Generation $ : These Twentysomethings Are Off to a Solid Start

Linda Kung started saving early. In fact, she opened her first bank account at age 8.

“I couldn’t even see over the bank counter,” she recalled, “but I’d deposit my allowance and pocket money.”

As Kung, 25, and her husband, Jon LaBree, 24, prepare to celebrate their third wedding anniversary in May, they can take satisfaction in knowing that they are in a solid financial position.

Kung works as an environmental engineer. Jon is a full-time student at Cal State Long Beach, where he’s studying to become a high school teacher, so he works only during academic breaks. The couple grossed $40,000 last year.

And at an age when most of their contemporaries are paying off student loans, Jon and Linda have built up a nest egg of nearly $30,000.

Yet they are worried. They are concerned about high housing prices in the Southland and whether they’ll be able to afford to buy a house and have children. They are concerned about what they’ll need for their far-off retirements, and they aren’t sure if their growing portfolio is invested wisely.

“We know a little bit about investing but not enough,” Linda said. “We know enough to be dangerous but not enough to help us.”

Preston S. Caves, a fee-only financial planner based in Manhattan Beach, commended the couple on their savings habits.

Jon and Linda take home $2,300 a month. They invest $300 monthly in three mutual funds and make $500 quarterly deposits in an individual retirement account. In addition, Linda puts 6% of her pretax earnings into her firm’s 401(k) plan. Her employer matches 50% of her contributions, so her retirement nest egg is growing by more than $250 per month.

“You are doing what all financial advisors advise: paying yourself first,” Caves told the couple. “You are putting money in savings before incurring any other expenses, and if you keep doing that, you’ll be in great shape.”

Jon and Linda can afford to earmark this much for savings in large part to their rather spartan lifestyle.

Neither took out student loans. In fact, Jon has taken time off from college to work rather than sink into academic-related indebtedness. They avoid high-cost entertainment and rigorously pay off the full balances on their credit cards every month. Their only debt is a no-interest loan from Kung’s parents to help buy a 1996 Saturn; they’re paying it back at $280 a month.

The couple’s portfolio contains $2,000 in a checking account; $4,000 in a bank savings plan; $4,000 in Fidelity Growth & Income Fund (five-year average annual return: 17.4%); $9,000 in Strong Funds Short-Term Bond Fund (five-year average annual return: 6.6%); $2,000 in Scudder Medium-Term Tax-Free Fund (five-year average annual return: 6.6%); and $6,000 in an IRA invested in the newer USAA World Growth Fund (five-year average annual return not applicable).

In addition, Linda has accumulated $2,000 in her firm’s 401(k) plan, divided among Dreyfus Worldwide Dollar Money Market; AIM Constellation A Fund (five-year average annual return: 16.6%); and the American Funds Group’s Investment Company of America (five-year average annual return: 14.1%), EuroPacific Growth Fund (five-year average annual return: 13.6%), American Balanced Fund (five-year average annual return: 12.5%) and Bond Fund of America (five-year average annual return: 8.9%).

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Ideally, the couple would like to own a home and have a child in the next three to five years, as Linda does not want to rear a child in an apartment or start a family after she’s 30. Mindful of the fact that such decisions are very personal matters, Caves laid out the possible consequences of different scenarios before ultimately creating a flexible financial game plan suited to their young age.

First, Caves urged the couple to designate $12,000--a little less than six months’ take-home pay--as an emergency fund in case of prolonged illness or unemployment. Jon and Linda can achieve this simply by rearranging their existing assets. They should continue to keep $2,000 in a checking account but put the $4,000 they have in bank savings into a Charles Schwab or Vanguard money market fund, both of which offer higher interest rates than a bank passbook account. For the remainder, they can earmark $6,000 in their Strong mutual fund for the same purpose.

Caves also said the contributions in the Linda’s 401(k) should be allocated differently. “You can’t touch this money without incurring penalties for 35 years. It’s a good place to invest aggressively and let it rip,” he advised them. Looking over the list of choices for Linda’s 401(k), Caves recommended that she transfer all $2,000 in the account to EuroPacific Growth. Forty percent of future contributions should be placed in that fund, he said. The remainder should be divided evenly between AIM Constellation A, an aggressive growth fund, and Investment Company of America.

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As for the couple’s retirement planning, Caves said they do not currently have the resources to invest more than 6% of Linda’s pretax salary in the 401(k). In addition, he pointed out that their retirement savings will increase once Jon is employed.

“Teachers have a pretty good retirement program,” he told them, “but it means you have to hang in there for the long haul.”

He also recommended that Jon and Linda transfer their IRA account to Managers Special Equity (five-year average annual return: 16.6%), a fund specializing in small companies. Besides diversifying their portfolio, the fund offers less risk than many others investing in small firms. Fund rater Morningstar Inc. of Chicago gives it a risk-adjusted performance rating of five stars, its highest mark.

After making suggestions for their emergency and retirement funds, Caves turned to the question of what to do with the money--it would be $9,000--in other investments. If they continue putting $300 a month toward these, and assuming they receive a moderate 7% return after taxes, they could have $18,000 after two years, when Jon hopes to graduate. If they then invest the entirety of Jon’s first-year salary (which Caves estimated at $20,000 after taxes), they should have more than $40,000 in the kitty at the end of three years. That would probably be enough for a 20% down payment on a home in Orange County, where they live now and where the median cost of a house is currently $195,000.

But should the couple buy a house first or have a child first? Caves pointed out some considerations for each choice: “There’s a bit of a risk to buying a house before having a child, since if you overspend, you might think it’s a tough position to be having a baby in. Some people get themselves into a spending cycle and they never have kids.”

But embarking on parenthood before owning a home poses problems too. After all, babies cost money. In 1995, the U.S. Department of Agriculture estimated that the average middle-income family will spend $145,320 to rear a child to age 18, and that figure doesn’t include the cost of college. Instead of saving, Linda and Jon could find themselves spending--for a larger apartment, for diapers and toys and, if both work outside the home, for child care. Caves estimates that even with two incomes, it would be highly unlikely that the couple could rustle up a down payment in less than seven years.

But by either scenario, Caves said, he believes the mutual funds Linda and Jon have been investing in don’t really serve their needs. Linda readily admitted that she chose the investments based solely on recommendations from her parents and friends. The tax-free fund, for example, would be perfect for an investor in the highest tax bracket. But Linda and Jon, who lose only 18% of their gross income to state and federal taxes, don’t need such an investment.

Caves suggested that they take $9,000 from their mutual funds and divide it between T. Rowe Price Spectrum Growth Fund (five-year average annual return: 15.6%) and T. Rowe Price Spectrum Income Fund (five-year average annual return: 9.0%). Both funds invest in other T. Rowe Price offerings, which are themselves composed of international and U.S. stocks and bonds, high-yield securities and growth and value stocks. Together they would give Jon and Linda’s portfolio a broad diversification that would be hard for them to achieve otherwise, given the relatively modest sum they are investing.

Should the couple decide to buy a house as soon as possible, Caves advises that they start by putting $4,500 in the income fund and $4,500 in the growth fund. Then, $200 a month should go to the income fund and $100 to the growth fund. This strategy does not seek to maximize long-term growth; rather, coupled with their emergency fund, it should assure that the money will be there three years hence even if the market takes a turn for the worse.

Should Jon and Linda hold off on buying a home, Caves recommends that they place $6,500 in the growth fund and $2,500 in the income fund and that additional contributions be evenly divided between the two funds.

If the couple seek a more aggressive investment strategy, they can always put more of their monthly savings into the growth fund.

“More aggressive people would do 100%, but they could lose big,” Caves noted.

The planner also advised the couple to temporarily halt contributions to their IRA, saying that if they feel they can afford it, to put that $2,000 a year into the T. Rowe Price funds. “You can’t use an IRA for a down payment or babies without incurring severe penalties,” he told them.

Jon did ask whether the couple might be saving too much. Yet he and Linda were hard-pressed to say what they would spend extra money on--neither professes to covet designer clothing or expensive electronic gadgets. Nor do they wish to retire early or travel around the world. Still, they have denied themselves the kinds of “goodies” that most Americans take for granted. For example, the day after their wedding found the two heading off to work and school, not on a honeymoon in Hawaii.

Despite his concerns, Jon is more than happy to let Linda take the lead in their household financial planning. “I don’t think I could tell you where the money is,” he admitted.

“Since Linda started saving before we married, and she makes most of the money anyway, I let her deal with it.”

Caves said it’s not unusual for one spouse to handle almost all of a family’s financial matters. And though there’s nothing wrong with leaving one person in charge of day-to-day financial monitoring, Caves said, it would be good for the two of them to sit down together for periodic goal setting and financial health checkups, so that both are deciding how much money they wish to invest and where they want to invest it.

Want to know more about how to build a retirement nest egg? Attend the Los Angeles Times Investment Strategies Conference on Feb. 22-23. To register, call (888) TIMES97.

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This Week’s Make-Over

* Investors: Linda Kung and Jon LaBree

* Ages: 25 and 24

* Occupations: Linda is an environmental engineer and Jon is a full-time student

* Combined gross annual income: $40,000

* Financial goals: Learn about different investment options and understand their consequences; build a down payment for a home and begin financial planning for future children; build a better invested retirement fund.

Current Portfolio

* Mutual Funds:

Fidelity Growth & Income, $4,000

Strong Short-Term Bond, $9,000

Scudder Medium-Term Tax-Free, $2,000

* Retirement Funds:

IRA: USAA World Growth, $6,000

401(k) currently valued at $2,000 and divided among Dreyfus Worldwide Dollar Money Market, Bond Fund of America, American Balanced , EuroPacific Growth, Investment Company of America and AIM Constellation A

* Cash:

$6,000

Recommendations

* Continue contributing 6% of Linda’s salary to 401(k) but cease IRA contributions temporarily.

* Allocate $12,000 for a six-month emergency reserve. The money should be divided as follows: $2,000 in checking, $4,000 in a money market account with check-writing privileges through an investment company such as Vanguard or Charles Schwab, $6,000 in Strong Short Term Bond Fund.

* Rebalance the remaining investment portfolio, putting more money into domestic and international growth funds to better diversify and spread risk.

Recommended Portfolio

* Move IRA funds into Managers Special Equity ([800] 835-3879)

* Reallocate all current 401(k) funds into EuroPacific Growth. In the future, direct contributions to EuroPacific Growth, Investment Company of America and AIM Constellation A.

* Divide remaining funds between T. Rowe Price Spectrum Growth and T. Rowe Price Spectrum Income ([800] 638-5660).

Meet the Planner

Preston S. Caves is a fee-only certified financial planner and chartered financial analyst based in Manhattan Beach. His firm, Caves & Associates, specializes in investment management consulting for retirement plans and large private portfolios. Caves also helps people with special financial-planning needs, such as business owners and individuals with high net worth. He holds both an undergraduate degree and master of business administration from Stanford University.