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Understanding your goals

Social Security may replace only about 40% of your pre-retirement income, according to estimates by the Social Security Administration. The remaining 60% has to come from other sources, including your savings. Recent declines in the equities market have made retirement goals that seemed readily attainable in September 2000 perhaps more elusive now. 
 The reasons for the market’s decline are numerous and have been explained and commented upon ad nauseam. The reality of the moment is many people's net worth is down. This is the reality we must deal with from this point on. From hindsight we can learn of the folly of lack of diversification, over-optimism and other errors. From today’s reality we must re-analyze our goals, our investment process and our ability to achieve our goals. 
 Ultimately, the investment decisions you make control how effectively and efficiently your resources work for you. The investor’s individual ability and willingness to take varying degrees of risk is the largest factor of consideration in portfolio design. Long-term goals allow for a more aggressive posture. Very short-term goals demand conservative investments. In the short term, a sound portfolio of stocks can be volatile in returns, both downward and upward, but historically stocks have the highest long-term returns of all asset classes. Fixed income investments may have less volatility but generally provide lower returns over time. Cash holdings have very minimal volatility or risk, but also garner very small returns. 
 Obviously a more conservative investment posture forces one to have more resources working over an extended period to reach a specific goal. However, any time we push the investment accelerator toward the floor in an attempt to increase our returns, we risk losing control, with dire consequences. Each investor must rationally decide on the speed limit appropriate for their financial journey. 
 Looking back since September 2000, we can measure the investment results of various investment choices. As a means of comparison, let’s look at three portfolios of $500,000, invested with varying degrees of risk, and look at the results.
 Aggressive Posture: 100% stocks measured by a 50% weighting in an S&P Index Fund (down 40%) and 50% weighting in the Lord Abbett Affiliated Fund, a value-oriented fund (down 17.7%). A $500,000 beginning investment resulted in $355,000 today - a loss of $145,000, or 29%.
 Conservative Growth Posture: 70% stocks (down 29%), 30% bonds (as measured by the Lehman Corporate/Government Bond Index) up 21.4%. Total return: $430,000 today, down 14% from a $500,000 investment.
 Balanced Posture: 50% stocks, 50% bonds. Total return on a $500,000 investment- $481,000, down 3.8%.
 In hindsight, it is obvious that while all of these portfolios had negative returns over this two-year period, in less aggressive portfolios the solid performance of bonds mitigated the stock market declines. The future is less certain, but if history is a guide we can assume that over extended periods of time, a decade or more, stocks will out-perform bonds or cash. Rationally, we should anticipate stock market returns in a diversified, well-designed, equity portfolio to be in the 8% to 10% area annually. Bonds should return at best 6% to 7%, and cash 3%. Return expectations of these three portfolios therefore may be: 
Aggressive Posture - 100% stocks = 8% to 10%; Conservative Growth Posture - 70% stocks, 30% bonds = 7.5% to 9%; Balanced Posture - 50% stocks, 50% bonds = 7% to 8.5%.
 Over ten years, optimum results between the three portfolios would show that a $500,000 portfolio invested in 100% stocks with positive average annual returns of 10% would grow to $1,296,000, while a balanced portfolio averaging 8.5% annually would grow to $1,130,000. That 1.5% difference annually adds $166,000 to the end results. One must always carefully measure the rewards versus the risk associated with the incremental long-term gains. 
 What can you do now? First review your existing investments. Are they working efficiently? Are you truly diversified? Is the asset allocation appropriate in light of your goals and risk tolerance? 
 Next, do you need to add more over time? Can you adjust your savings or contributions to retirement plans? Do you have non-productive assets that should be sold to fund more important goals? 
 Lastly, are your goals realistic? If your goals cannot be met from your current assets along with future investments working correctly and efficiently, the only choice is to modify your goals. This is painful to admit, but again it is reality. Small modifications to goals can make a large difference. Choosing to retire at age 65 versus 60 allows five more years of savings and five less years of taking money out of your retirement funds.
 Naturally, retirement goals are long-term since retirement can easily last 30 years from beginning to end. The long-term nature of these goals, therefore make some measurements imprecise, calling for continuing review. Think of the review process as using an odometer when taking a long journey.
 Nancy Hadley is an investment representative with D.A. Davidson in downtown Sandpoint.

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Nancy Hadley

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