Selecting the Right Asset Allocation – Part 2

Jane Young, CFP, EA

Jane Young, CFP, EA

Your asset allocation is the basic structure of your investment portfolio defining the target percentage you want to hold in different categories of assets.   Start creating your asset allocation by deciding how much you want to invest in the two major categories, stock mutual funds and interest earning assets.  Next break your allocation down into more specific categories including cash, CDs, bonds, large cap stock, mid-cap stock, small cap stock, international stock, emerging markets stock and real estate.  Setting an appropriate, well diversified asset allocation helps you balance risk and return within your portfolio.  Your asset allocation may change over time as your financial circumstances change.  However, avoid changing your allocation too frequently based on short term fluctuations in the market.

The appropriate allocation depends on several factors including your age and investment time horizon, your financial goals, other risk factors in your life, your experience with investing and your emotional risk tolerance.  Regardless of your investment goals, you need to maintain an emergency fund of readily available funds equal to at least four months of expenses.

Your financial goals are a major determinant in setting your allocation.  Identify your major financial goals and when money is needed to support these goals.  Design an asset allocation to meet these goals.  Money needed in the short term should be held in safer, interest earning investments. The stock market should only be used for long term needs – generally at least five to seven years out.

You may be able to assume more risk in your portfolio if the timetable for your goals is flexible.  The timeframe for money to cover things like college education or your emergency fund may be firm but there may be some flexibility on when you take a major vacation, remodel your home or plan to retire.   Money needed for retirement is generally spent over twenty or thirty years.  You won’t need your entire nest egg on the first day.

Your allocation is also dependent on risks taken in other areas of your life.  For example, if you work in a volatile career with unpredictable earnings, own a small business or own rental property, you may want to reduce the risk in your investment portfolio. On the other hand, if you have a secure job and anticipate a generous pension, you may be comfortable taking more risk.

Regardless of your situation you need to feel emotionally comfortable with your allocation. If you are constantly worried about market fluctuations you may need a more conservative allocation.   Historically the stock market has trended upward, but there will be years with negative returns.  Create an allocation that gives you adequate emotional security to ride out swings in the stock market and helps you avoid selling when the market is down. If you are new to investing, start out slowly and test the water to see how you will react in a volatile market.

Selecting the Right Asset Allocation

Jane Young, CFP, EA

Jane Young, CFP, EA

When investing money, one of the first decisions to be made is your asset allocation.  Asset allocation is the division of your assets into different types of investments such as stock mutual funds, bonds, real estate or cash.  In order to maximize the return on your portfolio it’s crucial to maintain a well-diversified asset allocation.  According to many financial experts, asset allocation may be your single most important investment decision, more important than the specific investments or funds that you select.

There is no one size fits all; the right asset allocation is based on your unique situation which may change as your circumstances or perspective changes.  Some major factors to consider include investment time horizon, the need for liquidity, risk tolerance, risks taken in other areas of your life and how much risk is required to achieve your goals.

Arriving at the appropriate asset allocation is largely a balance between risk and return.  If you want or need a higher return you will have to assume a higher level of risk.  If you have a long investment time horizon, you can take on more risk because you don’t need your money right away and you can ride out fluctuations in the market.  However, if you have a short time horizon you should minimize your risk so your money will be readily available.

If you want to minimize risk, invest in fixed income investments such as money market accounts, certificate of deposits, high quality bonds or short term bond funds.   If you are willing to take on more risk, with the expectation of getting higher returns, consider stock mutual funds.  Generally, avoid investing money needed in the next five years into the stock market.   However, the stock market is an excellent option for long term money.

Regardless of your situation, the best allocation is usually a combination of fixed income and stock mutual funds.  With a diversified portfolio you can take advantage of higher returns found in the stock market while buffering your risk and meeting short term needs with fixed income investments.

Once your target asset allocation is set, rebalance on annual basis to stay on target.   Rebalancing will automatically result in selling investments that are high and buying investments that are low.  Avoid changing your target allocation based on emotional reactions to short term market fluctuations.    Stick to your plan unless there are major changes in your circumstances.

If you are unsure where to start, a good rule of thumb is to subtract your age from 120 to arrive at the percentage you should invest in stock market.  In the past it was customary to subtract from 100 but this has increased as life expectancies and the time one spends in retirement have increased.   In the final analysis, select an asset allocation that meets your specific needs and gives you peace of mind.

Beneficiary Designations Trump Your Will

Jane Young, CFP, EA

Jane Young, CFP, EA

You really don’t want the state deciding how your money is distributed when you die, so be sure to specify how you would like your assets divided.  In Colorado this is most commonly accomplished through the use of a will or beneficiary designations, in more complicated situations a trust may also be used.

Virtually, any financial account can be divided using a beneficiary designation, but it is most commonly used with retirement accounts, life insurance policies and annuities.  Assets distributed through a beneficiary designation will pass to heirs outside of probate.  In addition to assets with a beneficiary designation, assets that are held in joint name or that are designated as “transfer upon death” (TOD) will also transfer outside of probate.

Beneficiary designations and TOD accounts supersede your will, so it is of upmost importance to keep your designations current.  This is especially important when there is a major change in your life such as a marriage, divorce, or death.  Beneficiary designations are legally binding and will be enforced regardless of any changes in your relationships.

You can also transfer your real estate using a beneficiary designation. According to Steve Ezell, a local Estate Planning Attorney, this type of transfer can be accomplished with a “Beneficiary Deed”.  A Beneficiary Deed does not go into effect until death so you will have full ownership of your home while alive and you home will transfer outside of probate.  In an effort to avoid probate, many people deed property to their children and themselves. However, this could create complications if you later decide to sell your home.  It could also affect your possible Medicaid eligibility. 

Probate is the process of legally distributing your assets upon death.  In Colorado, this is usually a relatively simple and inexpensive process.  According to the Colorado Bar Association, the Uniform Probate Code has dramatically simplified probate.   Currently, over 90% of Colorado estates are not court supervised allowing the personal representative to do most of the administration.

Most individuals need a will to control the disposition of everything in their probate estate, this excludes accounts in joint name, distributed by beneficiary or distributed by TOD.  If you want all of your financial assets distributed through your will, leave your beneficiary designations blank or list the estate as the beneficiary. 

When dividing your assets with beneficiary designations or a will, Steve Ezell suggests you consider the use of percentages rather than specific dollar values.  Over time, as you make changes to your various accounts, percentages can help you maintain the desired proportion of assets to be distributed to each heir.  Additionally, identify both primary and contingent beneficiaries, just in case your primary beneficiary dies before you. Should a primary beneficiary predecease you, you will need to specify if their share goes to the remaining beneficiaries or the deceased beneficiaries’ children.

Beneficiary designations and wills are both effective tools, if you utilize them and keep them current.

What to Do When You Lose Your Job

Jane Young, CFP, EA

Jane Young, CFP, EA

Breathe – Losing a job seems like a huge catastrophe when it happens, but it could free you up to pursue new opportunities.  Most jobs are lost due to a reduction in workforce, over which you have no control.   Try to move through this transition with grace.  It’s not personal;  try to avoid becoming sad, angry or bitter.    This process is difficult for everyone involved, and the person letting you go may be in a position to hire you in the future.

Carefully Review Your Severance Package – Make sure you fully understand and agree with the terms of your severance package.  Don’t hesitate to consult an attorney if you are unclear or disagree with the terms of your separation agreement

File for Unemployment – If you were laid off due to no fault of your own, you may be eligible for unemployment benefits.   Unemployment may not be available while you are covered by a severance package.

Review Your Budget – Review your expenses and cut-back on unnecessary expenses.  Develop a new spending plan that will help you cover expenses until you find a new job.   Hopefully, the combination of your emergency fund, severance pay and unemployment will cover your necessities until you find a new job.  To make ends meet, you may need to consider short term assignments or part time work.

Arrange for Health Insurance – Review options available through Cobra as well as insurance on your own.  If you are married, look at health insurance options through your spouse’s employer.

What’s Next?    You have just received the gift of freedom, to make a career change.  Do you want to continue in your current career or do you want to pursue something new?   How much training, education, time and money will it take to pursue your dream career?

 Update Your Resume and Start Job Hunting  – Update your resume and start looking for a new job.  Take advantage of services that may be offered by the outplacement firm hired by your previous employer.  If you decide to return to school, you may need to pursue a part time job while you re-tool.

Build and Nurture Your Network – Most jobs are found through word of mouth.  It’s essential to do a lot of networking.  Let all of your contacts know that you are job hunting and what you are looking for.  Actively maintain accounts on Facebook, Linked In and Twitter to help you with your job search.  It’s also advisable to have personal business cards made so potential employers can reach you more easily.

Use Your Time Wisely – Treat looking for a job as a job.   After a week or so, you should keep your days structured.  Spend your time working toward getting a new job, getting your life organized and taking care of your health.  This is a very stressful time, be sure to eat well and get plenty of exercise.

1 2 3 4 10