Cleaning Up Your Finances BEFORE You Invest
| August 4, 2008 | Posted by Roshawn Watson under Uncategorized |
By: Roshawn Watson
Their family consists of Wayne and Michele and their two sons (their youngest son has Downs Syndrome).
Their Financial Situation
Wayne (a veterinarian) and Michele (runs a part-time massage therapy business) have a combined annual income of $120,000. So far, they have $126,000 in home equity, $110, 000 in retirement accounts, and $5,000 in emergency savings.
Unfortunately, they also have some sizable debt loads and expenses too. They carry a $32,000 balance on their credit cards and require nearly $7,000 in monthly expenses. Note the article fails to disclose the percentages of their debt (i.e. mortgage, car loans, student loans, etc) and the break down of their expenses.
Currently, they pay roughly $667 monthly in credit cards bills ($8000/12 months) and save about $567 monthly ($6800/12). Note about $400 goes into retirement accounts and $100 goes into a variable annuity every month.
Recommendations To Clean Up the Mess
1. Build Their Financial Base– One of the first recommendations was to make eliminating debt and building an adequate emergency fund their top financial priority. I completely agree. It is hard to simultaneously invest (for retirement, education, etc) adequately and pay off mountains of debt.
The financial advisers said that they should take out a HELOC and use it to “pay off the (credit) card debt.” This way they can lock in a lower interest rate (4%) compared to their higher credit cards APRs. Although this seems like a reasonable initial strategy, I am weary because this does not “pay off” the credit debt, instead it just moves the debt to the house. Unfortunately, most individuals with these HELOCs end up in more credit card debt because they don’t fix the problem; they merely mask it instead.
The financial advisers also said to temporarily stop contributing to their IRA and 529 plan to get out of debt and increase their emergency savings. I also agree with this advice with one caveat: this only works if you are committed to quickly (i.e. less than 1 year and a half) getting out of debt. Otherwise, not investing can be disastrous. I also would put more emphasis on getting out of debt than increasing their emergency savings at this point. Apparently, Wayne was not too keen on stopping the investments and is now considering picking up additional shifts so that he can increase their monthly income by $1,500.
2. Develop a Low Cost Investment Strategy – One of the first things Wayne did was to invest in no load (commission-free funds). This conservative financial decision can save you a fortune. Although those fees associated with loaded funds seem small, over time they costs investors a substantial chunk of their portfolios.
3. Protect Your Wealth With Insurance – Here the financial advisers focus on having life insurance. They recommended $3 million worth of term-life insurance. Generally, you needed about 8-10 times your annual income insurance. This is enough to replace you (financially speaking) when you meet your demise. However, the Lipovitches have a special needs child, so I assume, that is the reason for the increased insurance needs. Wealth-protection is vital. A lifetime worth of work can be lost in a single day. Check out 5 ways to protect your cash flow like to rich for additional ways to protect your finances.
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Copyright 2008, Roshawn Watson, Pharm.D. All Rights Reserved.
Copyright 2012, Roshawn Watson, Pharm.D., Ph.D. All Rights Reserved.
I agree with you Shawn. I'm not too thrilled about the HELOC as it typically spells disaster if you haven't tamed that bad habits that got you into debt in the first place. But if he could pick up extra shifts bringing in $1500/mo, he could eliminate that $32,000 debt in just short of two years. As soon as they paid off that debt, they'd be able to put $1500/mo + the $600/mo they were already putting into savings & investing into an emergency fund. That $20K emergency fund would be complete in 7 months. It might sound like forever and he may loose a little time with the family. But it will be well worth it when they are debt free. Their finances will finally be free to work for them.
Correction: Sorry, if they're already putting $667/mo towards credit card debt an additional $1500/mo devoted exclusively to debt would have them debt free in a little less than 15 months. And then he could roll the 667+1500+567 into the emergency fund and make that $15K up in less than 6 months. He'd be free of the mess in nearly 1.5 years. Its the debt snowball!
great comments FD. You are right on point, and I definitely agree. It would take some time, but that same discipline that got him through vet school can get his family free from debt bondage