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Two ways to change a portfolio allocation

Q: I am a 67-year-old widow with no debt and enough monthly income to maintain my home and lifestyle. I have $884,829 in an account with Fidelity — a 401(k) plan plus lump sum pension. The account belonged to my husband, who died four years ago. He had set the portfolio asset allocation at 97 percent bonds, 3 percent stocks. The account averages an income of about $30,000 a year. Now that the stock market has improved, I’m wondering if I should move more into stocks. Maybe 80/20 instead of 97/3?

A: To make any changes, you will need to think about two things. One is whether you want to time the market. It’s seldom a fruitful undertaking. The other is what your risk tolerance is — how much loss you can suffer without losing sleep. But your allocation to fixed income is so large, an increase in stocks is reasonable in any case.

Here’s why: If your husband was 97 percent in bonds four years ago, he might have been blessed with an extraordinary ability to time the markets. Or he might just have been very, very conservative. Either way, his commitment to bonds was extreme and not likely to help you over a long retirement. A portfolio that Morningstar labels as a “conservative allocation” fund, for instance, typically has 40 percent invested in stocks. A more typical “balanced” portfolio or “moderate allocation” portfolio has about 60 percent invested in stocks.

Fidelity Puritan fund, rated four stars by Morningstar, has a long record of superior performance, a low annual expense ratio, and can be purchased without commission inside your current account. Typically, this managed fund is about 60/40 stocks/bonds, but the equity position is somewhat higher today due to the very low yield on fixed-income investments.

You might think of this as your “starter” fund — a way to get your feet wet. Even if you put half of your assets in this fund, your total commitment to equities would only be about 30 percent. That’s very conservative as measured over your entire account. There are other possibilities, but most involve higher expenses or leaving the familiarity of Fidelity.

Q: I am 70. I still work part time and draw Social Security. My wife is 64, retired and drawing a pension. She has not yet signed up for Social Security. We have a little more than $1 million in IRAs. They are invested in three bond funds: Franklin High Income fund, Franklin Income Fund and Templeton Global Bond Fund. We also have $100,000 in Templeton World Fund. We have enjoyed good dividends for the past three years, and we are taking only the dividends, while preserving our principal. Our financial adviser at a large brokerage house has suggested that we move some money out of bonds and into stock funds. He says that interest rates are going up and that we are not going to receive as much in income as in the past. In the past, when we moved our money from stock funds to bond funds, it cost me $12,000 in commission fees. So, should I move some money into stock funds? If so, how much should I move? And where would you suggest that I invest it? I want to avoid paying so much in commissions if possible.

A: There are two ways to avoid commissions on a change. Usually, if you move money from one fund in a fund family to another fund in the same fund family, there will be no commission charge. The transaction is called a “fund exchange.”

If you look under “Exchanging Shares” in the prospectus for a Franklin Templeton fund, you will find that you can do fund exchanges between funds of the same share class, such as A shares, without a sales charge. And since the Franklin-Templeton family of funds is quite large, your broker should be able to find one or more equity funds in that family that will serve your purpose.

If your broker can find opportunities only in other fund families that require paying a commission, it would not be unreasonable to question his motivation. If your broker suggests a fund in the same fund family, then he is assisting you in changing your asset allocation, which is what he says he is concerned about.

The second way to avoid commissions is to buy a no-load fund, preferably an index fund, but you will have to do this on your own.

Q: I have read one should withdraw only 4 percent, or less, from savings to avoid running short in old age. Is that net percentage after investment earnings are figured in, or should earnings be ignored? Last year I earned about $133,000 in my IRA and withdrew $145,000, so my net withdrawal is only $11,479, or roughly 0.7 percent of my IRA value. Is this the percentage I should be comparing to the 4 percent rule of thumb, or (ignoring the earnings) did I withdraw 9.4 percent? Obviously there is a big difference. Which one are the experts talking about? My homemade Excel forecaster says I will run out of money in about 23 years when I am 92.

A: It’s all about principal, not earnings. The famous 4 percent figure is drawn from research on safe withdrawal rates done by financial planner William Bengen. He found that you could have a starting rate of 4.3 percent from the total value of a typical balanced portfolio. You could then increase that original dollar amount by the rate of inflation each year. If you did that, you would have a very high probability of not running out of money for 30 years. Since 30 years is longer than most people will be retired, and inflation is our biggest long-term worry, his figure became the magical “safe withdrawal rate.”

It’s important to understand exactly what he was talking about. The 4.3 percent rate was the withdrawal from the value of the fund in the first year. So from a $1 million portfolio, the initial withdrawal would be $43,000. In all future years, the withdrawal would be $43,000 adjusted upward for the inflation rate. If inflation were zero, the increase would be zero.

It’s also important to understand that this is not the last word on withdrawal rates. Additional research over the last 15 years has suggested that withdrawals could be higher if you had some simple spending rules. Other research has suggested that high-valuation markets — such as the one we are now in — require a lower initial withdrawal rate.

Whatever the research suggests, however, the withdrawal rate was a starting percentage of the original portfolio. In your case, it would have been 4.3 percent of the value of your portfolio on Dec. 31 of the previous year.

And here’s where there is a problem. If the year-to-date difference of $11,479 between what your portfolio earned, $133,742, and what you withdrew, $145,221, is about 0.7 percent of your portfolio, your portfolio should be about $1,640,000. If so, a 4.3 percent starting withdrawal rate would be about $70,500, not $145,221.

To experiment with how long your money might last, go online to the required minimum distribution calculator on the Fidelity website. It allows you to input your age, current account balance and projected earnings for your account, and then displays the value of your account each year until well after age 100. (Note: The calculator does not factor in ups and downs of the market, which have a significant impact.)

This offers some reassurance Excel does not provide. According to the Fidelity minimum required distribution calculator, a 70-year-old with $1,640,000 earning a very conservative 4 percent would withdraw about $60,000 in 2014. Withdrawals would climb each year, peaking around $107,000 at 93. But even at 100, his withdrawal would be $87,000 — and he would still have nearly $500,000 left.

The combination of a relatively conservative portfolio and required minimum distributions turns out to be a very good simple tool to avoid going broke.


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