I am nearly 43 and single with plans to retire (at least semi-retire) at around 50. If the investment gods are smiling, I would hope to be somewhere in the vicinity of $1 million in net worth at that time, with my portfolio providing an after-tax income of approximately $3,000 per month. I have home equity of about $230,000, no debt to speak of and an annual income of approximately $130,000 of which I anticipate saving or investing $35,000 to $40,000 annually. My current portfolio is a mix of 401(k), IRA and taxable accounts totaling approximately $230,000. I have raised a relatively high amount of cash, due to my uncertainty regarding the current market situation. I plan on putting that cash to work when conditions appear more favorable. Am I in the ballpark on my goal to be worth $1 million when I'm 50? -- J.I.
Yes, you are on track.
Let's start with your home equity. Over the next seven years you'll continue to pay down your mortgage and, if past is prologue, your home will appreciate in value. I'm combining those two attributes to conservatively say the equity in your home will increase by 5% annually. That would make your home equity worth about $325,000 seven years from now.
Now your investment portfolio: Over the next seven years you expect to contribute, let's say $37,500, annually to that portfolio. Some of those contributions will be in tax-deferred accounts; the balance will be in your taxable account. Ignoring taxes for the moment, let's say your investment portfolio will average an 8% return over the next seven years. It would then be worth about $775,000, and, when combined with your home equity, you'll have reached your goal of $1 million net worth by the time you're 50. The table below shows that you'll be within spitting distance of your goal even if your portfolio only averages a 5% return.
OK, so you can't ignore taxes in your taxable portfolio. But you can manage your taxes in that portfolio by investing in tax-efficient mutual funds and being cognizant of tax effects when trading in that portfolio. Can you earn 5% after taxes in the taxable portfolio? You can earn almost 5% in insured tax-free municipal bonds maturing in 2007 and more than 5% if you extend the maturity out a little farther. So expecting to earn more after taxes in stocks isn't reaching for the stars.
Now that you've been reassured that you'll be worth a million big ones when you're 50, let's move on to the question of whether you can retire (or semi-retire) at 50 with your investment portfolio worth somewhere between $660,000 and $860,000. Investable funds are more important than net worth if you're not planning to sell your home to realize its equity.
Is $1 Million Enough?
What makes you think that $3,000 a month is all you're going to need at 50? Can you live on $36,000 a year after taxes now? Did you factor in an inflation rate to come up with that monthly number? Three percent inflation over the next seven years would increase that monthly number to $3,690, or $44,280 annually. Too many people think having a net worth of $1 million will allow them to retire and live off their portfolio's returns regardless of age, and it just isn't so. At 50, you're at least 12 years from Social Security benefits, and unless you annuitize your IRA or 401(k), you're 9 1/2 years away from withdrawing money from your tax-deferred retirement accounts without paying a 10% penalty. (For more on annuitizing your retirement accounts see this
It's good that you're flexible about your goal. Feet up at 50 may prove to be an unrealistic goal, but being willing to semi-retire at 50 should give you enough flexibility to take additional risks in your investment portfolio and improve the odds of attaining your goal.
On a short-term basis you look smart in moving part of your portfolio into cash. Now comes the really hard part. When do you start reinvesting in stocks? I suggest that you pick levels for the
Nasdaq Composite index,
Dow Jones Industrial Average and
S&P 500 index that are both higher and lower than today's levels and evaluate your cash position when two of the three indices have reached those decision points. The indices don't have to move in tandem, so I don't have a decision rule for you if the Nasdaq goes up 5% and the Dow drops 5%.
It's that time of the year when you should think about tax-loss selling in your taxable account. You can sell your dogs and use the capital losses to offset capital gains and up to $3,000 of ordinary income. If you've got some stocks you've written off in your taxable portfolio, now's the time to take the write-off.
You've done a good job in selecting mutual funds in your taxable portfolio and IRA account. I don't like the high expense ratios in the
Firsthand e-Commerce fund and the two
funds you own -- especially when compared to the low-cost
funds. More telling is that the expense ratios for these three funds are above the average expense ratio for their fund classifications. Don't sell a fund just because it has a high expense ratio; just watch its performance over time to make sure you feel that the extra money is worth it. For example,
Montgomery Global Long-Short earned a 135% return last year. Selling it because you're paying 0.75% annually above the average expense ratio could prove to be penny-wise and pound-foolish.
You should spend some time reviewing how your 401(k) plan is invested. You're invested in a 401(k) vehicle that is typically sold as a variable annuity but was sold to you as a funding agreement. You need to understand the costs and expenses associated with this investment option. If you decide you want to move the money to another investment option make sure you understand any fees or expenses you will incur in changing how the money is invested. It's not clear why you need an insurance company to act as middleman to own these funds in your 401(k). You can always lobby your employer for more investment options in your 401(k).
Send In Your Portfolio
If you would like to submit your portfolio for a makeover, send it to email@example.com. Give us enough details -- dollar values or percentages -- so we can determine how your assets are allocated. Also tell us a little about yourself and your investing goals, and let us know how we can contact you if we have further questions. Though we'll only use your initials publicly, please include your full name so we can verify your identity. Unfortunately, we cannot guarantee your portfolio will be selected for a makeover, nor can we promise to respond individually to everyone who submits a portfolio.
Dr. Don Taylor has been an investment professional for nearly 15 years, most recently as the treasurer for a nonprofit organization where he managed more than $300 million in assets. He is a chartered financial analyst, holds a Ph.D. in finance and has taught investment and personal finance courses at the University of Wisconsin and at Florida Atlantic University. Dr. Don's Portfolio Rx aims to provide general investing information. Under no circumstances does the information in this column represent a recommendation to buy or sell. Dr. Don welcomes your inquiries and feedback at