She Got By on Little and Now She’s Got a Lot

For many years, investing surplus money was not an issue for Loretta Tyson. Raising eight children on a tight budget guaranteed that there was none.

But as many expenses disappeared over the years, Tyson’s thrifty habits remained. Today, the semiretired Tyson, 63, finds herself with a portfolio worth $225,000 to manage.

“This amount is amazing to me,” Tyson said. “It just kind of grew. When you get in the habit of scrimping, it stays with you.”

Tyson traces her frugality back to the years when her children attended parochial schools and she and her husband borrowed money to pay the fees. Each year, the Tysons took out a loan to pay school costs, then spent the next 12 months repaying the money--just in time to repeat the exercise. To help make ends meet, she worked part time at Kmart.

Today, her children are self-sufficient and Tyson’s $115,000 Los Angeles home, near Interstate 105, is paid off. Now widowed, she lives on about $1,000 a month, which comes from Social Security and the income from a part-time job at a local church.

“I have learned to get by on very little, although I wouldn’t mind having a lot,” Tyson said. In October, she received $50,000 from the estate of her mother, who died in June. That money has been added to the portfolio she built from personal savings, an IRA that she rolled over from her Kmart 401(k) account after retiring from the store, and proceeds from a life insurance policy on her late husband.

The inheritance, along with disappointment in the performance of her nest egg so far, prompted Tyson to seek professional investment advice. And her mother’s death also inspired Tyson to do some estate planning of her own, even though she is in good health and expects to live at least as long as her mother, who passed away at age 89.

“I want to get everything in good shape,” Tyson explained.

Los Alamitos certified financial planner Delia Fernandez, who reviewed Tyson’s situation at The Times’ request, was impressed by her modest lifestyle. “I see a lot of people who have much larger incomes than you but really struggle to get by because of their spending habits,” Fernandez said.

By not tapping her savings, Tyson allows her money to keep growing, Fernandez notes. In fact, even if Tyson doubled her monthly spending, she would probably still see her net worth increase over time. That’s because her investments would grow more than $12,000 a year, assuming an annual return of 6%. Fernandez says Tyson’s goals of traveling more after she turns 65, taking care of her own expenses as she ages and leaving something for her children are attainable.

Another plus for Tyson will be a large increase in her Social Security benefit--from the current $410 monthly to $1,000--when she turns 65 and can collect widow’s benefits based on her husband’s higher earnings. Her current Social Security income, which she began collecting last year at age 62, is based on her own more modest earnings.

While Fernandez gives a thumbs-up to Tyson’s frugality, she is less impressed with her investment choices.

Diversification is not a problem--her funds are the right types for someone with Tyson’s portfolio, spending patterns and risk tolerance. About 60% of Tyson’s money is invested in stock mutual funds and the remaining 40% is in bond and money market funds.

But many of Tyson’s mutual fund selections have worked out better for the people who sold them to her than they have for Tyson.

Several funds carry high expenses. Some of Tyson’s stock and bond funds, for example, carried front-end sales loads--charges to get into the funds--of as high as 5.75%.

The one-time sales charges are how financial planners such as Tyson’s earn their living and do not in and of themselves signal that the funds are poor investments. But some of the funds also have high ongoing expenses.

On the other hand, her largest holding--Fidelity Advisor Growth Opportunity Class T, has outperformed the S&P; 500 in the last two years. That fund charges a 3.5% front-end load--lower than most sales charges--and its expense ratio is 1.7%, slightly above the average for domestic funds.

Despite such exceptions, investors on average tend to do better in “no-load” funds, which not only have no upfront fees, but typically charge lower expenses as well. Do-it-yourself investors generally use no-load funds, as do fee-only planners such as Fernandez.

So should Tyson sell all her holdings? Not necessarily, Fernandez said.

For one thing, selling funds that have a high front-end sales load does nothing to retrieve that sales fee. Once charged, it is gone.

In addition, Tyson would owe state income taxes and federal capital gains taxes on her mutual funds gains if she sold.

The federal capital gains rate for assets held more than one year is 20%--except for people in the 15% federal tax bracket, who pay 10%. Tyson’s adjusted gross income is usually well under this year’s $25,750 maximum for the 15% bracket, but her inheritance will add income and push her into the 28% federal bracket this year.

Inheritances typically are not taxable to the recipient. But because much of her mother’s funds were held in tax-deferred annuities, some of the income is taxable to Tyson. (Tyson and her siblings took a full distribution, but sometimes the taxable annuity payments from an inheritance can be spread over several years.)

Because of the tax consequences, Fernandez advised Tyson not to sell her fund holdings in 1999. However, she recommended Tyson immediately exchange her MetLife Preference Plus Aggressive Growth variable annuity (five-year average annual return: 9.38%) because it charges investors a 2% annual management fee and has had unimpressive returns. There are no surrender charges on the annuity because Tyson has owned it for nine years. (The surrender charges decreased each year until reaching zero after seven years.)

To avoid taxes that are normally due when cashing out an annuity, Fernandez recommends a “1035 exchange.” This allows Tyson to roll the investment into another annuity without tax consequences. The annuity she recommends, TIAA-CREF Growth (one-year return: 36%), has much lower expenses--0.23% annually--a stronger track record and no surrender charges.

Tyson should also plan on using this annuity to pay for her own expenses rather than passing it on to her children. As Tyson learned from her mother’s estate, annuities aren’t the best asset for an inheritance. Most other assets get special tax treatment at death, so that her heirs could sell the funds or property without owing capital gains taxes.

For future investments, Fernandez suggested, Tyson might want to keep her decisions simple by buying index funds. The Vanguard 500 Index (five-year average annual return: 25.86%) is the largest fund that aims to match the performance of the widely followed S&P; 500 index of large companies and can be purchased with no sales charge. It has extremely low management fees, less than 1%.

Another low-cost index fund that reflects the entire U.S. stock market is the Vanguard Total Stock Market Index A (five-year average annual return: 23.50%), which matches the Wilshire 5,000 index.

Fernandez also offered some alternatives for the bond portion of Tyson’s portfolio.

To ensure herself a predictable income stream, along with the assurance that her principal is safe, Tyson could purchase a U.S. bond fund, or individual U.S. Treasury bonds using a service called Treasury Direct. By purchasing through the Federal Reserve and holding the bonds to maturity, she would lock in an interest rate and not have to worry about the vicissitudes of the bond market or the possibility that other investors in a bond mutual fund will sell at an inopportune time.

As for her inheritance, Tyson should divide it into six installments and invest it monthly over the next six months, Fernandez said. This technique, known as “dollar cost averaging,” reduces the risk of putting too much money in the market at short-term high points.

Once she gets her investments in order, Tyson needs to have a frank discussion with her children about her estate, even if the topic may be troubling for them. “You don’t want to keep people in the dark about your assets and your plans,” Fernandez said. “Make sure everything is spelled out well ahead of the time it is needed.”

Though Tyson already has a will, Fernandez suggests that she meet with an attorney to draft several other documents, including:

* A Durable Power of Attorney for Health Care. This spells out what kind of treatment Tyson wants in case she becomes incapacitated and cannot speak for herself. The document also designates a decision-maker, known as an agent, who can make decisions about Tyson’s medical treatment.

* A Durable Power of Attorney for Assets. This designates a person who will have access to Tyson’s assets in the event that she becomes either temporarily or permanently incapacitated. This will help assure that bills get paid and other financial matters are dealt with during this period.

* A Living Trust. This document allows the transfer of Tyson’s assets at her death to heirs without the headaches and delays of probate court. To be effective, this document requires that users transfer title of assets such as homes, mutual funds, bonds and bank accounts into the living trust.

An attorney is likely to charge about $2,000 for the package--money that would be well-spent, Fernandez said.

Fernandez also raised the possibility of Tyson purchasing long-term care insurance.

The insurance, which covers some or all of the cost of nursing homes or in-home nursing care, is the topic of much debate in financial planning circles. The policies are probably unnecessary for the wealthy, who can cover the cost out of their assets--or for the poor, who will easily qualify for Medicaid coverage and are unlikely to be able to afford the policies anyway.

But there is little consensus about their appropriateness for someone in Tyson’s position.

On one hand, nursing home care can be extremely expensive. An extended stay for someone suffering from Alzheimer’s disease or some other long-term illness can eventually drain all the assets accumulated during a lifetime.

Tyson’s mother, in fact, spent seven years in a $3,500-per-month nursing home. Fortunately, she had a sizable portfolio of real estate and other assets that paid for the care.

A nursing home policy can be expensive as well; some policies cost $2,000 or more annually for someone in her early 60s, such as Tyson. There is risk that an individual’s insurance company will not pay or will have financial problems. And although many people may need short-term nursing care at some point in their lives, relatively few people actually have an extended stay in a home.

“I want to leave something to my children,” Tyson said. Still, she said, she plans to look into the coverage.

Fernandez encouraged Tyson to continue with the habits that have landed her in a relatively comfortable financial situation.

“It’s not how much you make that is important; it’s how much you keep after your expenses,” Fernandez said.

*

Graham Witherall is a regular contributor to The Times. To be considered for a 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, or to money@latimes.com. You can save a step and print or download the questionnaire at http://161.35.110.226/makeoverform.

Information on choosing a financial planner is available at The Times’ Web site at http://161.35.110.226/finplan. The site offers stories, phone numbers, addresses and links to related sites.

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This Week’s Make-Over

* Investor: Loretta Tyson, 63

* Income: About $12,000 a year

* Goal: A comfortable retirement

Current Portfolio

Money market and cash, including recent inheritance, $67,000; Fidelity Advisor Growth Opportunity Class T, $42,000; MetLife Preference Plus Aggressive Growth variable annuity, $28,000; Lord Abbott Bond Debenture Class A, $33,000; George Putnam Fund of Boston Class A, $22,000; Franklin Growth Class A, $13,000; Pilgrim High-Yield Bond Class A, $10,000; Pilgrim MagnaCap Class A, $9,000.

Recommendations

* Switch to a lower cost variable annuity.

* Purchase no- or low-load index mutual funds with low management fees.

* Prepare estate documents including living trust, power of attorney for health and power of attorney for assets.

Recommended Purchases

* TIAA-CREF Growth, (800) 842-2733

* Vanguard 500 Index, Vanguard Total Stock Market Index A and Vanguard Total Bond Market Index, (800) 662-7447

About the Planner

Delia Fernandez is a fee-only planner and owner of Fernandez Financial Advisory in Los Alamitos. She has 21 years of experience in the financial services industry and is an instructor for UC Irvine Extension’s personal financial planning certificate program.

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The Situation

* Investor: Loretta Tyson

* Annual income: $12,000

* Goals: Improve portfolio returns, invest recent inheritance wisely and plan estate

* Solutions: Switch to funds and annuities with lower expenses, invest inheritance in monthly chunks and have attorney prepare durable powers of attorney for assets and health care. Also consider establishing a living trust.