On the Horizon: Owning Home

With her 30th birthday fast approaching, Carole Panick figures some changes are needed in her life, starting with her address.

A renter since her student days at UCLA, Panick is determined to eventually move out of her Santa Monica apartment and into a home of her own.

“I’ve decided it’s time to think about how I can buy a condominium near the beach here so I won’t be 40 and still paying rent,” said Panick, an advertising copywriter for NBC.

Homeownership is not the only financial issue on Panick’s mind as she prepares to exit her 20s. She’s started to wonder if she’s been tucking away her 401(k) retirement money in the right places, admitting that her process for choosing those investments wasn’t much different from eeny, meeny, miney, mo.

She’s now eager to make financial plans for homeownership and to follow a coherent 401(k) investment strategy, but she has felt ill-equipped to get started.

Until now, “financial planning” has meant figuring out how to pay for a vacation in Europe every couple of years. Most spare cash has gone into a low-interest credit union checking account. Panick knew it’s wise to invest in mutual funds, but she had no idea how to get a prospectus, let alone how to select funds that would be right for her.

So she decided to seek some professional financial advice--even if it meant she might hear that her dream of a Santa Monica condo was unrealistic.

“I’m worried that a financial planner will tell me it will take about 10 years to get a down payment together and that I’d better start thinking about moving to a place I can afford--like Idaho,” she said before submitting her records for review.

Panick need not pack those bags for Boise just yet, said Los Angeles financial planner Margie Mullen.

“Carole’s goal is doable,” Mullen said. “She’s taken the initiative and the time to get some professional advice, so that indicates that she’s serious. I’ve seen people buy homes on a much smaller income than she has.”

*

To succeed, Panick needs to get organized, get motivated and get started, Mullen said.

Panick has some important things going for her. She’s earning almost $50,000 annually at NBC, where she writes advertising campaigns for television shows, and she’s been receiving regular raises. She has no credit card balances or other debts. And she’s accumulated almost $12,000 in her 401(k) account--a great start for someone her age.

But getting a home will not be easy, Mullen warned. Panick will be starting her down-payment fund virtually from scratch. She has no savings beyond her 401(k) account and the $1,200 in her credit union account.

Nor will it be cheap. Panick has shopped around Santa Monica, and the type of condo she wants currently carries a price of $220,000. With those things in mind, Mullen asked Panick some questions.

Is she set on the Santa Monica location? Or would she be willing to move somewhere more affordable?

“I’m very set on this location,” Panick said. “I’d rather keep renting than buy somewhere else.” She likes the beach, and her social life is centered on the Westside.

What’s the longest she can wait to get into a home?

“I’d like to do it in three years, but I’d be willing to wait five or even longer if I have to.”

Is there a chance that a relative will help with the down payment?

Panick said her parents might consider a small gift but that for planning purposes it would be safer to assume that she will do it on her own.

*

After studying the situation, Mullen, a former bank lending officer, suggested that Panick plan on saving for a down payment of 20%. Considering her income and the price of the home she wants, Panick is unlikely to qualify for a loan with a smaller down payment. Besides, a smaller down payment would mean larger monthly mortgage payments. Panick will be stretched enough with an 80% loan and the property taxes, insurance and condo maintenance fees. (Mullen’s estimate of total costs is $1,750 a month. Initially, the effective after-tax figure would be $1,150 because mortgage interest is tax-deductible.)

Mullen suggested that Panick plan on taking five years to accumulate the down payment. Less time would require an unrealistic level of saving that could prove fatally discouraging.

Mullen calculates the required down payment at $53,500, assuming a 4% annual rise in real estate prices. Real estate prices have fallen in recent years but are now recovering, particularly in Los Angeles County’s Westside, including Santa Monica. Consequently, Panick should expect a $220,000 condo to cost about $270,000 in five years.

To get started on her home-buying journey, Panick needs to establish a budget and follow it rigorously, Mullen said. To figure out how she will spend her money in the future, Panick must determine how her monthly take-home pay of $2,788 is currently consumed.

The budget exercise is not strictly for planning purposes. “It’s also a psychological exercise,” Mullen told Panick. “It’s a good way to get you thinking about what you’re spending your money on and whether it’s necessary.”

According to Panick’s calculations of monthly outflows, she spends $818 for rent on her Santa Monica apartment and about $110 for utilities. About $335 goes for lease payments and gasoline for her 1996 Toyota 4-Runner, and $292 for auto insurance. She estimates she spends $220 on food and $40 on movies and other entertainment. In savings, $123 is automatically deducted for her 401(k) account, and $150 goes to her credit union account.

That leaves $700 for discretionary spending--money that now gets consumed by vacations, gifts, clothing and other items such as photo developing. It’s from this $700 that savings for the condo will come, Mullen said.

After some discussion, Panick and Mullen settled on a goal to reduce Panick’s discretionary spending by about half, leaving $327 a month for the condo fund. In addition, Panick expects a raise this summer of about 5%, or $155 a month after taxes. Mullen advised adding that to the $327 for a total of $482 a month for the housing fund.

Rather than deposit that money into a bank savings account that might pay annual interest of 2% or 3%, Mullen advised putting it in mutual funds, where it will be more likely to grow faster.

*

With a five-year time horizon for her down-payment nest egg, Panick needs a mix of investments that will generate respectable returns with limited risk. Mullen suggested dividing the money between a stock and a bond mutual fund. The money in the stock fund would be expected to earn higher returns while that in the bond fund would protect her capital. (If the money would not be needed for a longer period, Mullen would suggest a greater proportion in a stock fund.)

Mullen suggests putting 45% of the $482--or $217--into Vanguard Index-Trust Value Portfolio (three-year average annual return: 20.28%). This fund buys stocks that are considered undervalued, meaning they typically have low price-to-earnings ratios or high dividend yields. The fund has no load and relatively low management costs, making for better returns for investors, Mullen said.

The remaining 55%--or $265 a month--would go into Hotchkis & Wiley Low Duration (three-year average annual return: 8.28%). This fund, which invests in a mix of corporate bonds and U.S. Treasury notes, gets high marks from fund raters, Mullen said, and it also has low expenses.

A drawback of the Hotchkis & Wiley fund is that the minimum initial investment is $10,000. But Panick can get into the fund with just $2,500 if she invests through Mutual Fund OneSource, a “fund supermarket” service at discount brokerage firm Charles Schwab & Co.

In addition, the Vanguard and Hotchkis funds accept automatic monthly deposits through a bank account.

“Setting your account up with this feature takes the temptation to skip a month out of the equation,” Mullen told Panick.

Now to the always tricky task of predicting investment performance. Mullen is assuming the stock market will cool off from its sizzling pace and, therefore, that the Vanguard fund will earn an annual average return of 10% and the Hotchkis & Wiley fund an average annual return of 7%. In five years, then, Panick would have $16,800 in the Vanguard fund and $19,000 in the Hotchkis & Wiley fund, for a total of $35,800.

In addition to her NBC pay, Panick earns about $2,000 annually in weekend freelance writing projects. Mullen recommends putting half that money into each mutual fund. After five years, those contributions should be worth $11,850.

These investments will give Panick a total of $47,650 at the end of five years, less than $6,000 short of her goal.

To make up the difference, Mullen suggests several options: Put money from all future raises into the investment funds; borrow against her 401(k) account or seek a loan from a relative; or reduce expenses further. For example, Mullen notes, Panick’s $292 monthly auto insurance premium seems extremely high. Mullen does not recommend discontinuing the $150 going to Panick’s credit union account every month. That money should be considered an emergency fund for unforeseen occurrences. It may also be tapped for special occasions that would otherwise blow Panick’s budget. She’s attending a close friend’s wedding in Hawaii later this summer, for example.

Overall, Panick should understand that there is still some risk in this plan--either or both funds may return less than expected. But a more conservative investment plan would be sure to add years to her wait.

All things considered, though, Panick feels encouraged. “It’s comforting to know that it’s doable.”

*

Mullen then turned to Panick’s more distant goal: retirement.

Panick has half a dozen choices as to where to put her 401(k) contributions and her employer’s matching amount: the stock of General Electric (NBC’s parent company), a stock mutual fund created for the 401(k) plan, a long-term bond fund created for the plan, a short-term bond fund created for the plan, a money market fund and U.S. Savings bonds.

Panick has 50% in the stock mutual fund (five-year annual average return: 15.24%), 30% in General Electric stock and 20% in the long-term bond fund (five-year annual average return: 7.14%).

Mullen suggests moving all the money in the bond fund and most of the money in GE stock into the stock mutual fund--even though GE’s stock price has tripled in the last five years. The reasons? “The bond fund is too conservative for someone who is about 35 years away from retirement. And it’s dangerous to rely on your company not only for your income but also for your retirement. At your age, I’d suggest 15% in GE stock and the remainder in the stock mutual fund,” Mullen told Panick.

The planning session now complete, Panick expressed relief. She has a strategy for her retirement funds and homeownership seems within her grasp. While she may not be happy about hitting 30, she is pleased to have been presented with a coherent financial plan.

“The situation is not as bad as I thought it would be,” she said. “I’ve always been good at setting goals and achieving them. I think I’ll be able to handle these goals.”

Graham Witherall 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)

This Week’s Make-Over:

Investor: Carole Panick

Age: 29

Occupation: Advertising copywriter

Gross annual income: About $51,000

Financial goals: Save for a down payment on a condominium and for retirement

Current Portfolio

Individual stocks and mutual funds: $11,747, split among General Electric Co. (parent company of her employer) stock, a stock mutual fund created for the plan and a bond mutual fund created for the plan.

Cash: $1,200 in a credit union checking account

Recommendations

* To save for a down payment on a condominium: cut discretionary spending, save income from freelance work and put future raises into savings. Invest 55% of these savings in a bond fund and 45% in a stock fund.

* Reorganize the 401(k) account to greatly reduce proportion in GE stock and to exit the bond fund. In the future, 85% of Panick’s 401(k) contributions should go to the plan’s stock mutual fund and 15% to GE stock.

* Continue monthly contributions to credit union account, to build up an emergency fund.

Recommended Mutual Fund Purchases

Hotchkis & Wiley Low Duration (800) 346-7301

Vanguard Index Trust Value Portfolio (800) 860-8394

Meet the Planner

Margie Mullen is a fee-only certified financial planner in Los Angeles with more than a decade of experience. She specializes in retirement planning and portfolio management using no-load mutual funds.