Too Many Eggs In One Basket

Most professional money managers would kill for Charles Boyet's record as an investor.

After retiring in 2000, Mr. Boyet grew his $695,000 nest egg into $1.1 million -- all during the worst bear market in a generation. Just as impressive: At a time when many retirees are enduring paltry yields, Mr. Boyet's portfolio generates 8% a year, kicking off $90,600 in cash.

Yet, the Albuquerque, N.M., retiree wonders if his portfolio is vulnerable. His concern is well-placed.

Aside from $22,000 in cash, the 67-year-old Mr. Boyet, and his wife, Michaeline, have their retirement savings invested entirely in real-estate investment trusts, which own everything from shopping centers to hotels. REITs pay much higher dividends than most stocks and their share prices have soared in the past three years. However, if real estate slumps or if REITs fall from favor, the Boyets' nest egg could crack wide open.

"I would never tell anyone to invest this way," says Mr. Boyet, a former chief financial officer for a small business. "But our main objective is income. The other option is to earn a lot less income from our portfolio."

Income is the Boyets' priority for good reason. They spend nearly all of the $146,000 they receive each year from their investments, his Social Security and her part-time job as a nurse practitioner. Switching to safer investments, like five-year Treasury issues yielding just 3.5%, would shrink their income and crimp their lifestyle.

THE BOYETS' PORTFOLIO Assets REITs: $1,125,096 Cash: $22,290 Total: $1,147,386 Total Annual Income $146,400 Total Annual Expenses $142,289

The couple faces the same issue so many retirees do: Generating enough money from their investments to live now, yet preserving principal for later years. Adding to the challenge: The Boyets are separated by nearly 20 years in age; she's just 49. As such, she's concerned about her financial well-being when she's older. She jokes with her husband that "I want to afford a boy-toy when you're gone."

As part of an ongoing series, we're asking readers such as the Boyets to open their portfolios so that three planners can rebuild the investments to better match the investors' needs. This time we consulted pros at the Lam Group, Key Financial and Jaffe Asset Management.

The planners recommend that the Boyets sell off as much as 83% of their REIT shares and buy a more diverse basket of investments. That means the couple must learn to live on less money. Otherwise, the portfolio could evaporate before Mrs. Boyet hits 70.

They all say the Boyets, like many retirees, have to give up the notion that they should live purely off their REIT dividends. Instead, the couple needs a portfolio that will grow over time as well as produce current income.

How do you structure such a portfolio? The planners have different thoughts. One would place two-thirds of the Boyets' nest egg in stocks; another recommends just 39%. All three want the Boyets to load up on income-producing debt instruments, including a dollop of high-yielding junk bonds and international bonds.

The challenge: Any prudent portfolio is likely to throw off a lot less income than the Boyets are currently withdrawing. That means the couple faces tough choices in where to pare expenses.

Being entirely in REITs isn't the only worry. In searching for high dividends, Mr. Boyet has picked a generally aggressive bunch of REITs that could be more vulnerable to market turmoil. The Boyets "are stretching too far for yield and giving up quality," says Mike Kirby, principal at Green Street Advisors, an independent REIT research firm in Newport Beach, Calif.

Mr. Boyet, who spends hours at a time researching REITs and reading through the financial reports of the ones they own, calculates that he and his wife spend more than $142,000 a year. A large chunk of that goes to health care ($15,332 a year), vacations back home to visit family and friends ($9,000), various types of insurance including long-term-care policies that Mrs. Boyet insists on ($14,395), and alimony ($10,062) Mr. Boyet pays to his ex-wife. Their other big expense: nearly $1,625 a month, or nearly $20,000 annually, on groceries and what Mr. Boyet calls "our weekly money," for breakfast, lunch and dinners out either separately or together.

Mrs. Boyet plans to work part time "as long as I need her to," Mr. Boyet quips. She stopped working when they moved to New Mexico from New York three years ago, but was bored. When she does call it quits, the couple expects to make do with one car instead of two and curtail expenses for discretionary items such as clothing and entertainment. They own an airy, 2,600-square-foot stucco home north of Albuquerque decorated in a Southwestern style. The home, which they share with two dogs, is mortgage free and valued at about $325,000. They have no qualms about downsizing at some point.

Mr. Boyet feels their portfolio is conservative, if overconcentrated, and hopes "to hear that I'm doing things generally fine." Mrs. Boyet feels their portfolio is neither conservative nor well balanced.

Here's what our planners say:

PROFESSIONAL GUIDANCE See how the planners would set up the Boyet portfolio. Adobe Acrobat required.

Patricia Brennan, President, Key Financial, West Chester, Pa.

The Boyets, Ms. Brennan says, must rethink their spending priorities.

Under their current investment strategy, she says, the couple could live as they do now for the next 10 years without changing a thing. But by about 2014, when Mrs. Boyet is set to retire at age 60, shriveling her income to about $14,000, the couple would begin to drain their account quickly.

To ensure that their portfolio survives as long as they do, she says the couple "needs to cut their expenses by at least 30%," she says. Vacation expenses "are a good place to start."

Mrs. Brennan's plan has the Boyets pulling out about $55,000 annually, a big drop from their current dividend income of $78,000. A lower withdrawal rate would allow the portfolio to grow faster, providing a cushion for Mrs. Boyet's retirement.

The current Boyet portfolio is exceedingly risky, Ms. Brennan says. During the 1998-99 bear market in REITs, she notes, "almost every one of the REITs the Boyets hold lost more than 50%."

As such, she recommends cutting back REIT exposure to no more than 20% of the overall portfolio. She says the Boyets should retain just three of their investments: NovaStar Financial Inc., a residential mortgage REIT; and the Cohen & Steers Premium Income Realty Fund and Quality Income Realty Fund. Ms. Brennan would put about $420,000 of the Boyets' nest egg in a variety of income-producing funds -- such as Pimco Real Return and Pioneer High Yield -- that the couple can draw on for expenses. The rest of the cash goes into longer-term investments designed for growth, including Templeton Foreign, Columbia Acorn and Davis New York Venture funds.

Ms. Brennan also says it would be "beneficial if Michaeline would work until at least 62, if not extending that to 65." Ultimately, she says, the Boyets "need to be focused on saving more now. In 10 years that money will be able to replace Michaeline's salary."

Marshall Jaffe, managing director Jaffe Asset Management, Beverly Hills, Calif.

The Boyets' biggest problem, says Mr. Jaffe, isn't their portfolio. He says you can create legitimate reasons they might want to be 100% in REITs, though he wouldn't recommend that. The real problem, he says, "is that you have to understand rationally the risk you're taking, and be willing to live with the worst that can happen -- and I don't see that."

He wonders how the couple would react if their REITs dropped in value or, even worse, cut their dividends -- two very real possibilities.

Mr. Jaffe also questions the holdings in the Cohen & Steers closed-end funds. If REIT prices fall for whatever reason, investors could bail out of these funds, driving their prices down below the value of the assets. On top of that, the funds use leverage to juice their returns. "A perfect storm environment," Mr. Jaffe says, "could turn a 20% drop in the average REIT into a 40% decline in the value of these funds." Sell them all, he advises.

In the immediate term, he suggests the Boyets reduce their REITs to about half of their portfolio, though over the next two or three years they should reduce REITs to 20% or less. And they should consider a less risky approach to the sector, such as the Vanguard REIT Index Fund, yielding about 5.5%.

The non-REIT portion of the Boyets' portfolio should be in income-producing investments such as American Funds Washington Mutual fund, T. Rowe Price Emerging Markets Bond fund and the Northeast Investors high-yield bond fund.

Overall, Mr. Jaffe's portfolio would generate annual income of about $57,000, once again a big drop from their current dividend income. "So they need to make a clear distinction between wants and needs to make appropriate adjustments to their lifestyle," Mr. Jaffe says.

Nelson Lam, president The Lam Group, Lake Oswego, Ore.

The Boyets should think in terms of total return, not just dividends, Mr. Lam says. With a portfolio geared for some growth, the couple can sell stock annually to supplement the dividends they receive.

Still, Mr. Lam doesn't recommend that the Boyets' buy a lot of U.S. stocks. He sees the dollar weakening, which makes foreign stocks better performers for Americans. He also says the Boyets should own bond funds and other debt instruments, both domestic and foreign. The rationale: When one asset class is struggling, another will pick up the slack. He would keep about 17.5% of the portfolio in REIT funds such as the Third Avenue Real Estate Value fund.

Mr. Lam's portfolio brings in high returns by investing in risky assets like junk bonds and international debt. However, because the investments don't correlate with one another, the result is "an aggregate portfolio with higher returns and lower overall risk," Mr. Lam says.

Under this revamped portfolio, the Boyets annual dividends would be halved. They could recoup a big portion of the shortfall by withdrawing a relatively conservative 3% of their portfolio each year. Combined with dividends, that would give them investment income of about $75,000, just shy of the $78,000 Mr. Boyet currently withdraws.

Such a setup would allow the Boyets to continue living generally as they do now, but would significantly reduce the risk of a 100% REIT portfolio. Equally important: Their money could still grow to meet Mrs. Boyet's needs later. To be on the safe side, Mr. Lam says the couple still must reassess their spending.

"At Mr. Boyet's age," Mr. Lam says, "he cannot afford to be wrong. He has to realize that if we have another event like 1998 [with REITs], he may never recover from that. That's not a position I'd want to be in with a young wife."

Write to Jeff D. Opdyke at jeff.opdyke@wsj.com

Updated November 12, 2003