What Is a Financial Plan? Part III — Investments

After careful review of the Franklins� situation, we provided specific recommendations to them in the area of investments. Our investment recommendations are intended to help them manage their money in an intelligent manner that reflects their needs and special circumstances, is tax sensitive, and keeps costs low.

Invest to meet income needs � Our first consideration for Larry and Jill is to build a portfolio that will support their income needs. Once they retire and start drawing Social Security, they will need to withdraw about $70,000 a year from their portfolio. We like to see 50% to 80% of this amount come from dividends and interest (yield) because these sources continue to pay even if the markets go down. This strategy prevents them from having to sell securities at inopportune times and deplete their principle. This means their portfolio must have a yield of between 2.7% and 4.3%. The remainder of their return will come from capital gains. Over the long run stocks have consistently earned the highest rate of return, and most retirees need some exposure to stocks in order to support a long, comfortable retirement.

Select an investment model � To implement this portfolio we recommend our Conservative Growth model. A model is a target allocation among specific asset types. Models provide us with clear guidance about what to buy and give our clients a better understanding of what to expect from their portfolio in terms of growth, income, and risk. The Conservative Growth model is one of seven we have designed. It is 70% stocks of varying degrees of risk and 30% income securities, and has an expected average yield of about 3.4%. This investment model gives Larry and Jill a secure level of income and a reasonable level of participation in the stock market.

Sell the mutual funds � Larry and Jill hold a lot of mutual funds, which is an expensive way to manage a portfolio of their size. There are many costs to owning mutual funds; the most notable are the annual expense charges, which average 1.42% across all mutual funds and 1.6% for equity funds. Investors can build fully diversified portfolios using individual stocks with as little as $250,000 for less than the cost of the average mutual fund. Larry and Jill will get all the benefits of a professionally managed portfolio of individual stocks for less than they are currently paying with their mutual funds.

Municipal bonds are not appropriate � Larry and Jill currently own $30,000 in municipal bonds. Though we understand that no one likes taxes, only those in the top marginal tax brackets benefit from tax-free bonds, because they pay significantly lower interest rates than fully taxable bonds and other income producing securities. The Franklins will be better off earning higher returns from other sources and paying the taxes.

Other stock selection techniques � We generally buy 30 to 40 different securities in an account and no more than 2% in any one company. This allows us to build a well-diversified portfolio without running up unnecessary trading costs.

We take advantage of the tax characteristics of securities to get the most value for our clients. For example, we buy high dividend stocks in taxable accounts, because dividends are taxed at only 15%. We buy interest-bearing securities in retirement accounts where interest is tax sheltered.

Finally, we ensure that retirees receive a level monthly income deposited directly to their bank account, much like they had while working. To prepare for these distributions, we hold sufficient reserves in a short-term bond fund to keep them secure.

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At BWFA we understand that it�s difficult for people to find sound financial advice. That is why our approach is to provide straightforward solutions you can understand and act on. At BWFA you get the highest quality advice available anywhere, at any price.

We are dedicating this Special Edition of our quarterly newsletter to helping you understand what REAL financial planning is by illustrating a real-life situation. We hope you have as much fun reading it as we did writing it.

~ Saxon Birdsong, President and Director of Investments 
Part 1: The Client Profile
Part 2: Retirement and Estate Planning
Part 3: Investments
Part 4: Taxes