Californians on Different Path With Portfolios

Are Californians different from other mutual fund investors around the country? In some respects, yes. In general, they appear to have slightly more money invested in funds than the national average, and they prefer a different mix of assets compared to U.S. investors as a whole.

The contrasts are most striking when it comes to tax-free securities. According to year-end 1989 figures compiled by the Investment Company Institute, an industry group, Californians accounted for a whopping 42% of all the money invested in single-state municipal bond funds, which hold debt issued by local cities, counties and other municipalities. The funds pay dividends that, for California residents, are exempt from federal and state taxes.

You can find single-state muni bond funds tailored to investors in other states (New York and New Jersey are the No. 2 and No. 3 markets, respectively), but they seem to have struck an especially responsive chord among Golden State residents.

“California has a large concentration of wealthy people, so there are more people here considering taxes,” explains Dan Nordvedt, president of Security Pacific Investments, a Los Angeles-based brokerage. The interest in munis also stems from the fact that California has one of the higher tax rates. Only six other states and the District of Columbia impose a bigger levy than California’s top 9.3% marginal rate.

Although single-state muni bond funds have an obvious appeal because of their double tax-free status, there’s a danger to overdoing it. “Some people have portfolios that are almost exclusively muni bonds, CDs and savings accounts, and they think they’re OK,” says John T. Blankinship of Blankinship & Foster, a fee-only financial planning firm in Del Mar. A more balanced and inflation-insulated portfolio should include some equity holdings and a broader mix of bonds, he says.

Blankinship recommends calculating the tax-equivalent yield on California muni bond funds, so you can compare them to competing investments. Even after paying taxes, you might wind up receiving a higher yield on a fund that holds corporate bonds, Treasuries or other government securities.

To determine the tax-equivalent yield, subtract your combined federal and state tax rate from 1, then divide that into the fund’s yield.

For example, Blankinship recommends Vanguard’s California Tax-Free Money Market Fund, recently yielding about 5.2%. For a top-income person paying 37.4% in federal and state taxes, that translates to an after-tax yield of 8.3% (5.2% divided by 62.6%). The Vanguard selection makes sense unless you can find a taxable money-market fund paying more than 8.3%. When shopping for yields, it’s important to make sure you compare funds whose holdings are of a similar credit rating.

Depending on current bond market conditions, you might even get a better rate on a fund that holds muni securities from around the country. The dividends on these funds skirt federal taxes, but they’re not exempt at the state level. Californians have shown noticeably less interest in these national muni bond funds, accounting for just 4% of the assets in this category. Floridians, who don’t pay a state income tax, are the main investors in this category (nearly 13% of the total).

Besides their popularity as a type of tax shelter, muni bond funds also have the distinction of being relatively low-risk securities. This agrees with other ICI figures from the 1989 study that indicate that Californians might be slightly more conservative than mutual fund investors as a whole.

Californians accounted for roughly 15% of all money-market assets, yet only 11% of the total for equity funds. To put those numbers into perspective, Californians had 13% of all mutual fund holdings, and the state’s population at the start of this year represented just under 12% of the national total, according to Census Bureau estimates.

However, if Californians are a bit more risk-averse than Americans on average, it’s not a strong tendency, nor is it uniform throughout the fund business.

Vanguard Group, the large no-load company based in Valley Forge, Pa., reports an unusually high interest among Californians in international equity funds, which are generally perceived by investors to be more risky than their domestic counterparts. Vanguard’s Index Europe portfolio has attracted a higher percentage of California accounts than any of the company’s 59 other mutual funds. Vanguard’s three other foreign portfolios also draw top rankings, in terms of their proportion of Californian ownership. Spokesman Brian Mattes says the firm can’t explain this preference among Golden State residents for foreign funds.

When it comes to growth vehicles, some observers believe that stocks and stock funds have had a harder time competing with real estate for the attention of Californians over the years because of strong local property markets. “Most people in Southern California still perceive real estate as being their first-, second- and third-best investments,” says Mike Marcin, the Southern California regional vice president for Pioneer Funds of Boston.

Now that local property prices are softening, will more state residents turn to equity funds for growth instead of, say, buying a rental home? It’s hard to tell, and at any rate the answer also depends on the health of the stock market.

But Nordvedt predicts a shift in favor of financial assets generally. “In the past, the portfolios of many (Californians) were chock full of real estate,” he says. “But with the slowdown in real estate and people no longer able to pull a quick profit, they’re going to look to alternative investments, including bond funds and stock funds.”

CALIFORNIANS AS MUTUAL FUND INVESTORS I. What Californians own in selected fund categories, as a percentage of the national totals:

Equity funds: 11%

Corporate bond/income funds: 11%

Government bond funds: 12%

Single state muni bond funds: 42%

Money market funds: 15%

All funds: 13%

II. How investors buy funds:

Sales force Direct marketing (mostly load funds) (mostly no-loads) Californians 74% 26% All fund investors 71% 29%

III. Selected characteristics of fund investors:

Californians All fund investors Median age 56.5 52.4 Married 61% 70% College graduates 70% 68% Retired 39% 32% Fund holdings as a percent of total financial assets (excludes real estate) 31% 33%

Source: Investment Company Institute. Data for I and II based on 1989 report; data for III based on 1986 survey.