Out of Gen-X Formation
For most 24-year-olds, financial planning is an alien concept. Many Generation Xers still haven’t figured out what they want to be when they grow up. Serious contemplation of issues like financing college educations for future children, buying a home and retirement? Forget it.
Jim Winner, a first lieutenant in the U.S. Air Force and soon-to-be second-year student at Loyola Law School in Los Angeles, is an exception. The Ohio native started investing a portion of the $200-a-month salary he received while still a teenage cadet at the Air Force Academy in Colorado Springs, Colo.
At first, Winner, who was on the football and rugby teams, socked away a few hundred dollars for big-ticket indulgences such as a self-propelled water ski. But in short order he started to invest in mutual funds, anticipating a future that would include marriage and family.
During a summer internship at the Court of Appeals for the Armed Forces in Washington, D.C., the country’s highest military court, Winner met Mary-Pat McConnin, a law student. They were married in 1994. Winner, a career officer, will graduate from law school in 1999. Then he’ll become a judge advocate general, commonly referred to as a JAG lawyer, working in the military’s justice system.
Twelve months after they were wed, Mary-Pat decided she liked what the Air Force had to offer and decided to become a JAG lawyer herself. She’s now stationed at Los Angeles Air Force Base, a small facility in El Segundo.
Mary-Pat, now 30, also began saving early, starting to invest in mutual funds soon after her 1994 graduation from the George Mason University law school in Virginia.
Now the couple is determined to make the most of their money. They are self-taught investors who aren’t afraid to assume some risk, but they want to make prudent, well-informed choices. They are avid readers of financial magazines and comb prospectuses in search of opportunities.
The Winners have three key goals:
* To pay off $30,000 in student loans that Mary-Pat racked up in law school;
* To purchase a house within three years; and
* To put aside money for the college educations of the two or three children they hope to have.
Since Jim’s got two more years of law school, they are postponing parenthood. That plan will give them a few years to save aggressively, said Edward O’Hara, a fee-only certified financial planner based in Silver Spring, Md.
O’Hara says the Winners have done a good job in managing their personal finances so far, with virtually no debt other than the student loans.
“Most people at their age spend more than they make,” O’Hara notes. But O’Hara recommends that they try to save even more and suggests they tinker with their portfolio to improve its performance.
First, the planner recommends they set priorities for their goals.
“They’re not going to be able to do everything they want to do at this point,” he cautions.
The Winners have $41,000 in total assets, but $30,000 in student loans means their net worth is only $11,000. For their net worth to grow, they’re going to have to reduce their liabilities or invest more.
“There’s no magic to this,” O’Hara says. “It’s just common sense.”
But the Winners hope to both reduce their liabilities and invest more. Their combined gross annual income of $72,630 leaves some extra cash; they are trying to be frugal, however.
“We know expenses will be coming up,” Jim says.
The couple live in a $600-a-month rent-controlled one-bedroom apartment in Santa Monica, carry no credit card debt, drive two modest cars that are paid for and keep a level head about purchases.
“After we pay the bills every month, we don’t go around buying big-ticket items,” Mary-Pat says. But at the same time, they’re not depriving themselves. They spend money on clothes and entertainment, and they’ll occasionally pop for a fun extra. For example, the couple recently flew to Washington, D.C., for a weekend trip to attend a wedding. That set them back $1,000.
“We know it was kind of a lot of money, but we did it anyway,” Mary-Pat says.
Perhaps surprisingly, O’Hara thinks this is good too.
“You’ve got to keep personal happiness in mind,” he says. “Don’t let the numbers drive everything you do.”
The Air Force offers the Winners many financial advantages. It’s paying the full freight of Jim’s legal education, although because he earned a scholarship, the Air Force will not have to cover the entire three-year cost of his eduction--$70,000 to $75,000. Meanwhile, Jim draws an Air Force salary and is required to work for the military during his school breaks.
They shop at the commissary, where grocery prices are 10% to 15% below supermarket levels, and the military provides free medical care, a nontaxable housing allowance, plus other benefits.
In an effort to get the most out of their income, the couple recently started living on one salary. But can they make it on Mary-Pat’s annual net income of $31,200?
“I think we can do it,” Jim says.
O’Hara says that’s a good tactic: “It allows you to identify where the money is. You can actually become more frugal by doing that.”
The planner advises that everyone set up an emergency fund equal to three months’ expenses, just in case. The Winners keep $3,000 or $4,000 in their checking account and $6,000 in a liquid money market fund, so they are in good shape.
At present, the couple is saving close to 10% of their gross income.
“That’s a great number,” O’Hara says. But he recommends that they increase that to 15% to 20% if they can. “It will make things easier down the road,” he told them.
That’s because compounding is wildly more powerful when saving begins early. Investing $10,000 at age 25 with an average annual return of 10%, for example, will give you about $500,000 at age 65. If you save that same $10,000 at age 45, you’ll have just $73,280 at retirement. Taxes may reduce those numbers, but the point remains.
With Air Force pensions and strong savings, the Winners are likely to be able to choose an early retirement or have the luxury of pursuing a less lucrative second career.
Today, the couple have $14,000 in individual retirement accounts invested in mutual funds: Fidelity Low-Priced Stock (three-year average annual return: 18%); Fidelity Equity-Income II (three-year average annual return: 17.05% ); and Fidelity Contrafund (three-year average annual return: 18.47%), which invests in out-of-favor stocks.
O’Hara recommends that they not contribute to their IRAs anymore because a 10% penalty is assessed if the money is withdrawn before age 59 1/2. Because the couple have shorter-term goals than retirement, they should be saving money outside an IRA.
They currently hold three mutual funds outside the IRAs: $5,200 in American Century 20th Century Ultra (three-year average annual return: 17.05%); $3,500 in Janus Growth and Income (three-year average annual return: 21.43%), and $2,700 in Van Wagoner Emerging Growth (a newer fund that has fallen by a third during the last 12 months).
O’Hara recommends that they unload the Van Wagoner fund, a high-risk fund that invests in smaller stocks, many of them technology issues.
In general, O’Hara advises the couple to stay away from mutual funds that are less than 3 years old.
“That way you know what you’re getting into,” he says.
Likewise, he thinks the Winners should sell American Century-20th Century Ultra, a volatile stock fund also heavily invested in technology. Although it’s performed extremely well in past years, it has stumbled recently, and he thinks it is time to get out.
O’Hara recommends buying Vanguard Index Trust 500 Portfolio, a fund that buys stocks in the blue-chip Standard & Poor’s 500. Essentially, this fund follows the general market trend and has low management expenses. It has a three-year average annual return of 24.02% and has been a top performer for 15 years, according to fund rater Morningstar Inc. Of course, it isn’t risk-free--like all index funds, it will follow the market down as well as up.
The planner is also high on T. Rowe Price Equity-Income, a lower-risk fund that invests for income as well as potential growth. It has a solid long-term performance and a three-year average annual return of 21.1%. He also recommends Janus Worldwide (three-year average annual return: 18.11%), which, he says, would expose the Winners to stocks of foreign companies. Since foreign companies may do better than domestic companies in some periods, it is wise to have some global diversification, O’Hara says.
The couple have 30 shares of computer chip giant Intel. The stock is up a nice 100% over the last 12 months. Its average gain for the last five years: 59%.
“I’m going to keep that for the long haul,” Jim says. O’Hara applauds the choice, since Intel is likely to be a leading technology company for a long time.
The Winners’ asset mix right now is 22% fixed income, 78% stock. O’Hara likes it.
“At their ages, they can afford to be aggressive,” he says.
Their most immediate effort is to eliminate debt.
“A lot of times when we have extra money, we’ll pay more on Mary-Pat’s school loans because in our minds that’s a hindrance to bigger savings,” Jim says. “One of our primary goals is to get this loan off our backs.”
As for their longer-term goals, the answers are harder to come by.
First, they don’t know where they’ll be living after Jim finishes law school. The military has the say on that. Wherever they’ll be bound, that assignment will last only three or four years. This impermanence will be a fact of life for perhaps the next 20 years.
“It’s the Air Force,” Jim says.
O’Hara thinks they should not buy a house soon, especially because they enjoy a comparatively low rent now.
But even several years from now, O’Hara isn’t sure a home purchase would make financial sense, considering the sales commissions and other costs of buying and selling they’d have to pay on a property they’d probably have to flip over in a relatively short time. But when the Winners do decide they can take the homeowner plunge, their military status will help tremendously. They’ll be eligible for a Veterans Administration loan, which means they won’t need a down payment.
And what of the Winner children and higher education? O’Hara ran projections of different scenarios for three kids. Varying the amount of annual tuition--from $15,000 to $20,000 a year--and the average rate of return on the funds the Winners will set aside, O’Hara estimates that Jim and Mary-Pat will need to save from $640 to $1,317 a month to finance four years of higher education starting in 20, 22 and 24 years.
Overall, O’Hara is impressed with the couple.
“They’ve started a program, and that’s the best part right there,” he says. Many people seek help when they’re staring at retirement in five or 10 years. “People wait until it’s too late.”
Obviously, this won’t happen with the Winners.
Freelance writer Jennifer Pendleton is a regular contributor to The Times. She can be reached by e-mail at jpendle327@aol.com
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
This Week’s Make-Over
* Investors: Jim and Mary-Pat Winner
* Ages: 24 and 30
* Occupations: Jim is a first lieutenant in the U.S. Air Force and full-time law student. Mary-Pat is a captain in the Air Force and an attorney.
* Gross annual incomes: $72,630
* Financial goals: To pay off student loans, save to buy a home within three years, finance college for two or three future children and save for retirement.
*
Current Portfolio
Mutual Funds
* Jim: $5,000 in Fidelity Contrafund and $2,000 in Fidelity Low-Priced Stock, both invested in an IRA
* Mary-Pat: $5,000 in Fidelity Equity Income II and $2,000 in Fidelity Low-Priced Stock, both invested in an IRA
* Both: $5,200 in American Century-20th Century Ultra; $3,500 in Janus Growth and Income, $2,700 in Van Wagoner Emerging Growth Fund
Individual Stocks
* $4,300 in 30 shares of Intel
Cash
* $9,000 in money funds and checking account
*
Recommendations
* Pay off student loans quickly, as the couple plans.
* Increase savings rate from 10% to as close to 20% as they can, for their goals of buying a home and paying for their children’s educations.
* Stop contributing to IRAs.
* Sell Van Wagoner Emerging Growth and American Century-20th Century Ultra funds.
Recommended Fund Purchases
* Vanguard Index Trust 500 Portfolio (800) 662-7447
* T. Rowe Price Equity-Income (800) 638-5660
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
MEET THE PLANNER
L. Edward O’Hara is a certified financial planner and principal owner of Capital Asset Management Services, a fee-only investment management, tax and financial advisory firm based in Silver Spring, Md. He is chairman of the Financial Planner training program and adjunct professor at Florida Institute of Technology’s Virginia-based graduate center. He serves as president of the National Assn. of Personal Financial Advisors, Northeast/Mid-Atlantic Region.
