By Scott Burns
Q. I need a pep talk. As of early January, my Vanguard 500 Index fund is 4.65 percent lower that it was at the close of 1999. So, for the last 8 years of patient investing, I have a 4.65 percent capital loss. Yes, I realize I am ignoring the roughly 1.6 percent dividend yield. And yes, my investment portfolio is diversified. But I have looked to the S&P 500 as the bellwether for the domestic equity portion of my portfolio. Market prospects for the next 1 to 5 years appear daunting.
I shudder to think what might have happened had I retired in 2000. Can you give me--- and others--- a few words of encouragement to stay the course? Right now, a money market fund is looking very attractive.
---J. F., by email from Houston, TX
A. The key is not the performance of an individual asset class--- such as the large cap domestic stocks represented by the Vanguard 500 Index fund. The key is the performance of your total portfolio. The reason I preach diversification is that we regularly go through periods where major asset classes are underwater.
Our choice is simple, but difficult. We can try to guess the future and pick the asset class that will do best for the next month or year. Or we can own a variety of asset classes and know that the returns of some asset classes are likely to offset the losses of others.
Diversification works a lot better than guessing.
Q. What part, if any, does home equity play in calculating asset allocation? In my case I’m concerned about proper distribution of assets for retirement. My assets include $215,000 in a bond fund, $500,000 in various stock funds and a mortgage-free home worth about $200,000.
Are my stocks, at 55 percent of total assets, acceptable for long-term inflation/return goals? Or are my stocks at 70 percent of my investment assets unacceptable, too risky, for long-term goals?
--- M.G., by email
A. Good question. Home equity represents the bulk of net worth for most retirees. As a consequence, they should be reluctant to invest in financial securities that represent real estate assets such as REITs. In your case, home equity is a reasonable 22 percent of your net worth. Equities are only 55 percent of your net worth but 70 percent of your financial assets.
From a portfolio survival perspective, having 70 percent of your financial assets in equities is entirely reasonable since the portfolios with the longest survival periods contain 50 percent to 75 percent equities. Bottom line: You may have arrived where you are by accident (or feel that way), but you’re pretty nicely positioned.
Q. Which assets should one consider when rebalancing a portfolio at year end? For example, my wife and I have set aside a large sum of cash that we will use to buy our retirement home in about 3 years. Should I include that amount in my rebalance calculation? For that matter, should one also include other assets in the calculation, such as the equity in one's home?
---R. and C. B., by email from Dallas
A. Money that is set aside for a particular purpose isn’t part of your permanent portfolio--- the money you expect to use to produce your retirement income. So it should not be included in any rebalancing exercise. You should include things like home equity, pension income and Social Security income by estimating how much they affect the vulnerability of your living standard.
For example, a retiree with no pension, average Social Security benefits, and a mortgaged home with little equity should have a relatively low-risk portfolio of investment assets. On the other hand, a retiree with a pension, above-average Social Security benefits, and a debt-free home can have a higher-risk portfolio of investment assets.
Why? The mortgage-free retiree would suffer less in a broad market decline. Less of his living standard depends on financial assets.