Asset Dedication Part III: Case Study“Gen-X” John
It is worth noting again that asset dedication means an allocation of your assets with dedicated goals first. An investor should not invest his/her money with a higher risk for a potentially high return unless your dedicated financial goals are funded adequately.
Below, we will discuss how to apply asset dedication during the late accumulation period when half of the retirement nest egg should be accumulated, and the protection of that retirement nest egg is a priority.
Asset Dedication During the Late Accumulation Period
John is 50 years old. He is a digital marketing consultant. His gross annual income is $180k, and he lives in San Mateo. Married, he has a 20-year-old student son. John managed to save $1,300,000 in his SEP IRA and Roth IRA by the time he turned 50. He invested heavily in stocks for several years and was very lucky with his return. Now it is time to protect his retirement nest egg. In addition, John has a plan to retire as early as 60.
Now it is time to protect his retirement nest egg. In addition, John has a plan to retire as early as 60.
Formal Financial Plan
He has prepared a formal financial plan, which includes a projection of his pre-retirement period and time after retirement. These projections have taken into consideration inflation rate, potential Social Security, income from other sources, taxes, and his projected cash outflow.
The formal financial plan has helped John to determine if he has already saved enough and if annual savings are sufficient to meet his retirement objectives. The formal financial plan is his financial roadmap for the next decade.
His financial plan has shown that he must accumulate around $2,000,000 in savings during next ten years to retire early. Currently, he has $1,300,000 saved.
How Much to Save
He makes a decision keep saving around 20% of his gross income, or $36,000, annually to achieve the goal. He must save $3,000 every month or $100 in a single day.
Also, he makes a decision to set aside $100,000 in his savings account to cover his monthly expenses up to six months in the case of emergency.
Assume that his marginal tax rate is 30%.
Using the compound interest calculator (Table 2), he has found that investing his available $1,200,000 in a dedicated portfolio of individual bonds with an average yield after fees of 5% will require only $2,200 in monthly additions to achieve his goal in the next ten years.
The other $800 of his monthly savings will be invested in the stock market for long-term potential growth. If he manages to save more next year, all savings above $2,200 that needed to be invested in a dedicated portfolio could be invested in a stock market.
In this example, his nest egg will be fully protected from market and interest change risks (i.e. immunized) and his goals will certainly be achieved. If John sticks with this plan, he could retire early in his 60s with $2 million in his pocket and extra money in his equity-based investment account.
If John sticks with this plan, he could retire early in his 60s with $2 million in his pocket and extra money in his equity-based investment account.
An Alternative for Risk Takers
There is an alternative asset dedication strategy for John if he prefers to take more risk and would like to play for a high potential return from the equity market in the next ten years.
He could reserve all of his monthly savings to invest in a dedicated bonds portfolio and set aside more funds for investing in stocks. If he uses the same average yield after fees of 5% and invests $3,000 every month in a dedicated portfolio of individual bonds, he only needs $1,100,000 for initial allocation in this portfolio.
If he uses the same average yield after fees of 5% and invests $3,000 every month in a dedicated portfolio of individual bonds, he only needs $1,100,000 for initial allocation in this portfolio.
The remaining $100,000 of currently saved funds could be invested in equities for long-term potential growth (Table 3).
Again, regardless of what happens with the stock market or interest rates during this 10-year period, his portfolio allocation is exactly set to achieve her $2,000,000 goal, and there is a guarantee that goal will be achieved.