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Makeover Finds High Price for Peace of Mind


By Christine Benz, Morningstar

CHICAGO ( Morningstar) -- Ernesto, a 63-year-old former engineer, is looking forward to a long and happy retirement with a peace of mind most retirees and pre-retirees would find enviable. Having retired seven years ago and still earning some income through periodic consulting work, he relies on a pension that more than covers his day-to-day living expenses. His children are grown, and he owns his home outright. In addition, he has managed to set aside more than $1 million in investment assets.

His investments' conservative positioning meant minimal losses during the bear market. But with more than two-thirds of his portfolio sitting in cash, Ernesto acknowledges he's very likely playing it too safe. "I am uneasy about the opportunity costs I might be incurring," he wrote.

Given that his main goal for his investment portfolio is to leave a legacy for his children rather than fund near-term living expenses, he recognizes that a larger share of his portfolio should be in investments that have the potential to earn a higher return and outpace inflation. At the same time, he's not sure how to execute the shift into longer-term assets, particularly given the stock market's two-plus-year run-up. "The question for me is how to avoid buying high and selling low," he said.

More from Morningstar
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The before portfolio
Ernesto's portfolio is streamlined and conservative to the hilt, and his long-term investments are all favorites of Morningstar's (MORN) fund analyst team.

In addition to holding $837,000 in a money market fund and certificates of deposit earning just 2%, he holds another 17% of his assets in bonds, including Vanguard Inflation-Protected Securities (VAIPX) and Vanguard Intermediate-Term Tax-Exempt (VWIUX). Vanguard Wellesley Income (VWIAX), a conservative-allocation fund, also includes a sizable fixed-income stake.

Equity assets, by contrast, consume just 12% of the portfolio, according to Morningstar's Instant X-Ray tool. Ernesto's sole pure equity offering is Vanguard Dividend Appreciation (VDAIX), which is itself fairly conservative for a stock fund. It focuses on firms that have increased their dividends in each of the past 10 years. Most such names are very large companies, and Morningstar has assigned wide-moat ratings to many of the fund's holdings.

Given the limited equity stake and heavy cash position in Ernesto's portfolio, its recent returns have also been muted, gaining about 4% during the past year, while the S&P 500 gained about 17% during that stretch. With inflation rearing its head of late, Ernesto is wise to worry that higher future prices could gobble up an outsized share of any return his investments are able to generate.

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