Fix Our Mix
This one's too risky. This one's too staid. Ah, this one's just right. Check out how MONEY made over the portfolios of five families. You'll learn a lot about striking the right balance in your own investing plan.
By Carolyn Bigda

(MONEY Magazine) – THE BUDDS

Try a Little Aggressiveness

Goal to earn higher returns on their retirement savings

For much of Eric and Juanita Budd's marriage, savings came second. Juanita, now 45, stayed at home with daughters Alexis and Alera, while Eric's consulting income paid the bills. By 1999, with Juanita working as an executive at a local nonprofit and Eric, now 53, teaching special education full time at a college in Austin, their income hit six figures. They bought a small fixer-upper on Lake Travis and started socking away money, but they are nervous investors. Stocks scare them. "I'd put the money under a mattress if I could," says Juanita.

Where They Are Now

They're practically stuffing the mattress now. About two-thirds of the Budds' $96,000 in retirement savings is in cash and bonds, including $17,000 in Hertz corporate bonds--a buy made on a broker's tip. The couple have another $18,000 in CDs earning less than 1% interest. On the minus side of the ledger, they have $20,000 in credit-card debt. Add it all up, says Louis Kokernak, a certified financial planner in Austin, and the Budds are actually more vulnerable to inflation and the vagaries of the financial markets than they would be if they owned more stocks.

What They Should Do

The Budds are realistic in stating that retirement is another 15 years off. They can retire comfortably, says Kokernak, if they save $14,000 a year, remix their portfolio and follow through on the plan to sell their Austin home and move to the lake. Including their pensions and Social Security, the Budds should end up with a retirement income of $82,000.

While the Budds' main strategy should be to own more stocks overall, Kokernak suggests they first load up their retirement accounts with fixed income. Since bonds generate income that's taxed at a higher rate than stock gains, it makes sense to keep bonds in retirement accounts, which qualify for serious tax breaks. Eric should reallocate the $10,000 in his 403(b) to his TIAA-CREF fixed-income option. Juanita holds $39,000 in 11 mutual funds in her 403(b). About $26,000 of that is already in a Vanguard fund that maintains a 60-40 split between stocks and bonds, so Kokernak recommends she consolidate all of her money there to help push up the couple's stock allocation. Because Juanita's employer doesn't match her 403(b) contributions, the planner also suggests that for now she divert her $500 monthly investment to paying off credit cards. If she adds another $500 a month, the couple will be debt-free in less than two years.

For the $23,300 in their taxable account, Kokernak recommends trading the Hertz notes for a broad stock fund like the ultra-low-cost Fidelity Spartan 500 Index (FSMKX), a MONEY 65 fund. And they should replace their low-yielding CDs with a bond index exchange-traded fund like the MONEY 65's iShares Lehman 1-3 Year Treasury (SHY). That would bring the couple's mix to about half stocks, half bonds, which is still conservative.

Older daughter Alexis will rely on scholarships and loans when she starts college next fall, with the Budds contributing no more than $5,000. For 14-year-old Alera, the Budds should try to put $2,000 a year into an education IRA--but not at the expense of retiring debt.

Problem Too little potential growth in their portfolio

Plan Add stocks

Payoff Lower taxes, less risk and a comfortable retirement

The fix

Cash 4% Bonds 48% U.S. stocks 44% Foreign stocks 4%

Remix By putting 48% of their money in stock funds, the Budds give themselves a shot at better returns without too much risk.


Cash Poor, House Rich

Goal Do more with their biggest asset: a home in a hot market

Nelson Handel and Elicia Laport were doing okay money-wise early in their marriage, but their decision to become parents--and the ensuing odyssey through fertility treatments and eventually adoption--cleaned them out.

Now Charlie is five, and Laport, a television-commercial producer, and Handel, an author and freelance journalist, are playing catch-up. The couple, both 46, have just $100,000 in their retirement accounts, so they need to save and invest aggressively, a prospect Handel finds daunting: "I'm risk-averse when it comes to playing with the stability of our lives."

Where They Are Now

The couple make $120,000 or more a year depending on Handel's assignments, and Laport puts 6% of her salary into a 401(k) matched dollar for dollar by her employer. They also have one extremely valuable asset: a house in the now trendy Silverlake neighborhood of Los Angeles that's worth $1 million, nearly four times what they paid in 1995.

The equity, Handel says, is "lovely," but it's not doing them much good right now. Meanwhile, as mortgage rates are rising, the couple are headed into the year when their $250,000 adjustable-rate loan will be adjusted upward. Rates are already up on their $30,000 home-equity line and $12,000 credit-card debt.

What They Should Do

San Diego-based certified financial planners Christopher Van Slyke and Terry Green recommend an unconventional plan: taking out a new $500,000 ARM.

Handel and Laport can pay off their existing mortgage before the rate rises and retire their other debts. They can put the remaining $200,000 into stock and bond funds. To be sure, borrowing against a house to put the proceeds into the market rarely makes sense. But in Handel and Laport's case it does because so much of their net worth is tied up in their home, and the superhot L.A. real estate market looks primed for a fall. They can convert equity that might melt away. And with a $500,000 mortgage, even if the L.A. market drops 30%, they would still have substantial equity in the house, which they hope to sell in five to seven years.

"This is very aggressive," says Van Slyke. "For them to catch up, they've got to be unconventional. Over time, their investments should grow by more than the interest rate" on their mortgage, which should be under 6%.

Green recommends that the couple use a discount brokerage to buy exchange-traded funds, including the MONEY 65's iShares S&P 500 (IVV) fund and iShares MSCI EAFE Value fund (EVF), which tracks an index of big stocks in developed nations, as well as ETFs that follow small-cap and emerging markets stocks. For bonds, Green suggests Vanguard's Short-Term (VBISX) and Intermediate-Term (VBIIX) index funds.

Handel wonders about focusing on retirement when it seems so far away, but he's game. "I can't imagine living the life of leisure. That seems kind of empty. But would I like to play more golf? Sure."

Problem Not enough in retirement savings

Plan Cash in some home equity and invest it

Payoff Less risk, more reward: They can diversify and catch up.

The fix

Other 9% Bonds 10% Large-cap stocks 36% Small-cap stocks 18% Foreign stocks 27%

Remix Put $200,000 of home equity into an aggressive portfolio, with 45% allocated to foreign and small-cap stock funds.


Still Playing with Fire

Goal to make up for losses in the tech crash

In the heyday of the '90s bull market, Mike and Sue Peters of Durham, N.C. got a jump-start on retirement. As Blue Cross and Blue Shield employees, they were eligible for pension and health-care benefits at age 55. That, on top of their 401(k) savings, allowed Mike to kick back.

A year into Mike's retirement, however, the stock market nosedived and the couple's 401(k) portfolios--stuffed with technology and other high-risk stock funds--lost a third of their value. Mike returned to Blue Cross, where he works 30 hours a week as a business analyst. Still, he hopes to cut back by fall, and Sue wants to retire completely in 2007.

Where They Are Now

Mike, 60, and Sue, 55, make a combined $150,000, and they dutifully contribute at double-digit rates to their 401(k)s. Most of their finances are the picture of prudence: They'll pay off their mortgage this year, they own a house in Myrtle Beach free and clear, and they have no other debts beyond a car loan.

But when it comes to investing, the scalding they took in the tech crash hasn't stopped them from chasing after what looks hot: a full 45% of their $450,000 portfolio is in international stock mutual funds, and another 20% is in energy-related funds. Those are two of the market's star sectors of late, but they're also prone to flaming out. "We've caught up some," says Mike. "The return is good now but should things go bad again, I don't know."

The Peterses are taking on huge risk just when they're at the cusp of a comfortable retirement. They need a portfolio that can provide a steadier return, not a roller-coaster ride.

What They Should Do

Peter Langer, a certified financial planner in Wilmington, N.C., recommends that the couple maintain their 80% stocks-20% bonds mix to keep building wealth, but he also suggests that they turn down the heat, using funds available in their 401(k)s.

For starters, they should cut back on their exposure to energy stocks to no more than 5% of their portfolio, putting the proceeds in diversified stock funds such as Fidelity Spartan Total Market Index (FSTMX) and Fidelity Large Cap Value (FSLVX), and in Fidelity Real Estate Income (FRIFX), an inflation hedge. They should also vary their bondholdings. While they can stay with Pimco Total Return (PTRAX), an intermediate-term fund, Langer recommends buying Fidelity Strategic Income (FSICX), a global bond fund, and Pimco Real Return (PARRX).

Mike and Sue should cut way back on their foreign-stock allocation, Langer says. At their age, having nearly half of their money overseas is a strategy almost no planner would recommend--all the more so because foreign funds have run up so much in the past few years. (What goes up...). Langer also advises that, since Mike and Sue have no small-cap holdings, they allocate 8% of their money to Royce Low-Priced Stock (RYLPX) and 7% to Rainier Small/Mid Cap Equity (RIMSX).

This portfolio, plus their pensions and eventually Social Security, will give the Peterses $75,000 a year to spend. When Mike turns 65, Langer says, the couple can go with a more conservative 60% stocks-40% bond ratio. "It's a set-it-and-forget-it strategy," Mike says. "I was chasing things. This way, I'll have more time with the grandkids."

Problem A penchant for chasing yesterday's winners

Plan Stay heavy in stocks but diversify

Payoff A chance for growth, but with less risk

The fix

Large-cap stocks 30% Other 10% Bonds 20% Foreign stocks 25% Small-cap stocks 8% Midcap stocks 7%

Remix Lowering foreign stockholdings to 25% lessens the chance that the Peterses will get burned again.


Willing Spirit, but Advice Was Weak

Goals College for the girls and a carefree retirement

A diligent saver and eager student of investing at 31, Art Zalla has a good grip on the big picture. He and his wife Susan, 32, have healthy savings, no credit-card debt, and a modest mortgage on their Syracuse, N.Y. home. The couple live for well under Art's $90,000 engineer's salary, and Susan will return to full-time teaching soon. Art knows that with the right moves, they'll be able to afford college for Farrah, 2, and baby Alexza, and fund a retirement of travel and golf.

Where They Are Now

So what's the problem? Zalla has heeded all manner of advice, from Suze Orman's books to local brokers' tips to financial seminars at the office. The upside: $190,000 in retirement savings. The downside: a lot of investments that worked out better for the broker who sold them. There's the tech-stock tip that lost $4,000, the lackluster rental property, and the high-cost variable annuity and mutual funds. Plus the couple have no money in bonds.

What They Should Do

To clean up their portfolio and set it on a surer path, certified financial planner Timothy M. Hayes of Rochester, N.Y. offers three simple moves for the Zallas: Sell the individual stocks that Art holds in his tax-sheltered accounts in favor of mutual funds; add fixed income; and dump the high-cost mutual funds.

Art holds about $32,000 spread over seven stocks in his 401(k) and IRA, plus another $26,000 in employer stock. But when you buy stocks in tax-sheltered accounts, Hayes explains, you can't write off any losses. Art should sell the individual issues and pare back his employer's stock to less than $19,000, or 10% of his investable assets. The proceeds from those sales should go into the stable-value fund in Art's 401(k) (think of it as a cross between a bond fund and a high-yielding CD) and into a bond fund in his IRA.

Given their ages, Art says, he was comfortable not holding bonds. But Hayes likes the stability they offer. People look at stocks' high historical rate of return and figure that's what they want, but Hayes says: "The whole notion of a high concentration of equities is predicated on staying the course. Problem is, when stocks go down, people often don't stay the course."

To get to an 80-20 mix of stocks and bonds, Hayes recommends that Art change the way he directs his 401(k) contributions. Starting now, he should put 25% of his money into the stable-value fund and 40% into Vanguard Windsor (VWNDX), which looks for undervalued stocks. He should split the rest between his plan's small-cap and international-stock index funds.

As for the past mistakes, Hayes suggests replacing the high-cost funds but leaving the annuity alone; it can be expensive to escape because of surrender fees. "Just put it behind you," Hayes advises.

Finally, Hayes recommends that as soon as they can afford it, the couple open 529 college savings accounts for their children. New York offers a low-cost, well-run Vanguard plan and a state tax deduction of up to $10,000.

"This feels much less confusing," Art says of Hayes' strategy. "It's going to be a lot easier to track and see where I'm going."

Problem Too many high-cost, high-risk investments

Plan Redirect savings into bonds and index funds

Payoff A lower-cost portfolio on autopilot

The fix

Midcap stocks 15% Small-cap stocks 15% Foreign stocks 15% Fixed income 20% Large-cap stocks 35%

Remix The Zallas should sell stocks and redirect money into the fixed-income funds in Art's 401(k).


Making Time for the Family

Goal to save enough so that Mom or Dad can stay home with the kids

Michael Erickson thought he'd lead the breezy life of a Windy City bachelor forever. His government job paid the rent with more than enough left for golf trips, and he could retire at 50 with a generous pension, never having deliberately saved a dime. Then he met Jaime Arndt on the shores of Lake Michigan. Eight years and three kids later, his perspective on life has changed. "I'm cautiously optimistic we'll still have some nice golden years," Michael says, "but the experience of raising our kids together is a reward presently."

For Michael and Jaime, the ideal experience includes something they can't yet afford but hope to soon: one parent staying home with Emily, 7, Michael, 5, and baby Matthew. It also means saving for three college educations.

Where They Are Now

The Ericksons' lifestyle costs them all of their joint income of $130,000, and more. They recently refinanced their mortgage to pay off a $36,000 home-equity loan and $10,000 in credit-card debt. Jaime still has a $23,000 loan on her 401(k). Their emergency fund is a paltry $1,000.

While cash flow is tight today, tomorrow looks considerably brighter. Michael, 47, will indeed be eligible for a $60,000 pension in three years. Jaime, 40, also has a small pension plan. The administrator of her firm's 401(k) plan, she's turned Michael into a good long-term saver. Together their retirement accounts hold about $178,000. Their investments, however, are more of a mess than a mix. Jaime holds 32 mutual funds, including single-country and regional funds from Japan to Canada to Latin America. Michael has another 10. Why so many? "Every quarter, I circle all the funds with decent returns," Jaime says. "Then I go back to my account and see, do I have money in them?" Yikes!

What They Should Do

Leisa Aiken, a certified financial planner in Chicago, suggests a two-track approach to putting the Ericksons' financial house in order so one of them can eventually stay home.

First, and easier, is to streamline and rebalance their portfolio. Aiken suggests a leaner mix of 11 funds, relying on broad-based stalwarts including Dodge & Cox Stock (DODGX) and the MONEY 65's American Funds EuroPacific Growth (AEPGX), plus the high-quality fixed-income fund offered through Michael's government retirement account. The couple should get out of their junk bond and single-country funds. "I wanted them to have more regular bonds," Aiken says. "High-yield bond funds act like stocks," rising and falling in step with the economy. Regular bonds tend to do the opposite, offsetting some of the stock market's risks. She recommends the MONEY 65's Dodge & Cox Income (DODIX). As for single-country funds, she adds, "You're making a bet that you don't have enough information to make." Aiken also wants the couple to substitute small- and midcap U.S. funds such as American Century Small Company (ASQIX).

More important than fixing their portfolio is addressing their savings and debt levels. "Before anyone leaves their job, the family needs to save at least three months of living expenses," Aiken says. That's at least $15,000. Second, they must pay off Jaime's 401(k) loan. If she were to leave and not pay it back immediately, she would be subject to taxes and a 10% penalty. Third, they should take stock of their health-care expenses. The family is covered under Jaime's generous policy. Should she be the one who stays home, they'll need to budget for the expenses Michael's plan won't cover.

If they do all of this, the Ericksons will be able to live on Michael's pension and one salary in about five years, Aiken estimates. "I can't believe Emily's already seven," Jaime says. "The next five years will fly by too."

Problem A portfolio that's all over the place

Plan Boil 42 funds down to 11

Payoff A less risky mix that's easier to maintain

The fix

Large-cap stocks 30% Midcap stocks 6% Small-cap stocks 18% Foreign stocks 21% Other 5% Bond funds 20%

Remix The Ericksons should sell their high-yield bond funds and bring their share of traditional bond funds to 20%.