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Pat Miller, 58, is six years from retirement and terrified she could run out of money in her old age.
It’s not that Miller, who teaches English as a second language for adults in the South Bay, didn’t start thinking about retirement before now.
Quite the contrary. She had been saving for years and had a nest egg of a few hundred thousand dollars when she started talking nine years ago with a real estate investment manager who was a member of her church. He said he wanted to help her secure her future. With that kind of personal reference, how, she thought, could she go wrong?
The man headed a small private company that managed real estate partnerships, and he persuaded her to invest in it. The California real estate market was red-hot then, and many people were climbing on the partnerships bandwagon, expecting to profit from rising real estate values and from the income generated from property rentals.
For a while, everything went well. She was getting checks from her investment, and she thought she had chosen something secure.
Everything was going so well, in fact, that over a three-year period ending in 1990, Miller put the bulk of her savings--more than $200,000--into 11 equity limited partnerships. Miller had heard that it’s important to diversify one’s investments, but the fact that she had so many different stakes rather than a single one meant, she thought, that she had a diversified portfolio.
And then everything did go wrong. The California real estate market went bust. Many properties the partnership invested in were abandoned to foreclosure; of those remaining, none has operated successfully enough to pay out cash distributions, according to Miller’s records. Her investment had become all but worthless.
It was a loss that pushed her into a depression so deep that she cried nearly every day, even on breaks at work. From then on, she vowed, no more surprises. She would have to understand everything she invested in, and it would have to be rock solid.
In not understanding what she was investing in, Miller made, to be sure, a serious mistake. Real estate limited partnerships--not to be confused with government-regulated real estate investment trusts--are, for several reasons, one of the riskiest places a small investor can put money. But she compounded her error by not having a truly diversified portfolio.
It’s all too tempting to keep putting money into an investment--even one you understand--if it’s doing well, whether it’s real estate, your employer’s stock or anything else.
The greater the concentration, the greater the risk and the greater your potential for losses should something untoward happen.
Miller, who has a son, 29, earns about $35,000 a year from her job. She now has her savings in three safe but low-returning vehicles: about $70,000 in bank certificates of deposit; about $77,000 in a guaranteed-return annuity in her 403(b) tax-deferred retirement savings plan; and $20,000 in an IRA savings account with her teachers credit union. None of these is bringing her a great return.
Fortunately, Miller owns a three-bedroom house in Hermosa Beach that she is only a few years away from paying off--she owes just $30,000 on it. She estimates the property is worth about $350,000.
Since the real estate partnerships fiasco, things have been tight. Miller hasn’t been able to save much, although she’s been trying to cut her expenses by taking in renters. She did manage to put aside $3,000 for a trip to spend this past Christmas with a friend in Bethlehem, and a like amount for her son’s wedding next month.
It seemed to her, she told fee-only financial planner Preston Caves in Manhattan Beach, that she was facing a real dilemma: At her age, she wouldn’t have time to recover from another big loss in either stocks or real estate, but if she didn’t start getting better returns from her savings, she’d be forced from her house at some point. She was feeling desperate. What to do?
Miller had been estimating that she would need $2,000 a month in retirement, including mortgage payments for the first several years, to maintain an acceptable standard of living.
She is counting on a lifetime pension of about $1,000 a month from the State Teachers Retirement System, or STRS, a program similar to Social Security that is run under state jurisdiction for certain categories of professionals, including teachers. But Miller, because more than half her working life was spent in the public sector, won’t be able to count on any Social Security.
Tina Kaufman, retirement systems coordinator for the Los Angeles County Office of Education, which administers the STRS program for the county, says some public sector employees aren’t entitled to the same Social Security benefits they might otherwise expect. When STRS kicks in, these people’s Social Security benefits are reduced, sometimes dollar for dollar. The reasons for this are complicated, but essentially, the law was written this way to prevent a kind of “double-dipping” whereby a public employee getting a state or local government pension would also get full federal Social Security based on a minimum numbers of years of work in the private sector. Nonetheless, most people who also worked in the private sector “can still collect something from Social Security--but not always,” Kaufman said.
Unfortunately, Miller, who worked for many years as a flight attendant, is in the “not always” category.
The question, Miller had thought, was how to generate another $1,000 a month from her savings.
But Caves pointed out that her calculations were in error. Miller, he said, had underestimated her monthly expenses by about $700. Items she had neglected included $150 a month for car replacement; $150 for home maintenance; and $200 a month for travel, something she enjoys immensely.
Until four years ago, Miller was taking about a dozen trips a year--to Europe, Asia, the Middle East--with a friend who worked for an airline, thus being able to travel for next to nothing. Then the friends parted ways. Although Caves’ travel allowance would restrict her to mostly low-cost domestic trips, it would keep her from being totally cut off from an aspect of her life she loves.
The remaining $200 comes from factoring in the effect of inflation, Caves said.
Caves said Miller also did not consider the “present value” of her retirement account. Caves figured that those STRS payments over a likely retirement of 200 months are worth the equivalent of having $115,000 now.
The significance goes beyond making Miller feel wealthier. The guaranteed retirement income from STRS means Miller is in better shape financially than she thinks she is, and that she can take more risks with her investments now than would otherwise be the case, Caves said.
How much more risk could she take while still maintaining her newly reacquired peace of mind?
True, that is a decision any investor must ultimately make for herself, on the basis of the best available information. Risk measurement may help one in deciding, but it is essentially an estimate, generally based on how various investments have performed in the past. The future may be different, whether because of changes in the nature of the economy, major technological breakthroughs or some kind of disaster.
Caves asked Miller to consider her risk tolerance with the help of an asset allocation chart that he gives nearly all of his new clients. It provides expected rates of return for various hypothetical portfolios on the basis of levels of risk--reduced risk, medium risk and increased risk. Numbers are adapted from the distribution of actual results over a 65-year period to show the range, with a 95% probability, of positive returns or losses each strategy could be expected to generate.
Each portfolio has six major asset classes: cash, U.S. taxable bonds, international bonds, U.S. stocks, international stocks and real estate.
The projected annualized return ranges from roughly 6.7% for the reduced-risk portfolio to 8.2% for the medium-risk portfolio to roughly 10.4% for the increased-risk portfolio. Conversely, the reduced-risk portfolio would not be expected to lose more than roughly 6.1% a year; the medium-risk, 11.4% annually; and the increased-risk, roughly 18.9%.
Over time, Caves explained to Miller, the increased-risk portfolio could generate a return about 50% higher than that of the reduced-risk portfolio, but over the shorter term, it could also sustain losses more than three times greater than those of the reduced-risk portfolio. One thing for anyone looking at such projections to keep in mind, though, is that these figures are averages. In reality, there could very well be several years of losses before the investments would start gaining again.
Miller, whose new portfolio would consist of mutual funds, decided on something midway between the reduced- and medium-risk portfolios.
Within that framework, Miller and Caves agreed on the general proportion of stock funds (40%) to fixed-income funds, generally ones that invest in bonds (60%). The mutual funds should be diversified, with roughly two-thirds of those being funds that invest in U.S. companies and one-third being funds that invest in foreign companies. No-load funds, he told her, would make her investment dollars go further.
As for actual purchasing, Miller could buy the funds directly from each fund family, “the cheapest--but also the most time-consuming way,” Caves said, or she could go through a fund supermarket such as the one offered by discount brokerage Charles Schwab. A fund supermarket is a selection of mutual funds--the largest supermarkets offer more than 1,000 choices--from various companies, all of which can be bought through the one source.
Investing through a fund supermarket would simplify the record keeping--all her holdings would appear in a single statement.
To start the new portfolio, Miller would cash out of the CDs when they mature and invest the roughly $70,000 in the following mutual funds: $21,000 in Vanguard Index-Trust 500 (five-year average annual return: 19.4%), a large-cap stock fund fund that seeks to replicate the performance of the Standard & Poor’s 500 stock index; $17,000 in Managers Special Equity (five-year average annual return: 17.9%), which invests in small U.S. companies; $27,000 in T. Rowe Price International Stock (five-year average annual return: 12.5%); and $5,000 in the newer Acorn International (five-year average annual return: 13%), which invests in small foreign companies.
The $20,000 in the credit union individual retirement account would be rolled over into another IRA and invested as follows: $8,000 in Vanguard Specialized Energy (five-year average annual return: 17%), a sector fund, and $12,000 in Pimco Total Return Institutional (five-year average annual return: 8.8%), which invests in U.S. government and corporate bonds. The Pimco selection is an institutional fund favored by top mutual fund advisors and usually requires a minimum investment of $5 million, he said. However, a small investor can also buy into the fund through certain fund supermarkets.
With this, he told Miller, “you’re getting what the big institutions get, something which is generally beyond the reach of little people.”
To reinvest the $77,234 in her 403(b) annuity, Miller would surrender the annuity contract, which would involve certain charges, and do a tax-free exchange to an account permitting mutual fund investments. The reasoning is that Miller would avoid the annuity contract charges she’d incur if she merely changed her present annuity contract to one offering mutual fund options.
Part of that money would go into bond funds: $24,000 in Strong Government Securities (five-year average annual return: 8.2%), $13,500 in T. Rowe Price International Bond (five-year average annual return: 8%) and $10,000 in Northeast Investors (five-year average annual return: 14.6%), which invests in high-yield corporate bonds. Part would go into stock funds: $9,734 into Harbor Capital Appreciation (five-year average annual return: 19.3%), a large-cap growth fund, and Sound Shore (five-year average annual return: 20.6%), a mid-cap fund that focuses on the stocks out-of-favor companies. The remaining $5,000 would go into Cohen & Steers Realty Shares (five-year average annual return: 18.5%), which invests in real estate investment trusts.
Caves chose the real estate and energy funds because they have low correlations to the U.S. stock market and thus would provide a further measure of stability for someone a bit leery of investing.
Although this portfolio will generate money for Miller in retirement, she will still have to draw on her principal, so that by age 78, all her savings would be gone. Caves recommended that when Miller is around that age, she consider taking out a reverse mortgage on her home. In a typical reverse mortgage arrangement, the lender makes monthly payments to the homeowner. There can be any of a number of other loans and contingencies attached, depending on what the homeowner wants and what the lender will offer. For Miller, though, the most important thing would be that she would get to keep her house indefinitely and still have adequate money to live on.
Caves also advised Miller to get a durable limited power of attorney, allowing her son or a designated agent to manage her finances, including paying bills or directing her investments should she be unable to. This is a standard recommendation for single people who want to take care of this matter in a simple way. “Because she’s 58, she has more of a chance of getting ill than [does] someone younger, and so taking such a step becomes more urgent,” Caves said.
Miller could get a limited power of attorney document for a few hundred dollars or less, he said. Were she to be become disabled without doing so, he said, a family member would have to obtain a “cumbersome and expensive” conservatorship, requiring the court to OK any changes in the estate for the duration of the disability. Such a conservatorship would boost costs into the thousands of dollars--money her estate could ill afford to spend, he said.
For Miller, all this advice gives her a lot to think about. But, she said, it’s a relief to finally have a direction.
*
Joseph Hanania is a regular contributor to The Times. 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.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
The Situation
* Investor: Pat Miller, 58.
* Gross annual income: $35,000
* Occupation: Teacher
* Goal: To have enough money to last through retirement.
* The problem: Investor suffered heavy loss several years ago, so savings now invested too conservatively.
* The plan: Invest in a diversified mix of stock and bond mutual funds that will produce better returns at acceptable risk. Around age 78, take out a reverse mortgage on home.
This Week’s Make-Over
* Investor: Pat Miller, 58
* Occupation: Teacher
* Gross annual income: $35,000
* Financial goals: To have enough money to last through retirement and remain in the home she owns
Current Portfolio:
* Real estate: Estimated $320,000 equity in Hermosa Beach home
* Cash: About $70,000 in certificates of deposit
* Retirement accounts: About $77,000 in a guaranteed-return annuity in 403(b) tax-deferred savings plan; about $20,000 in credit union savings in an IRA
Recommendations:
* Invest the approximately $167,000 in retirement savings in a diversified new portfolio of mutual funds, with 40% of assets in stock funds and 60% in bond funds.
* Miller will have to draw on her principal in retirement, so her savings will be gone by the time she is 78. Around that time, she should take out a reverse mortgage on her home to tap its equity.
* Provide for a durable limited power of attorney for her son or for another person, which will allow someone else to manage her finances should she become unable to.
Recommended Mutual Funds:
Stock Funds:
* Acorn International: (800) 922-6769
* Harbor Capital Appreciation: (800) 422-1050
* Managers Special Equity: (800) 835-3879
* T. Rowe Price International Stock: (800) 638-5660
* Sound Shore: (800) 551-1980
* Vanguard Index-Trust 500: (800) 662-7447
*
Bond Funds:
* Northeast Investors: (800) 225-6704
* Pimco Total Return Institutional: (800) 800-0952
* T. Rowe Price International Bond: (800) 638-5660
* Strong Government Securities: (800) 368-1030
*
Sector Funds:
* Vanguard Specialized Energy: (800) 662-7447
* Cohen & Steers Realty Shares: (800) 437-9912
Meet the Planner
Preston S. Caves is a fee-only certified financial planner and chartered financial analyst. His firm, Caves & Associates in Manhattan Beach, specializes in investment management consulting for retirement plans and large private portfolios. Caves also helps people with special financial planning needs, such as business owners and individuals with high net worth. He has an undergraduate degree and a master’s of business administration from Stanford University.
