What should I do with $50,000?
We have received several requests from readers in regards to where they should invest their money based on different scenarios and various stages of their life. We are happy to provide the following recommendations as a baseline. This is how we would allocate the investment. In the following three scenarios, we have a 10 year old, 40 year old and a 65 year old retiree. We hope you find these subjective recommendations useful.
The 10 year old
In the first scenario we have a 10 year old child who has just inherited $50,000 and will need it for college. The goal here is to grow his initial investment to an amount that will cover for their college expenses. We have about 8 years to work with before the child first enters college. The child’s risk tolerance level is medium to high and is looking to increase his investment as college is costly. In looking at how his investment portfolio is going to look the best option would be to put the majority into stocks. The stock market has historically provided an average rate of return of about 12 percent, which is greater than putting it into a savings account, CD or other investment types that provide less of a return. We will invest 70 percent into stocks as chosen below. The reasons behind these selections are as follows:
Microsoft (MSFT) holds a monopoly over the computer Operating Systems (OS). While there are alternative OS available, we believed MSFT will continue to dominate the Operating Systems and remain the number one choice. Moreover, MSFT will continue to play an important role in our digital lives. For this reason and the time we have to work with, we believed investing in MSFT will yield a hefty return in 8 years.
Valero Energy (VLO) is one of the largest refineries in the United States. We like VLO because the company is fundamentally sound. The earnings have been excellent and the dividend payout is a plus. Moreover, refineries are in great demand as demand for gasoline continues to grow. While there’s the risk of “alternative energy”, we believe any alternative is far from reality. This country will continue to run on gasoline for a long time. New refineries are also hard to build as nobody wants them in their backyard. Therefore, the long term prospect of VLO is impressive and should yield above average return.
General Electric (GE) is a well diversified company and should offset potential weakness that could occur with our other securities. A large conglomerate that produces everything from light bulbs to jet engine, we believed GE can provide the stability that is needed in any portfolio.
McDonald’s (MCD) holds a consumer monopoly when it comes to fast food. Ask anyone on the street to name a fast food restaurant and MCD will always be on the list. In the last few years, MCD has transformed itself into a decent and clean restaurant with relevant menu items. We believed the continued growth overseas in places like China will propel MCD share prices to great heights. Since we have 8 years to work with, we believed MCD should be worth 3x more than today.
Kraft Foods (KFT) is our defensive stock. In the next 8 years, we’ll likely to see at least one recession. During bad economic times, KFT should help offset the decline in the other securities.
Procter & Gamble (PG) is another defensive stock. However, unlike other defensive stocks, we believe PG will perform well under any economic conditions. People will always need PG products regardless of the economic cycle.
Pfizer (PFE) is the leader in the pharmaceutical industry. We believe PFE is currently undervalued in respects to its peers. As the baby boomer retires, the need for drugs will be immense so PFE is our drug pick. PFE should provide our 10 year old investor with a healthy return in 8 years.
United Health (UNH) is a leader among the Health Management Organization (HMO). Health Care is recession proof. Everyone needs it whether we like it or not. While there are many HMO’s to choose from, we like the fact that UNH has a good reputation and sound fundamentals. We anticipate UNH will also provide a healthy return to our 10 year old investor.
One important thing to note in regards to our portfolio of stocks is it is diversified across various industries. We have securities invested in hi-tech, energy, media, food, restaurant, food and health care. In our view, these best of breed companies should perform well within the time frame.
To help offset the risk that comes with stocks, 20 percent of the $50,000 will be invested in mutual funds as they are a great way to reduce the overall systematic risk. We have chosen to invest 10 percent each into two mutual funds as investing in one will not provide the needed diversification. Therefore, we have chosen Fidelity Diversified International, Fidelity Mid Cap Growth. The primary reason for the international mutual fund is to provide the international exposure and be a counter-balance to the US market, the other mutual fund.
In our efforts to provide a well diversified portfolio with minimal risk, the remaining 10 percent will be invested in bonds. Bonds will help minimize the risk and provide a stable fixed-income that can be re-invested, thus the return should be rewarding. Our selection for this is the Fidelity Short-Term Bond.
The 40 year old
The next scenario we have a 40 year old engineer who want to invest $50,000 for his retirement. We can assume someone in this age group is likely in the accumulation phase with obligations such as mortgages and family to take care of. He is probably worried about being able to send his kids to college. Although retirement is the ultimate goal, liquidity is also important as having access to his investment for emergency situation is important factor to consider.
Although the investor has at least 25 years before retirement, it is prudent to less aggressive in terms of the investment strategy. For this reason we have chosen to invest 50 percent in stocks, 30 percent in mutual funds, 10 percent in bonds and the remaining 10 percent in money market.
Stocks (50 percent)
Best Buy (BBY) is the current leader in the consumer electronics retailer. We believed BBY should continue to do well by taking market shares away from Circuit City and the Good Guys. Moreover, we also like the fact that BBY has embraced the e-commerce strategy by aggressively promoting their bestbuy.com.
Capitol One Financial (COF) is a leader in the credit card business. This company is fundamentally sound and is undervalued compared to its peers such as Bank of America and American Express. We believed COF will eventually get acquired by one of the larger banks. Until then, COF should continue to provide a decent return.
Chipotle Mexican Grill’s (CMG) is a new issue that has recently IPO. While still new, CMG has showed impressive growth. As the popularity of Mexican food continues to spread, we believed CMG is in a great position to capitalize.
Toyota Motor (TM) is expected to become the number one car company in the world, overtaking GM. We like Toyota because the company does not have the “legacy cost” that the GM and Ford of the world has to contend with. The quality of Toyota’s products continues to improve. We see Toyota going higher and will eventually dominate the automotive industry.
AT&T (T) appears to be back on track after several years of negative growth. The original ma bell has been acquiring the regional bells such as SBC and Bell South. The consolidation of telecom will benefit AT&T as it will once again come very close to holding a monopoly.
We believe these stock picks represent companies that are undervalued and more importantly, very diverse. Given the time horizon we have to work with, these best of breed companies should provide our investor with above average return.
Mutual Funds (10 percent)
We chose the following from www.vanguard.com based on an expense ratio less than 1 percent, 10 year return greater than 10 percent and a fund type that is internationally and domestically balanced.
American Funds Capital Inc. has earned top ratings with Morningstar which means it has historically generated above-average returns given the amount of risk it has, so the volatility is low. We meet the minimum investment requirement of $250. The fund invests in the information, service and manufacturing sectors as well as internationally which provides for diversification. This is a great fit for the 40 year old investor as they are looking for below average risk and strong returns.
Dodge & Cox Balanced has also earned top ratings with Morningstar, so it has had strong returns and low risk. We meet the minimum investment requirement of $2,500. The fund mainly invests in the financial, health and industrial materials sectors domestically. This provides a good counterbalance to the international fund as well as healthy returns relative to the risk.
Bonds (10 percent)
After evaluating several choices, we believed the best choice is to invest in corporate investment grade bonds like Citigroup Inc. More information regarding this bond can be found at http://www.investingbonds.com
Money Market or CD (10 percent)
Our primary reason for the 10 percent in money market account or CD is for liquidity purposes. In case of emergency, funds can quickly be withdrawn without complication or penalties. According to bankrate.com, the highest return on a 6-month CD will yield about 4.66 percent.
The 65 year old retiree
In the last scenario we have is a 65 year old retiree who has $50,000 in his IRA roll-over. As a retiree, steady income and relatively low risk is an important consideration. Finding the balance between steady streams of income to supplement retirement activities and low risk is an important factor when choosing the right investment vehicle. With these considerations in mind, we have elected to invest 40 percent in Mutual funds that provides income, 50 percent will be invested in Fixed Income Securities, with the remaining 10 percent invested in bonds.
Income Fund (40 percent)
The first 20 percent will be invested in Fidelity Municipal Income Fund. This fund seeks high returns exempt from federal income tax. This is a great advantage to a retiree that wants to shield as much of their income from taxes. The fund also invests in investment grade bonds that have lower risk which fits with the risk tolerance of a retiree. We can meet the minimum investment requirement of $10,000, it has a low beta and standard deviation which provides the low volatility required for a retiree, a monthly distribution to supplement retirement income and highly rated by Morningstar which validates its’ strong performance and low risk.
The remaining 20 percent will be invested in Fidelity Strategic Dividend & Income Fund. This fund seeks reasonable income and capital appreciation. It has been highly rated by Morningstar for its’ consistent strong returns and lower than average risk. This fund also provides quarterly dividends that will help supplement a retirees’ income, we also meet the minimum investment requirement of $2,500. The major sectors the fund invests in are financial and information technology.
Fixed Income Securities (50 percent)
The first 25 percent will be invested in Fidelity Investment Grade Bond Fund. This fund seeks a high level of current income, which is what a retiree is looking for to supplement their income. It invests in domestic investment-grade bonds like the top Government Sponsored Entities, Fannie Mae and Freddie Mac. These bonds are medium to high quality and have lower risk. The bond is highly rated by Morningstar and we meet the minimum initial purchase requirement of $2,500. Distributions are monthly which provide a frequent supplement of income to the retiree.
The remaining 25 percent will be invested in Fidelity Ultra-Short Bond Fund. This fund seeks to obtain a high level of current income and mainly invests in investment-grade bonds of all types with provisions for repurchase as a safe guard. The bonds are from top issuers like Fannie Mae and Freddie Mac as well as other corporate issuers. Fidelity Ultra-Short Bond Fund is highly rated by Morningstar, we meet the minimum investment requirement of $2,500 and it provides monthly distributions. The bonds are short-term, average maturity is less than 2 years. This provides the retiree not only low risk, good monthly distributions but also the flexibility to change investments based on their evolving needs.
Money Market or CD (10 Percent)
Every investment portfolio whether you are a child or retiree needs to provide for quick liquidity. We choose to provide a minimal amount of 10 percent for incidentals or emergencies where the money can be quickly accessed. Bankrate.com provides the highest return on a 3-month CD that has a $2,500 minimum deposit with a yield of 5.12 from Discover Bank.
In conclusion, different situation calls for different strategies. Whether the goal is to save for college or retirement, everyone has specific needs and risk tolerance level. In order to meet the objectives of the client, you must outline the goals and objectives that fit within the appropriate needs. One of the best ways to achieve this is through a policy statement. A policy statement is important as it provides you and your financial advisor a guidelines and a benchmark to measure performance.
As we have outlined in the three scenarios, the risk tolerance level will tend to decrease as one gets older. A child saving for college at an early age can afford to be more aggressive than a retiree trying to live off retirement income. A family man in his 40s must take into account the various needs in his life. While he can be fairly aggressive in his investment, it is important to plan for the unexpected.
In constructing any portfolio, diversification is paramount. Whether it is spreading the investment across different sectors or investing in overseas, the idea is to help protect the client against lofty losses. Through discipline and careful selection of securities, we believe the portfolio we have constructed for our three scenarios will meet their long term goals.
