Financial Planning Case Study - Young Family with 2 Kids

Hey, what's up everyone and welcome to the School of Personal Finance. In this video, we are going to walk through a case study of creating a financial plan. I always find that it is much easier to learn by example. So, we're going to look at a profile for a young family, they have two young children, saving for retirement, saving for college, trying to make it all work. We're going to go through some recommendations and things that I think they should be doing to ensure that they're going to reach their goals. I hope that you find this one helpful. Let's get to it. All right, so a couple things real quick. Number one is I would love to connect with you over on LinkedIn. So, head over there, send me a connection request. It's under Rich McCormick. I'd love to learn more about you. Number two, head over to schoolofpersonalfinance.com, join my email list, download the free PDF for the 15 numbers that you should be tracking to become great with money. Check out everything I have going on at The Educational Center. And then finally, I started offering what I call power sessions, where we would work one-on-one using RightCapital. I would send you an invitation to create your profile, and then we would have a Zoom call and go over your specific situation. At the end of it, I would give you my recommendations and provide you with a printout also of everything that we put into the system. So, if you're interested in that, go check it out at schoolofpersonalfinance.com under power session. All right, so now for this case study, we have Frankie and Lucy Beans, and they have two children. They have a six-year-old and a two-year-old. So, I'm going to go ahead, I'm going to share my screen with you into the RightCapital software and walk you through everything that goes into creating their financial plan. Now, I'm going to go through this fast. I don't want this video to take forever. So, I'm going to try to bang through all of this as quickly as I can, where at least you get value and you see exactly what I would recommend to them and the direction where my mind goes when I start to look at all these different pieces of their financial life. Okay, so we're going to start in the profile section of the software. So, for Frankie and Lucy, they're both 35 years old, and they have two children. They have Junior and Peewee, ages six and two. So, now let's skip over to their goals and take a look. So, now Frankie, he'd like to retire at age 67, where Lucy would like to retire at age 60. And monthly expenses in retirement, now obviously, they don't know this yet, right? They're just guesstimating that they want $4,000 a month to be able to spend in retirement. And this would be above and beyond any living expenses that we've already accounted for in the software. So, if they're going to be owning a house at that point, the mortgage payment, taxes, insurance, things like that. For healthcare costs, we're just taking the national average for when they get into retirement, how much it will cost each year for healthcare. And then they have a goal of being able to pay for their kids to go to college. So, now this is the average annual cost currently for a four-year state school. So, that's what we're going to use for the assumption in here. We could always juice that up. For example, if we wanted to do a private school, you see the cost basically doubles, which is crazy. And we have no idea what college costs are going to look like by the time their kids go to school. But just for planning purposes, we're going to say four-year in-state on campus, and we're going to go with that. And that's for both children. And then as far as an emergency fund, their cash reserve goal, they have a target amount of $25,000 cash in the bank. And then we added a vacation goal as well. So, $4,000 a year, earmarked to take the family on vacation once a year. So, now let's look at their current income. All right. So, now Frankie, he has $100,000 income, and Lucy has a $30,000 income. Her job, she has a flexible job where she doesn't work a full 40 hours a week, and she's hoping that she can maintain this all the way through until retirement. And then we have Social Security. That's going to be their only income in retirement. Neither one of them are going to have pensions when they retire. All right. Next, let's look at what they're currently saving. So, Frankie, he saved 6% into his 401k. So, he makes 100 grand. He saved 6%. So, that's $6,000 a year going into his 401k. And his employer, they match 50% up to a 6% contribution. So, they're putting in $3,000 a year. So, between his contribution and the employer match, there's $9,000 a year going into that 401k. Lucy's current, she doesn't have a 401k through her employer, so she's not currently saving. And then they're doing $1,200 a year into each of the children's 529 plans. Okay. So, now let's look at their living expenses. So, it costs them $4,000 a month to live. And now, this is on top of their current housing expenses. We account for that in another place in the software where I'll show you in a minute. But for their living expenses, $4,000 a month. Now, for this number, it makes such a huge difference as we project out over time. So, you have to be tight with this number. You have to know how much money it costs you to live every single month. There are great apps out there like Mint or Personal Capital where you could budget. You could track your monthly expenses and see how much money it costs you. But it's a very important number to know how much money you spend each month. All right. So, now let's go look at their net worth. So, as we could see in the bank, they currently have $13,000. Now, if you remember, their goal is to have $25,000 of liquidity in an emergency fund. So, they're not there yet. And then they have this $8,000 debt on a credit card. So, they're paying 19% on this. The minimum payment each month is $160 a month, $8,000 that they owe on that card. Now, for their investments, so Frankie's 401k, he's $120,000 in there. And then they have in the two 529 plans, $8,000 and $4,000. So, when you're creating your net worth statement, this is exactly what you're doing. You're listing out all of your assets, all of your investments, right? So, your bank accounts, your investment accounts, 401ks, IRAs, HSA accounts, 529 plans, any asset that you have. If you own your car without, you're not leasing it, then you put the value of your car under your assets. And then for your liabilities, those are going to be all of your loans. So, like your mortgages, personal loans, student loans, car loans, credit cards, any debts that you have. And this is how we come to that bottom line number of your net worth, which is basically just your assets minus your liabilities for your net worth. All right. So, now if we look at the loans here, so they have a current mortgage of $403,000. So, now this monthly payment, 1886. And that is just the principal and interest payments on this loan. And it's a 30-year mortgage. And the reason we just use principal and interest, because under this property tab, this is where we have the details of the home. So, they bought it for 500,000. It's currently worth 600,000. And here we have their property taxes and insurance, and we're accounting for it here. So, when we said that their living expenses were $4,000 a month, that did not include this property taxes, the insurance, and this mortgage payment, because we're accounting for it here. So, if they had any other loans as well, like for example, if they had a car loan that we had in here, then that would also be included here. And we wouldn't include it in that monthly expense number. And I'll show you where all this information ties in together as well. And now for insurance, the only life insurance that they have is Frankie has a group life insurance policy through his employer for $270,000. And that's it on that. And that's everything. So, that is their net worth. So, if we go and we look at the balance sheet, we could see at details of this. So, this is the point that you want to get to starting out to create your financial plan. This is the first thing that you want to see. You want to see what are your assets, what are your liabilities, and what is your net worth? So, just by looking at this, there are a couple of things that are obvious that jump out at us. Number one being this $8,000 credit card. We need to get rid of that, but we're going to have to dig in a little bit deeper and see what their net income looks like on a monthly basis. So, their net income minus their expenses, how much positive cash flow do they have where we could attack these different priorities and different things that we want to do. Now, the fact that they have $8,000 in credit card debt makes you think that maybe they don't have positive cash flow, or maybe it's very tight, or maybe we're not accounting for something in here. Because if they have positive cash flow, then they shouldn't have credit card debt, right? If their income is more than their expenses, then there's no reason for them to carry credit card debt on this $8,000. So, we got to dig in a little bit further and see what's going on there. All right, so next we're just going to take a quick look at their investments. Now, we're not going to dive into asset allocations in this video, but I just want to see an overview. So, for his 401k, that's the only investment that they really have besides these small 529 plans. But for the 401k, we could see that it is an aggressive allocation. It's 90% stock, 10% bonds. So, this is good considering Frankie's 35 years old, and he basically has 30 plus years before he is going to be retiring. So, he wants to invest that money aggressively, and this is a good allocation to have. Now, I don't know what's under the hood. So, if I was working with Frankie and we're digging into all of this stuff, then we would look at statements, see what it's invested in, see what the asset allocation really looks like, what funds are in there, and make some suggestions around that. But as far as the stock to bond ratio in there, 90% stock, 10% bonds, a nice aggressive portfolio for the long-term. One other thing to show you real quick, we could see that $120,000, that's the amount in the 401k, that's under tax deferred assets. So, that is a traditional 401k. So, when this money comes out in retirement, it is going to be taxed. Now, in many of my videos, I talk about tax diversification, meaning having your money in different tax buckets, like tax-free buckets, tax-deferred buckets, and then after-tax accounts, like a brokerage account. So, in their case, all of their retirement savings is in that tax-deferred bucket. So, it's just something to keep in the back of your mind. This $12,000 of tax-free assets, those are the 529 plans. So, when that money comes out, as long as it's used for higher education, then it's going to be tax-free coming out. All right. So, now we're going to go ahead and we're going to look at the actual breakdown of their cash flow numbers. All right. So, this is their cash flow going year by year. And again, it's just taking all of the data that we enter into that profile. So, it's very important to have all accurate information in here, or else it's going to be garbage in, garbage out. So, now for incoming flows, we could see for 2022, $130,000, right? Frankie's making $100,000 and Lucy's making $30,000. So, that's where we get to that. Then after that, we're going to have their expenses. So, if we break down their expenses, their living expenses, which is that $4,000 that we put in there, then they have their housing expenses, which is their principal interest, property taxes, insurance, maintenance. Then on top of that, they have their debt. So, they have the American Express making that minimum payment every month. It's $1,920 a year that they are paying on there. And then this is for Frankie's group life insurance as well. So, total expenses, $84,752. And then goals, this is the vacation goal of $4,000 a year. And as you can see, it goes up by inflation a little bit every year. And then their tax payments. So, now this comes directly out of their paychecks, but it's still an expense throughout the year, right? So, their federal tax, their state tax, their FICA taxes, all of that that's payroll deducted, reducing their net income each and every month. And then we have their planned savings. So, the 401k, that's the $6,000 that Frankie's putting in there. And then this is the $1,200 each into the 529 plan. So, after all of those expenses and savings, their total outflows, $121,394. So, this is the net number that we have, $8,606. So, that's a little bit over $700 a month that we're not really sure where that money's going. Now, in the system right now, I have it set to just assume that they're going to invest that money into a brokerage account. Now, I could also make it assume that they're just spending that money and that it's disappearing, but I mean, that's probably the case, but hopefully it's not the case. So, when I see these net flow numbers, my goal is to give that money a job. What could we do with that money? Now, we know that they have a goal of $25,000 in an emergency fund. So, that's probably the first place that we would earmark to try to build that emergency fund up. But now, there are other things that might take priority over that, that we might want to do before throwing it all into the emergency fund. But this net flow number at the end, that's hopefully what we have to work with to start hitting other goals. But as you could see, it's just so important to know all the numbers and be able to lay it all out so that you could see what you're working with and start to make decisions to optimize everything that is going on here. Now, if we scroll through and we look into the future, so now they're both getting increases. So, their income is going up every year. Their expenses are going up by inflation as well. Their goals, their tax payments, everything is going up every year as inflation and they get raises and they want to save more money and all of that stuff is happening. So, as we can see, we start to have distributions. So, now, these big distributions here, this is money coming out of the 529 plans to pay for college. So, 2033 is when their first child is going to be going to college and you can see it has a very big impact on their cash flow. So, with the first 529 plan, they almost depleted in the first year. So, we know right away that they're not saving enough for college if that's going to be one of their big goals to be able to pay that much money towards them going to school. So, the $1,200 a year into the 529 plan, it's just not nearly enough. So, what the system is going to assume then at that point is they're going to deplete the 529 plan and then they're going to use either a brokerage account or other savings to be able to pay for their kids to go to college. But this is going to have a negative impact on their overall financial plan. So, they're in negative cash flow these years because they're actually withdrawing money to be able to pay for the goal of sending their kids to college and you can see what the number is in the future. So, 51, let me click on goals right here. So, we're 2033. So, these are big numbers and it lasts for eight years because two children. So, two kids, you know, almost 50 grand a year gets to be over 60 grand a year sending them to college. So, that has a big impact on their overall financial goals. And then once the kids are out of college, now we get back into having positive cash flow up until Lucy retires. So, once Lucy retires at age 60, then they're back in the negative and they have to start living off of savings again. And then you can see when Frankie retires at age 67, now they really are depending on living on their savings on their retirement accounts. So, we have to make sure that they're saving enough into their retirement accounts to sustain them from when they retire all the way until the end of the plan. Now, in this plan, I have it at age 90, but you never know when your plan is up, right? Nobody knows when they're going to die. So, they have to be prepared that they might live well beyond that or, you know, that they could pass prematurely before that. But we have to make sure that they are saving enough in retirement to be able to enjoy themselves and survive. All right. So, if we go back over to the analysis, now this is what's called a Monte Carlo simulation. So, they're going to take all the information, all the data that we put into the system and they're going to run a thousand different trials, what's called the Monte Carlo simulation, and they're going to come out with a probability of success. And what success means is that you get to the end of plan, age 90, and you still have money left over that you didn't run out of money. So, in their current plan, we could see they have a 70% probability of success, which is okay. It's not amazing, but it's okay. And we could work with that, right? Again, they're very young and who knows where life is going to take them, right? They're 35 years old, but we like to have it higher than 70%, especially if they're walking into retirement. So, now this number over here, this is just the median number out of those thousand different trials. That is the median amount of money that they are left with at age 90. All right. Now, if we go down here, we could take a look at all of the things that are in their current plan, right? So, these are the things that we input into the system and then we could make changes. We could make proposals to see if we could go ahead and increase the probability of success. So, to show you one simple example and one thing that I would highly recommend for these two is that they attempt to max out Roth IRAs for retirement, right? So, they have no tax-free money coming in retirement. By opening up Roth IRAs, each of them contributing as much as they possibly can to the Roth IRAs each and every year, that is a great way for them to start adding to their retirement savings and increasing this probability of success. So, now that is one thing that I would definitely recommend to them. Another thing is to cut back on junior and PeeWee's college savings goals because those two things, they are kind of crippling this plan a little bit and you have to put your own retirement in front of paying for your kids to go to college, especially with the uncertainty of what it is going to look like in the future. So, I am going to say that their goal, we are going to cut this down, let us say to $13,000 a year for each junior and PeeWee. Now, this is going to go up by inflation. So, $13,000 in today's money, which is going to be basically like almost $30,000 once they actually reach college, a little bit less than that. All right. So, going into this, we are both at 70% on the current and the proposed. If I hit refresh right here, let us see what kind of difference that makes. All right. So, right there, they jump up to an 88% probability of success and the median amount that they end is over $4 million. So, that one change right there makes a tremendous difference and I would highly recommend that they do this. Now, they might not have the cash flow right away to each put $6,000 into their Roth IRAs, but let us just take a quick look right here. So, now for planned savings, if we click on this, they are doing $12,000 into the Roth and we could see that they have negative cash flow. So, how are they doing that if they have negative cash flow? Basically, they are using the money that they have in their savings account in order to fund this. So, it does make things a little bit tight by them doing that. And we could even look, if we look at ending balance by account, their taxable account is only going to have $9,736. So, that is their emergency savings. Their Roth is going to have $12,000 and then we have the 401k and the 529 plan. So, they are cutting it close on the taxable savings account on their emergency fund by funding these Roth IRAs. Now, we would have to keep an eye on this and make sure that they do have enough money liquid that they could get access to if they really did have an emergency. And if they were in a really bad situation, then we would have to look at the Roth IRAs as a way to be able to access money in a worst case scenario. Like with the Roth IRA, you could take out what you put into it at any time without taxes or penalty. Obviously, we do not want them doing this. Another lever that they could pull is Frankie would be able to take a loan from his 401k plan in a worst case scenario. But we have to keep an eye on this because we still want that cash balance to at least be $10,000 or so. So, they feel like they have enough money in that emergency fund. So, this will be a little bit of a juggling act. But I do think it is more important to max out those Roth IRAs each year and start saving for retirement in the tax-free manner. Now, one other thing that I would like to see them do is to pay more towards that credit card. So, we might be in a situation where we actually need to take care of that first before maxing out the Roth contributions. So, that credit card, I mean, it was at 19% and they owe $8,000 on it. So, making the minimum payment on that and paying 20% interest, it makes zero sense. That really has to become priority number one. So, what I would advise them to do is to take all their excess cash flow and attack that thing. And then once they're done attacking that, then we move to maxing out the Roth IRAs. So now, for the sake of time, I'm going to cut this one here, even though there are more pieces to this financial plan that we would really want to look at. Like for example, their insurance. So now, Lucy doesn't have any life insurance. Frankie only has his group insurance through his employer. So, we take a deeper look at that and see how much insurance do they actually need, how much term insurance, and what would it cost if they were to go and get it out in the private marketplace instead of Frankie just having it through his employer. So, something that I would definitely recommend for them to do, most likely 20-year terms for each of them to take them through the college years for their kids. Other things we'd be looking at would be their estate planning documents. So, they have a will, power of attorney, healthcare proxy, making sure they have all those things in place, looking at their tax situation, seeing if there are additional ways that they might be able to save on taxes, taking a look at those 529 plans as well, seeing if maybe we should stop contributing to the 529 plans for now until we've paid off that credit card and we're maxing out our Roth IRAs. It's probably something that I would recommend to them. We could also run comparisons to see how much more money you would end up with the proposed plan compared to the current plan that you're currently doing, which is pretty cool. We could look at savings rate, so how much money you are saving compared to your total income. So, there's so many capabilities and there's much more to show you in here. All right. So, I'm going to cut this one off here or else we could be here all day. I hope that you found this helpful. Please let me know down below if you like these types of videos and I'll do more and more case studies with different scenarios. I can even dive a little deeper and have longer videos as well. Over in the Education Center, I plan on doing longer videos going through all the details of creating a financial plan. Hit that like button if you enjoyed it. I'll see you in the next one. Thanks. Bye.