She’s Got Time on Her Side

As a financial analyst for a Los Angeles venture-capital firm, Deena Williams spent the last two years poring over the financial statements of companies her employer was considering for investments.

But until she lost her job six weeks ago, she spent little time thinking about an equally important balance sheet: her own.

“I’ve lived paycheck to paycheck without any real budgeting or financial plan,” said the Westchester resident, who graduated from USC with a bachelor’s degree in engineering two years ago. Apart from about $5,000 in a company retirement program, “I never really saved much,” she said.

Although Williams was “restructured” out of her $45,000-a-year job, she still got an $11,000 year-end bonus, which has helped tide her over. “If not for that bonus, things could have been scary,” she said.

Williams has several good leads on employment. But the loss of her job has convinced her that it’s time to get serious about her money. Williams knows that she has not been as disciplined as she should have since graduating from college, which she paid for with student loans and part-time jobs. She realizes she’s been living beyond her means, whether it was dining out too frequently or spending too much on clothes.

Now she wants a plan that will compel her to budget her money and create an emergency savings fund. She also hopes to pay off about $5,000 in high-interest credit card debt as soon as she can. And she wants to start making plans for retirement.

At 28, she is young enough to generate a sizable pool of savings for retirement, said Timothy Wallender, a Manhattan Beach fee-only certified financial planner who examined Williams’ finances for Money Make-Over. As soon as she pays off her debts, he said, she can get started in earnest. “It’s good that you’re in the goal-setting process at a young age,” Wallender told Williams.

A substantial savings pool, both in and out of retirement plans, can mean freedom. For example, it can allow a return to school, ease a career change or permit taking time off for family or other reasons.

Williams will be well-positioned once she returns to work because she has a relatively small monthly mortgage payment and her other fixed costs are reasonable, Wallender said. And with 39 years to go before reaching what for people her age will be the standard retirement age of 67, Williams has the luxury of time to help her build a sizable nest egg.

Williams’ first challenge is to change her financial philosophy, Wallender said. Rather than letting her spending dictate her finances, her finances must dictate her spending. That means spending only money she already has after her expenses and savings are taken care of. In practice, it might mean eliminating the occasional ski trip and changing incidental things, such as where she eats lunch.

“I was spending $6 or $7 every day on going out to lunch, and I know that can really add up,” Williams admitted sheepishly.

To begin setting up a monthly budget, Wallender urged Williams to add up all her fixed expenses. These include a $755-a-month payment for her condominium’s mortgage, taxes and insurance, a $126 condo association fee and a $205 car payment. She also pays $226 monthly on her student loan.

The school loan, mortgage and car payments are automatically deducted from her checking account. Wallender applauds that arrangement as a helpful way to avoid the temptation to delay payment of important bills.

To plan the rest of Williams’ budget, Wallender told her to factor in infrequently paid expenses such as car-registration fees and auto insurance. She should divide these by the number of months they cover and count as part of her monthly fixed expenses. Then, by subtracting all fixed monthly expenses from her income once she is again employed, Williams can determine her discretionary income--the money for everyday spending and for savings.

Williams’ immediate problem is the $5,000 she owes on five credit cards, which carry annual interest rates ranging from 15% to 19%. Williams said the debt piled up from a series of purchases on clothing and entertainment.

Those high interest rates “eat away at your ability to save for your other goals,” Wallender warned Williams.

How to go about eliminating the debt? Wallender recommends getting rid of all but one credit card and to keep that one at home with a yellow sticker on it stating “For Emergencies Only.” She should then withdraw enough cash to live on each week and avoid spending any more.

Williams said she has tried removing the credit cards from her wallet before, “but they keep sneaking back in.” Now, though, she says she’ll give the credit-free approach a serious try.

In the meantime, Williams could seek to consolidate her card debts, either onto a new card carrying a low rate for three to six months on transferred balances or with a loan from a credit union or bank.

But the point for Williams and anyone else tempted by easy credit: Live within your means. Overspending by even $20 a week can have a dramatic effect over time. If, for example, you charge $1,000 worth of clothes this year and only pay the minimum due on that balance every month, you would have a debt of $5,234 after a decade, assuming an annual interest rate of 18%. Had that $1,000 instead been put into an investment growing 10% a year, it would be worth $2,594 after 10 years. That $1,000 decision in effect carries a $7,828 potential cost.

The same kind of compounding shows how saving just $20 a week can create a substantial nest egg within a few years.

Creating a financial plan while unemployed is tricky, of course. But it never hurts to get started, no matter what financial shape you’re in. If Williams lands a job quickly, Wallender said, she could realistically expect to have the credit cards paid off within six months.

In fact, much of the debt could be paid off with the bonus money she received if she doesn’t need it to live on in the next few months.

Once Williams is back to work, she should use the remaining bonus money to pay down the credit card debt, Wallender said.

After the credit card debt is eliminated, Williams can turn her attention to her emergency fund--money that would help her through any unexpected financially draining situation. Wallender recommends a reserve representing two to four times Williams monthly expenses.

While still employed, Williams had in fact started what she had intended as an emergency fund, with $1,100 she put into Profit Value Mutual Fund (one-year return: 23.48%). The fund, created just over a year ago, invests mainly in large companies whose stocks it considers undervalued.

But Wallender explained that a stock fund is not an appropriate place for emergency money. A stock investment by definition lacks the short-term security needed for money kept for emergencies. Her investment could be way down just when she needs the money. A drawback for this fund in particular is that it has a relatively hefty 1.95% expense ratio.

Wallender suggests Williams cash out of the fund and use the money to help pay down her credit card debt. If she encounters an emergency, she can tap a credit card. If Williams would feel more comfortable keeping that money available for emergencies, she should transfer it into a money market fund, such as the Strong Money Market fund (currently yielding 5.38%). Money market mutual funds invest in low-risk securities such as Treasury bills, short-term corporate bonds and certificates of deposit, and thus are better suited for rainy-day savings.

The only other non-retirement savings Williams has is $400 through an investment club she and some friends formed last year. Its name is Ujaama, Swahili for “collective economics.” Each of the eight members contributes $50 per month. So far, the group has one holding: 20 shares of Nike stock purchased last November at $49 a share. It’s now around $40.

Wallender was impressed that Williams is interested enough in investing to be part of a club, but he said he discourages his clients from investing in individual stocks. A better bet, he said, is to invest in no-load mutual funds, with an emphasis on index funds. Over time, he said, a portfolio composed of these kinds of investments can be expected to produce better results and have lower volatility.

Many financial planners recommend that inexperienced investors begin with a core holding of mutual funds that mirror standard stock indexes such as the Standard & Poor’s 500 or the Wilshire 5,000. These funds typically have lower expenses and in the current bull market, about 9 out of 10 actively managed mutual funds have failed to match the returns of the S&P; 500.

Williams explained that the investment club is a social as well as a financial group: It keeps her in touch with friends and gives her a forum to discuss money issues. “I wouldn’t increase your contribution above $50 per month,” Wallender responded.

As for retirement, it may seem premature for an unemployed 28-year-old to be thinking about that, but it actually is prudent. By starting now, Williams’ investments will have that much longer to grow. That said, there obviously will be many unknowns in her future that make it impossible to predict exactly how much money she will need. These include whether she will marry, have children, what kind of jobs she will have and where she will live.

For the sake of this planning exercise, Williams figured that she could continue to live on the roughly $33,600 she had in take-home pay last year.

To estimate Williams’ needs, Wallender assumed that she would retire at age 65 and get the equivalent of $10,000 annually in today’s dollars in Social Security benefits.

Assuming inflation continues at a mild pace, Wallender calculates that she will need an after-tax nest egg of about $2.3 million to generate the income to sustain her current standard of living. That sounds lofty indeed, but Wallender assured her that goal is achievable.

Williams has $5,372 invested in three stock mutual funds in her former company’s 401(k) account: Neuberger & Berman Genesis (five-year average annual return: 18.8%), PBHG Growth (five-year average annual return: 21.4%), which invests in small companies, and Schwab 1000 (five-year average annual return: 19.8%), a growth and income fund. Wallender recommends rolling that account over into an individual retirement account--that way she won’t be limited by the small number of choices offered in the 401(k) plan. For the IRA, Wallender recommended Vanguard’s newer Life-Strategy Growth Fund (three-year average annual return: 22.02%), which invests in a variety of Vanguard index funds, and so includes domestic and foreign stocks and bonds. He likes its low expenses and says the fund is diversified enough that investors should be able to ride out the vicissitudes of any single investment category. The fund is designed for investors far away from retirement.

As a rough estimate for returns on that money, and not taking taxes into account: Assuming a 10% growth rate for the next 37 years--the time before she reaches age 65--Williams’ $5,372 would grow to $182,680.

The next piece to fit into Williams’ retirement puzzle is her home. It’s unlikely that Williams will remain in her condo until she retires. But for planning purposes, Wallender assumes that she will in fact stay put and pay off the mortgage on schedule in 29 years. Assuming 4% annual appreciation, the condo would be worth $384,128 when she retires. She would then have the option of living there for comparatively little, increasing her savings or spending at that time, or selling the condo.

The remaining money to reach her target would come from pretax company retirement-savings plans. Williams will need to contribute $7,300 annually to such plans, including any matching amount a company contributes.

“When you think about $2.3 million, it sounds like a lot of money, but you have time on your side to take advantage of the power of compounding,” Wallender said. Williams seemed surprised by the size of the numbers, but she is encouraged that her goal is achievable. In fact, she felt buoyed by the entire financial planning exercise.

“I know where I am financially, and it’s helpful to know where I need to be,” Williams said. Already, she has applied for a low-interest credit card on which she plans to consolidate her debt, and she has established a monthly budget and sent away for mutual fund information.

“A lot of things [Wallender] talked about were things that I had been thinking about but not doing,” she said. “It helps to have someone give you the push.”

Graham Witherall is a regular contributor to The Times. The Money Make-Over column is published most Tuesdays. To be considered for a published 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. Questions can be left at (213) 237-7288. We cannot respond to all inquiries.

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The Situation

Investor: Deena Williams, 28

Income: Last year, $56,000; currently unemployed

Goals: Pay off credit acard debt; create an emergency fund; save for retirement

The problem: Spending is dictating finances

The plan: Finances must dictate spending

This Week’s Make-Over

* Investor: Deena Williams, 28

* Occupation: Financial analyst

* Gross annual income: About $56,000 last year; currently unemployed

* Financial goals: Become debt-free; develop an investment plan

Current Portfolio:

* Retirement account: $5,372 in 401(k) account with former employer, evenly divided among three mutual funds: Neuberger & Berman Genesis, PBHG Growth and Schwab 1000

* Other investments: $1,125 in Profit Value Fund; $400 in investment club, with about a third of that in Nike Inc. stock, and the rest in cash

* Cash: $3,000 in checking account; $475 in savings account

* Debts: $5,000 in credit card debt; 18,000 in student loans

Recommendations:

* Pay off credit card debt as soon as possible; draw up a budget and stick to it.

* Create an emergency fund in a money market account.

* To give herself a wider choice for her tax-deferred retirement savings, Williams should take what’s in her former employer’s 401(k) and roll it over into an individual retirement account to be invested in a mutual fund of index funds.

Recommended Mutual Fund Purchases:

* Strong Money Market Fund: (800) 368-1030

* Vanguard LifeStrategy Growth: (800) 662-7447

Meet the Planner

Timothy Wallender is a fee-only financial planner based in Manhattan Beach.