Dear Dr. Don: I am submitting my portfolio in the hope that you will advise me if I am heading in the correct direction. I am married, age 78, in good health and have annual pension and Social Security income of $40,000, which does support my wife and me. We have no outstanding debt and foresee none. Our portfolio is maintained for the purpose of providing security against inflation, protecting the principal while hoping for enough income to provide quality-of-life extras. Our home is valued at $200,000 and we own it free and clear. I recognize that I am heavy in cash but recent market variations have kept me ultra-conservative. If I can preserve principal and earn 6% to 10% a year, I should be comfortable. I hope you have the time to review this portfolio. Thank you in advance for any advice you can give me. K.D.
I'm pleased that you're in good health in retirement and that you're looking to keep your portfolio healthy, too. Your goals for the portfolio are realistic and it should be able to continue meeting those goals for you. Your cash allocation has served you well in recent months but as I'll point out later, you should consider branching into other investments as a way to help you meet your financial goals.
Your portfolio has the lowest expense ratio that I've seen in the portfolios that I've reviewed for this feature. That's partially because you have more bond fund investments than any portfolio I've reviewed to date, but even with that caveat, you've done a good job in managing the annual expenses in your mutual funds.
I don't see the need for hybrid funds in your portfolio and you own three of them --
Vanguard Asset Allocation,
Vanguard Star and
Vanguard Wellington. Morningstar also considers the
Merger Fund a hybrid fund, but I disagree, so I left the hybrid count at three funds.
Hybrid funds have a mixture of stocks, bonds and cash. They're good for investors just starting out who want to allocate money among asset classes without owning several mutual funds, or for people that want to leave the asset allocation decision to the fund manager. But in a portfolio like yours worth close to a quarter-million dollars, I think you can allocate your investments between stock and bond funds without using hybrid funds for the allocation.
Vanguard Star fund is a domestic hybrid fund that is also a fund of funds, meaning that it invests in shares of nine other Vanguard mutual funds, rather than holding individual stocks and bonds in the fund. The table below shows the aggregation of the asset allocations in your hybrid funds.
Altogether, you have about 40% of your portfolio in cash and 20% in bonds. That's reasonable given your age and your goals, but if you want your portfolio to grow between 6% and 10% annually and you're only earning 5% on your cash investments and 5% to 8% on your bond investments, then your stock holdings will have to earn between 16% and 17 1/2% for you to reach your desired 6% to 10% level of return.
One observation I have is that you've got more mutual funds than you need to accomplish your financial goals. One advantage of the tax-deferred IRA account is that you can switch funds within the account without worrying about any tax ramifications. Between the
Vanguard Total Bond Market Index,
Total Stock Market Index,
Mid-Capitalization Index and your money market fund, you should be able to dial in your asset allocation with greater precision.
For example, the stocks held in the mid-cap index fund are also held in the total market index. By owning both funds, you're overweighting the mid-caps. The overlapping funds aren't a problem, though, as long as it's your plan to overweight the mid-caps.
Here's another thought: U.S. government-issued inflation-indexed securities are one of the easiest ways of investing to preserve principal and protect your purchasing power against the ravages of inflation. You have your choice between Series I savings bonds and Treasury inflation-indexed securities. I prefer the
Series I Savings Bonds because they're more flexible on when you have to pay income tax on the investment returns, they have minimal transaction costs and you can cash out after just six months with a three-month interest penalty if you need the money. There are also no state or local income taxes due on the interest earnings of U.S. government securities.
The bottom line is that your money is very safe in cash investments and is protecting your principal, but there's not much inflation, or purchasing-power, protection in a money market fund. As the
continues to lower the target rate for fed funds, the yield in your money market funds will continue to drop. The lower short-term interest rates will have a mixed effect on your bond investments. Lower rates mean higher bond prices, and higher bond prices mean a greater potential for capital gains.
Your income needs may be modest, but staying in cash will put pressure on the other sectors to perform. Moving money from cash to investments like the Series I savings bonds will help to keep up your yield.