They’re Saving the Best for Later
Alvin and Marie Lo have mastered the art of delayed gratification.
Their Alhambra home is furnished with hand-me-downs, they avoid buying brand names, shun expensive restaurants and never carry balances on their credit cards. They keep their eyes open for any kind of bargain--such as a local gym’s recent $30-a-year membership offer.
“Neither of us has very extravagant tastes,” said Marie, who drives a 5-year-old Mazda. Their one big indulgence is Alvin’s leased late-model Saab.
Marie teaches third grade in Arcadia. Alvin is an optometrist. They have always been dedicated savers. Both amassed real estate down payments by living with their parents for several years after they graduated from UCLA. Last summer, when Marie was on vacation, they discovered they could get by just fine on Alvin’s income, about $60,000 a year. So now they’re saving most of what she makes--more than $3,000 in a good month.
And they know the importance of investing all that money they’re saving. At 31, the Los already have a substantial portfolio of real estate, mutual funds and individual stocks.
The couple are confident they’ve laid a strong financial foundation. What concerns them now, as they prepare for the arrival of a baby later this year, is how they should be building from here.
You might say they believe in constructive worrying. Their first baby is not due until October, but they’re already wondering about how much they should be putting aside so that the child can attend a good college.
“Overall,” Percy E. Bolton, a fee-only financial planner based in Culver City, advised the couple, “I think you’re on the right track with your discipline and saving habits, but you need to make some adjustments.”
Starting with the real estate.
“You are extremely over-weighted” there, he told the couple. They have about $70,000 equity in the Alhambra duplex Alvin bought in 1993 and which he estimates is worth about $240,000 now. He and Marie live in one unit and rent out the other. In an effort to build equity quicker and save on interest, he’s been paying an extra $1,400 a year on the mortgage. They have about $114,000 equity in a Torrance house Marie bought, also in 1993. That property, recently appraised at $270,000, is rented out.
The Los say they have had good experiences with their renters and are happy with their real estate set-up, viewing the monthly mortgage payments as a de facto savings plan and the properties themselves as a means of retirement income.
*
“We’d like to hold on to our properties because they pretty much pay for themselves and eventually we’ll own them outright,” Marie explained.
But Bolton doesn’t see it that way.
It takes just one bad tenant to make a landlord’s life hell. “It can take up to six months with no rent to evict” a bad tenant, Bolton warned. Managing income property involves other kinds of headaches, too, he said, pointing out to the Los that “if you’re trying to concentrate on your job and run your family, being a landlord can be a real distraction.”
Those worries aside, Bolton believes the couple could be earning better returns in other kinds of investments. “I expect equities to appreciate much faster than real estate in the future,” he said.
The Los were not persuaded.
They want to buy a new home in about five years. When that time comes, they intend to continue renting out the Torrance house and to rent out both units of the Alhambra duplex.
With those desires in mind, then, Bolton suggested some moves that will reduce the real estate emphasis in the Los’ portfolio, even if they do hang on to the properties.
First, they should consider alternative ways to invest the money going to make the extra payment on the duplex’s 7.152% mortgage. Over the long haul, he explained, that $1,400 a year invested in a mutual fund would be expected to earn more money than they’re going to save on interest by accelerating the mortgage payments.
“Another problem with the extra payment,” Bolton said, “is that you’re unnecessarily turning a very liquid asset--cash--into an illiquid asset--real estate equity.”
Second, they should tap some of their real estate equity when they need a down payment for their next house.
The Los plan to buy a house worth roughly $400,000, and they had considered cashing out of mutual funds to come up with a 20% down payment.
“By refinancing and pulling some equity out of your rentals,” Bolton told them, “you won’t have to sell funds that will likely be generating strong returns. And by pulling equity out of one property to pay for another, you will not be raising the proportion of your wealth invested in real estate.”
Obviously, a higher debt on the rentals will mean higher mortgage payments. But Bolton notes that it’s likely rents will also be higher in five years, keeping the properties at or close to break-even status.
Bolton also encouraged the Los to keep focused on their retirement planning.
The couple hope to retire by age 60. If they can keep up their current saving and spending patterns and do not experience some financial catastrophe, they should enjoy a comfortable retirement.
Marie intends to stay in public education until she’s 60. Assuming she does, she’ll collect a lifetime State Teachers Retirement System pension.
That pension alone will generate about half the retirement income the couple estimate they’ll need. Alvin will be entitled to Social Security, although he and Bolton agree that it would be premature to make any hard-and-fast assumptions about what he could collect, in light of the political debate about changing the system. There would also be the income from their rental properties, which the couple hope to own free and clear before they retire.
The rest of their retirement income would come from their other investments, and here Bolton would like to see the couple make an overhaul. He said their current selection of individual stocks and mutual funds is poorly diversified, exposing them to too much risk.
In retirement accounts--Marie’s 403(b) tax-deferred plan with the school district, Alvin’s simplified employee pension individual retirement account and their IRAs--and outside them, the couple have about $118,000 saved, with $79,150 spread among 13 mutual funds and a total of $38,850 in six individual stocks.
About 60% of the portfolio is in large-company stocks, 13% in small-company stocks and 27% in international stocks.
The proportion of small stocks is about right, Bolton said, but he recommended that the large-stock percentage be cut by about half and that the international holdings be realigned to reduce their exposure to Asia and to increase their exposure to Europe.
He said the Los could also benefit by putting some of their money into bonds--perhaps 30% of the money now in large-cap stock holdings could be reinvested in a mixture of domestic, international and high-yield bond funds.
“You want to be exposed to more asset classes because then you’re less susceptible to a downturn in any one area,” Bolton explained. “Stocks have performed very well in the past few years, but you never know what the future holds, so it’s a good idea to have some bonds to cushion your fall in case of a steep downturn in stocks.”
*
Even though the Los have enjoyed success with some of their individual stock picks--Wal-Mart Stores, for example, is up 30% since October--Bolton frowns on individual stocks for small investors.
“It’s easier to diversify with good mutual funds,” he said, recommending that the couple gradually liquidate their individual stock holdings in favor of funds. “When you buy on the advice of friends,” as the Los have, you tend to purchase what those friends are interested in, such as high-tech.” Indeed, three of the Los’ six stocks--Sun Microsystems, Iomega and Oracle--are technology companies. “Then you don’t get exposed to other areas that have good potential, such as financials or health care.”
But Alvin relishes the challenge of stock-picking. “There’s a certain thrill to buying individual stocks and seeing if you can find the right stock at the right time,” he said.
If the couple insist on holding individual stocks, Bolton responded, they should limit those holdings to 10% of their non-real estate investments.
As for the Los’ selection of mutual funds, Bolton saw some he agreed with and others he thought did not make sense for the couple. Marie’s 403(b) choices, for instance, given the selection available to her, were acceptable, he said. They are T. Rowe Price Equity Income (five-year average annual return: 21.2%) and the newer Janus Overseas and Berger Small-Cap Value. But he disagreed with their holding the newer Warburg Pincus Japan OTC, Fidelity Hong Kong China and Matthews International Pacific Tiger. Experts believe Asia will remain a risky place to invest for some time. Bolton suggested they dump those three funds in favor of two others that would give them a broader international exposure: Vanguard International Growth (five-year average annual return: 15.8%) and T. Rowe Price International Stock (five-year average annual return: 14.1%).
In making bond investments, Bolton encouraged the Los to consider three funds: Dodge & Cox Income (five-year average annual return: 7.8%), Federated High Yield (five-year average annual return: 11%), and the newer MAS Funds International Fixed Income.
As for saving for college for their offspring, Bolton estimated that the Los will need to set aside $364 a month for the next 18 years to reach a target sum of $100,000 in today’s dollars. He recommended that about 55% of the money be invested in U.S. stock mutual funds and 45% in international stock funds.
Bolton also urged the couple to take advantage of the new tax break known as an education IRA, which allows savers to set aside $500 a year in after-tax money for a child’s education. Earnings on the savings grow untaxed and are not taxed when withdrawn for education purposes.
The planning session complete, Bolton offered the Los a few words of encouragement: “I’ve seen people who earn much more than you but who don’t save nearly as much. You’ve been very good at setting goals and working to achieve them. You are already in a financial position that many people in their 50s or 60s would envy.”
The Los, for their part, were happy to hear an impartial professional say that their goals are achievable. They said they will be making most of the recommended changes--although Alvin’s vow to stop buying individual stocks sounded a bit less than convincing.
“Percy’s investment recommendations make sense,” Marie said. “It’s good to hear that we are on the right track.”
Graham Witherall is a regular contributor to The Times. To be considered for a 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.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
This Week’s Make-Over
*Investors: The Los, Alvin and Marie, both 31
*Occupations: Optometrist and teacher
*Combined gross annual income from employment: About $107,000
*Financial goals: Retire comfortably at 60 and be able to send children to a good college
*
Current Portfolio
*Real estate: About $70,000 equity in Alhambra duplex worth an estimated $240,000, and $114,000 equity in a Torrance house worth an estimated $270,000
*Retirement accounts:
Marie: $6,000 in 403(b) plan, invested in the mutual funds Janus Overseas, Berger Small-Cap Value, T. Rowe Price Equity Income; about $11,000 in IRAs invested in Warburg Pincus Japan OTC and Matthews International Pacific Tiger
Alvin: $3,000 in a SEP-IRA in American Century-Twentieth Century International Growth; $9,500 in IRAs invested in four Fidelity funds--Hong Kong and China, Contrafund, Southeast Asia, Low-Priced Stock
*Other investments: About $38,850 total in the stocks of Boeing, Indiana Energy, Iomega, Oracle, Sun Microsystems, Wal-Mart Stores; about $49,650 in Fidelity Contrafund, Alger Small Capitalization, Central European Value and Merrill Lynch S&P; 500 Index
*Cash: About $16,000 in savings, checking and money-market accounts
*
Recommendations
*The couple should take care that their real estate weighting, which financial planner Percy Bolton believes is already too heavy, does not become heavier yet.
*Realign other investments to achieve a broader diversification. Limit individual stock holdings to 10% of non-real estate investments.
*To build a college fund for their first child (the baby is due in October), set aside $364 a month for the next 18 years, and invest those savings in stock mutual funds.
*Recommended Mutual Fund Purchases
Bond Funds
Dodge & Cox Income: (800) 621-3979
Federated High Yield: (800) 245-5040
MAS International Fixed Income: (800) 354-8185
International Funds:
T. Rowe Price International Stock: (800) 638-5660
Vanguard International Growth: (800) 662-7447
Meet the Planner
Percy E. Bolton, a fee-only financial planner, is founder and managing associate of Percy E. Bolton Associates in Culver City. He is a former vice president of the Institute of Certified Financial Planners. He provides consulting services to individuals, investment committees and trustees.
