Get With The Plan: June 23, 2013

62313Tyrone and Bette, in their mid-40s, are juggling today’s spending with their want to save for retirement.

“I feel like while we have savings for the future, we don’t have enough cash for the everyday bills,” says Tyrone, 45. “I don’t want to slow down the savings but I hate dipping into savings to pay off the bills.”

An inability to pay as they go has led to credit card balances topping $11,000.

The Middlesex County couple, whose names have been changed, have set aside $267,300 in 401(k) plans, $146,360 in IRAs, $2,600 in a money market, $400 in savings and $300 in checking. They also have $42,180 in 529 plans for their three children, ages 12, 8 and 6. Bette has a pension that will pay $350 per month at age 65.

The Star-Ledger asked Jerry Lynch, a certified financial planner with JFL Total Wealth Management in Fairfield, to help the couple better manage their cash flow today while planning for the future.

Lynch says he found this profile to be a difficult one because Tyrone and Bette didn’t want to share their tax returns or copies of investment accounts, but instead only shared account balances and mutual fund names.

Like a doctor, Lynch says, financial planners can’t give a good diagnosis without a full picture of the patient. He likens Tyrone and Bette to a hypothetical patient who visits a doctor, refuses to share family history, take a blood test or give a urine sample.

“The cherry on top is as the patient is leaving, he says, ‘Doc? So am I in good health?’”

Lynch says when he meets with a client for the first time, he performs what he calls a “financial physical,” which is designed to give a good idea of where the person currently is and where there are areas of concern. Without tax returns, investment statements and more, he says it is really impossible to give good advice.

Because of their privacy concerns, Lynch’s advice for this couple is more general.

The couple says they have a moderately aggressive risk tolerance, which Lynch says should be 70 to 80 percent in stocks. The couple is currently higher, with 85 to 90 percent in stocks.

Lynch says there’s nothing wrong with being more aggressive, provided they understand the potential “pain” this strategy can give them over time. He doesn’t want to see them try to time the market, but instead stay invested over the long term no matter what the daily moves of the market are.

Twenty percent of Tyrone’s 401(k) plan is invested in a long duration bond fund — something Lynch doesn’t recommend — because the fund holds bonds with durations of about 30 years.

“This has done very well over the past few years as interest rates dropped, however, if rates rise by 1 percent, a 30-year bond can lose around 18 percent of its value,” he says. “Rates drop by 2 percent and you are losing 36 percent.”

Most of their investments are index funds, which Lynch says he likes because of their low cost. Still, he wouldn’t recommend using only index funds.

“In the S&P 500, around 10 stocks comprise 20 percent of the value of the fund and the top 25 stocks control about 33 percent of the entire index,” he says. “I would prefer a mixture of index funds supplement with some actively managed funds to offer more diversification.”

Tyrone and Bette redid their wills six years ago when their youngest of three children was born. He says they also need powers of attorney, living wills and medical directives.

He also says their life insurance beneficiaries are set up wrong, with the kids as the secondary beneficiaries. He says a probate judge would probably put the funds in trust and the children would receive the accounts at age 18.

“So now imagine this: it’s your 18th birthday and you now have access to these funds. What do you do?” he says. “You party like a rock star and blow through money like there is no tomorrow. Giving a 18-year-old kid who has never had to deal with money before a lot of money is a recipe for disaster.”

He recommends they meet with an estate planning attorney who can set up all the basic documents, including trusts that are set up by the will.

Next, they’d need to change the beneficiaries on their life insurance, IRAs and 401(k)s, because these assets are distributed based on the beneficiary designation, not what’s stated in a will.

Tyrone and Bette also need to do something about their credit card debt, which has interest rates ranging from 11 to 20 percent. They’re also pre-paying their mortgage and maxing out Tyrone’s 401(k) plan.

“Paying down your mortgage does not reduce the mortgage payment, does not help increase the value of your home, and the only thing it does is reduce the interest cost, which is tax deductible,” he says.

Moreover, most investment portfolios do not return 11 to 20 percent annually, which is what the credit card debt is costing them.

“I would rather have them put less in the 401(k) plan and not pay down the mortgage,” Lynch says. “Having the extra funds will eliminate the credit card debt that is costing them substantially more than what they benefit by investing in the 401(k) or paying down the mortgage.”

Finally, the couple has little cash for financial emergencies. Lynch recommends they open a home equity line of credit, to be used for real emergencies only, and over time they can build their cash reserve. He recommends that over time, they accumulate $50,000 in a safe and liquid account.