In an era of low returns, maximize amount of money you can put to work PERSONAL FINANCE

MUTUAL FUNDS

April 04, 1993|By WERNER RENBERG | WERNER RENBERG,1993 By WERNER RENBERG

"My husband is 60 years old and, unfortunately, was a victim in his company's restructuring when he was 59 -- a forced retirement at a 33 percent reduction of his monthly pension," a Florida reader writes.

"He only receives $800 a month and still has two years before he can apply for Social Security -- provided that doesn't change. We need to augment his pension by $350 a month to pay our bills until then.

"Fortunately, we were in our company's ESOP [employee stock ownership plan], so we have $80,000 to invest. This must carry us the rest of our lives."

She adds that she called Fidelity and Vanguard to ask about their no-load funds but was overwhelmed by their large selections. And she's reluctant to buy load funds suggested by her bank. So, she pleads:

"Do you have any suggestions?"

Her touching request reflects circumstances that may prevail in many households around the country, despite the economy's gradual recovery. The challenge -- making a small sum of money go a long way in an era of lower expected returns -- may apply to you, too.

How do you deal with it?

First, by trying to maximize the amount of money you can put to work. And then, by looking at the problem in appropriate time frames.

If the $80,000 is still in the ESOP -- exposed to the risk of being concentrated in one company's stock -- they should sell the shares as soon as possible and roll over the proceeds on a tax-deferred basis into one or more IRAs.

If $80,000 is what's left after paying income tax on liquidating an ESOP account, the money would have to be invested in taxable accounts. (A larger amount could have been available now for investment if the tax had been deferred via a rollover.)

For the next two years, the couple's primary investment objective is to generate $4,200 of cash annually. A desirable secondary objective: to build the principal sum. For ensuing years -- "the rest of [their] lives" -- the goal must be to enlarge the nest egg while generating income to supplement Social Security and pension checks.

The $4,200 required annually in the next two years is 5.25 percent of $80,000. But taxable money market funds now yield only about 3 percent. So, they have at least three choices:

* Put all of the $80,000 into a money market fund and use some of the principal sum to supplement their income.

* Assume some risk by investing the money in one or more bond funds likely to yield at least 5.25 percent after tax (6.18 percent before tax, if you assume the 15 percent federal bracket).

* Go for growth -- and assume more risk -- by investing in funds that own both bonds and stocks.

The money market fund is the least risky. But unless inflation heats up, causing a sharp increase in money market rates, it would result in a moderate shrinkage, instead of growth, of the principal over the first two years.

No-load bond funds invested in intermediate- or long-term investment-grade securities could yield 6 percent or more, making it unnecessary to touch principal. They would be vulnerable, however, to a decline in bond prices, affecting their net asset values (NAVs), in the event interest rates rise. Their NAVs would rise only in the unlikely -- but not impossible -- event that rates would fall further.

The third alternative -- a combination of bond and stock funds or funds that invest in both bonds and stocks -- requires a mix that could achieve the objectives of income and growth while avoiding too much volatility. A 70-30 or 65-35 blend might do the job.

Vanguard's Wellesley Income Fund, which tends to be invested 35 to 40 percent in blue-chip stocks and the balance in high-grade corporate bonds and U.S. Government obligations, is example of a fund that might be suitable. For the last five years, it had an average annual total return of 13.5 percent -- 85 percent of the Standard & Poor's 500 Index's 15.9 percent and only 50 percent of its volatility. Its latest 12-month yield: 6.3 percent.

zTC Unlike money market funds, which don't provide for growth, such funds are appropriate for the longer run. In fact, given the ever-present risk of short-term fluctuation, it would be imprudent to invest in long-term bond or stock funds for only a couple of years.

The importance of retirees' allocating part of their assets to funds that own stocks can hardly be overstated, because pensions usually aren't increased to match inflation, as Social Security payments are. Should inflation continue at the 3.8 percent average annual rate that we've seen in the last 10 years, the Florida couple's $800 monthly pension check will have the purchasing power of $543 in 1993 dollars 10 years from now.

To make up for the shortfall in purchasing power, they should be partially invested in funds owning quality common stocks, which can be expected to appreciate and provide increasing income over time as corporate earnings grow with the economy.

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