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Asset Allocation Advice for the Sandwich Generation

Deciding how much to put into stocks versus bonds gets tricky when you have to factor in the finances of your parents and children

By Jeff Brown | August 16, 2012
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Jeff Brown has nearly 20 years experience as a personal finance columnist for publications including The New York Times, The Nightly Business Report on PBS, The Philadelphia Inquirer and MSNBC.com.

Jeff Brown writes a biweekly blog about the Sandwich Generation and the financial issues its members face as they try to help their parents and their adult children. The blog appears on Next Avenue and on the website of the public television show Nightly Business Report. A highly respected financial journalist, Brown brings personal expertise to the subject: He is himself part of the Sandwich Generation.
 
Every brokerage and mutual fund firm worth its salt provides an online asset allocation tool so customers can figure how to split their holdings among stocks, bonds and cash. Plug in some numbers, click “enter,” and you get an answer like: Put 50 percent into stocks, 40 percent into bonds, 10 percent into cash.
 
It’s a valuable exercise, one that I do every year or so to see if my retirement savings match my needs. But what if you’re in the Sandwich Generation and are concerned not only about your own finances, but also the finances of your parents and children?

(MORE: 'Lifestyle' Investing: A New Path to Successful Retirement)

That can be a problem because asset allocation calculators are designed for a single investor or couple, not a multigenerational team. And the calculators generally focus on retirement or college savings, not issues like a 20-something’s need to pay off school loans and save for a down payment on a home.
 
Adjusting Your Portfolio for Your Family

The more your family's finances are intertwined across generations, the more important it is to adjust the calculator’s asset-allocation recommendations.
 
For example, you might be told to go with a 50/40/10 allocation of stocks, bonds and cash for you and your spouse, but imminent needs to assist your parents and children might make it wise to be more conservative, with a 40/40/20 split.
 
In my case, I have an unusually heavy stock allocation for a 60-something because I’m pretty confident I won’t need to serve as another generation’s safety net. If I’m wrong, I have a fallback: As a freelance writer, I can keep working full- or part-time well past the typical retirement age.
 
At its heart, the principle of asset-allocation is simple: Younger people should put most of their long-term investments into stocks, older people should go heavy on bonds, and the middle-aged should opt for a balanced mix of the two.
 
That’s because of the potential risks and returns of each type of investment. Stocks tend to have the highest returns but also the greatest risk. Bonds are safer, though generally not as generous. Money-market funds and money-market accounts (what investment pros call “cash”) are the safest investment, but typically earn nothing once inflation is figured in.
 
The young have time to ride out the stock market’s reversals, but the elderly don’t, so the emphasis shifts toward safety as people age.
 
Clearly, decisions become more difficult when you need to consider three age groups at once.

(MORE: Investing in Stocks With or Without Dividends)

If you’re caring for more than one age group, begin your asset allocation process by running the calculations separately for each generation. This will give you a baseline.
 
Do the Calculations Multiple Times

In fact, I’d run the numbers at least 10 times for each generation, to test various scenarios. That’s not as much of a chore as it would seem, because each run would change only one input.
 
You might start by plugging in an average annual inflation rate of 3 percent and in the next run change it to 4 percent, noting the investment split recommendations in each case. Next, see how you should divide your portfolio using different projected investment return assumptions. You can keep doing this by changing one variable, such as your life expectancy or annual spending in retirement.
 
These multiple runs will give you a sense of how your investments would fare in the worst case as well as the best. They will also show the effects of other factors, such as a decision to retire two or three years later than planned.  
 
Then comes the tricky part: massaging the results to account for factors that a calculator doesn’t consider.
 
For instance, if you and your spouse are 50-something parents expecting an inheritance, you could take more risks with your retirement and college-savings accounts by putting a higher percentage of your portfolio into stocks.
 
Of course, it can work the other way, too.
 
If one generation is financially dependent on the others, it might be wise for everyone to be more conservative, putting less money into stocks and more into bonds and cash. The trick is to avoid being so conservative that meager investment returns will leave the family short.
 
Other Factors Affecting Investment Choices

Another question to consider: How certain are your projections?
 
A retirement income centered on a rock-solid pension with annual cost-of-living adjustments is much more dependable than a 401(k) heavily invested in stocks.
 
Finally, look at the risks embedded in various trade-offs.
 
Parents and grandparents may feel duty-bound to raid their retirement accounts to pay for kids' and grandchildren’s college, for instance, making them inclined to invest conservatively to ensure that the tuition bills will be paid. But the older generations have little time for their investment gains to compensate for such a big withdrawal. So it may be better for the grandkids to borrow for college, since they have many years to pay off the debt.
 
All of this, I realize, is frustratingly imprecise. It would be nice if there was an asset-allocation calculator that would crunch data all at once for three generations and tell everyone what to do.
 
As far as I know, there isn’t one, and I suspect that’s because no such calculator could possibly provide reliable results. There are just too many variables and tough personal choices. Is it more important to send a grandchild to a pricey private college or put grandma in a better nursing home? A machine can’t answer that.
 
Ultimately, the most important tool for the multigenerational financial enterprise is communication.
 
Each generation should have a clear idea of the others’ financial situation, as well as a sense of who is available to help whom, for how long and at what cost. 
 
These are tough subjects to broach, and I’ll come back to them in a future blog post.