When a Cool Million Still Isn't Enough

By Debora Vrana

Nov. 12, 1996 12 AM PT

Pam Donner wants to get a life.

A life that doesn’t demand 12-hour workdays managing real estate assets. A life that includes time for golf weekends in Scottsdale, Ariz., vacations with close family members and, eventually, a comfortable retirement on $100,000 a year.

While other workaholic baby boomers may have similar goals, Donner, 44, is different. With an estimated net worth of $1.6 million, Donner actually has the wherewithal to make her dreams come true--if she continues to add to her wealth and overhauls her investments now to make sure they are sufficiently diversified and properly positioned to carry her through the next 40 years, said certified financial planner Tim Kochis in San Francisco.

Kochis, who reviewed Donner’s investment portfolio, said the news is good, but not all good.

First, the entrepreneurial Donner is in an enviable position. Her savvy, long-term financial planning, successful career and heavyweight portfolio of valuable real estate assets have given her a strong cushion of retirement savings.

“I started out with nothing,” said Donner, who has only a high school degree, “but I took my bonuses and always reinvested in real estate. I managed to save $25,000 every year.”

She earned her net worth through hard work as a property manager--only $22,000 of her wealth was inherited--and by taking calculated risks in real estate that eventually paid off big time.

But it was taking an even bigger risk at age 37 that helped Donner create the wealth that most Southern Californians only dream of. When the property management firm Donner was working for decided to sell a small division, Donner was able to buy the assets and turn it into a successful small business.

Single and with no children, Donner was able to save more than most. She didn’t get much financial help from family members, including her father, a retired federal wildlife agent, and does not receive any alimony from her ex-husband, whom she divorced more than 10 years ago.

Another plus: Donner estimates that her one-third stake in her Newport Beach real estate company is worth about $1.3 million, and she earns an annual salary of $100,000 plus bonus. She has $67,000 in money market accounts, $79,214 in stocks and an additional $216,000 in real estate equity, including two small apartment buildings in Riverside and San Bernardino and a home in Colorado.

Now the bad news.

Although Donner might seem awfully wealthy, to achieve her goal of retiring on $100,000 a year in today’s dollars, she still needs a lot more money and needs to work full time for 10 more years, Kochis said.

That’s because of inflation, something many investors just don’t consider when they plan for retirement, he said. Factoring for inflation, the $100,000 in today’s dollars will be a much higher amount by the time Donner can retire.

Considering a conservative 3% inflation rate, the $100,000-a-year income she has now will be $138,000 in today’s dollars by the time Donner is 55, Kochis said. When Donner is 70, that $100,000 will amount to $216,000 in today’s dollars. By age 80, it will be $290,000.

“People planning for retirement don’t give appropriate thought to what even a small amount of inflation will do to them,” Kochis said. “They think they are rich with $200,000 invested in CDs and munis. That won’t get them through.”

This means Donner will have to work until age 55, maximize her investment returns and put aside an additional $50,000 a year until 2006 to meet her goal. She will need to more than double the assets she has now, to $3.2 million pretax, if she hopes to retire comfortably and still leave something behind for her brother’s three children.

Most of all, she should rely somewhat less on real estate investments, although they’ve gotten her where she is today, Kochis said.

She also should drastically change her investment habits to develop a portfolio of liquid assets that will see her into old age.

Too much of her wealth is in real estate and all in the same region, making her assets vulnerable to environmental disasters, economic swings or other problems, Kochis said. Her investments could be difficult to sell if she suddenly needs cash for an emergency.

“She needs to put her investments on a more automatic pilot in a diversified portfolio of equities if she wants to free up her time,” Kochis said. “She is so involved in all this real estate.”

There’s just one problem. Donner is afraid of Wall Street. She likes sticking to real estate because it’s her area of expertise.

“I don’t understand the stock markets,” she said. “If I lose my shirt in an apartment building deal, at least I understand why. If I lose my shirt in a stock deal, I don’t even know what happened.”

Many investors feel the same way, Kochis said. Whether it’s real estate, gold, stamps or antique cars, many investors are more comfortable sticking exclusively with investments they know, often to their peril.

She doesn’t want to sell all her real estate now, and Kochis doesn’t recommend that she do so. But he does advise that she sell a home she owns in Pueblo, Colo., and put the money in stocks. Future retirement savings should be invested on Wall Street, not Main Street.

Selling the home and pooling the more than $50,000 she has in certificates of deposits and the more than $60,000 she already has in stocks will give Donner about $156,000, Kochis said. About $20,000 should be set aside in cash reserves.

That will give her a a portfolio of about $136,000, said Kochis, a fee-only planner who doesn’t earn commissions on investments he recommends.

Donner should leave alone her investments in Janus Worldwide (five-year average annual return: 18.69%) and SoGen International Fund (five-year average annual return: 12.06%) because they have excellent prospects in overseas markets, Kochis said. However, she should take her money out of several load funds, such as the relatively new Oppenheimer Quest Small Cap Value B (three-year average annual return: 7.28%).

Her $136,000 portfolio should be invested aggressively, as Donner has an appetite for risk and is still young. Her stock portfolio should be 40% invested in international equities, 40% in small U.S. company funds and 20% in large U.S. company stocks, Kochis said.

For the portion in international equities, he recommends Montgomery Emerging Markets (four-year average annual return: 9.05%) and T. Rowe Price International Stock (five-year average annual return: 11.3%).

Among small-company funds, Kochis recommends the relatively new Heartland Small Cap Contrarian (one-year average annual return: 20.8%) and the Navellier Aggressive Growth (return as of Sept. 30 since the fund’s inception on Dec. 29: 27.4%).

For large-company stock funds, Donner might consider the Schwab 500 Index (year-to-date return as of Sept. 30 since its inception April 30: 6.00%) and Neuberger & Berman Guardian Trust (three-year average annual return: 14.5%).

Her new portfolio is expected to have about a 12% annualized return on a pretax basis, Kochis said. That return figure sounds low to Donner, who sometimes enjoys greater returns on her real estate assets.

Still, Kochis cautions her against just doing what is familiar: jumping for those high returns that can come with greater risk. She is better off being in a diversified portfolio of stocks that are both more liquid and in the long term will offer a greater probability of a higher return.

Kochis developed a plan that assumes that Donner’s stake in her company will be worth $1.9 million when she retires. This assumes a conservative 3% growth rate. The value of Donner’s stake was determined by her and her partners using a gross revenue formula that is standard in the industry. Though the company does not own real estate assets, it has many long-term lucrative property management contracts.

All this would change, of course, if Donner’s company faltered. It would then be less likely that she could reach her current retirement goals.

Trying to value a private company is one of the toughest things for a business owner to do while trying to set up a plan for retirement, Kochis said.

“The big question is whether the company is worth what she thinks it is. The second question is whether it is really going to grow,” he said.

To save the additional $50,000 annually she needs, Donner should try to put at least $15,000 a year into a company-sponsored pension plan. She should put the other $35,000 into her stock portfolio each year.

Donner thinks that might be tough, although she keeps her expenses down. She has about $14,000 on three credit cards that she plans to pay off by year-end. She also has an additional $2,000 of credit card debt. Her car is leased from her company , so she has no car payments.

Donner, who moved from Arizona to Southern California in the last year, is renting rather than owning. She pays about $1,650 a month in rent and that’s a smart move, Kochis said, given that she already enjoys the tax advantages of real estate ownership.

Assuming she follows Kochis’ plan, Donner will retire with the $1.9 million from the company, $900,000 from her investments and $400,000 in her pension plans. Kochis didn’t factor her real estate buildings into the retirement plan, so they could be a cushion that will allow her to leave a legacy to her brother’s children.

Because the $3.2 million Donner would have under the plan would be mostly pretax, she would probably use up all her principal during her retirement years, Kochis said. The plan doesn’t include any Social Security, as those funds may not be available for Donner in the future.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

THIS WEEK’S MAKE-OVER

Investor: Pamela Donner

Age: 44

Occupation: Real estate executive

Annual income: $100,000

Primary investment goal: Secure enough for an early retirement with $100,000 in annual income

Current Portfolio:

Stocks: $79,214 (6%)

$5,800 Janus Worldwide

$5,800 Mutual Series Beacon

$5,000 Northeast Investors Trust

$5,000 Royce Micro Cap

$5,000 Sogen International

$5,000 20th Century Vista

$4,000 Alliance Growth Fund Class B

$3,300 Colonial Newport Tiger Fund Class B

$4,000 Oppenheimer Quest Small Cap B

$4,000 Putnam Health Sciences Trust Fund Class B

$10,000 in shares of Interferon Sciences Inc.

$22,314 Pioneer Mutual Funds II

Cash: $67,000 (4%)

Real Estate: $1.5 million (90%)

$31,000 equity in home in Pueblo, Colo.

$42,000, or 30% ownership, in 38-unit apartment complex in Riverside

$56,250, or 33% ownership, in Chief Auto Parts site in Tujunga

$87,500 equity in 17-unit apartment building in San Bernardino

$1.3-million stake in property management firm

RECOMMENDED PORTFOLIO

Real Estate Equity: Donner should sell her Colorado home now. She doesn’t need to sell all her other real estate holding at this time, but she should put future savings into equities. For now real estate will continue to be 90% of her assets.

Cash: She should reduce her cash position to $20,000 or 2%. That other cash will be used to beef up her stock portfolio to 8% or $136,000 of her overall portfolio.

Stocks:

Of the funds she currently owns, she should sell: Alliance Growth Fund, Oppenheimer, Northeast, Mutual Series Beacon and 20th Century Vista. She should also take a loss in the investment she made in shares of Interferon Sciences and sell it. Her $136,000 earmarked for stocks should be invested 40% or $54,000 in international equities; another 40% or $54,000 in U.S. small company stocks and 20% invested in U.S. large company stocks. All her future investments should go in her equity portfolio.

For the international portion she should buy:

Montgomery Emerging Markets, (800) 572-3863

Warburg, Pincus Emerging Markets, (800) 888-6878

Warburg, Pincus International Equity, (800) 888-6878

T. Rowe Price International Stock, (800) 638-5660

Acorn International, (800) 492-6437

She should keep:

SoGen International, (800) 443-7046

Janus Worldwide, (800) 525-8983

For the small U.S. company stake she should buy:

Heartland Small Cap Contrarian, (800) 432-7856

Mutual Discovery, (800) 448-3863