Dear Friends,
Back in February I wrote a two-part series on “Portfolio Housekeeping” (read them here and here) that discussed the need to annually review your portfolio. As I pointed out, there are lots of free tools available. Using the calculators you can find at: http://www.morningstar.com, for instance, I suggested you start by taking a close look at the investments you currently own, including those in company-sponsored retirement plans.

Then you should determine the appropriate mix of investments, i.e. your “asset allocation,” based on your risk-tolerance and time horizon. Based on how much you’re saving and how you’re investing it, you can test to see if you will have the next egg you’re planning to have by the time you retire. If not, you need to make adjustments.

At the end of each column I invited you to write and tell me why you would like to receive a free copy of Morningstar’s investor handbook, “Find the Right Mutual Funds.”

I have a funny feeling that most of you never read to the end of these columns (I’m crushed!) because unlike all other offers of free books, we received relatively few requests.

Sooooo, here’s another shot at it. We’ve got 20 books left. If you want one, tell me how you’d use it, why you want it, etc. (please keep this short) and respond to this column by typing “Mutual Fund Book” in the subject line. If you leave out your post office address you will automatically be disqualified!

For taking the time to thoroughly read the original columns (or perhaps for having Type-A personalities), the following individuals will receive “Find the Right Mutual Funds” as well as two additional books that the folks at Morningstar have graciously agreed to send, “Diversify Your Portfolio” and “Maximize Your Returns.”

If you submitted an entry, please read this entire column as two individuals did not include their mailing addresses. Matt and Tony, I need to hear from you!

Hi Gail,

I am finally at a point in my life where I can seriously think about investments (20 years in the Air Force). Not having time to study it much over the years, I am trying to get my hands on anything that I can learn from, and try to play catch up for my retirement.

Thanks for all the great articles, keep up the great work.

Tony

Dear Tony,

Question: When is a book “winner” not a book “recipient?”

Answer: When he doesn’t include his post office address! Please send ASAP. Respond to this column and type “Morningstar Winner” in the subject line.

Thanks,

Gail

Gail,

I have spent much of the last 4 years deployed and away from family but my wife and I manage to save about 25 percent annually. We are mostly in mutual funds however we have picked up a few individual stocks. We got clobbered in our IRAs in 2000 due to some ill timed decisions and diversification issues. We also have started a 529 plan for our daughter and the book may help us choose which investment choice better suits us. Thanks for your time. Thanks,

James

Dear James,

25 percent is an unbelievable savings rate! Hope these books help you invest it wisely.

(Maybe you can share them with others in your unit?)

I can’t believe you’ve been away so long. Please come home safe and sound.

Take care,

Gail

Gail,

I would like to receive a free copy of Morningstar's Find the Right Mutual Funds because I inherited a portfolio from my mother's estate and have no clue if I have the right mix of stocks when combined with my 401K. I'm 57 years old and thinking about early retirement but don't know if I can retire soon ???

Thank You,

Charlotte

Dear Charlotte,

This book is a great first step to help you understand more about mutual funds. But don’t stop there. The two additional books you’ll be receiving go into progressively more detail about constructing a portfolio.

In addition, be sure to visit Morningstar’s website which will enable you to drill down into individual funds to find out how they’re really invested and the costs involved. Re-read the two columns from February and try out different combinations of funds and asset allocations. “Part Two” walks you through how to test if your asset mix is on-target to achieve the nest egg you need for retirement.

Please think long and hard before you retire “early.” Keep in mind that you are not eligible for any Social Security benefits until age 62. Since you were born in 1948, your “full” retirement age”- the age at which you are entitled to 100 percent of your Social Security benefit—is 66. If you choose to start receiving Social Security at age 62, your benefits will be permanently reduced by 25 percent.

Women are especially vulnerable when it comes to retirement income. Because, on average, we earn less than men, our Social Security benefits are already lower to begin with! In fact, the average Social Security benefit paid to women today is 30 percent less than the average monthly benefit being paid to men. This is reduced even further when a woman starts receiving her benefits before her full retirement age.

On top of this, we tend to live longer than men, so inflation is a bigger threat to our standard of living. The longer you live, the less your money buys. Or, to look at this another way, the longer you live, the more income you need each year to maintain your standard of living. An annual inflation rate of “just” 3 percent cuts your purchasing power in half in just 24 years, meaning by the time you’re 81 you’ll need twice the amount of income you have today to cover the same expenses.

When you put these two factors together, it means women have to make less retirement income stretch out over a longer period of time. In reality, we should aim for [arger next eggs than men. And we should probably have a larger allocation to equities because historically, stocks have provided the best cushion against inflation.

I’m guessing that you’re thinking of retiring soon and using your inheritance to provide the income you’ll need until you can start collecting Social Security. I have no idea how large an inheritance your mother left you, but I would encourage you to use this, instead, as an emergency fund instead of an income source.

Although Social Security benefits can start at age 62, many people don’t realize that Medicare coverage doesn’t start until age 65. If you retire today, how will you cover your medical expenses for the next 8 years? Since an unexpected and serious medical issue could wipe out your inheritance, I’m assuming you don’t want to go without any health insurance at all. Even if you choose a high-deductible policy, purchasing private insurance can run [hundreds of dollars a month] at your age!

Have you factored this into your retirement expenses? Most people don’t. In fact, you’re probably not even thinking about the possibility of a major medical expense. Hopefully, you feel pretty healthy right now. But age has a funny way of creeping up on you when you least expect it. Did you know that unexpected medical bills are the number one reason people are forced to file for bankruptcy?

I hate to spoil your plans, but I would encourage you to consider working until age 66. This would have a tremendously positive impact on your prospects for a financially secure retirement. The extra years of work would enable you to contribute more to your retirement nest egg and also boost your Social Security benefits. More importantly, assuming you have health insurance through your employer, this would eliminate the need for you to spend thousands of dollars a year on a private policy.

If you detest your job and feel you absolutely must make a change, why not look for another position? Just be sure it offers healthcare coverage.

Don’t rush into things,

Gail

Ms. Buckner,

I have been working in Saudi Arabia for twenty-one years and plan to take early retirement from my company two years from now at the age of fifty-five. At that time, I will be rolling over a quite significant lump sum pension distribution directly into an IRA. Our company 401(k) plan is with a large no-load mutual fund company. I will need to determine whether or not to invest my pension distribution with them or if I should invest the distribution in mutual funds from other companies.

When I retire, I have the option -- for a fee -- of letting them manage my account or doing it myself. I’m hoping this book can give me enough information so that I don’t have to pay for this.

Thanks,

Tom

Dear Tom,

I’m quite familiar with the company that is providing your 401(k) investments and I strongly encourage you to investigate the many mutual funds they offer. In fact, once you roll over your assets to an IRA, you will no longer be limited to the funds available through your 401(k) and will have dozens more to choose from. In all likelihood, you will find suitable choices for your asset allocation.

If you don’t want to pay an on-going annual fee for this mutual fund firm to manage your account, there’s another option. Upon retirement, you can pay a one-time fee for a “comprehensive” financial plan. I’m told this generally costs $1,000, but you can get as much as a 50 percent discount depending upon the total amount of money you have invested with them. So it might be worth keeping all or most of your money in one place.

Whatever you decide, reading these books should give you greater confidence that you’re headed in the right direction.

Best wishes,

Gail

P.S. Since you were born in 1952, your “full” retirement age is also 66. Be sure to read my response to Charlotte (above) about the financial pitfalls of early retirement!

Gail:

I decided to leave my stable, well-paying job in 2000 for a different lifestyle, more self-directed and better connected with my family. I felt confident being under age 50 and having a significant portfolio, I could enjoy life more independently.

By early 2001 my mutual fund-based portfolio, began a process of self-destruction. I think of the experience as being like that of watching our house burn down and having no insurance. We had "lived in" that house for so long, i.e. owned that mutual fund, since 1979. I kept waiting for the losses to stop. They didn't. I always said that if "the worst" were to happen, a significant portfolio loss, I'd simply go back to work.

In 2002 I gave up trying to make a go of the new life and went back to my previous defense contracting work. It's not personally inspiring, but the pay is good. We've been able to build back up our savings and investments, my very supportive wife of 27 years has a job with a potential retirement, and we've bought a house.

The downside now is that I don't have a position with much security. Project cuts are unpredictable and could leave me looking for work with little warning. Now approaching age 53, I'm concerned I really need to nail down retirement by age 60, when I will have a modest Army Reserve retirement.

I've been stuck sifting through the embers of my portfolio for far too long. It was a great fund back in the old days when the former portfolio manager was at the helm. But I need to salvage what I can and make a change. We need a portfolio that offers growth with moderate risk and reasonable safety of capital. I’m hoping I can figure this out with the help of this book.

Regards,

Paul

Dear Paul —

Yikes! Timing is often everything. Unfortunately, you launched into an independent lifestyle just before the stock market nose-dived and took your mutual fund along with it.

I’m glad you’ve found a new job and have such an understanding spouse!

The good news is you have time to re-coup. And if you use your experience wisely, you should be fine.

Lesson #1: Diversify! This doesn’t mean you need four large-cap stock funds. But it does means you should have a large-cap stock fund, one that invests in mid-sized companies, and a third that owns smaller companies. Or, look for a stock fund that invests across all three market capitalizations.

In addition, make sure you diversify geographically. According to Dr. Jeremy Siegel, author of “The Future for Investors” (see last week’s column), American investors are woefully lacking in their exposure to foreign companies.

Finally, diversify by owning different types of assets. At a minimum this means you should allocate a portion of your portfolio to bonds, real estate funds (often referred to as Real Estate Investment Trusts, or REITS), and commodities (a fund that invests in oil, minerals, and other natural resources).

Lesson #2: When an investment that’s had a good track record turns south, don’t just wring your hands. Investigate what might be the source of the problem. For instance, if it’s a technology fund and the tech sector is getting hammered, don’t expect that your fund will completely avoid the carnage. But if your fund is significantly under-performing similar funds, that’s a sign you should look for a different investment.

(By the way, in my opinion, investing in a “sector” fund, negates the biggest benefit of investing in mutual funds: diversification. By definition, sector funds invest only in a single industry, such as financial services companies, or biotech. Usually, if one company in that industry is hit with negative news, the entire sector is punished. I haven’t met anyone who is smart enough to know when to move in and out of different market sectors.)

Lesson #3: Don’t fall in love with your investments. A mutual fund is not a family member. You owe it nothing. Admittedly, selling a losing investment is one of the toughest things to do. However, if, after doing your homework (see Lesson #2), you conclude that the problem is fund-related (such as a new manager who isn’t as skilled as the former one), it’s better to sell and take your losses (and the tax-deduction that goes with them). Then, reinvest your remaining assets in an investment that has better prospects.

I’m sure these books are just what you need!

Enjoy,

Gail

Dear Gail,

I've been retired for over 10 years and have been taking withdrawals each year from my IRA. I have two mutual funds in it and am fearful that they may be the wrong ones and will not hold up in this tenuous world situation.

Thank you very much,

Donald

Dear Donald,

Thank you for reading to the end of my column! Your books will be on their way shortly.

Best wishes,

Gail

Dear Gail,

For many years I neglected my finances. Then about two years ago I realized that I was headed for major trouble and decided to do something about it. Since that time we have paid down almost $27,000 worth of debt. Before long we will be debt free. I will be 48 by the time that happens, and I won't have long to build my retirement nest egg. I want to be able to find the right funds for my IRAs and SEP so that I can recover from my mistakes of the last 25 years. I would appreciate any help I could get in doing that.

Thanks! Bob

Hi, Bob —

If having the right asset allocation is the first principal of smart investing, saving as much as you can is the second. So be sure you max out your allowable contributions to your SEP and IRA. When you turn 50, be sure to sock away the additional money you’re allowed to contribute to retirement plans by virtue of your age.

Over time, saving a few extra thousand bucks a year really adds up, especially if you’re using tax-sheltered accounts like the ones you have.

Congratulations on your financial turn-around! (Now start telling your kids so they don’t make the same mistake.)

Gail

Gail,

I am hoping to use this book to help me get away from the "chase the hot fund" syndrome. In the past I have invested in the best performing funds over the previous three- and five-year periods, but they have not done as well as their recent past.

I also want to avoid duplicating their top holdings, as I have found the top funds in a fund family often invest in the same companies making it difficult to properly diversify.

I am approaching retirement and my goal is to revamp my entire portfolio now worth close to half a million dollars using the guidance in your columns along with help from Morningstar.

Thank you for your continuing good investing insights.

Horace

Dear Horace,

As you found out, chasing “hot” funds is one sure way to get burned. Often, the reason a fund has an outstanding year is that it took a big risk, such as investing a large portion of the assets in a particular industry or even a specific stock. It’s virtually impossible to repeat that kind of luck. And it’s probably not the kind of risk most mutual fund investors are looking for.

Instead, seek out funds that deliver consistent returns. Focus on five- and ten-year numbers instead of three-year results. Consistent returns — over both good and bad markets — are a sign of skillful managers. An additional benefit is that as an investor in such a fund, you’ll sleep better at night.

What most people don’t realize is that funds with erratic performance often leave you worse off in the long run than a fund that has a lower (positive) return, but delivers this on a consistent basis. Unfortunately we’re so enamored of “double digit” returns, or funds that rank in the top ten in a particular year, we dismiss the significance of a few bad years.

Even if you had a crystal ball and I TOLD you what a fund would return in the future, I bet you’d make the wrong choice!

For instance, say you’ve got $10,000 to invest for 5 years and have narrowed down your fund choices to two:

Fund A: It’s annual return over the next 5 years will be: 8 percent, 8 percent, 8 percent, 8 percent, 8 percent. (“Boring.”)

Fund B: It’s annual return over the next 5 years will be: 20 percent, minus-15 percent, 25 percent, minus-10 percent, and 20 percent.

If you didn’t know where I was headed with this, you’d probably say Fund B is the better investment. And you’d be wrong. (For fun, try this out on a family member or friend and see which they pick.)

Here is where you would stand at the end of each year:

Fund A Fund B

Year #1 $10,800 $12,000 (“Ha! I was right!”)

Year #2 11,664 10,200 (“It’ll come back.”)

Year #3 12,597 12,750 (“See, I told you!”)

Year #4 13,604 11,475 (“My stomach’s killing me.”)

Year #5 14,693 13,770 (“How did you beat me?!”)

Not only did Fund A result in more money at the end of the 5 years, it did so without the “Maalox moments” of Fund B.

The one drawback is that it’s a lot less fun to brag about Fund A to your co-workers.

Use these books in tandem with Morningstar’s website, Horace, and you’ll not only sleep better, you’ll probably also come out ahead!

All the best,

Gail

Dear Gail:

I'm a 36-year-old teacher, who spent the better part of a decade working towards my PhD, with an income to match. I grew up with parents who could safely rely on a defined-benefit pension and, thus, provided me with next to zero financial education. I got out of school and landed my first job three years ago.

Unlike my parents, I’ve got a defined “contribution” plan, which means I’m largely responsible for funding my own retirement. I'm single and not earning a lot (thankfully my only debt is a 20K student loan, locked in a 3.1 percent), but I'm putting 10 percent of my gross income into my 403(b) plan in an attempt to catch up.

Right now, I'm trying to read everything I can in order to use wisely the money I do have to plan for the future, and the Morningstar guide looks like something that should be on my shelf.

Sincerely,

Matt

Dear Matt —

You’ve got the books... provided I’ve got your post office address! Reply to this column by typing “Morningstar Winner” in the subject line.

Thanks,

Gail

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