MONEY retirement planning

Why Women Are Less Prepared Than Men for Retirement

Women outpace men when it comes to saving, but they need to be more aggressive in their investing.

Part of me hates investment advice specifically geared towards women. I’ve looked at enough studies on sex differences—and the studies of the studies on sex differences—to know that making generalizations about human behavior based on sex chromosomes is bad science and that much of what we attribute to hardwired differences is probably culturally determined by the reinforcement of stereotype.

So I’m going to stick to the numbers to try and figure out if, as is usually portrayed, women are actually less prepared for retirement—and why. One helpful metric is the data collected from IRA plan administrators across the country by the Employment Benefit Research Institute (EBRI.) The study found that although men and women contribute almost the same to their IRAs on average—$3,995 for women and $4,023 for men in 2012—men wind up with much larger nest eggs over time. The average IRA balance for men in 2012, the latest year for which data is available, was $136,718 for men and only $75,140 for women.

And when it comes to 401(k)s, women are even more diligent savers than men, despite earning lower incomes on average. Data from Vanguard’s 2014 How America Saves study, a report on the 401(k) plans it administers, shows that women are more likely to enroll when sign up is voluntary, and at all salary levels they tend to contribute a higher percentage of their income to their plans. But among women earning higher salaries, their account balances lag those of their male counterparts.

It seems women are often falling short when it comes to the way they invest. At a recent conference on women and wealth, Sue Thompson, a managing director at Black Rock, cited results from their 2013 Global Investor Pulse survey that showed that only 26% of female respondents felt comfortable investing in the stock market compared to 44% of male respondents. Women are less likely to take on risk to increase returns, Thompson suggested. Considering women’s increased longevity, this caution can leave them unprepared for retirement.

Women historically have tended to outlive men by several years, and life expectancies are increasing. A man reaching age 65 today can expect to live, on average, until age 84.3 while a woman can expect to live until 86.6, according to the Social Security Administration. Better-educated people typically live longer than the averages. For upper-middle-class couples age 65 today, there’s a 43% chance that one or both will survive to at least age 95, according to the Society of Actuaries. And that surviving spouse is usually the woman.

To build the portfolio necessary to last through two or three decades of retirement, women should be putting more into stocks, not less, since equities offer the best shot at delivering inflation-beating growth. The goal is to learn to balance the risks and rewards of equities—and that’s something female professional money managers seem to excel at. Some surveys have shown that hedge fund managers who are women outperform their male counterparts because they don’t take on excessive risk. They also tend to trade less often; frequent trading has been shown to drag down performance, in part because of higher costs.

Given that the biggest risk facing women retirees is outliving their savings, they need to grow their investments as much as possible in the first few decades of savings. If it makes women uncomfortable to allocate the vast majority, if not all, of their portfolio to equities in those critical early years, they should remind themselves that even more so than men they have the benefit of a longer time horizon in which to ride out market ups and downs. And we should take inspiration from the female professional money managers in how to take calculated risks in order to reap the full benefits of higher returns.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

Read next: How to Boost Returns When Interest Rates Totally Stink

MONEY IRAs

The Extreme IRA Mistake You May Be Making

A new study reveals that many savers have crazy retirement portfolios. This four-step plan will keep you from going to extremes with your IRA.

When did you last pay attention to how your IRA is invested? It’s time to take a close look. Nearly two out of three IRA owners have extreme stock and bond allocations, a new study by the Employee Benefit Research Institute (EBRI) found. In 2010 and 2012, 33% of IRA savers had no money in stocks, while 23% were 100% in equities.

Many young savers and pre-retirees have portfolios that are either too cautious or too risky: 41% of 25- to 44-year-olds have 0% of their IRAs in stocks, while 21% of 55- to 65-year-olds are 100% in stocks.

An all-bond or all-stock IRA may be just what you want, of course. Perhaps you can’t tolerate the ups and downs of the stock market or you think you can handle 100% equities (more on that later). Or maybe your IRA is part of a larger portfolio.

But chances are, you ended up with an out-of-whack allocation because you left your IRA alone. “It seems likely many investors aren’t investing the right way for their goals, whether out of inertia or procrastination,” says EBRI senior research associate Craig Copeland. An earlier study by the Investment Company Institute found that less than 11% of traditional IRA investors moved money in their accounts in any of the five years ending in 2012.

To keep a closer tab on how your retirement funds are invested, take these four steps.

See where you stand. Looking at everything you have stashed in your IRA, 401(k), and taxable accounts (don’t forget your spouse’s plans), tally up your holdings by asset class—large-company stocks, short-term bonds, and the like. You’ll probably find that the bull market of the past five years has shifted your allocation dramatically. If you held 60% stocks and 40% bonds in 2009 and let your money ride, your current mix may be closer to 75% stocks and 25% bonds.

Get a grip on your risks. An extreme allocation—or a more extreme one than you planned—can put your retirement at risk. Hunkering down in fixed income means missing out on years of growth. Putting 100% in stocks could backfire if equities plunge just as you retire—what happened to many older 401(k) investors during the 2008–09 market crash.

Reset your target. If you also have a 401(k), your plan likely has an asset-allocation tool that can help you settle on a new mix, and you may find that you need to make big changes. That’s especially true for pre-retirees, who should be gradually reducing stocks, says George Papadopoulos, a financial planner in Novi, Mich.  A typical allocation for that age group is 60% stocks and 40% bonds. As you actually move into retirement, it could be 50/50.

Make the shift now. If moving a large amount of money in or out of stocks or bonds leaves you nervous, you may be tempted to do it gradually. But especially in tax-sheltered accounts, it’s best to fix your mistake quickly. (In taxable accounts you may want to add new money instead to avoid incurring taxable gains.) “If you’re someone who’s a procrastinator, you may never get around to rebalancing,” says Boca Raton, Fla., financial planner Mari Adam. And you don’t want a market downturn to do your rebalancing for you.

Get more IRA answers in the Ultimate Retirement Guide:
What’s the Difference Between a Traditional and a Roth IRA?
How Should I Invest My IRA Money?
How Will My IRA Withdrawals Be Taxed in Retirement?

MONEY retirement income

The Single Biggest Retirement Mistake

faucet pouring money into bottomless bucket
C.J. Burton—Corbis

Don't think of your retirement savings as one big bucket of money. Instead, divide up your assets.

The single biggest retirement mistake I see is that retirees don’t set aside funds for income during the early years of their retirement. They go directly from accumulating retirement funds to withdrawing them. And that can be a big problem.

Let me explain. The usual approach to retirement savings is to treat the client’s funds as if they are all in one pile. Under this method, the account is divvied up between stocks, bonds, and cash. A systematic monthly withdrawal begins to provide income, typically starting out at 4% of the client’s portfolio value for the first year. Each year afterward, the withdrawal amount is adjusted upward to match inflation.

This rate is considered by many advisers to be safe in terms of generating sustainable income over a two- or three-decade retirement. Unfortunately, it leaves many clients concerned about outliving their money. Let’s use 2008 as an example. At the time, I saw recent retirees who had $1,000,000 in their 401(k)s and who thought, based on the 4% formula, that they were set with $40,000 of annual income. Within the first year or two of their actual retirement, however, the market crashed and they were then drawing on a balance of $600,000. Most could not decrease their expenses, so they continued to withdraw $40,000 through the downturn, which was an actual withdrawal rate of almost 7%.Worse yet, the market crash caused retirees to lose confidence in their original plans. They pulled most, if not all, of their retirement funds out of the market, thus missing the ensuing recovery.

The compounding errors of higher-than-anticipated withdrawal rates and bad market-timing decisions doomed many to outliving their funds. This syndrome actually has a name: “sequence risk.” Academics are well aware of this risk, but few planners properly address the issue with clients and almost no individual investors are aware of the concept.

The problem can be alleviated by setting aside up to ten years’ worth of income at the inception of retirement. I address this problem with an approach called the Bucket Plan, which segments a retiree’s investible assets into three categories, or buckets.

Here is the breakdown:

  • The “Now” bucket is where the client’s operating cash, emergency funds and first-year retirement income reside. It will typically be a safe and liquid account such as a bank savings account, money market fund, or CD. These are the funds on which the client is willing to forgo a rate of return, in order to keep them safe and liquid. The amount allocated to the Now bucket will vary based on the clients assets and sources of income, but typically you would want to see no less than 12 months of living expenses here.
  • The “Soon” bucket has enough assets to cover up to ten years’ worth of income for the retiree. The Soon bucket is invested conservatively with little or no market risk. That way, we know we have ten years covered going into the plan regardless of what the stock market does.
  • The “Later” bucket funds income, and hopefully an increase in income, when the Soon bucket is exhausted. By then, the Later bucket has been invested uninterruptedly for at least 10 years. We reload another round of income into the Soon bucket, and the process starts all over again. The Later bucket is the appropriate place for capital market participation.

Financial planners have long used the analogies of an emergency fund and an accumulation/distribution fund. The real innovations here are the addition of the Soon bucket for near-term income and the method for communicating the concept to clients.

A client who was recently referred to me had the 4% systematic withdrawal that most financial advisers recommend. This did not seem to make him happy, though, since he could not see how his finances would last in the long run. He was not confident about what might happen if he needed more than the 4% income because of an emergency. He wondered whether there would be anything left over for his children to inherit. He was losing sleep and not enjoying his retirement at all.

I explained our Bucket Plan method. The Later bucket funding the Soon bucket made perfect sense to him. He also loved the idea of the Now bucket for emergencies and unexpected expenses. The real beauty of this approach is it gives retirees great peace of mind. They are much less likely to make bad market-timing decisions because a market correction will have no effect on their current income.

The bucket concept is simple to explain, and clients always understand the role their money is playing and why. Most importantly, they have the confidence to ride out market volatility because they know where their income is coming from. Sometimes simplicity can be quite sophisticated.

———-

Jeff Warnkin, CPA and CFP, of the JL Smith Group, specializes in holistic financial planning for pre-retired and retired residents of Ohio. He incorporates investments, insurance, taxes, and estate planning when building financial plans for clients’ retirement years. Warnkin has more than 25 years of experience in the financial services industry, and is life- and health-insurance licensed.

Read next: Here’s a Smart Strategy for Reducing Social Security Taxes

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MONEY retirement planning

3 Simple Steps to Crash-Proof Your Retirement Plan

piggy bank surrounded by styrofoam peanuts
Thomas J. Peterson—Getty Images

The recent stock market slide is timely reminder to protect your retirement portfolio from outsized risks. Here's how.

At this point it’s anyone’s guess whether the recent turmoil in the market is just another a speed bump on the road to further gains or the start of a serious setback. But either way, now is an ideal time to ask: Would your retirement plans survive a crash?

The three-step crash-test below can give you a sense of how your retirement plans might fare during a major market downturn, and help you take steps to avert disaster. I recommend you do this stress-test now, while you can still make meaningful adjustments, rather than waiting until a crisis actually hits—and wishing you’d taken action beforehand.

1. Confirm your asset allocation. The idea here is to divide your portfolio into two broad categories: stocks and bonds. (You can create a third category, cash equivalents, if you wish, or throw cash into the bond category. For the purposes of this kind of review, either way is fine.)

For most of your holdings this exercise should be fairly simple. Stocks as well as mutual funds and ETFs that invest in stocks (dividend stocks, preferred shares, REITs and the like) go into the stock category. All bonds, bond funds and bond ETFs go into the bond category. If you own funds or ETFs that include both stocks and bonds—target-date funds, balanced funds, equity-income funds, etc.—plug their name or ticker symbol into Morningstar’s Instant X-Ray tool and you’ll get a stocks-bonds breakdown. Once you’ve divvied up your holdings this way, you can easily calculate the percentage of your nest egg that’s invested in stocks and in bonds.

2. Estimate the downside. It’s impossible to know exactly how your investments will perform in a major meltdown. But you can at least estimate the potential hit based on how your portfolio would have fared in past severe setbacks.

In the financial crisis year of 2008, for example, the Standard & Poor’s 500 index lost 37% of its value, while the broad bond market gained just over 5%. So if you’ve got 70% of your retirement portfolio in stocks and 30% in bonds, you can figure that in a comparable downturn your nest egg would lose roughly 25% of its value (70% of -37% plus 30% of 5% equals 24.4%—we’ll call it 25%). If your portfolio consists of a 50-50 mix of stocks and bonds, its value would drop about 15%.

Remember, you’re not trying to predict precisely how the market will perform during the next crash. You just want to make a reasonable estimate of what kind of hit your retirement savings might take so you can get an idea of what size nest egg you may end up with when things get ugly.

3. Assess the impact on your retirement. Go to a retirement income calculator that uses Monte Carlo simulations and enter your nest egg’s current value as well as such information as your age, income, when you plan retire, how your savings are invested and how much you’re saving each year (or spending, if you’re already retired). You’ll come away with the percentage chance that you’ll be able to generate the income you’ll need throughout retirement based on things as they stand now. Consider this your “before crash” estimate. Then, get an “after crash” estimate by plugging in the same info, but substituting your nest egg’s projected value after a downturn from step 2 above.

You’ll now be able to gauge the potential impact of a market crash on your retirement prospects. For example, if you’re 45, earn $80,000 a year, contribute 10% of pay to a 401(k) 70% in stocks and 30% in bonds that has a current balance of $350,000, you have roughly a 70% chance of being able to retire on 75% of pre-retirement salary, according to T. Rowe Price’s Retirement Income Calculator. Were your portfolio’s value were to drop 25% to $262,500 in a crash, your probability of retirement success would fall to 55% or so.

Once you see how a major setback might affect your retirement prospects, you can consider ways to protect yourself. For someone like our fictional 45-year-old above, switching to a more conservative portfolio probably isn’t the answer since doing so would also lower long-term returns, perhaps reducing the odds of success even more. Rather, a better course would be to consider saving more. And, in fact, by boosting the savings rate from 10% to 15%, the level recommended by many pros as a reasonable target, the post-crash probability of success rises almost to where it was originally.

If you’re closer to or already in retirement, however, the proper response to a precipitous drop in the odds of retirement success could be to invest more cautiously, perhaps by devoting a portion of your nest egg to an annuity that can generate steady, assured income. Or you may want to maintain your current investing strategy and focus instead on ways you can cut spending, should it become necessary, so you can withdraw less from your portfolio until the markets recover.

Truth is, there’s a whole range of actions you might take—or at least consider—that could put you in a better position to weather a market crash (or, for that matter, provide a measure of protection against other setbacks, such as job loss or health problems). But unless you go through this sort of stress test, you can’t really know what effect a big market setback might have on your retirement plans, or what steps might be most effective.

So run a scenario or two (or three) now to see how you fare, assuming different magnitudes of losses and different responses. Or you can just wait until the you know what hits the fan, and then scramble as best you can.

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.

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MONEY stocks

Your 3 Best Investing Strategies for 2015

Trophy with money in it
Travis Rathbone—Prop Styling by Megumi Emoto

Racking up big investing victories over the past six years was easy. Now, though, the going looks to be getting tougher. These three strategies will help you stay on the path to your goals.

There’s nothing like an extended bull market to make you feel like a winner — and that’s probably just how you felt coming into the start of this year.

Sure, the recent wild swings in the stock market may have you feeling a bit more cautious. Still, even now, the Standard & Poor’s 500 stock index has returned more than 200% since the March 2009 market bottom, while and bonds have posted a respectable 34% gain.

The question is, will the winning streak continue?

Should it persist through the current bout of volatility, the stock market rally will be entering its seventh year, making it one of the longest ever; at some point a bear will stop the party. Meanwhile, the Federal Reserve is signaling the end to its program of holding down interest rates and thus encouraging risk taking. And there’s zero chance that Congress will add further fiscal stimulus. In short, the post-crisis investing era—when market performance was largely driven by Washington policy and Fed ­intervention—is over. “As the global risks have receded,” says Jeffrey Kleintop, chief global investment strategist at Charles Schwab, “the focus is going back to earnings and other fundamentals.”

The stage is set for a reversion to “normal,” but as you’ll see, it’s a normal that lacks support for high future returns. For you, that means a balancing act. If you don’t want to take on more risk, you’ll have to accept the probability of lower returns. Following these three guidelines will help you maintain the right risk/reward balance and choose the right investments for the “new” normal.

1) Keep U.S. Stocks As Your Core Holding…

Stocks are expensive. The average stock in the S&P 500 is trading at a price of 16 times this year’s estimated earnings, about 30% higher than the long-run average. A more conservative valuation gauge developed by Yale finance professor Robert Shiller that compares prices with longer-term earnings shows that stocks are trading at more than 50% above their average.

“Given current high valuations, the returns for stocks are likely to be lower over the next 10 years,” says Vanguard senior economist Roger Aliaga-Díaz. He expects annual gains to average between 5% and 8%, compared with the historical average of 10%. Shiller’s numbers suggest even lower returns over the next decade.

That doesn’t mean you should give up on U.S. stocks. They remain your best shot at staying ahead of inflation, especially today, when what you can expect from a bond portfolio is, well, not much. “Stock returns may be lower,” says Aliaga-Díaz, “but bond returns will be much less, so the relative advantage of stocks will be the same.” And the U.S. economy, though far from peak performance, is the healthiest big player on the global field.

Your best strategy: Now is a particularly important time to make sure your stock allocation is matched to your time horizon. “The worst outcome for older investors would be a bear market just as you move into retirement,” says William Bernstein, an adviser and author of The Investor’s Manifesto. A traditional asset mix for someone in his fifties is the classic 60% stock/40% bond split, with a shift to 50%/50% by retirement. If your allocation was set for a 35-year-old and you’re 52, update it before the market does.

On the other hand, if you’re in your twenties and thirties, you should be far less worried about today’s prices. Hold 70% to 80% of your portfolio in equities. The power of compounding a dollar invested over 30 to 40 years is hard to overstate. And you’ll ride through many market cycles during your career, which will give you chances to buy stocks when they’re inexpensive.

2) …But Spread Your Money Widely

With many overseas economies barely out of recession or dragged down by geopolitical crises, international equity markets have been trading at low valuations. And some market watchers are expecting a rebound over the next few years. “Central banks in Europe, China, and Japan are making fiscal policy changes that are likely to boost global growth,” says Schwab’s Klein­- top. Oil prices, which have fallen 40% in recent months, may boost some markets as consumers spend less on fuel and step up discretionary buying.

But foreign stocks aren’t uniformly bargains. The slowdown in China’s economic growth threatens the economies of the countries that supply it with natural resources. Japan’s stimulus program to date has had mixed success, and the reason to expect stimulus in Europe is that policymakers are again worried about deflation.

Your best strategy: Spread your money widely. The typical investor should hold 20% to 30% of his stock allocation in foreign equities, including 5% in emerging markets, says Bernstein. Many core overseas stock funds, such as those in your 401(k), invest mainly in developed markets, so you may need to opt for a separate emerging-markets offering—you can find excellent choices on our ­MONEY 50 list of recommended mutual and exchange-traded funds. For an all-in-one fund, you could opt for Vanguard Total International Stock Index VANGUARD TOTAL INTL STOCK INDEX FD VGTSX -0.9476% , which invests 20% of its assets in emerging markets.

3) Hold Bonds for Safety, Not for Income

Fixed-income investors have few options right now. Today’s rock-bottom interest rates are expected to move a bit higher, which may ding bond fund returns. (Bond rates and prices move in opposite directions.) Yet over the long run, intermediate-term rates are likely to remain below their historical average of 5%. If you want higher income, your only alternative is to venture into riskier investments.

Your best strategy: If you don’t want to take risks outside your stock portfolio, then accept that the role of your bond funds is to provide safety, not spending money. “After years of relative calm, you can expect volatility to return to the stock market—and higher-quality bonds offer your best hedge against stock losses,” says Russ Koesterich, chief investment strategist at BlackRock. Stick with mutual funds and ETFs that hold either investment-grade, or the highest-rated junk bonds. Don’t rely solely on government issues. Corporate bonds will give you a little more yield.

You may be tempted to hunker down in a short-term bond fund, which in theory will hold up best if interest rates rise. But this is one corner of the market that hasn’t returned to normal. Short-term bonds are sensitive to moves by the Federal Reserve to push up rates. The Fed has less ability to set long-term rates, and demand for long-term Treasuries is strong, which will keep downward pressure on the rates those bonds pay. So an intermediate-term bond fund that today yields about 2.25% is a reasonable compromise. Sometimes in investing, winning means not losing.

Read next:
How 2% Yields Explain the World—and Why Rates Have Stayed So Low for So Long

 

MONEY Markets

3 Key Lessons Investors Can Take From 2014

NYSE New York Stock Exchange
Stephen Chernin—Getty Images

The market was up, the market was down, but the smart money held steady.

Many investors will look back on 2014 as an exciting year during which the stock market hit new highs and delivered impressive returns. Then again, some of those very same investors may also remember 2014 as an anxious, uncertain time when stocks often seemed on the verge of flaming out.

So, what can you learn from such an up-and-down (and back up) year?

Here are three key lessons from 2014 that you can apply to your investing for 2015 and beyond.

1. Don’t give in to gut reactions. Unless something goes drastically wrong in the last few trading days of the year, stocks will deliver double-digit gains in 2014. But it’s hardly been a smooth ride, with stock prices dipping by 4% or more five times during the year. Indeed, the year got off to a rocky start with disappointing earnings and a lackluster manufacturing report pushing the Dow Jones Industrial Average down 7% by early February.

The problem is that when the market falters, it’s virtually impossible to tell whether it’s the start of something big or a minor setback from which stocks will quickly rebound. If you cut and run every time it looks like stocks might melt down, you can miss out on big gains if stocks recover and move to higher ground, as they did five times this year.

So how do you reap stocks’ rewards without becoming an emotional wreck during crashes? You create a mix of assets based on your tolerance for risk that gives you a shot at the returns you need while offering adequate downside protection. In other words, you diversify. Which brings us to the second lesson…

2. Diversification works—but you may not always like the results. If you had invested 100% of your money in a Standard & Poor’s 500 index fund at the beginning of the year, reinvested dividends, and ridden out the market’s ups and downs, you would be sitting on a double-digit gain going into the last week of the year.

But if you had expanded your holdings to include bonds, you would have earned less, as the broad bond market was on pace to earn less than half the S&P 500’s return. And if you had broadened your holdings still further into foreign shares, your portfolio’s return would have dipped even more, as international stocks were down roughly 3% heading into the last few days of the year.

Does that mean diversification didn’t work? Not at all. You don’t diversify to maximize return. You do it to manage risk. Spreading your money around limits your downside by assuring that you’ll never have all your money in the worst-performing assets. It also dampens the swings in your portfolio’s value. Lower volatility makes building a nest egg less of a crap shoot in which you either win big or lose big and also helps reduce your chances of running through your savings too soon when you begin tapping your nest egg in retirement.

There will always be years in which you’ll wish you’d had more money in some assets than others. But you can take comfort from the fact that it’s impossible to know in advance what those assets will be. U.S. stocks creamed foreign shares this year; the reverse was true in 2004 through 2007. Diversifying assures you’ll have at least some money in the better performers every year. Just don’t overdo it, turning diversification into di-worse-ification.

3. Ignore the investing noise. Virtually every time the stock market experienced a setback this year, some putative sage or another stepped forward to warn of impending doom and/or recommend fleeing stocks for more defensive investments. And, of course, in 2014 as in previous years market watchers warned of of a coming bond-market collapse. Which didn’t happen, again. In fact, the broad bond market is headed toward a return of more than 5% this year, while it appears long-term Treasuries will actually outperform stocks with a 20%-plus return.

If you draw no other lesson from 2014, at least hold on to this one: Don’t be swayed by the cacophony of pundits and advisers with their predictions and prognostications, telling you to buy this investment, sell that one, or move your money from here to there. Once you’ve settled on a mix of assets that jibes with your goals and appetite for risk, stick to it. That was the right thing to do in 2014, as it will be in 2015 and beyond.

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.

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MONEY Ask the Expert

How to Invest an Inheritance

Investing illustration
Robert A. Di Ieso, Jr.

Q: I’m 22 years old and inherited quite a bit of money from a parent who passed away. What is the best thing to do with the money in terms of investing and long-term growth? — Val

Step One:
Before all else, you want to look at how this money fits into your overall finances, says Ken Moraif, a certified financial planner and senior advisor with Dallas wealth management firm Money Matters.

Do you have high-interest debt, such as a car loan or credit cards? If you do, it makes sense to use some of this gift to pay off the debt, says Moraif — but don’t use it as a license to overspend.

On the other hand, if you have a mortgage outstanding, hang onto that. After factoring for low rates and tax deductions for interest on that loan, your inheritance is better put to work elsewhere. Ditto for student loans, for which interest may also be tax deductible.

Step Two:
Take a look at your cash cushion. If you don’t have one, consider tucking away a small portion of your inheritance in a savings account. Ideally, you want to set aside enough to cover three to six months of expenses. By keeping some cash on the sidelines, you won’t have to tap your investments (perhaps at an inopportune time) if you get into a bind.

Step Three:
Before you think about specific investments, you’ll want to figure out the best investment vehicle for you. If you have access to a tax-advantaged 401(k) retirement plan, bump up your contributions so you’re on track to contribute the maximum ($18,000 in 2015).

The money will need to come from your paycheck, says Moraif, but you can use some of your inheritance to supplement your income if need be. Likewise, you can also set up a Roth IRA and tuck away up to $5,500 a year.

In a Roth, you won’t be able to make tax-free contributions, but your investments will grow tax free and won’t be subject to tax when you withdraw – assuming you do so after age 59½. “You want to take full advantage of any tax breaks,” says Moraif. “Those are grand slams.”

Step Four:
With the ground work laid, then you can finally look at where exactly to invest your money. The answer will depend on how much you inherited and how much you ultimately think you need.

If you are looking for a single place to park your inheritance over the long term, look for a low-cost index fund that offers broad, inexpensive exposure. The Vanguard Total Market Index fund (VTSMX), for example, holds more than 3,700 U.S. stocks of all sizes, across virtually all sectors.

This is a good place to start, but you will eventually want to look at further diversifying with international stock fund, alternative funds and even bond funds. If your retirement plan or brokerage offers target-date funds, this is one way to get the right balance. These funds base their allocation (mix of stocks and bonds) for your target retirement age and automatically shift the allocation as you get closer to your retirement date.

Of course, depending on just how large of an inheritance you’re talking about, you may want a more tailored allocation – one that is just aggressive enough to get your nest egg to where you need it.

“Your asset allocation should be a function of your hurdle rate,” he says. “You only want to take as much risk as is necessary to accomplish your financial goals.”

Read next: Buying or Selling a Home in 2015? Here’s What You Need to Know

MONEY asset allocation

How Much Stock Is Too Much? Here’s a Quick Rule of Thumb

Investing illustration
Robert A. Di Ieso, Jr.

Q: My wife and I are 54 years old and we still have about 94% of our retirement savings in a variety of stock mutual funds and ETFs. Should I begin moving some of that to bond funds? — Gary Wirth, Pittsburgh

A: Assuming you and your wife are still more than a decade away from retirement, you’ll want to keep the bulk of your investments in stock funds and ETFs.

Even so, your 94% allocation to equities is on the high side at this stage of the game, says Mitch Tuchman, managing director of Rebalance IRA, a national independent investment advisory service that specializes in asset allocation.

At this point, while you’re still working and accumulating savings, adding bonds to your portfolio isn’t as much about earning income as it is giving your investments some ballast in case the stock market goes topsy turvy — as it did briefly in late September and early October.

The question then isn’t if you need some additional bond exposure, but how much more?

Most experts, including Tuchman, do not recommend relying on the old rule of thumb that says the percentage of your portfolio in fixed income should equal your age. According to that old standard, 54-year-olds ought to keep 54% of their portfolios in bonds while holding a minority of their money in equities.

That rule doesn’t apply for a couple of reasons, says Tuchman. First, people are working longer and living longer. Second, you have to consider the environment you’re in. With bond yields as low as they are, for as long as they’ve been, there is a real risk interest rates will go up.

Why is that bad?

Market interest rates move in the opposite direction of bond prices. When rates rise, prices on existing bonds in a portfolio will likely go down. In theory, this means you could lose money in bonds when this shift takes place.

Your target allocation to bonds will also depend on other factors, such as how long you and your wife plan to keep working and your emotional tolerance for market swings. If you lose sleep and make rash choices (i.e. move to cash) when the market dips, you should probably own a larger helping of bonds.

With all that said, Tuchman suggests a good target for you and your wife is about 15% in bonds. He recommends divvying that up among high-quality corporate bond funds, high-yield funds, and emerging market debt funds. “Those groups still pay a reasonable amount of interest and, for various reasons, are a better hedge in a rising rate environment,” he says.

Having 15% of your portfolio in bonds may still seem like an aggressive stance.

Keep in mind, though, that Tuchman is not saying that the rest of your investments belong in equities.

In addition to the bond holdings, Tuchman says it’s also a good idea to allocate 5% to 10% of your total portfolio to real estate — in the form of real estate investment trusts — and another 5% to 10% to dividend-paying stocks, which are considered more conservative than other types of equities.

As for the remaining 70% or so of your portfolio, make sure that’s well diversified among large-cap stocks, small-cap U.S. shares, foreign equities, and emerging-market stocks.

This mix should get you through the next several years, says Tuchman, who at 58 adheres to a similar strategy in his own portfolio.

Read more on asset allocation:

What is the right mix of stocks and bonds for me?

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MONEY financial advice

The Downside of Financial Jargon

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If you focus too much on charts, graphs, and asset allocation, you can end up overlooking what's really important about someone's finances.

Sometimes our clients’ simplest questions are the ones that we overlook.

Not too long ago I started prepping for an annual meeting with one of our clients. As is the case with most financial planners, our process involved collecting data from various sources so that we would be prepared to discuss not only our annual agenda items but also any questions our client might raise about her overall financial plan.

Our annual meetings are an opportunity for us to discuss with our clients their life changes, re-focus their goals, and address any other external events that might have an impact on their overall plan. So we made sure we were ready to discuss portfolio performance and allocation, even if we didn’t intend to spend much of the meeting going over performance. We also made sure to review various benchmarks, mutual fund performance reports, and any other information that might bear on our client’s ability to achieve her goals. Suffice it to say, I felt it better to be overprepared than underprepared.

Meeting day arrived, and I was ready. I glided through the agenda items with my client while highlighting the areas that I thought needed addressing. Of course, I showed her colorful pie charts in order to highlight her portfolio’s diversification and performance. As I concluded the agenda, I noted that since there were no major life changes, I didn’t see a need to alter the portfolio.

I thought our hour-long meeting had gone well — until, that is, my client looked at me and said, “Frank, I just want to know if I’ll have enough money to continue living my current lifestyle.”

I was floored. All of my prepping for the meeting was to highlight that she was on track and that everything was moving along as we had planned. The problem, however, was that the information was in a language that made the answer to her question obvious to me but not to her. My charts looked pretty to me, but didn’t address her question.

I thanked her for her question, and I made a commitment to change how I would address that in future meetings. In other words, I would make sure we discussed her current spending as well as other aspects of her financial life within the context of how her lifestyle might be affected.

After our meeting, I continued to ponder her question, because she was right. My meeting agenda was filled with language and jargon that I understood but not my client.

I reflected on whether we as an industry overcomplicate concepts that can be easily communicated in a way that more directly addresses our clients’ basic fears. The answer for me was to question my assumptions about my client communications in general and re-evaluate how I would communicate moving forward with all my clients. I made a commitment to listen more for their fears and address them more directly — free of industry jargon whenever possible. I would not assume my spreadsheets and pie charts said it all. In other words, I would keep it simple.

———–

Frank Paré is a certified financial planner in private practice in Oakland, California. He and his firm, PF Wealth Management Group, specialize in serving professional women in transition. Frank is currently on the board of the Financial Planning Association and was a recipient of the FPA’s 2011 Heart of Financial Planning award.

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