Budget Will Help Keep Spending to a Minimum

Ajay Malik thought he had investing pretty much figured out. You bought stocks, the stocks went up, you reaped the profits. One, two, three.

Of course, that was more than a year ago, before the Nasdaq Stock Market and the technology stocks that fueled its rise collapsed. Today, the 30-year-old environmental engineer is a humbler but wiser investor, the reluctant recipient of a lesson in market volatility that cost him nearly half the value of his portfolio.

“I had only known one kind of market, the sort that went up and up and up,” said Malik, who lives in a Westwood apartment. “I just needed one more year of things staying on track to put me over the top, to be able to really change my lifestyle.

“But then everything started to slide. I thought about getting out and getting rid of the stocks, but I kind of felt like I was in a committed relationship.”

Malik’s short-term goal of home ownership and long-term plans for a comfortable retirement were dealt setbacks. But he shouldn’t panic, said Judi Martindale, a fee-only financial planner based in San Luis Obispo.

“It’s not the end of anything . . . there’s just been a downturn,” she said. “The clock doesn’t stop ticking until you need the money, and because of his youth, Ajay has plenty of time to more than make up for any losses.”

In fact, despite the last year and a half of market mayhem, Malik is in excellent financial condition for someone his age, Martindale said. He’s got about $100,000 stashed in various tax-advantaged retirement accounts, a secure income and manageable debts.

But, she noted, he needs to get a grip on his spending--and get over his infatuation with volatile tech stocks.

Father’s Advice Didn’t Quench Tech Lure

Malik, a fan of the gaming tables of Las Vegas, admits he should have known better than to apply the same gambling spirit to his investment portfolio. He was rolling the dice on Internet highfliers even as his father was warning him about the risks of betting so heavily on such shooting stars.

“My parents met while going to school in the United States after coming over from India. They were always very careful with their money, and they didn’t take many risks,” Malik recalled.

“My father always emphasized to me the power of compound interest, and now that my parents are both retired, they are even in better shape financially than they were when they were working.”

But even though Malik respected his father’s knowledge of financial matters, the lure of the once-hot tech market and his early successes investing in it proved irresistible.

His experience with Healtheon Corp. (now WebMD), a company providing services to the medical industry, was typical of the roller-coaster ride. He bought the stock in June 1999 at $81 a share. By April of this year, it was under $5. His portfolio swooned along with it, shrinking from a peak of around $200,000 to about half that today.

But despite the market’s swan dive, Malik’s cupboard is far from bare. For starters, there’s the $93,000 annual salary from his engineering job with the Los Angeles County Sanitation District.

For savings, he has $60,000 in a 457 deferred compensation account through his employer. He also has $9,000 in a Roth IRA invested in growth and value mutual funds and he owns about $14,000 worth of individual stocks, including Microsoft Corp. and Goldman, Sachs & Co.

He also has a total of $23,500 in three mutual funds: PBHG Technology & Communications, Janus Global Technology and Janus Mercury. All three funds invest in volatile areas of the market--and all have taken a beating in the technology sell-off of the last 18 months.

Finally, Malik’s engineering job with the county qualifies him for enrollment in the CalPERS retirement plan, where his balance is about $31,000.

As for debts, he has a $19,000 loan on a 2001 Lexus IS 300, a $15,000 student loan and a $5,000 line-of-credit loan from his credit union at 11% interest. His rent is $700 a month, but both of his roommates are getting married and will be moving out within a year, which gives his desire to buy a house a greater urgency.

“I’m prepared to be patient, but by this time next year I expect to have purchased a house,” he said. “Whether it happens or not, I don’t know, but it’s certainly a goal.”

When Nasdaq was peaking in early 2000, Malik was looking at houses costing from $300,000 to $400,000. Now, his affordability range will depend a great deal on his fiscal discipline over the next year.

For starters, Martindale said, he needs to rein in his sometimes free-wheeling spending habits.

“I am living a sort of hedonistic lifestyle,” Malik admitted. “I like to travel, eat at nice restaurants and buy clothes.”

He said it is not unusual for him to drop $800 on an outlet-mall shopping spree--on the way to one of his regular visits to Las Vegas.

Deductions, Discipline Can Limit Spending

To help him resist spending temptations, Malik has $1,000 deducted from his paycheck each month earmarked for his 457 account, which uses pretax dollars for retirement savings, much like a 401(k) plan. Tax rules allow him to put $8,500 into the account this year, but that goes up to $11,000 next year. Another $1,000 is funneled into the three mutual funds he owns outside his tax-advantaged retirement accounts.

“I like the fact that I don’t even see that money,” he said. “That’s how I impose some sort of discipline on myself.”

That’s fine as far as it goes, Martindale said. “How badly he wants to achieve his goals will determine how much he is able to discipline his spending habits,” she noted, adding that a computer-based budgeting program such as Quicken or Microsoft Money could help him track his spending.

Martindale also recommends that Malik pay off his $5,000 line of credit and its nondeductible interest charges before he puts any more money into his three mutual funds.

With his income, Martindale says Malik should be able to set aside at least $2,000 a month to pay off the line of credit and then begin saving for a house. (His car and student loans, at 7.18% and 8%, respectively, are at reasonably good rates, and should just be paid off as scheduled, she said.) She suggests he sell his stocks to bolster his savings, liquidating a third now, a third in three months and the final third in six months to balance market fluctuations.

She says Malik should put savings toward his house in a money market or short-term bond fund to generate interest on the money, yet maintain easy access. Malik figures he needs to have a 10% to 15% down payment of $40,000 to $50,000 for the West L.A. condo or townhouse he will be looking for.

Meanwhile, Martindale said, Malik should continue investing in his employer 457 savings plan, the proceeds of which are taxed only when withdrawn, and especially the Roth IRA, which offers nontaxable withdrawals, giving him maximum flexibility when withdrawing money at retirement.

More broadly, Malik needs to rethink his investment strategy, Martindale said. His portfolio--which includes his 457, the Roth IRA, individual stocks and the three non-retirement-account mutual funds--is over-weighted in technology stocks. Tying the fortunes of a portfolio to a single sector, especially one as volatile as technology, is a recipe for disaster, she said.

Martindale suggests shifting his Roth IRA retirement account from the three PBHG funds to the Vanguard S&P; 500 Index fund to broaden and simplify his portfolio while reducing fees. Shealso suggests selling his three non-retirement-account mutual funds and investing in Vanguard Total International Stock Index fund.

“It is very tax-efficient and will provide the international exposure that is missing now” from his portfolio, she said.

She said the new strategies offer the most dependable means of avoiding a repeat of his experience with the Nasdaq meltdown.

Between his Roth IRA, CalPERS plan and 457 account, Malik should have plenty of money to retire on, assuming he sticks to a conservative plan. But will Malik be able to resist the urge to play another round of tech-stock roulette?

“I’m keeping my eye on the market,” he said. “I think there are still some companies out there that are going to do great things.”

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(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

This Week’s Make-Over

Subject: Ajay Malik, 30

Gross annual income: $93,000

Goals: Buy a house while maintaining lifestyle; maximize investments for a comfortable retirement.

Current Portfolio

457 account: $60,000 invested in mutual funds ($30,000 in Franklin Small Cap Growth; $26,000 in Putnam Vista; $3,000 in Janus)

CalPERS retirement account: $31,000

Mutual Funds: $23,500 ($16,000 in PBHG Technology & Communications, $4,000 in Janus Mercury and $3,500 in Janus Global Technology)

Individual stocks: $14,000 in Silicon Storage Technology, USA Video Interactive, Microsoft, Goldman Sachs and WebMD

Roth IRA: $9,000 split among these mutual funds: PBHG Technology & Communications, PBHG Large Cap Value, PBHG Mid Cap Value

Cash: $2,000 in checking account

Other assets: 2001 Lexus IS 300

Debts: $19,000 car loan; $15,000 student loan; $5,000 line of credit

Recommendations

* Establish a budget and live by it. Use a computer program such as Quicken or Microsoft Money to track spending.

* Sell stocks and put money into a short-term bond or money market fund to save for down payment on a house.

* Pay off line of credit as soon as possible and then student and car loans as scheduled.

* Shift Roth IRA from aggressive, tax-inefficient mutual funds to Vanguard S&P; 500 index fund to simplify portfolio and reduce fees.

* Balance 457 fund by splitting investments equally among three funds.

* Continue saving for retirement.

Meet the Planner

Judi Martindale is a fee-only certified financial planner based in San Luis Obispo. She specializes in planning for middle-income clients.