Not the Retiring Types
When Robert Pedigo met Cynthia Anderson eight years ago in San Francisco, he was lucky to have $20 in his wallet and enough in the bank to cover the next month’s rent. Unpaid back taxes and student loans totaled $16,000. Saving was something other people did.
Anderson, for her part, was living comfortably within her means and had accumulated a nest egg equal to six months’ living expenses. If not her top priority, financial security was certainly never far from it.
Today, after four years of marriage, Pedigo and Anderson describe themselves as two middle-aged (he’s 50, she’s 42) freelancers (he’s a photographer, she’s a video producer). They recently bought their first home, a cozy bungalow the couple calls “the cheapest in Culver City,” and have some money--$93,400--saved, but no coherent strategy for investing it.
And though they worry that they’re “frightfully behind regarding retirement savings,” the good news is that they have no debts except a mortgage, are saving a whopping 25% of their $108,000 gross annual income, and together have started a sideline wedding photography business that is steadily attracting clients.
Fortunately, retirement, at least in the normal sense of the word, is not in their plans.
What Anderson and Pedigo want is enough financial security to continue their current life of freelance work and regular foreign travel indefinitely, adjusting the proportion as they age.
Now, they work far more than they travel, though in recent years they’ve been to Turkey and Portugal, and they’re planning a monthlong sojourn in Mexico later this year. But as the years go by, they want to work a lot less and travel a lot more.
“I can’t imagine not working,” Pedigo says, as Anderson nods, “but I’d like to be doing the jobs I want at the pace I want.”
As do all self-employed people, Anderson and Pedigo have a great deal of control over their work and can take a flexible approach toward their retirement.
The fact that Anderson and Pedigo like the idea of working long into the traditional retirement years makes it less urgent that they have a large nest egg. For as long as they can attract clients, their continued earning power can make up for their late start at saving.
But their current challenge, says Tom Lancaster, an investment advisor and pension consultant in Lake Forest, is to remain financially disciplined during their years of peak earning power while still satisfying their wanderlust.
If they can do it, Anderson and Pedigo should achieve their goal of greater financial freedom by the time Pedigo qualifies for his first full Social Security check in 16 years. (The age for full benefits rises to 66 in 2008 and hits 67 in 2024.)
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Lancaster’s plan, which assumes an average annual inflation rate of 4% and an average annual return of 10% on investments, would produce a portfolio for Anderson and Pedigo that is worth more than $900,000 by the year 2012. Lancaster says earnings on the portfolio should replace about 50% of the couple’s current inflation-adjusted income by the time Pedigo turns age 65.
“Your late start hinders your progress toward your goals,” Lancaster told the couple, “but your inherent thriftiness bodes well for the effort.”
Why did Anderson and Pedigo wait for so long to think about retirement?
Pedigo, like so many of the baby boom generation, says he could never really take the concept of retirement seriously, let alone visualize himself as actually being retired.
And besides, he adds, money has never been terribly important to him.
“I’m a Vietnam vet. I’m just glad to be alive,” he says. “I never thought about retirement until I got married and saw how important all this financial security is to Cynthia.”
Although Anderson acknowledges that, she confesses that because she doesn’t understand investments, her concern usually just made her worried that she would spend her retirement years “alone in an apartment eating cat food,” but too paralyzed to do much beyond opening a money market account.
Since becoming a couple, though, Anderson and Pedigo have made considerable progress toward building a firm financial future.
When they moved to Los Angeles five years ago, Anderson recalls, their annual incomes increased immediately and have been rising steadily since then. Today, they each earn about $54,000 a year.
Beginning in January 1996, the couple started saving 50% of their gross income, much of which they later used to start their wedding photography business.
A few months later, they found a two-bedroom cottage in Culver City for $167,000, and took advantage of Pedigo’s still-unused Veterans Administration loan eligibility for a no-down-payment mortgage. The monthly payment, including taxes and insurance, is nearly $1,600 per month.
Although the couple is now saving 25% of their gross income, it would be better yet if they could save more. Anderson says that a thorough scrutiny of their spending, which Pedigo faithfully records on a legal pad each month, will uncover potential sources of additional savings.
Lancaster’s plans assume such thriftiness, along with a good dose of immediate attention to critical issues such as wills, life insurance and disability insurance--none of which Anderson and Pedigo have.
Lancaster also suggests that the couple establish a medical savings account through Anderson’s health insurance provider, Blue Shield PPO.
MSAs, which were designed for the self-employed and those who work for small companies, allow individuals to deposit pretax funds into the account and let them accrue interest tax-free. All withdrawals are tax-free if they are used for medical expenses. Untapped balances may be rolled over year to year for future medical needs at retirement.
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Because the couple, as freelancers, can’t count on a predictable, steady income, Lancaster recommends that Anderson and Pedigo create a “rainy day” savings account to cover six months’ worth of living expenses. The easiest way to do this, he says, is to leave $18,000 of the $36,000 currently in Anderson’s name in the Franklin Money Fund. (The rest will be invested elsewhere.)
Another jointly held Franklin Money Fund account, which now contains $40,000, should be converted into a “life and living” account to cover travel expenses and tax bills. Lancaster recommends using $8,000 of the money already in that account for this purpose, and that the couple deposit an additional $750 into the account each month, along with the $70 that the “rainy day” account should produce each month in interest. (The $32,000 balance will be invested elsewhere.)
Although there are other money funds with better return records, Lancaster said Anderson’s comfortable 15-year relationship with the fund was reason enough to stay. Money fund interest rates do not vary much, anyway.
Lancaster says Pedigo and Anderson should immediately begin making the maximum contributions the Internal Revenue Service allows to their SEP/IRA plans, which are tax-deferred retirement accounts available to the self-employed. This year, that amount is about $7,020 for each. Neither has ever made the maximum contribution allowed to the SEP/IRA.
Anderson currently has $9,100 in her SEP/IRA invested in USAA Cornerstone Strategy Fund (five-year average annual return: 14.4%), a multi-asset global fund that Lancaster said has had fair-to-middling returns. Lancaster suggests dividing that sum and future contributions between two Janus mutual funds: Flexible Income (five-year average annual return: 9.3%) and Worldwide (five-year average annual return: 21.4%).
Janus Worldwide was selected on the strength of fund manager Helen Young Hayes’ performance over the last five years. Lancaster says Hayes selects companies, not countries or themes for the fund, and that she searches the globe, including the United States, for companies that meet her performance criteria.
Janus Flexible Income, a bond fund, was selected to give the couple’s overall portfolio some diversification and to drop the monthly dividends produced by the fund into a tax-sheltered account. Although this investment is admittedly conservative, Lancaster says that because this fund is “flexible,” it is able to invest somewhat more aggressively and change investments more quickly than traditional bond funds.
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To further diversify their portfolio, the $5,500 in Pedigo’s SEP/IRA, also in USAA Cornerstone Strategy, should be invested differently. The current balance and future contributions should be divided between two Neuberger & Berman funds: Partners (five-year average annual return: 22.7%) and Genesis (five-year average annual return: 22.5%).
Lancaster selected Genesis, a relatively new creation, because of the strength of the company’s management and because that fund invests in small companies, providing investors an opportunity to share in some fast growth.
He selected its older sibling because recent new management of the growth fund has gained a reputation for aggressive stock picking. Equally important, both funds should appeal to Pedigo’s desire to be more aggressive with his portfolio.
With the remaining $52,800 in the couple’s Franklin fund and a credit union account, Lancaster recommends the following:
* Put $12,800 into the Dodge & Cox Stock Fund, a growth-and-income fund that Lancaster says “has everything that one should look for in a mutual fund: low risk, outstanding long-term returns (19.22% average annual return for the last 15 years; its five-year average annual return is 22.8%), low expenses . . . and a management team that has been in place for 19 years.” Each month the couple should deposit $250 into the fund.
* Put $15,000 into the T. Rowe Price International Stock Fund (five-year average annual return: 13.2%), which Lancaster says “will deliver the international diversification to the portfolio without exposing it to unnecessary risk and/or volatility.” Each month the couple should deposit $100 to the fund.
* Put $15,000 in Cohen & Steers Realty Shares, a real estate investment trust, or REIT, that Lancaster selected because it is not directly tied to the “changing fortunes” of the stock market and because it boasts of a five-year average annual return of 19.51%. “This fund can be expected to zig when most of the rest of the market zags,” he says.
* Put $10,000 into Baron Asset Fund (five-year average annual return: 24.4%), which, because it invests in small companies, is the highest-risk investment Lancaster recommends for the couple. But Lancaster says the fund has the greatest potential for highest return because manager Ronald Baron operates it with a keen eye to economic and social trends.
Some, Lancaster says, call this the “boomer fund” because of its emphasis on companies that “will be benefiting most from the needs of the baby boom generation.” It was named one of the “Ten Terrific Funds” in the July 1997 issue of Morningstar Investor, a trade magazine published by fund tracker Morningstar Inc. Each month the couple should deposit an additional $150 into the fund.
Finally, Lancaster said, beginning next year Anderson and Pedigo should take advantage of the new Roth individual retirement accounts and each open one and begin depositing $2,000 annually into it. These accounts, created in the tax law signed last month by President Clinton, allow taxpayers another tax-advantaged vehicle to save money for retirement.
Contributions are not tax deductible, no matter your income. However, the returns on them accumulate tax-free, and withdrawals from the account by taxpayers at least age 59 1/2 (or for certain other limited purposes) will never be taxed on an account that has been open for at least five years.
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Pedigo and Anderson say they feel a great sense of relief and are pleased with Lancaster’s plan.
“It’s a big thumbs up for us,” Anderson says. “We were surprised at how positive the news was. We now realize that we do have enough money--or at least can get enough money--for our retirement years.”
The problem, as Anderson recalled it, was that friends kept insisting that she would need a minimum of $1 million before hitting retirement age, words that left Anderson “totally intimidated” because she says she couldn’t fathom how the couple could ever reach such a lofty goal given their late start.
But now the goal doesn’t seem so distant or elusive. And if they are indeed able to work for decades, it isn’t even so important.
“There are three ways to accumulate wealth,” Lancaster told the couple in his plan for them. “Make more money; spend less money; and make the money you already have work harder for you.” The plan he presented, Lancaster added, “will take care of No. 3. The first two are up to you.”
* Carla Lazzareschi is The Times’ Money Talk columnist. To participate in Money Make-Over, send your name, age, phone number, income, assets and financial goals to Money Make-Over, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053.
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This Week’s Make-Over
* Investors: Robert Pedigo and Cynthia Anderson
* Ages: 50 and 42
* Occupations: Pedigo is a freelance photographer; Anderson is a freelance film and video producer.
* Gross annual income: About $54,000 each.
* Financial goals: An investment plan that allows for retirement savings and for annual travel now.
Current Portfolio
* Net worth: About $100,000
* Pedigo: $2,800 in the Long Beach Schools Federal Credit Union, $5,500 SEP/IRA invested in USAA Cornerstone Strategy Fund.
* Anderson: 20 shares of stock in Coherent Inc., a laser company; $9,100 SEP/IRA invested in USAA Cornerstone Strategy; $36,000 in Franklin Money Market Fund.
* Jointly: $40,000 in Franklin Money Market Fund.
Recommendations
* Address estate planning and insurance issues. Have wills prepared immediately. Buy $100,000 10-year level term life insurance policy on Pedigo to give Anderson, who is concerned with financial security, assistance in case of his premature death. Consider disability insurance for Pedigo, though securing a policy for an individual can be expensive and difficult in California.
* Consider establishing a medical savings account through Anderson’s health insurance provider, Blue Shield PPO. (For more information on the program, see Blue Shield’s Web site: https://www.blueshieldca.com)
* Create a stable $18,000 “rainy day” emergency fund from some of what’s in the money fund accounts. Establish a separate $8,000 account for travel and taxes and replenish it with regular monthly contributions of about $750, plus the interest earned by the $18,000 account.
* Take the remaining $52,800 in Franklin Money fund plus the $2,800 in the credit union account (which should be closed) and make the following mutual fund investments:
$12,800 in Dodge & Cox Stock ([800] 621-3979); add $250 monthly
$15,000 in T. Rowe Price International Stock ([800] 638-5660); $100 monthly
$15,000 in Cohen & Steers Realty Shares ([800] 437-9912)
$10,000 in Baron Asset ([800] 992-2766); $150 monthly
* Transfer the $9,100 in Anderson’s SEP/IRA in equal amounts to two Janus funds ([800] 525-8983), Flexible Income and Worldwide. Make annual contributions at legal maximum rate (about $7,000 annually) and divide them the same way.
* Transfer the $5,500 in Pedigo’s SEP/IRA in equal amounts into two Neuberger & Berman funds ([800] 877-9700), Partners and Genesis. Make annual contributions at maximum legal rate and divide them equally.
* When Roth IRA accounts become available next year, each partner should open one and begin contributing $2,000 a year to it.
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Meet the Planner
Tom Lancaster is an investment advisor and pension consultant in the Lake Forest office of Royal Alliance Associates Inc. He specializes in retirement planning, investment portfolio risk management and charitable giving strategies for businesses and individuals.
