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Surprise: There’s Safety in Her Numbers

SPECIAL TO THE TIMES

Judy Orlanski would seem to have little cause for financial anxiety. A dozen years from retirement, she owns a portfolio worth $450,000 and adds about $35,000 to it each year.

But rather than enjoy a sense of security, she frets that she doesn’t have enough money nor any overall financial strategy.

“I don’t feel like I have a clear direction or any rhyme or reason to my portfolio,” she said. Her worries even crimp her lifestyle. “I get nervous about spending money on things I would like, such as taking a vacation.”

Orlanski certainly hasn’t allowed her concerns to keep her out of the stock market--she has 99% of her portfolio in stocks and equity mutual funds. In fact, getting some money out of stocks was the primary advice offered by Manhattan Beach certified financial planner Preston S. Caves, whom The Times asked to review Orlanski’s portfolio.

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Why does Orlanski worry about money? A key reason is that she has been on what seemed like a firm foundation before, only to see it crumble.

During the 1980s, Orlanski, an executive secretary, inherited $500,000 from an aunt. She and her husband poured that windfall into a variety of poor investments, including windmills near Palm Springs and an expensive Los Angeles house that lost much of its value.

They later divorced and eventually sold the home at a substantial loss. By the time their split was settled in 1996, Orlanski found herself, at age 50, living in a West Los Angeles apartment with her share of the proceeds: $189,000.

“I feel very fortunate to have [had] that lump sum,” she said, “but when I think of what happened to that original $500,000, I feel sad,” she said.

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Eager to see her nest egg grow, she invested the entire amount in a variety of stock mutual funds. She adds $2,500 to those funds monthly, earmarking most of the $3,000 monthly alimony she receives from her ex-husband. Orlanski uses the remaining $500 to supplement the $2,275 she earns after taxes and other deductions.

Thanks to a roaring stock market, her portfolio has grown to $377,000. She also has $41,000 in her 401(k) account and another $36,000 tucked away in an IRA that she rolled over from an earlier employer’s 401(k). And it grows still. She contributes $4,000--about 10% of her gross pay, to her 401(k) each year, and her company matches another $1,000.

An Appropriate Allocation

She credits “beginner’s luck” for entering the stock market during a historic bull market. Now, she seeks professional financial advice to determine the odds of maintaining her current lifestyle when she retires at age 65 and an opinion on her investment program.

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After analyzing Orlanski’s finances, planner Caves had good news for Orlanski--as well as a warning.

On the positive side, Orlanski is on target to continue her lifestyle--and then some--in retirement. Even fairly modest returns in the 6% to 8% range annually will bring her portfolio to $1 million by age 65. If the tax-deferred investments grow 10% annually and the taxable investments increase at 6% after taxes are paid, Caves said, she could end up with $1.6 million.

That sum is likely to allow Orlanski to live at least as comfortably after age 65 as she does now. Caves estimated she could have an income of about $73,000 per year in today’s dollars for 30 years--far more than the $47,000 he thinks she will need. To make this estimate, Caves factored in a 3% annual inflation rate and about a 25% annual tax rate. In addition to that, Orlanski is on schedule to receive $12,000 per year from Social Security.

“Wow, I’d be happy with that!” Orlanski exclaimed after seeing the projections. “I guess that would make me a wealthy old broad.”

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But Caves warned that Orlanski’s current portfolio is risky and unnecessarily aggressive, given the ever-present possibility that an extended bear market will run into her retirement years.

So what would be a more appropriate mix of investments for Orlanski? An oft-quoted rule of thumb says a portfolio’s percentage of stocks should equal 100 minus the investor’s age. That formula would place 47% of Orlanski’s holdings in stocks.

But as Caves noted, that estimate ignores many factors, including longer life spans, income, the amount already accumulated and goals. While a 53-year-old starting to build retirement savings from scratch might accept a higher-risk portfolio, Orlanski is already well on her way to her goal, decreasing the need to take risks.

Planning appropriate asset allocation also requires weighing an investor’s tolerance for risk, Caves said. If losses would scare someone out of stocks altogether, they shouldn’t be loaded with equities in their portfolio. The reverse is possible, too--an overly conservative portfolio will probably be discarded by a more risk-tolerant person who feels shortchanged when the stock market races ahead.

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To find the proper mix for Orlanski, Caves had her fill out a questionnaire exploring her financial expectations, fears and tolerance of risk. He also engaged her in an hourlong discussion about her outlook.

Like most people, Orlanski has some contradictory feelings. On one hand, she said she wants to be fully invested in the stock market: “I really want my investments to be in stocks. My tolerance for risk is good.”

But in her questionnaire, Orlanski indicated that the maximum decline she could accept in a single year is 5%, which isn’t even considered a correction on Wall Street.

“How would you feel about a 20% loss?” Caves asked.

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“I’d be terrified,” she replied.

Sometimes It’s Best to Pay Capital Gains

After some discussion, Orlanski agreed to a portfolio that would reduce her stock holdings to 70%. Caves thought she could go lower but did not press the issue. “A relatively long time horizon of 12 years can justify that mix,” he said, adding that she could change the mix as she grew older.

Caves outlined a portfolio that calls for putting the remaining 30% of her portfolio in bond mutual funds. That category hasn’t enjoyed the long-term returns of stocks but doesn’t lose value as easily and can generate higher returns for shorter periods.

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“In effect, you’d be accepting that some of your upside potential would be cut in return for reducing your potential declines,” Caves told Orlanski.

To reallocate her portfolio to minimize capital-gains taxes on the profits she already has in stocks, Caves suggested moving the tax-deferred IRA and 401(k) money into bonds. The income those bond funds generate would also be tax-deferred.

But those funds amount to only 17% of her portfolio. Outside her tax-deferred accounts, Orlanski could minimize the tax hit by selling funds with losses to offset gains.

While most of Orlanski’s funds have sharply appreciated during the last three years, some have declined, such as American Century Vista, which dropped 8.7% in 1997 and 14.3% in 1998, giving it a three-year average annualized return of -6.2%. Another loser in her portfolio is Scudder Emerging Markets Growth, which lost a quarter of its value in 1998.

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Caves suggested she sell those and pair them with gains she can realize by selling some funds with capital gains in the large- and medium-capitalization categories, where she has more than enough holdings, including the Oakmark Fund and Berger Growth & Income.

Even then, Orlanski will need to declare some capital gains to reallocate her portfolio. Caves said Orlanski shouldn’t hesitate to generate a tax bill in the process. “Although you always want to take taxes into account, you don’t want to let the tax tail wag the investment dog,” he said.

Bond Funds

Caves recommends a mixture of bond funds that include U.S. governments, tax-free municipals, corporates, international and a small percentage of high-yield. The yields of these funds vary by the riskiness of the bonds they own, from 6% for government-backed bonds to 9% or more for high-yield corporates. Market interest rate movements will affect these funds as well, with rising rates dampening value and falling rates increasing returns.

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His suggestions include Pimco Total Return Class C (one-year average annual return: 7.43%), Vanguard Total Bond Market Index (five-year average annual return: 7.08), Vanguard High Yield Corporate (five-year average annual return: 8.55%) and T. Rowe Price International Bond (five-year average annual return: 6.76%). Outside the IRA and 401(k) accounts, Orlanski may consider a tax-free California income fund as well.

Stock Funds

Orlanski has already done a fairly good job of diversifying her stock investments, with about 40% of her money in mutual funds composed of large-cap U.S. stocks, 30% in small- and medium-cap domestic stock funds and 20% in international stock funds. The remaining 9% is in the stock of her employer, Kennedy-Wilson International.

But Caves recommends adding a few funds for increased diversification.

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These include putting $20,000 into Acorn International (five-year average annual return: 7.47%) to increase her exposure to small foreign stocks and $22,500 into Vanguard Specialized Energy (five-year average annual return: 6.06%) to get into oil and gas, a downtrodden sector that Caves believes could eventually rebound smartly. Caves would like to see 5% of her portfolio linked closely to a tangible asset as an inflation hedge.

Also, because Orlanski is a committed renter--the big loss she suffered on her previous home has soured her on the prospect of home ownership--Caves suggests investing $9,000 in real estate through Cohen & Steers Realty fund (five-year average annual return: 9.76%). Her shares in her employer, a real estate management and consulting company, also allow her to participate in the industry.

*

“We’ve had some remarkably good years in the market recently, but you can almost certainly count on lean years sometime in the future,” Caves said. “A greater balance will allow you to handle those challenges better.”

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Orlanski is a little reluctant to bid farewell to some funds that have served her well. “But I guess it is a little naive to think that the market will just keep going up like it has,” she acknowledged.

And she agreed that diversification could be helpful.

“I do like the idea of a little more balance if it will protect me in down times,” she said. “After seeing the calculations of how much money I will have, I guess some major shifting does make sense.”

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Graham Witherall 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. You can also send e-mail to money@latimes.com or save a step and print or download the questionnaire at https://www.latimes.com/HOME/BUSINESS/FINPLAN/make-over.htm.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

This Week’s Make-Over

* Investor: Judy Orlanski, 53

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* Occupation: Executive secretary

* Income: About $75,000 annually from employment and alimony

* Goals: A comfortable retirement

*

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Current portfolio

* Regular (taxable) account: About $377,000

* Major holdings: Schwab S&P; 500 Investor Shares $69,700; Scudder International Growth, 57,500; Baron Asset Fund $54,200; Oakmark Fund $47,400; Wasatch Micro Cap $45,100

n Other funds ($10,000 to $20,000 each): Scudder Emerging Markets Growth, American Century Vista, Vanguard Total Stock Market, Berger Growth & Income

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* Kennedy Wilson International stock: About $30,000 Tax-deferred accounts

* IRA worth about $36,000 invested in Scudder International, Wasatch Micro Cap, Schwab S&P; 500 Investor Shares and shares of Merck stock ($7,000 to $12,000 each)

* 401(k) account worth about $41,000, most of which is invested in Pacific Horizon Blue Chip, plus small amounts in other funds

Recommendations

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* Reallocate investments, putting 30% in bonds, 41% in domestic stocks, 14% in international stocks, 10% in real estate stocks and 5% in oil and gas stocks.

* To create that balance but minimize capital gains taxes, sell equities in tax-deferred account first, then sell funds with losses.

Recommended mutual fund purchases

* Acorn International: (800) 922-6769

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* Cohen & Steers Realty: (800) 437-9912

* Pimco Total Return C: (800) 426-0107

* T. Rowe Price International Bond: (800) 638-5660

* Vanguard Total Bond Market Index

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* Vanguard High Yield Corporate Bond

* Vanguard Specialized Energy: (800) 662-7447

Meet the Planner

Preston S. Caves is a fee-only certified financial planner and chartered financial analyst. His firm, Caves & Associates, is in Manhattan Beach. He has an MBA from Stanford University.

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