Managing Your IRA in Retirement – Part 1
I don’t normally respond to subscriber letters in this forum, but I got one recently from a reader name Ray that asks a question that I suspect is on a lot of retirees’ minds these days. Here it is:
“I have a ‘problem’ that I expect an increasing number of your readers are having. I recently retired and rolled a substantial 401k into an IRA. It currently consists of 4 funds: DODGX (44%), VIEIX (38%), PTTRX (7%), and VFWAX (10%). I’ll be taking mandatory distributions in 2 years. I’d like to diversify, but am somewhat daunted at the available possibilities. Probably a bit much to cover here, but I’m sure a lot of us would appreciate an expanded article in the newsletter. Thanks for your help.”
Ray, thanks for the great question, and you are correct; there is a lot of ground to cover to give you a complete answer. So, today I will address the question of portfolio diversification and tomorrow I will discuss distribution strategies for someone facing mandatory IRA withdrawals.
Before we start with the analysis, let’s take a quick look at what Ray currently owns in his portfolio:
- Dodge & Cox Stock Fund (DODGX) – A blended large-cap stock fund that we recommend in our Personal Finance Fund Portfolio. Over the past five years, it has grown by an average annual rate of 12.5%.
- Vanguard Extended Market Index Fund (VIEIX) – Owns about 3,000 mid and small-cap stocks, accounting for roughly 25% of the total value of the U.S. stock market. Over the past five years, it has grown on average by 12.2% annually.
- PIMCO Total Return Fund (PTTRX) – A “long/short” diversified bond fund that owns mostly investment-grade debt securities. Over the past five years, it has provided an average annual total return of 2.7%.
- Vanguard FTSE All-World ex-U.S. Index Fund (VFWAX) – An international, large-cap fund with 90% of its holdings in Europe and Asia. It has delivered a 6.7% average yearly gain over the past five years.
The Right Retirement Route
First, I commend Ray for having a broadly diversified portfolio with respect to equities. He pretty much has all of the major bases covered in terms of capitalization and sectors.
However, given the weightings of each fund, 82% of his equity exposure is in the United States. There isn’t as much geographic diversification as I’d like to see despite the inclusion of the Vanguard All-World Fund.
That concentration in U.S. stocks has worked in Ray’s favor over the past five years as reflected in the performance figures, but it could prove problematic if the American economy hits a soft spot just as Ray must begin taking mandatory distributions in two years.
I’m also not crazy about the PIMCO bond fund. Bonds should be in a portfolio for one of two reasons; either to provide income and/or to act as a hedge against a stock market crash when investors flee stocks for the safety of bonds.
However, this fund doesn’t do either particularly well. It passes through the net interest it collects in the form of a dividend yield that isn’t much higher than what large-cap stocks are paying, and the long/short strategy it employs limits its ability to appreciate fully if a surge in demand for bonds suddenly materializes.
Assuming Ray is nearing his 70th birthday, I think a better weighting for most folks that age would be something along the lines of:
- Large Cap Stocks – 25%
- Mid Cap Stocks – 15%
- Small Cap Stocks – 10%
- Foreign Large Cap Stocks – 15%
- Foreign Small Cap Stocks – 10%
- Investment Grade Bonds – 15%
- Commodities – 10%
To be clear, this is a hypothetical portfolio that should not be construed as specific advice for any one person. Also, it clearly violates the financial planning rule-of-thumb that the percentage of stocks in a portfolio should be equal to 110 minus the person’s age. In Ray’s case, that would work out to roughly 40% of his portfolio.
I don’t like that rule given the recent trend towards rising interest rates around the world. Until recently, we have known nothing but declining rates over the past forty years, which drives up the value of bonds. However, rising rates will do just the opposite, and I think most retirees would not enjoy seeing 60% of their portfolio steadily erode in value over their remaining lifetimes.
If anything, a rational case can be made for eliminating bonds altogether and increasing the commodities weighting to 25%. Hard assets rise in value with inflation and would do a much better job of preserving purchasing power over the long haul in a rising interest rate environment.
Are you making the right investment moves for your retirement, or are you putting your golden years at risk? My colleagues at the Radical Wealth Alliance have developed a money-making system that can help you quickly build a comfortable nest egg. Investors who know about this strategy have already bagged profits of 2,167%… 3,958%… 1,615%… 1,455%… 1,636%… and even 4,532%. Want to find out more? Click here for a presentation.