Thursday, January 21, 1999

Q. My dad is going to sell off his rental property, one each year, over the next five years. Lets say that he has 5 houses valued at $100,000 each, with no mortgage balance. He is thinking that he can sell the houses and carry the notes. For example, he would sell house #1, receive $20,000 as a down payment, and carry the note at the market rate of interest for real estate loans. That might be 8.5 percent for rental property. He would then repeat this procedure each year until all of the property was sold.

He is 62 and planning to retire at 65. The income from these properties is intended to supplement his 401k and pension plan savings during retirement. My parents are in the 28 percent tax bracket.

I think he may be making a mistake. It seems to me that with the time value of money, getting $500,000 on day one and investing it would be better than getting $20,000 at the beginning of each year, followed by interest payments. It also seems that the market would give him a better return on his money. What do you think?

—W.T., by e-mail

A. In a world of absolute financial calculations, a one time sale looks like the best option: basically, your father would trade a portfolio of houses for a portfolio of financial assets that might (repeat, might) earn more over the next few years.

More is involved here, however, than absolute financial calculations. There is familiarity and pace to deal with. Your father is planning on a lengthy transition and learning period. He is probably concentrating on current income, which real estate investors tend to do, and his plan produces more cash income than a move into financial assets would produce. He would be hard pressed to earn an 8.5 percent interest income return in the current market.

He can also change his plan after selling one or two houses and invest the entire proceeds in financial instruments, so he has flexibility.

Put these factors into the hopper and his plan starts to like good life management. I'd be willing to bet that there are still some things you might learn from your dad.

Q. What mutual funds can you recommend for people in their distribution years (retirement)? Every one reads that their ratio should be about 50/50 (stocks/bonds) or 65/35. But can you give a list of good funds that would provide a person in retirement with income to live off?

—J.P., Plano, TX

A. You have just asked for the Holy Grail of portfolio management. In the current market, most people dont have enough capital to generate the income they need. If you have a 50/50 portfolio it will generate an average yield of less than 4 percent. Most people need to withdraw more to meet their monthly needs.

My suggestion: Put an emphasis on equity-income type funds that generate above average current income. Value funds of this type have done poorly in the last year compared to growth funds but their long-term performance tends to be equal to, and often better than, growth funds. In addition, you can substitute a GNMA fund for a straight bond fund and gain a little current income that way.

After that, the next step is to examine your spending and reduce it, bringing your spending in line with your investment and pension income.

Q. I am really interested in current events and have read news articles and reports about the banks and super affluent that invest in high risk "hedge" funds. Of particular interest is the near bankruptcy of one hedge fund in which the Federal Reserve may be asked to "rescue" the investors. Isnt it interesting that those who are into stocks and bonds seem to be willing to take their risks (like "Boston Market") without asking the Federal Reserve to rescue them. Can you explain this?

—M.C., Lewisville, Texas

A. It isnt quite like that. First, the Federal Reserve did not do the rescue; it urged private parties to do it. Second, the Federal Reserve can, and does, step in to help financial institutions remain liquid whenever there is an event that threatens the financial system as a whole. They did this long ago when Penn Central failed. They did it when the Hunt brothers tried to corner the silver market and nearly busted a major brokerage firm and a major bank. They did it in October 1987 when the market crash brought thousands of margin calls and could have caused brokerage firms to collapse. And they did it when Long Term Capital, a hedge fund, learned that reality was a lot more violent than computer models.

Most institutions can, however, fail without threatening other financial institutions or the banking system.