Where to start. I've been reading a lot but don't feel I know the best course of action for my unique situation. I'm mid 40's and more or less retired (luckily) from my own business. The business is in the hands of partners and generates income to me of about 350k, but things there could go up or down so I'm trying to diversify. I feel I fit in either the "stable income and >20 years to retirement camp" or the "retired with fixed income camp." I've done well the last few years but not so astronomically well that I wouldn't notice a dip. If I screw up I could go back to work, but the longer I'm out of the game the less appealing/realistic that sounds. This is where things stand:
- 600k at MorganStanley (2% CFP fee)(60k is IRAs, 45k is 529, rest is taxable)
- 100k at a budget brokerage (10 individual stocks)
- 100k in angel investments (high risk/reward potential)
- 500k in cash (too much)
- a rental house turning about 7.5% on the 100k downpayment after expenses
- 240k left on my home's mortgage at 3.8% (this 1% higher than I earned on MS money last year)
- No debt
- 2-4mm in value in the business but locked up
- After taxes and living expenses I have about $100-150k to invest annually
I'm basically growth minded because I still have income, but I'd like to have enough of a nest egg that I don't have to worry about what happens if the business goes south. I'm not that happy with my MS advisor and I've been considering Vanguard single funds, Marketriders, Betterment, or some hybrid. I'm not sure if I should look at tax free bonds and self manage Vanguard as you have mentioned. I have even considered something like Vangaurd's Managed Payout Funds to replace income and take any income the business generates and funnel it back in. I have of course considered paying off my own home (and possibly the rental), but the thinking was I should be able to make more than 3.8% with MS but that wasn't true last year! I also still like the idea of fixing up properties as rentals as way of deriving cash flow, some sweat equity, and hopefully appreciation. The first one went well and I'm consider more. Any help limiting my choices would so appreciated. Thanks!
Thanks for writing and congratulations on building such a successful business! Here is how I would think about your situation... Somewhere between half and three quarters of your net worth is locked up in your business. Obviously I have no idea what your business is -- and even if I did I still couldn't begin to predict its future prospects. Some businesses are riskier than others, but ultimately we all know that no business is truly safe. The aggregate stock market is as a good a proxy as we have for safest possible business -- and as we were reminded in 2007-9 that level of safety still involves occasional 50% haircuts (and an 80+% haircut during the Great Depression). Your particular business is almost certainly much less safe than that. It almost certainly has a very real chance of going all the way down to zero. This is reality for any business, no matter how established and well-run.
Because of this reality, the first thing you should realize is that your asset allocation starts with a very risky position. Over half your money is tied up in something that, while very profitable now and hopefully for many years to come, might well be a ticking time bomb. Many more businesses wither and die than stay profitable for decades or go on to be bought or become public. That would be an unpleasant but not devastating scenario if you were willing and able to go right back into the workforce. But you indicated that that idea is neither appealing nor, increasingly, feasible. If I were you I would treat the business as all the risk I need and want to take. With all my other investments I would build up a very substantial allocation in relatively safe assets -- primarily fixed income but perhaps also some real estate owned outright since you sound like you enjoy that business.
To motivate that idea some more, consider two possible scenarios... In both scenarios you invest quite aggressively in your non-business assets -- say 75% in stocks and angel investments and 25% in bonds/property. In Scenario A the economy booms and both your business and your aggressive investments go on to grow several times over. Your annual income rises from $350K to full $1MM and your net worth rises from around $5MM to $15MM! In Scenario B, the economy turns Japanese, your aggressive investments end up with deeply negative returns and your business slowly dies. Your net worth drops from $5MM to less than $1MM.
Would your lifestyle and general happiness be more positively impacted in scenario A or more negatively impacted in scenario B? If you are like most people, scenario B would represent a far more dramatic negative change than scenario A a positive one. In scenario A you are still retired and instead of living comfortably as you do now you are living extremely comfortably. In scenario B, on the other hand, if you want to stay retired you will be counting every penny and hoping Social Security or Medicare benefits don't get cut. More likely you will be going back to work, at least part-time -- assuming you can find a job since, remember, the economy is not exactly booming and you are older and possibly with out-of-date skill set.
Bottom line, if I were you I would put every penny thrown off by the business that I don't spend on living expenses in safe fixed-income investments. Think CDs, I- and EE-Bonds, high-quality muni and corporate bonds. None of them will have particularly impressive returns -- but they don't have to. As long as your business is yielding $350K annually you don't need to get high returns from your investments. And if and when your business cashflow ends, you will be happy to have plenty of safe investments to fall back on -- even if the economy if crumbling all around.
Once that decision is made, the rest becomes relatively easy:
- Take the cash and pay off the mortgage and the rental. Those mortgage rates are certainly much higher than you can get from cash and possibly higher than safe bonds can get you even with the interest tax deduction. Paying off mortgage with spare cash is almost always a solid, if very conservative, investment. And outside of your business I would keep things as conservative as possible -- at least until I build up a few million worth of safe assets.
- Ditch that awful 2% CFP. Here are a couple of posts that illustrate what paying 2% in expenses means in practice: http://www.longtermreturns.com/2010/12/how-much-investment-expenses-really.html and http://www.longtermreturns.com/2012/03/why-investment-expenses-matter.html. Chances are you are paying even more than that since that CFP likely has you in some actively-managed funds that add another 1% or more to expenses.
- Keep the $100K in angel investments, but don't add anything to them until you have a few million in safe investments. $100K is a rounding error in the scope of your larger portfolio and you probably can't extract $100K anyway, even if you wanted to.
- Treat all non-business investments as one large pool of conservative assets and invest them into any number of reasonable -- and most importantly, low-cost, options.
In taxable accounts, it seems logical to focus on high-quality municipal bond funds such as Vanguard's lineup which includes both state-specific and nationwide ones. In addition to being exempt from federal income tax today's municipal bonds have very competitive yields relative to corporates or treasuries. In the bigger picture those yields are still very low in historical terms and future returns will be mediocre, but again, the goal here is to provide a large cushion of safe investments -- the striking-it-rich part has already been taken care of. Now you are playing defense.
In tax-sheltered accounts you could include corporate bonds and US treasuries. Very long maturity US treasuries have a nice property of going up in a deflationary crisis when everything else around them is crashing. Gold has a similar property in an inflationary crisis, and I would recommend including some (but not a lot -- maybe 10% of the "safe" portfolio) gold in your holdings -- more as insurance than as an investment. I would also max out I- and probably EE-Bond purchases annually, at least until interest rates increase significantly. You are limited to $10K/year/person for each of those but if you are married, that's $40K/year you can put away in very safe and conservative investments. I-Bonds especially are a no-brainer. EE-Bonds require a 20-year committment to see them double in value, but are probably still a good move, since they (like I-Bonds) come with deferred taxation.
There is no one perfect mix of conservative investments, but here is one simple example... Suppose your $500K in cash is used up in paying off the mortgages on the house and the rental... Then you sell your $100K in individual stocks and combined with $600K in MS you have about $700K to invest. What I would do is:
- $10-20K to I-Bonds and $10-20K to EE-Bonds (depending on whether you are single or married)
- $100K or thereabouts in emergency fund cash at a place like Ally bank, paying 0.90%
- $400K in VWLUX or possibly VWALX or split between either of those and state-specific muni bond fund if you happened to live in a state that is covered by Vanguard: https://personal.vanguard.com/us/funds/byobjective/detail?category=TEBondLT
- $60-80K in gold, either physical metal or ETF GLD.
- The IRA could hold a dollop of Vanguard long-term treasuries ETF EDV plus corporate bonds VFIDX (or even longer-term corporates in VWETX). EDV, much like gold, is there as insurance as much as an investment. I would expect very mediocre returns from both EDV and gold, but if and when a major crisis strikes you will be happy you have them.
- The 529 can be invested in something like VFIDX as well.
Then going forward, assuming interest rates stay largely where they are now, I would put away the new savings into a mix of I-Bonds, EE-Bonds, and VWLUX/VWALX. If and when interest rates rise you can re-evaluate to see if there are more appealing but still conservative investments (I-Bonds and EE-Bonds will likely become less appealing at that point in time). When I get to, say, $3MM in bonds and real estate (owned free and clear) then I could re-evaluate. By that time chances are something will change -- either for better or for worse -- with your business as well. But while the value of that risky business towers over the value of my safe investments I would focus on building up the latter.
Again, all of these boring bond investments are not there because I think they will outperform stocks. I fully expect stocks to beat them in the coming years and decades. But that expectation is contingent on the economy getting back at least close to its long-term growth trajectory. I think it's likely -- though maybe 2% GDP growth will become the new 3% -- but it's absolutely not guaranteed. And all those conservative investments will serve you well if that expectation of growth does not materialize, especially because your business is more likely to be struggling around the same time too.