A New Maneuver

As a career soldier rearing a daughter alone, Pauline Bates learned to be frugal.

She and Hanah, now 18, camp on every vacation instead of staying at hotels. Pauline drives a 1984 Bronco with 160,000 miles on it. She pays her credit card bills in full each month. And she socks away a whopping $1,000 of her $3,250 take-home monthly pay.

Pauline, whose Army rank is sergeant first class, saves money in other ways, too. She charges everything she can on her credit cards to rack up frequent-flier miles so she and Hanah can visit each other more often. She saves up for big purchases for several months, then applies for a charge account at a department store offering a one-time discount of 10% to 15% for opening an account. She pays off the bill for the purchase immediately, then cancels the account.

Resisting society’s consumerist pressures has paid off: Pauline, who is 38, has managed to save a total of about $74,000, in CDs, in an IRA invested in a money market account and U.S. savings bonds--plus the down payment for the two-bedroom Los Alamitos townhouse she bought in 1992.

But Pauline also feels she has made some financial errors. She once invested $20,000 in junk bonds that she sold at a loss. The townhouse, bought for $165,000 and on which she owes $127,000, has depreciated by $20,000, a casualty of Southern California’s real estate slump. And she regrets having made conservative investment choices at a time when stock investors have been profiting handsomely from the ‘90s bull market.

“I feel that I’m a good saver but a poor investor,” confessed Pauline in explaining why she was seeking a Money Make-Over. The Times linked her up with E. Martin von Kanel, a fee-only certified financial planner based in Torrance.

Pauline also sought advice for her daughter, a freshman studying literature and journalism at San Francisco State. Hanah is living away from home for the first time and spending impulsively on clothes and entertainment, her mother said.

“She’s lonely and bored, so she goes shopping. We agreed that she’d have $200 a month spending money, so I put $600 in her checking account in August, and two weeks later it was all gone,” Pauline explained ruefully. “She needs to learn how to manage her money better, and this should be a good start.”

One reason Pauline is concerned is that her daughter has an annuity from a legal settlement that will pay $25,000 a year during the four years she is in college. Both mother and daughter worry that if the $15,000 that remains each year after school fees and living expenses isn’t saved and invested, Hanah will miss an opportunity to start out with a nice financial cushion.

Pauline, whose military specialty is finance and accounting, hopes to retire in five years, then finish college herself and embark on a new career as a part-time ranger with the U.S. Forestry Service. Pauline also wants to be financially secure enough to afford the occasional trip to Europe and to buy gifts for her daughter, close friends and nieces and nephews.

If Pauline retires from the military in 2002, she’ll start receiving a pension of $1,500 a month (and that will rise with inflation). However, it won’t be enough to cover current monthly expenses of $2,250, and Pauline knows she’ll have to work part time until her middle-60s, when she’ll become eligible for full retirement benefits.

Pauline doesn’t mind that--she can’t imagine just sitting around. But what the mother and daughter really want to know is how to position their assets to ensure financial security once Hanah’s annuity ends and Pauline retires.

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In speaking to von Kanel, Pauline was gratified to learn that she and her daughter are actually off to a flying start on meeting those goals.

“You’re what we call a golden client,” von Kanel told Pauline. “You understand the management of money, and you’re disciplined enough to save for the future. Your debt-to-equity ratio is 54%, and that’s phenomenal with a one-income earner, a house and a child in college. You can’t cut back any further, because you’re already socking away everything above your expenses.”

Attempting to evaluate her risk tolerance, however, von Kanel asked Pauline where she saw herself on the investment spectrum, with 1 being the most conservative and 10 the most aggressive. Pauline responded that she saw herself as 5 or 6.

“Well, right now your investments are at 2,” von Kanel countered.

That drew a laugh from Pauline.

“I know I’m too cautious, too conservative, and I’m missing the boat. That’s why I’m talking to you,” she said.

Adding up the money in Pauline’s savings bonds, certificates of deposit and individual retirement account, and figuring in the money from Hanah’s annuity for this year, von Kanel concluded that Pauline has about $88,750 that could be repositioned. (Pauline, at her daughter’s request, will be deciding how to invest the $15,000 left over each year from Hanah’s annuity.)

Von Kanel recommended that Pauline put that money into moderately aggressive no-load mutual funds, estimating that those would bring, on average, a 10% annual return on her money, or nearly double what her savings are earning her now. (Stock investments have produced an average annual return of 10% since the 1920s.)

By way of example, von Kanel estimated that if Pauline moved the $34,000 in her IRA into mutual funds now, then added $2,000 to that pot each year until she retires altogether in her mid-60s, her IRA money would grow to $690,000 by then. If she leaves her current and future IRA savings in a money market account, however, she would have only about a third as much by retirement age. Assuming a life expectancy of 85 years, von Kanel continued, would mean that by investing her IRA in mutual funds, Pauline could have an income stream of $2,000 a month in today’s dollars from her IRA alone.

In general, he suggested that Pauline put 37% of her savings and the annuity money into mutual funds investing in companies with large market capitalizations, 36% into small-cap funds, and 22% into funds that invest abroad. He advised that she keep 5% in a money market account that would serve as a reserve for future mutual fund purchases.

But Pauline hesitated at the thought of selling her savings bonds.

“I know they have a low return, but I bought them to be patriotic,” she said.

“You can also be patriotic by investing in the economic growth of your country,” von Kanel responded.

An avid outdoorswoman and Sierra Club member, Pauline said she was concerned that at least a majority of her investments be invested in a way that is socially responsible and environmentally sensitive. Yet when pressed, Pauline told von Kanel that she doesn’t want to forgo profits either.

Pauline at first thought of investigating each company whose stock is in the portfolios of the mutual funds she would buy.

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But Laura Lallos, a senior analyst consulted separately who specializes in “socially conscious” funds at fund tracker Morningstar Inc. in Chicago, pointed out that practically speaking, such an undertaking would be extremely difficult and time-consuming.

Instead, Pauline could try investing in “socially conscious” mutual funds. Most such funds screen their stocks for particular variables, such as levels of charitable donation and promotion of women and minorities.

Lallos suggested that any investor with such concerns might want to review the newsletter Insight, published monthly by Franklin Research & Development Co. in Boston, a portfolio management firm that also evaluates and rates the approximately 50 socially and/or environmentally conscious mutual funds on the market. (The newsletter is $225 a year; for information or to request a free sample issue, call [800] 548-5684). There also are several other publications devoted to the topic for individual investors, such as the quarterly newsletter GreenMoney Journal ($35 a year from GMJ, West 608 Glass Ave., Spokane, WA 99205, or visit the Web site http//:www.greenmoney.com).

“Some of the older names, like Calvert, have been mediocre performers, but some of the newer ones have been very competitive,” Lallos said of this variety of mutual funds. Two in particular have produced returns very close to that of the benchmark Standard & Poor’s 500-stock index, Lallos said: Domini Social Equity (five-year average annual return: 19.7%; [800] 762-6814) and Citizens Index Fund ([800] 223-7010), which is less than 5 years old.

Both funds invest in perennial “green” favorites such as Ben & Jerry’s Homemade Inc. but also include Fortune 500 companies such as McDonald’s Corp.

“A lot of what they’re doing” in selecting stocks is relative, Lallos said, such as picking the “cleanest” of the oil companies.

Only one mutual fund, New Alternatives ([800] 423-8383), focuses exclusively on the environment, Lallos said, investing in companies involved in solar and other alternative forms of energy, but it has a five-year average annual return of just 10.4%. (All three funds can be purchased directly by individual investors. New Alternatives charges a maximum front-end load of 5.66%.)

Pauline did not ask von Kanel about green funds, however.

For funds investing in large-cap stocks, von Kanel recommended putting roughly equal amounts into:

* MAS Value Institutional (five-year average annual return: 23.3%), which follows a value investing style. That is, it looks for stocks whose price-to-earnings ratios or other measures indicate that they are undervalued.

* Fidelity Advisor Growth Opportunities-Class T, a growth fund (five-year average annual return: 20.9%) that is moderately aggressive and that has been steered by the same respected manager for a decade.

For funds in investing in small-cap companies, von Kanel recommended that roughly equal amounts go into:

* Franklin Small Cap Growth I (five-year average annual return: 21.29%);

* Dreyfus Small Cap (fund is less than 5 years old).

For funds investing in foreign stocks, he suggested:

* BT Investment International Equity (five-year average annual return: 19.6%), which would get two-thirds of the money Pauline would invest this way. This fund is heavily focused on Europe and its current exposure to financially troubled Japan is low, von Kanel said;

* Templeton Developing Markets I (five-year average annualreturn: 13.1%), an emerging-markets stock fund whose manager, Mark Mobius, is an internationally recognized guru of foreign markets.

Of course, as Pauline’s situation changes, she will want to reevaluate her portfolio, von Kanel said.

“It sounds like good advice,” Pauline said, adding that she’ll probably act on his suggestions for at least part of her savings. But she admitted that this fall’s market gyrations have given her pause.

“As an investor, you’re going to have peaks and valleys, but if you’re looking long-term, there’s no reason to get panicky,” von Kanel counseled. “The market is very sound, and you should be able to ride along that wave by simply diversifying your portfolio.”

Pauline also wondered whether she should hold on to her townhouse after the Army transfers her to Ft. Belvoir in Virginia, outside Washington, in January. She has lined up an Army family who will rent the property for $1,100 a month, almost covering her $1,170 obligation for mortgage payments, condominium association fees, taxes and insurance.

Von Kanel agreed that the arrangement will make sense as long as Pauline doesn’t lose more than $200 a month, a general rule of thumb.

“You can notch the rent up 2% to 3% each year to keep up with inflation, and in the long run, you’ll have an additional $2,000 worth of rental income from a property that will be almost paid off,” he explained.

Von Kanel also suggested that Hanah could consider taking a part-time job, perhaps on campus, to provide spending money and make up any shortfall between her budget and actual expenses.

“It will build discipline, teach her time and money management and responsibility,” von Kanel said.

“And keep her busy, so she doesn’t spend money,” Pauline added approvingly.

With a more aggressive investment strategy to accompany her long-ingrained habits of thrift, Pauline will be well on her way to Easy Street, von Kanel believes.

“When you leave the Army in five years, you’ll have to do something, but not much,” he said. “And when it comes to retirement age, you won’t have to work at all.”

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Denise Hamilton 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: Pauline Bates, 38

Gross annual income: $43,800

Goal: A comfortable retirement for herself and a good financial start for daughter Hanah, 18, a college student

The problem: Savings invested too conservatively

The plan: Move nearly all of what’s in CDs, savings bonds and money market accounts, along with money to be invested for her daughter, into a mix of stock mutual funds

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Meet the Planner

E. Martin von Kanel is a fee-only certified financial planner based in Torrance. Von Kanel, who is fluent in Spanish, is president-elect of the Los Angeles chapter of the Institute of Certified Financial Planners.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

This Week’s Make-Over

* Investor: Pauline Bates, 38

* Occupation: Career soldier

* Gross annual income: $43,800

* Financial goals: A comfortable retirement and a good financial start for daughter Hanah, 18, a college student

Current Portfolio

* About $18,000 equity in a Los Alamitos townhouse on which she owes about $127,000

* $34,000 in an individual retirement account invested in a money market account

* $9,750 in U.S. Savings bonds

* $48,500 in bank and credit union certificates of deposit

* Pauline also will be investing about $15,000 a year for the next four years from an annuity for Hanah

Recommendations

* To give herself a chance to earn much better returns on her savings, Pauline should move nearly all of what she has in CDs, savings bonds and the money market account into mutual funds. The mix should be 37% large-cap funds, 36% small-cap funds, 22% international funds and 5% kept in reserve. The money from her daughter’s annuity should be invested the same way.

* Pauline will be stationed in Virginia beginning in January. She should keep her townhouse and rent it out.

Recommended Mutual Funds

* MAS Value Institutional: (800) 354-8185

* Fidelity Advisor Growth Opportunities T: (800) 522-7297

* Dreyfus Small Cap: (800) 373-9387

* Franklin Small Cap Growth: (800) 342-5236

* BT Investment International Equity: (800) 730-1313

* Templeton Developing Markets I: (800) 292-9293