A 36-year-old IT executive crafts a plan for fulfilling his financial ambitions.
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By Christine Benz | 05-17-11 | 06:00 AM | Email Article

Manish feels like he blinked and found himself grown up. A 36-year-old IT executive, he's been married for almost nine years and has a nearly 3-year-old son. (His wife is a stay-at-home mom.) Having graduated 15 years ago with a degree from an elite university, he has received a steady series of promotions. At this stage in his life, he is content with his career and happy in his family life.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

But he and his wife still have a ways to go to fulfill their financial dreams. First on the list is funding a comfortable lifestyle and retirement. Manish wrote, "[I'd like to] make sure my wife and I are financially independent throughout our lifetimes." In addition, they'd like to send their son--and any other children who might follow him--to an Ivy League university, start a charity, and travel extensively. Manish also says that he and his wife might at some point need to return to India, where they spent much of their lives, to provide both physical and financial support for their aging parents. Finally, they'd like to be able to purchase a rental property or two, with an eye toward generating passive income.

Achieving all of those goals will require considerable resources, which is why Manish wrote to be considered for a portfolio makeover. Even though he has an annual income of more than $100,000 per year, supporting a household in a major metropolitan area is costly and has weighed on his family's ability to save. Manish would like tips on positioning his current holdings and allocating future investable assets wisely.

The Before Portfolio
Manish's portfolio is split into a few separate silos. First, he and his wife have roughly $35,000 set aside in an emergency fund consisting of cash. Manish notes that they currently have six months' worth of living expenses in the fund but are aiming for 12 months' worth. In addition, Manish has $46,000 in a rollover IRA, $13,000 in the 401(k) of his current employer, and another $5,000 in a taxable brokerage account. He has been saving about $3,000 of his salary per month.

Holding
Market Value ($)
Weight (%)
Rating (Funds)
Rating (Stocks)
Taxable: Abbott Laboratories 
1,320
1.3
N/A
Taxable: France Telecom 
375
0.4
N/A
Taxable: Johnson & Johnson 
1,657
1.7
N/A
Taxable: Procter & Gamble 
329
0.3
N/A
Taxable: Cash
35,000
35.3
N/A
N/A
401(k): Russell US Small & Mid Cap Idx Fund
3,242
3.3
N/A
N/A
401(k): Barclays Cap. Aggregate Bond Idx Fund
2,005
2
N/A
N/A
401(k): Global ex-US Idx Fund
3,292
3.3
N/A
N/A
401(k): S&P 500 Idx Fund
4,698
4.7
N/A
N/A
IRA: Vanguard FTSE All-World ex-US ETF 
12,571
12.7
N/A
IRA: Vanguard Total Bond Market ETF 
8,894
8.9
N/A
IRA: Vanguard Total Stock Market ETF 
24,285
24.5
N/A
IRA: WisdomTree India Earnings 
1,389
1.4
N/A
Total
99,057
99.8
 
 

 

Manish's portfolio is compact and anchored in low-cost broad-market index funds; he holds traditional index funds in his 401(k) and exchange-traded funds in his IRA. All are sound anchor holdings as he builds out his nest egg. In his taxable brokerage account, he has built small positions in a handful of blue-chip stocks that are favorites among Morningstar's analyst team:  Johnson & Johnson ,  Abbott Laboratories ,  Procter & Gamble , and  France Telecom . All have fairly rich yields of at least 3%; Manish noted that dividend-paying ability is one of his key criteria when purchasing individual companies. Finally, Manish's IRA includes a small position in an ETF that invests in India,  WisdomTree India Earnings .

The After Portfolio
An index-centric portfolio such as Manish's is a fine starting point for a long-term investment program, providing a lot of diversification with just a handful of holdings. Given a fairly long time horizon, his stock-heavy asset allocation is also appropriate.

Holding
Market Value ($)
Weight (%)
Rating (Funds)
Rating (Stocks)
Taxable: Abbott Laboratories 
1,320
1.3
N/A
Taxable: France Telecom 
375
0.4
N/A
Taxable: Johnson & Johnson 
1,657
1.7
N/A
Taxable: Procter & Gamble 
329
0.3
N/A
Taxable: Cash
35,000
35.3
N/A
N/A
401(k): Russell US Small & Mid Cap Idx Fund
2,000
2
N/A
N/A
401(k): Barclays Cap. Aggregate Bond Idx Fund
2,005
2
N/A
N/A
401(k): Global ex-US Idx Fund
5,500
5.5
N/A
N/A
401(k): S&P 500 Idx Fund
3,731
3.8
N/A
N/A
IRA: Vanguard FTSE All-World ex-US ETF 
18,000
18.2
N/A
IRA: Vanguard Total Bond Market ETF 
8,894
8.9
N/A
IRA: Vanguard Total Stock Market ETF 
18,857
19
N/A
IRA: WisdomTree India Earnings 
1,389
1.4
N/A
Total
99,057
99.8
 
 

 

The main adjustment I would suggest for investors in a similar situation would be to increase foreign-stock exposure. Given that U.S. stocks are less than 50% of the global market capitalization at this point, an equity portfolio that is two thirds U.S.-focused and the rest foreign has a significant bet on the U.S. market. For young people with longer time horizons, such as Manish and his wife, a stock portfolio with at least 50% overseas is a good starting point. (It makes sense to ratchet back foreign exposure as retirement draws near, however, as this article discusses.)

I also like all of Manish's stock holdings, which, as I noted earlier, are favorites of our analyst team. However, Manish should bear in that all of his holdings also take up sizable positions in his index funds and ETFs; as his individual holdings grow in size, he should use the Stock Intersection view in Morningstar's Instant X-Ray or Portfolio Manager tools to gauge his full exposure. In addition, he should bear in mind that transaction costs to buy and sell individual stocks can take a healthy bite out of his return. From that standpoint, it may be worthwhile to make larger purchases of individual stocks quarterly or semiannually rather than putting smaller amounts of money to work in stocks every month.

In terms of future allocations, I have a few suggestions. First, I completely agree that continuing to build out the emergency fund should be a key priority for this couple. Given that Manish's wife doesn't earn a salary, it's essential that they have a solid backup plan in case of income disruption. Once investors like Manish have amassed six months' worth of living expenses in a true cash account, they might consider steering the next six months' worth of living expenses into a high-quality short-term bond fund such as  T. Rowe Price Short-Term Bond . That will offer them the opportunity to pick up a slightly higher yield than they can on true cash, albeit with the potential loss of principal. (This is the "two-part emergency fund" idea I discussed in a previous article.) Manish also indicated that both he and his wife have life insurance policies, which is important given that they're parents.

In addition to contributing to his 401(k), Manish should consider opening a Roth IRA. He might also think about moving the money he currently holds in his taxable brokerage account into a Roth. His wife could also open a spousal Roth IRA, the specifics of which I discussed in this article. By holding money inside of a Roth wrapper, he'll give his assets a chance to compound on a tax-free basis. The Roth also offers attractive flexibility for investors who are saving for retirement and also thinking about college savings. They can withdraw their contributions at any time, without taxes or penalty, to pay for college, for example.

Finally, I would suggest that most investors in similar situations focus on building out their investment nest eggs before plowing money into an income-producing rental property. Although rental properties can be a decent way to generate income, the long-term growth of the nest egg should be the key priority. An investment account anchored in low-cost index funds, ETFs, and blue-chip stocks allows for greater diversification and liquidity than a rental property would afford.

Data as of May 16, 2011.

Please note that the information above is not intended to be personalized portfolio advice for the makeover subject or any other investor. It is meant to illustrate a common investor dilemma and offer general portfolio ideas for consideration by investors in similar circumstances. Every investor's situation is distinctive and may include several important variables not accounted for in this makeover.


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Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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