Invest for Growth Without Getting Burned

Reena and Will Watts met in 2006 through an online dating service where they had posted their personality profiles. But they couldn't have imagined how closely aligned their risk profiles would be. Says Will, who drove six hours to meet his future bride: “We want our lives to seem like an endless adventure.”

Each had already been living by that mantra. Determined to get into TV, Reena had traded her hometown of Louisville for Chicago, where she landed a job as a producer on the raucous “Jerry Springer Show.” After nearly three years, she pulled up her roots, planting herself in Los Angeles to join the team behind “Nanny 911.” (Despite her three-year stint with the show, she can’t coerce her toddler into sleeping through the night.)

As for Will, his nomadic path included a two-year layover at a “hippie commune” near Taos, N.M., where he meditated daily. Reared in Houston, he attended University of California, Berkeley because “I associated the West Coast with success,” he says. “I was worried that the South would cause stagnation. I still worry about that.”

But Will and his wife have more pressing concerns, says Jill Schlesinger, MoneyWatch.com’s editor-at-large and a certified financial planner. Schlesinger, who reviewed the Watts’ finances, says they have made a common error: They failed to diversify. “It’s easy for young people to not care about retirement savings — until they really care,” she says. Both of their 401(k) plans are invested entirely in high-risk stocks. Given their ages, Schlesinger says, it’s smart for them to invest aggressively, but “being completely in stocks is overdoing it,” she adds. Retirement could be 35 years away, but bear markets are unlikely to become extinct. Whatever your economic outlook, you need a financial plan that will protect you from both market risk and inflation risk.

Spread the Risk Around — Even Just a Little

Like anyone who has a long time horizon to retirement — measured in years or decades, not months — Will is investing with an eye to an eventual economic recovery, and intends to be well positioned to profit from it. Yes, it’s reasonable to assume that 30 years from now the economy will have left its current doldrums behind. But who knows how many booms and busts will grow and fade, what new drivers of growth will appear (or won’t) — and how high the Fed may have to raise interest rates to keep international markets (China, for example) buying our Treasury bonds?

The Watts’ 401(k)s total $22,000; every cent invested in stocks. They couple will still be well-positioned to profit from the global recovery — but less exposed to a bear market shellacking — if they move 20 percent out of stocks and put it into a high-quality corporate bond fund, Schlesinger says. Of the remaining 80 percent, she advises that they divide it along these lines: 40 percent in large-cap U.S. stocks, 30 percent in international stocks and 10 percent in small-cap stocks.

Dump Actively Managed Funds

For most people, and certainly those buy-and-hold investors who have relatively little capital to commit, full-service brokers are not only expensive but also unnecessary. A broker is unlikely to provide enough benefit to overcome the fees he charges — sales loads of up to 5.75 percent on mutual funds, and that’s before you factor in the fund fees — plus commissions on any other products. Investors are better off in broad index funds, which will allow them to capture almost all of the market’s return.

Schlesinger says investors should apply the same logic to their retirement accounts. Will’s 401(k) is invested in actively managed funds, which means they are run by stock pickers who are trying to beat the market. He is paying an annual fee of more than 1 percent, yet stacks of academic research have shown that most fund managers actually lag the market. To reduce costs immediately, Schlesinger recommends that he switch to no-load Index funds, which will cost him about 0.1 percent a year. Compounded annually for nearly half a century (the Watts won’t sell all their stocks on the day Will retires) the difference will be tens, if not hundreds, of thousands of dollars.

Get Real About Your Predictions

To borrow some wisdom that may have come from Yogi Berra: “Prediction is very difficult, especially when it’s about the future.” Which is why no matter how the market is behaving, there’s never any shortage of theorists willing to claim they know what’s ahead — for a fee.

The Watts are buying their first house, yet they have built assumptions about the $25,000 profit they’ll make when they move in five years. Schlesinger is unequivocal about the value of such prognosticating. “It’s delusional,” she says. “Never make an assumption about making money on a house.” Recent history bears her out: Do the Watts really think they can foresee shifts in macro-economic trends, buyer confidence and speculator enthusiasm?

Their own home-buying process has already followed a twisted path. They were getting ready to buy a house in Palo Alto when they moved, and made an offer on a house in their new neighborhood. They pulled out of that one — which cost $40,000 more than the house they are buying — after an inspector found that it needed $15,000 worth of repairs.

Review the Plan Regularly

As certain as Reena and Will seem about their priorities now, they may feel differently as they grow older. It’s hard to know, Schlesinger points out, whether they’ll feel the need to keep moving once they have one or two more children. Their assumptions about Will’s income — namely that his salary will remain on a consistently upward trajectory — may be dashed by the industry’s fortunes. Or he may decide he’d rather retire when he’s 60.

“Priorities are always changing,” warns Schlesinger, who suggests that the Watts, and you, revisit your financial plan on an annual basis. And make sure that if you’ve moved the goal post, you also move the ball.

More on MoneyWatch:

• Your 30s: Prepare for Big Expenses Ahead
• Save for College and for Yourself

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