Young Grocery Manager Should Take Stock of His Spending

Casey Lynch would love to get a handle on his financial future. But first the 22-year-old has to get a handle on where all his money is going in the present.

“That is the million-dollar question,” he says.

At his age, that’s no exaggeration. If Lynch could simply save $150 a month, he could virtually guarantee a million-dollar retirement nest egg. But, despite earning roughly $30,000 annually and having fairly modest fixed expenses, Lynch rarely finds himself with much left over for savings at the end of the month.

Nonetheless, he’s committed to trying. He’s anxious to begin building an investment portfolio and saving for retirement, as well as preparing for the day when he has to replace his primary means of transportation--a 1967 Volkswagen Beetle with a working radius of about 15 miles.

But when Lynch tried to jump-start his financial education by visiting the online site of the Charles Schwab brokerage firm, he found himself both over- and underwhelmed. He didn’t find anything especially helpful in Schwab’s basic investor advice, so he checked up on a few stocks that friends had told him about and read about different kinds of retirement accounts, he says.

Frustrated, Lynch temporarily turned his attention away from investing, and instead paid off an outstanding credit card bill of several thousand dollars.

“I’m interested in having a good time, but the future’s coming up pretty fast,” he said. “I’m getting tired of every week turning around and using all my money for bills.”

When it comes to planning for the future, Lynch’s instincts are right on the money, said Peg Downey, a fee-only certified financial planner with Money Plans Inc. in Silver Spring, Md. Yet before he embarks on an ambitious financial plan, he needs to step back and assess his assets and spending patterns, the planner said.

Financially, Lynch is somewhat ahead of most 22-year-olds. He may not have much saved other than a fluctuating $3,000 in his checking account and a collection of savings bonds given to him by his grandfather. But he grosses more than $30,000 annually, and he’s been a member of the Southern California United Food and Commercial Workers Union since he got a job bagging groceries at a supermarket near his home at age 16.

Lynch plans to remain in the grocery business at least three more years, when he’ll graduate from Cal State Los Angeles with a degree in computer information systems. Not only does his job as a supermarket manager allow him to take 12 credits a semester, if he holds on for those three years he can expect to collect a pension when he reaches retirement age--the reward for 10 years of service as a dues-paying union member. Certainly, it’s not likely to be a lot. But, as a 25-year-old with a vested pension, he would certainly be off to a good start.

Despite this promising foundation, Lynch’s finances could use a serious overhaul, Downey said. The planner’s first bit of advice: Create a spending plan.

Lynch, she pointed out, has no real idea of how much money he goes through every month. Although he thinks he spends a little more than $1,000 monthly on expenses ranging from rent on his San Gabriel Valley home to tuition and car repair, he’s not counting in such occasional expenses as travel and gifts. And for Lynch, these tallies are not inconsiderable.

Over the last several months, he’s given a sister $900 to pay off her credit card bill, bought gifts for several relatives and friends, and still found cash to take vacations with his friends to Las Vegas and Lake Tahoe.

“I have a lot of friends who have a lot of money, so when we go out and have fun, it’s usually pretty expensive,’ Lynch observed ruefully.

Lynch’s savings strategy also made the planner cringe. He holds off cashing his paychecks so that he’ll have more money than he expects when he finally makes a bank deposit. But, Lynch isn’t earning any interest on paychecks he has stashed in his sock drawer.

Instead, Downey suggested, Lynch should keep careful track of all his expenses over the next several months--down to the 25 cents he puts in a parking meter. Once he averages the number out, he will understand how much he is spending and how much he is saving. That should give him a foundation to make more reasonable decisions about how to save money.

Next, Lynch needs an emergency fund of several months’ living expenses. His checking account, with its wildly fluctuating balances, simply isn’t a reliable cushion against unanticipated expenses.

It may not have the cachet of saving for retirement, but it’s equally if not more vital, the planner said. Without money set aside, anything from an unexpectedly expensive car repair to unemployment has the ability to devastate the most dedicated investor’s strategy.

“You need at least three months’ expenses set aside,” Downey said. “It’s not exciting, but it’s there if you need it.”

In fact, Lynch already has the seeds of an emergency fund: his bond portfolio. Downey urged Lynch to check out https://www.publicdebt.treas.gov/sav. The site, run by the Treasury Department, features a savings bond calculator, which tells investors how much their bonds are worth. But Downey also cautioned that Lynch use his fixed-income cache to cover only true emergencies and not to finance one of his Vegas flings. That way he avoids the common pitfall of tapping into emergency funds to pay everyday expenses.

Once Lynch’s financial foundation is in place, he can then turn his attention to an investment strategy. Downey suggested he open an individual retirement account. Instead of putting $2,000, the maximum amount allowed annually, into the account all at once, Lynch should choose to have $166.67 automatically deducted each month from his checking account and placed in the IRA, she said.

The smaller monthly amounts would make it easier for Lynch to get started. And because the money comes out of his checking account automatically, it forces a disciplined approach to saving, which is something that Lynch currently lacks.

Downey suggested investing the sum in American Century Ultra, a large, aggressive growth mutual fund that is prone to sharp price swings but has a five-year annualized return of 20%, according to Bloomberg News.

“If you’re investing for the long term, you can stand the volatility,” Downey said.

As for the choice between a traditional IRA or a Roth IRA, the planner said the decision should be determined by whether or not Lynch would get a tax break for using the former. For single earners, even if they have a pension, the government allows some tax breaks for saving for retirement in the traditional IRA, but the benefits begin to phase out when the depositor earns more than $32,000 annually. At that point, it’s often a better decision to turn to a Roth IRA. The Roth offers no initial tax benefit, but the money is allowed to grow tax-free.

Moreover, because Lynch is currently in a low tax bracket, the upfront tax deductions probably won’t amount to as much as the value of being able to withdraw all his investment earnings tax-free at retirement. The Roth is also a touch more flexible than a traditional IRA, since participants can withdraw their contributions without penalty. However, if Lynch withdraws interest or investment earnings on the account prior to retirement, he’s likely to face both taxes and penalties.

If Lynch feels he can save even more money, Downey suggested he consider setting up a second, taxable investment account and use it to invest in mutual funds. He could set up an account at Schwab, which offers its customers access to thousands of popular mutual funds, or at one of the major mutual fund families, such as Vanguard or Fidelity.

Downey then recommended that Lynch look into investing in a stock index fund designed to mimic the Standard & Poor’s 500, such as Vanguard 500 Index, or another similar fund offered by a no-load mutual fund family.

“When you have a relatively small amount of money, a mutual fund is best,” she said. “You’ll get a lot of diversity, which you won’t get with individual stocks because you don’t have enough money to buy enough stocks to get enough diversity.”

The stock holdings of index funds are also fairly stable because these funds do not trade stocks unless a company in the underlying index is changed--a fairly rare occurrence. That low turnover means index funds typically generate few capital gains--an important consideration if the fund is being held in a taxable account.

Last, Downey was even optimistic about a new car for Lynch, especially when she learned he was expecting a significant raise later this year. Depending on his financial situation, she recommended that he either buy another used car, or look into leasing.

“It would take you a lot longer than six months to accumulate the amount of money you need to buy a car outright,” the planner said.

Lynch’s verdict on his new financial plan: “You hit all the points,” he said.

Well, maybe. Lynch never got around to telling Downey another one of his future goals: owning a boat.

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This Week’s Make-Over

Investor: Casey Lynch, 22

Profession: College student and supermarket manager

Gross annual income: $30,000

Goals: To create an investment strategy that allows him to begin putting aside money to deal with changing life goals.

Current Portfolio

Cash: $3,000 in checking account

Retirement savings: Can expect small pension if he stays on the job for three more years

Personal savings: 24 $50 savings bonds

Debt: None

Recommendations

* Keep track of monthly spending.

* Set up emergency fund containing three months’ living expenses.

* Open an individual retirement account.

* After reviewing three months of spending, set a realistic monthly savings goal and have the money automatically deducted from checking account.

* Find out what savings bonds are worth.

Meet the Planner

Peg Downey is a fee-only certified financial planner with the firm Money Plans Inc. in Silver Spring, Md. She specializes in investment strategies for middle-income people.