The Means to an End

By Debora Vrana

Oct. 29, 1996 12 AM PT

Frank Cramer poses the ultimate financial-planning challenge. The Huntington Beach mortgage collection agent wants to accumulate enough savings to retire, and then spend nearly every dime of it before dying--but not a moment sooner.

“I want just enough left over for a nice cremation,” said Cramer, 59, who is in fairly good health, has two dogs but no spouse or children.

Sounds easy, right?

Wrong.

Cramer’s goal, which is shared by many Americans, is one of the hardest to achieve. Having sufficient funds to retire comfortably, and then making those funds last as long as you need them--but no longer--is tough for several reasons.

For instance, you might live longer than you expected. Investment returns are frequently volatile, so you could earn more--or less--on your savings than you anticipated. Throw in a financial emergency or two over 20 years and your whole plan is shot to pieces.

In Cramer’s case, the problem is complicated by the fact that, like many Americans, he has underestimated how much he needs to retire. When volunteering for a Money Make-Over, Cramer said his main financial goal was to retire at age 63 on what he considers to be a fortune: his investment savings of $145,000, not counting his home equity of $65,000.

He has no pension. As a result, his retirement--which, based on average life expectancies, could last more than two decades--must be completely financed through savings and Social Security.

Victoria F. Collins, a certified financial planner in Irvine, took a long look at Cramer’s finances. She estimates he’ll need almost $26,000 annually to meet living expenses in retirement. Social Security will pay just under half that amount. If he maintained his current investment strategy and retired at 63, Cramer would probably run out of savings five to 10 years too soon.

Given that troubling scenario, Collins recommends a series of changes.

First, Cramer needs to work a few additional years--until he’s 66. Second, he needs to accumulate a bigger nest egg--about $100,000 more. By working those extra years, he’ll be able to partly meet his savings goal because he’s socking away about 15% of his annual $38,000 salary into a 401(k) plan, which is partly matched by employer contributions.

Third, he’s got to better diversify his stock holdings to protect his nest egg from market swings that could devastate his financial plan, and to beef-up his returns to meet his savings goal.

Cramer’s current investment portfolio is about 90% invested in stocks, with nearly all of that in U.S. large-company shares that he’s purchased directly or through mutual funds.

Specifically, he has more than $70,000 in six individual stocks: 685 shares of General Electric, 100 shares of Circuit City, 50 shares of Microsoft, 100 shares of Sciclone Pharmaceuticals, 100 shares of Silicon Graphics and 10 shares of Fleet Financial.

Another $47,614 of his savings is invested in three mutual funds: $9,757 in Fidelity Growth & Income (the fund’s average annual return over the last five years: 17.2%); $33,857 in Janus (five-year average return: 14.1%); and $4,000 in Northstar Special B (a relatively new fund that is up 17.2% this year).

The remainder of his savings includes more than $17,000 in money-market investments, plus his 401(k), which is invested in small-company stocks (4% of his total portfolio) and international equities (1% of his total).

What’s wrong with this picture?

The biggest problem is that the portfolio is not well diversified, says Collins. About 50% of Cramer’s investments are in just one stock: GE. Though GE is a high-quality company whose stock has performed well, too much of Cramer’s wealth is resting on a single issue that is hovering near its all-time high.

Meanwhile, all but one of Cramer’s other individual holdings are large U.S. companies. And both the Fidelity and Janus funds, though strong performers, invest in large U.S. companies as well.

That makes Cramer highly vulnerable to losing a good portion of his wealth in a rough market. And because he’s just seven years away from retirement--after pushing back the date--he doesn’t have enough time to risk too much in riding the highs and lows of a single stock. Still, he needs the fast-paced growth that stocks overall can best provide.

Collins recommends that Cramer maintain a portfolio made up of 85% stocks. But he should divide that equity share among a wider range of stock classes to reduce the risk that one bit of bad news could topple the whole portfolio. Specifically, the equity portion of his portfolio should be 20% in large-company stocks, 10% in mid-size companies, 20% in small companies and 50% in international.

The remaining 15% of his total portfolio should be invested in corporate bonds (10% of his total)--they yield more than government securities--and money-market accounts (5%).

Collins suggests that Cramer sell the Northstar fund--it’s a high expense fund--and lighten his holdings in GE, Sciclone and Circuit City.

He could then use the cash generated from those sales and from liquidating part of his money-market holdings to buy international-stock funds such as Vanguard International Growth Fund (five-year average return: 11.5%) or T. Rowe Price International Stock Fund (five-year average return: 11.3%). Both are well-positioned for future performance and have long-term track records with international markets, she says.

Though foreign stocks are often considered higher-risk, when combined with U.S. large- and small-company stocks in a balanced portfolio they improve returns and decrease risk overall, Collins says. That’s mainly because U.S. and foreign stock markets tend to rise and fall at different times.

Internationals have under-performed U.S. stocks in the last three years, Collins acknowledges, but that’s partly because of the stronger dollar, which reduces the value of securities denominated in other currencies.

“It’s a major defensive move to be in internationals in case of a U.S. market correction,” she says.

For the 30% of the equity portfolio she recommends be invested in small and mid-size stocks, Collins suggested, among others, Schwab Small Cap Index (a newer fund, with a two-year average return of 18.6%,) Rainier Small/Mid Cap (also relatively new, with a two-year average return of 30.9%) and Nicholas Fund (five-year average return: 14.7%).

As for bonds, Cramer shouldn’t own tax-free municipal bonds because he is in the 10% marginal tax bracket and thus won’t get much benefit from them, Collins says.

But, she said, he should put 10% of his assets into corporate bond funds such as Vanguard Fixed Income: Short-Term Corporate fund (five-year average return: 6.7%) or Vanguard Fixed Income: High-Yield Corporate (five-year average return: 11.5%). Both are no-load and have low expense ratios, Collins said, important qualities for small investors when picking fixed-income funds.

The bond funds and the 5% money-market holding would serve as a safety net, Collins said, giving Cramer relatively protected assets that could be used to pay an unexpected bill, without having to sell stock investments at inopportune times.

In the final analysis, what benefit does Cramer get from this make-over?

Assuming a 10% average annual return on his portfolio while working and an 8% average return while retired, plus his Social Security, he will be able to generate the $25,862 annually that he will need to live on in his first year of retirement in 2003.

In subsequent years, barring significantly higher inflation, his plan will allow him to preserve his buying power while drawing down his portfolio.

And by 2021, he’ll have spent all but about $26,000 of his savings. That’s just about enough to tide him over if he lives a touch longer than he thinks he will--or to pay for a nice funeral.

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Meet the Planner

Victoria Collins is a certified financial planner with a doctorate in psychology. She is a partner with Keller, Coad & Collins Investment Counsel Inc. in Irvine and works with high-net-worth individuals who are in a financial transition such as divorce, widowhood, retirement and inheritance. She is the author of the book “Couples and Money” and the co-author of “Divorce and Money.” Her firm manages more than $260 million.

This Week’s Make-Over

Investor: Frank Cramer

Age: 59

Occupation: Mortgage collection agent

Annual income: $38,000, plus bonus

Primary investment retirement goal: Have enough money to retire on, and spend all of it before dying

Current Portfolio

Stocks: 90%

Cash: 10%

What He Owns

* Stock funds: Fidelity Growth & Income, Janus Fund

* Individual stocks: Silicon Graphics, Circuit City, General Electric, Microsoft, Sciclone Pharmaceuticals, Fleet Financial