing: T. Rowe Dividend Growth (PRDGX) 8,849 3.29 Jenny's Profit-Sharing: Primecap Odyssey Stock (POSKX) 8,000 2.97 Jenny's Profit-Sharing: Dodge & Cox Intl Stock (DODFX) 8,000 2.97 Taxable: Cash 150,000 55.76 N/A Total 269,003 100


Data as of June 5

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Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.