Advice to 24-Year-Old: Sit Tight and Salt It Away
Living with her parents might not be Kristine Chang’s ideal arrangement, but moving back home to Palos Verdes has allowed her to save more than $30,000 in her first two years out of college.
Chang, 24, tucks away about $2,300 each month, about half her pay from her job as a computer systems consultant for PricewaterhouseCoopers. A recent raise put her annual salary at about $57,000.
Although she enjoys watching her savings grow, the 1997 UC Berkeley graduate is eager to have her own place. And instead of renting an apartment, which she views as a waste of money, she wants to buy a home or condominium in the South Bay area with a high school friend. Chang and her friend already have started looking for a place in the $300,000 range.
Her other priority is to lower her taxes, possibly by taking advantage of her parents’ offer to shift a portion of their real estate holdings to her. Right now, Chang’s only tax-saving strategy is contributing 6% of her pay to her 401(k).
“I’m interested in lowering my taxes and figuring out what I should do with my money,” Chang said. “Should I buy stocks, mutual funds, a home? I’m not really sure.”
Percy E. Bolton, a fee-only certified financial planner in Los Angeles, said Chang is financially precocious and, because she is in a profession that provides opportunities for advancement, can be confident of the future. “If you stay on course,” he advised her, “you’re on your way to wealth.”
Chang’s assets include $13,000 in a checking account and about $10,000 in brokerage accounts, mostly invested in equity funds and technology stocks. She has about $5,400 in her 401(k), invested in a variety of equity funds. Her only debt is the $11,000 she owes on her 1999 Honda Accord.
Chang describes herself as fairly frugal, although she says she could eat out less and buy fewer clothes. Aside from her $350 car payment, her only monthly obligation is the $300 she gives her parents to help with food, phone and utility costs. Because she attended a state university and won a few scholarships, she finished school without a heavy student loan burden.
After reviewing her situation, Bolton discouraged Chang from buying property soon, for several reasons.
First, he noted, the longer she has low living costs, the more liquid assets she can build up.
“If you save $24,000 a year, you’ll eventually have a substantial estate,” Bolton said.
Also, the planner said it is risky for young, single people to buy property, because their lives often change rapidly. There is a high short-term risk that real estate prices will fall, and property is expensive to sell and often difficult to rent out.
“What if you get married in five years and your husband owns a place?” Bolton asked Chang. “What if your place becomes too small?
“You should enjoy being free and easy while you can,” Bolton advised Chang, noting that life naturally grows more complicated as the years pass by.
“If I were in your position, I would delay as long as I could and accumulate wealth by saving and investing. Once you’ve figured out all the things you want to do, like where you want to work, you can make more major commitments.”
Bolton cautioned that there are special risks involved in buying real estate with a friend.
For instance, if Chang’s friend became unable to share the mortgage payments or decided to move out, Chang could be stuck with the entire cost. And she and her friend may also have different ideas about how much to spend on furnishings, improvements and repairs, which could create ongoing conflict.
The planner said that condominiums can be especially risky, because they are often harder to sell than single-family homes and require close contact with other owners.
“Sometimes you can be at odds with your neighbors [in keeping] the property improved and the value up. And in your position, since you’re traveling a lot, you don’t have time to go to [condo association] meetings to make sure your interests are considered,” Bolton said.
Despite Chang’s resistance to the idea of renting, Bolton said it is a logical step. Renting would allow her to set up her own household and get a sense of the costs of living without the risk of buying. For some people, especially disciplined savers such as Chang, there may not be a big financial difference between renting and buying.
“You can find a fairly nice place in the South Bay for $1,000 a month,” he said. “You won’t be able to save as much as before, but you’ll have your independence. But if you buy property, I guarantee almost all of your income will go toward your mortgage and maintenance.”
In any case, Bolton recommended that Chang increase her 401(k) contribution to the maximum 16%, which will allow her to shelter a larger portion of her income from taxes. (Chang currently contributes 6%, the maximum that her company will match at 25 cents on the dollar.) That will still leave plenty of room to save for shorter-term expenses or a home.
If she decides not to buy property, Bolton recommended that her 401(k) be invested as follows: 62% in a Standard & Poor’s 500 index fund; 20% in an international fund; 10% in an emerging markets fund; and 8% split between small-cap growth and value funds.
However, if she moves ahead with homeownership, Bolton suggested a more conservative investment strategy, because Chang may want to take advantage of rules allowing her to borrow up to $10,000 from her 401(k) to acquire her first home.
“If [buying a] home is very important to you, you shouldn’t be too aggressive with your investments,” Bolton advised, noting that a bear market could occur just when she needs the money. For that reason, Percy recommended that Chang place a portion of her 401(k) funds in a short-term bond fund or money market account if she buys a place.
In her taxable brokerage accounts, Chang now owns shares of Delia’s Inc., Dell Computer, EBay, Fnit.com, Yahoo, Speedus.com, Schwab Market Track Conservative (a domestic hybrid fund); and Schwab Market Track Growth (a large-cap blend fund). All the stocks are in the Internet or high-tech sectors.
“I guess I got caught up in the online trading hype,” Chang said. “I picked the stocks based on word of mouth. For instance, my brother uses EBay all the time, so I bought it.”
Chang said the wild swings in the value of her Internet stocks do not bother her. She hasn’t purchased more stable stocks, she said, because “they seem boring.”
Despite her high risk tolerance, Bolton believes that Chang needs to adopt a new investment strategy, especially because she works in the high-tech industry and may need to tap her brokerage accounts if she chooses to buy a home.
“You don’t have any diversification, because your career and your money are invested in the same industry,” the planner said.
If she does not buy property, Bolton said, Chang could allocate less than she does now--possibly 10% of her portfolio--to high-tech or Internet stocks. The remainder should be invested in other sectors, such as finance, telecommunications, leisure and health-care stocks. However, until Chang becomes more versed in the stock market, Bolton encouraged her to first invest in diversified mutual funds.
“Right now, you don’t have the time, the ability or inclination to choose great companies,” Bolton said. “Mutual funds are a better choice.”
But if Chang insists on buying a home soon, her taxable account investments should be more conservative, such as a money market or a short-term bond fund, Bolton said.
Because her parents are nearing retirement and are willing to adjust their finances to help Chang, Bolton suggested that she discuss with them a family limited partnership that would include their Palos Verdes home and two rental properties. A lawyer could set up such a trust, and tax-deductible interest expenses associated with the rental properties could be taken on Chang’s tax returns.
A family limited partnership is often used to reduce the value of an estate for tax purposes while allowing the original owners to maintain full control of their assets. The partnership is composed of general partners, who make all investment decisions, and limited partners, who can share the profits or losses but do not have any say in the day-to-day decisions. (See story above.)
A husband and wife can transfer up to $650,000 each ($1.3 million total) into a family limited partnership.
Using the annual gift exclusion of $10,000, general partners can give away limited partner shares to their heirs. Trust property is appraised at a substantially lower dollar amount than equivalent properties because it consists of limited partner shares, which are difficult to sell.
“The property is appraised lower because it’s not easily liquidated, since more people own it and you have to have unanimous consent to sell it,” Bolton said.
If Chang’s parents do create such a trust, it would increase her overall exposure to real estate investments--which may be another argument for her to put off buying her own home and focus instead on building financial assets.
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Diane Seo is a regular contributor to The Times. 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, or to money@latimes.com.
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This Week’s Make-Over
* Investor: Kristine Chang, 24
* Gross annual income: About $57,000
* Goals: Buy a home; reduce tax burden
Current Portfolio
* Cash: $13,000 in checking account; $2,000 in money market
* Investments: About $10,000 in two brokerage accounts; about $5,400 in a 401(k)
* Debt: $11,000 owed on car
Recommendations
* Delay buying property and continue saving $2,000 a month.
* Increase contribution to 401(k).
Meet the Planner
Percy E. Bolton is a fee-only certified financial planner in Los Angeles. He has been named one of the nation’s top financial advisors by Worth magazine for the last four years.
