Adjusting to a softer real estate market

Fiona Saulness, Phoenix, Age 52.

Goals Quit working full time at 62 Be able to take care of her mom Travel to 100 countries Assets $720,000 in home equity $290,000 in retirement accounts $250,000 in cash and emergency savings $60,000 in taxable investments

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(Money Magazine) -- A big reason that Fiona Saulness has saved as much as she has for retirement is real estate.

Not only has the 52-year-old made a good living as a realtor, her investments in her Arizona house (which she owns free and clear) and a Seattle condo (which she rents out) have helped her amass nearly three-quarters of a million dollars in home equity.

But if she continues to focus so much on real estate - at the expense of her investment portfolio - it may threaten her retirement plans down the road. In part because she's been hoarding money in case she finds a third property, her hodgepodge of a portfolio is offtrack.

She currently has a quarter of a million dollars sitting in cash. Yet she needs to make more on her investments than cash pays, since she can't count on earning what she did as a realtor at the market's peak - in 2006, she made more than $200,000.

So even though she's doing a lot of things right, like saving aggressively after paying off her mortgage, Saulness' retirement house is out of order.

It's not just Saulness' own retirement that is on the line. As an only child, she knows that someday it may be up to her to care for her mother Joan, who is 76 and lives nearby. In fact, one reason she chose the house she did was that it has bedrooms at opposite ends, which will give Joan space and privacy if she ever needs to move in.

But that's for later. For now Saulness plans to continue working full time until at least 62 and keep traveling. She has a goal of visiting 100 countries, and she has already checked 40 destinations off her list. If she wants to see the other 60, she'll need to earn more on her money.

Look beyond real estate. Since Saulness already owns two homes, Scottsdale, Ariz. financial planner Lisa Woodside discourages her from buying a third. "It's normally not a good idea as you get close to retirement because real estate is an illiquid investment," she says.

Woodside adds that Saulness should also prepare to sell her condo at some point around retirement. Some of the proceeds can be used to buy an inflation-indexed immediate annuity after age 70. That, plus Social Security, should be enough to cover most of her modest fixed expenses from that point on.

Put her cash to work. While it's wise to have an emergency fund, Saulness has too much in cash. Woodside says Saulness needs to set aside only six months of living expenses. Since she's done with her Phoenix mortgage, this works out to about $20,000 (if she ever needs more, Woodside says, Saulness can tap some of her short-term bonds).

With the rest Saulness should first pay off her $23,400 car loan. If she qualifies for a Roth IRA as she did last year (despite making $125,000 in 2007, her modified adjusted gross income fell below the contribution cap), she should take full advantage of it. And if she doesn't qualify, she should simply dollar-cost average the rest of her cash into a taxable account, Woodside says.

Create an investing strategy. Saulness needs to pare down her portfolio. Her IRA alone holds more than 50 different stocks and ETFs. More important, she needs a coherent strategy.

Woodside recommends a so-called core-and-explore approach. Roughly three-quarters of her assets should be invested in a diversified mix of low-cost stock and bond funds and ETFs - such as Harbor Bond (HABDX) and Fairholme (FAIRX) - that can anchor her portfolio.

With the rest, Saulness can "explore" other assets that might beat the market, Woodside says. Among the investments she suggests for this portion: multi-cap funds, whose managers aren't confined to any one type of stock.

Overall, Woodside says, about a third of Saulness' portfolio should be in bonds, with the rest mostly in stocks along with a small weighting in alternative assets like commodities. That's a far cry from her current mix of more cash than stocks.

If she does this, her portfolio should grow to $1.5 million by retirement - assuming she earns nearly 8% a year and continues to max out her 401(k) and Roth IRA and saves another $13,000 a year. With this and the annuity, "she should easily have enough for retirement even if she quits completely at 62," says Woodside.

Saulness is thrilled. "I always worried that I was never going to have enough money," she says, adding that since she has no kids, there will be no one to take care of her. Now the only thing she needs to worry about is what's next on her list: Egypt or Machu Picchu?

The makeover

* Problem #1: Saulness is thinking of buying a third house, which will only add to her real estate dependence.

* The plan: Just say no. Also, prepare to sell her Seattle condo in the coming years to fund an immediate annuity after age 70.

* The payoff: Reducing her real estate holdings will free up funds with which to invest and purchase guaranteed retirement income.

* Problem #2: Saulness has a quarter of a million dollars stashed in cash earning paltry yields.

* The plan: Set aside $20,000 for emergencies, but gradually invest the rest in a diversified mix of stock and bond funds.

* The payoff: The long-term growth from stocks will help her keep up with inflation, travel the world and retire comfortably.

* Problem #3: She owns a jumble of more than 70 stocks, funds and ETFs with no clear strategy.

* The plan: Invest the majority of her portfolio in "core" buy-and-hold stock and bond funds.

* The payoff: This ensures the bulk of her assets will grow safely. But she can still "explore" other assets with the remainder.

Thinking of retiring early? Money is looking to speak with people who would like to leave the workforce in the next few years but don't yet know what they'll do for health insurance (before they get to Medicare age). If that sounds like you, send your name, age, occupation, a brief description of your retirement savings and a photo to makeover@moneymail.com.