Financial Makeover: Scrambling to catch up

June 7, 2002

Student loans, military service, and the joys of spending prevented this doctor from saving. He needs to buckle down and build up a nest egg.

 

FINANCIAL MAKEOVER

Scrambling to catch up

Jump to:Choose article section...What Singer told the Wilsons Further thoughts on finding more cash A retirement investment portfolio

Student loans, military service, and the joys of spending prevented this doctor from saving. He needs to buckle down and build up a nest egg.

By Leslie Kane
Senior Editor

Bill Wilson, a 48-year-old family physician in Pensacola, FL, knows he has to get serious about saving. With five children to raise, Bill and his wife, Bev, who's 46, have close to nothing stashed away for retirement.

"A couple of my colleagues have retired, and I still have $25,000 worth of student loans to pay off," says Bill. "That's an eye-opener. I thought I had years to start putting away money. Now I see time passing."

Bill started his solo practice in 1989. A year later, he was recalled to active duty in the Naval Reserves during the Desert Storm operation. He served for about five months. "The Navy paid me $3,000 a month, but office and household expenses ran almost $30,000 a month; we went through $125,000," says Bill. "It took us 10 years to recover financially."

A few years of indulgent spending also left the Wilsons with hefty credit card bills, which at one time reached $50,000. They've since whittled the balance to $6,800. Among their biggest expenses were vacations with the kids, which they took once or twice a year at a cost of about $6,000 each time. "Bill also likes gadgets," says Bev. "He gets on the computer and goodness knows what he'll buy. I'm very careful about money, but Bill needs someone besides me to tell him to quit spending."

The years of heavy cash outflow have left their mark. The Wilsons have no emergency fund. They have about $24,000 saved, most of it in mutual funds and individual stocks. "Two years ago, we started putting $50 a month into stocks," says Bill. The value of those and other stocks stands at about $8,000. Retirement seems a long way off: Bill's practice has no retirement plan, and on their own the Wilsons have saved only about $4,600 for retirement, in IRAs.

Bill's practice has a staff of 11, including a physician assistant and Bev, who's a former CPA and runs the office. The practice has only recently begun to turn a significant profit. Bev's financial skills have helped; since 2000, she has brought in an additional $30,000 a year in copay collections. Bill's annual salary is now about $250,000. Bev makes about $37,000.

Some big expenses loom ahead, however: With seven of them living under one roof, the family is too crowded in their modest 2,100-square-foot house. Bill and Bev own a vacant plot of land nearby and want to build a new house on it that will be twice the size of their current home. They'll also face college costs soon. Their children, ages 6, 10, 13, 14, and 17, currently go to parochial school. Tuition's relatively inexpensive but still costs about $18,600 annually. Housekeeper and babysitter expenses add $9,600 a year.

The Wilsons' major financial goals are building a retirement fund, paying for the children's education, and buying a larger home. Secondary goals include tax reduction and creating an emergency fund that will cover three months' worth of expenses. "I want to have a cushion for a rainy day," says Bev.

"We need a plan and some direction," adds Bill.

We introduced the Wilsons to Marc Singer, a financial planner with Singer Xenos Wealth Management, in Coral Gables, FL. Singer met with them, analyzed their financial situation, and came up with a budget and strategy to help them reach their goals.

What Singer told the Wilsons

"Bill has a good income, and the practice is doing well," says Singer. "Having Bev work there also is a major asset. Just as important, they're both committed to getting themselves on track financially. They've paid down much of their credit card debt and are making efforts to save regularly.

"However, because they've reached this point in life with little in savings and essentially no emergency fund, they'll have to put away a significant sum each year to plan for a comfortable lifestyle. They need to get aggressive about cutting expenses and investing.

"With this plan, the Wilsons will be able to retire at age 65," says Singer. "However, there's little margin for error. They can't overspend."

Singer's first move was to help the Wilsons find more money in their budget. They need to snare $53,000 this year to put toward long-term savings. And to help them keep pace with anticipated inflation, that savings goal will increase 3 percent a year until Bill turns 65. About 10 percent of the money will be earmarked for an emergency fund; the rest will be set aside for their retirement. "Saving more is the most crucial element of the entire plan," says Singer.

Singer says they can get the money by:

• Reducing debt. Fortunately, two cash drains will soon disappear: The $6,800 credit card balance, which they'll pay off by the end of the year, and $9,400 remaining on their auto loan that they'll retire this summer. Closing out those debts will provide an additional $16,200 in the coming year toward savings.

• Cutting life insurance premiums. Bill has a $500,000 whole life insurance policy and substantial term coverage. "The term coverage is enough to protect his family," Singer says. "The whole life policy is unnecessary, and even though it builds up value, it's an inefficient investment vehicle. Bill should cancel it and put the $10,000 cash value plus the $12,000 in annual premiums into long-term investments."

• Saving more current income. To meet the balance of their annual savings goal—$24,800 this year—the Wilsons will have to set aside cash from current income. Because they don't save any pre-tax money in retirement or pension plans, Singer recommends that they put $14,000 of it ($7,000 each for Bill and Bev) into SIMPLE IRAs this year. (That's the limit for 2002; it will increase by $1,000 a year for each to a maximum of $10,000 in 2005.) Doing so will decrease their taxable income, saving them about $5,400 this year alone in taxes—money they can also bank. (Depending on how the practice is structured, retirement contributions could significantly exceed the projections here.)

Those steps will provide the annual savings the Wilsons need in order to achieve their long-term goals. But, Singer warns, "it is essential that they keep their expenses close to what they're running now."

For that reason, building a new 4,000-square-foot house would be a mistake, says Singer. "I realize their current living situation isn't adequate, but construction costs plus higher mortgage payments, taxes, and maintenance expenses would nearly double their current commitment. That would significantly diminish their savings ability and destroy their financial plan.

"The time required to deal with construction and building issues would also be taken from the practice," adds Singer. "If they build a new home, in four years they might still be in the same financial situation they're in now."

Instead, Singer suggests the Wilsons sell the vacant land, which should fetch about $120,000, and their current home, which is worth $155,000. After paying off the $86,000 mortgage balance remaining on the properties, they'd have enough to buy an existing home for up to $350,000, and take on a mortgage of $161,000. The upgrade would increase their monthly mortgage payment by a much more manageable $210.

Further thoughts on finding more cash

In addition to rethinking the new house, Singer also suggested that the Wilsons:

Fund education expenses from current income. The Wilsons have been paying for private school tuition out of current income, and plan to continue to do that. They'll do the same for college expenses and assume the kids will go to state colleges. "Total college expenses would be $98,000 in today's dollars," says Singer. Their oldest teenager will start college next year, and the next two will enter within five years.

"If these expenses were further in the future, they could invest enough to build an education fund," says Singer. "However, at this point we can't rely on the market to bring sufficient returns in such a short time."

Invest aggressively."If Bill and Bev can save a couple hundred thousand dollars by 2006, they'll have a good start. Thanks to compounding of earnings, their money will start making money," says Singer.

Singer predicts that Bill will have to work until age 65 to retire comfortably. "He can decide to work longer, but shouldn't have to count on doing so," says Singer.

Based on the Wilsons' current lifestyle, and assuming a 20 percent decline in living expenses when the children are grown, Singer estimates that the Wilsons will need an annual post-retirement income of $84,000 in today's dollars. To generate that income, they should have a $1.8 million nest egg by the time Bill retires.

Because the Wilsons have at least 15 years until retirement—long enough for them to recover and rebuild their savings if the market suffers another downturn—Singer recommends a diversified portfolio with 65 percent of assets in domestic equities, 10 percent in international equities, and 25 percent in bond funds (see below for details). "The portfolio is reasonably aggressive, but it's most likely to give them the returns they need," he says. It should bring an after-tax annualized return of at least 7 percent.

"This portfolio contains a good mix of asset classes, and the equity funds include large-cap, mid-cap, and small-cap stocks, as well as growth and value stocks," says Singer. He currently favors value funds over growth funds. "The country's economic slump has sapped the momentum from growth funds, and value is performing better.

"Two years ago, we felt the growth sector was overpriced and tremendously risky," says Singer. "We started moving portfolios from 60 percent growth/40 percent value to 20 percent growth/80 percent value. This helped protect investors when the market fell. In the coming 12 months as the economy recovers, growth will pick up, and we'll move back in that direction.

"The portfolio I recommend for the Wilsons also contains a high proportion of small-cap value investments, because those were somewhat insulated from the market downturn. The 10 percent in foreign holdings I've recommended is deliberately on the light side," Singer adds. "Although the international arena did very well in 1999, it's gone down since then."

Singer suggests that the Wilsons stick with no-load funds and invest through a mutual fund supermarket, such as Charles Schwab & Co. or TD Waterhouse. He also recommends that they stop buying individual stocks. "They made a good effort, but like most people they should let an expert decide what and when to buy and sell," says Singer. The Wilsons can keep their current stocks, he says, but they shouldn't add to these holdings.

"This financial plan is conservative and simple, and we should be able to implement it," says Bill. "Meeting with Marc made us realize that previously, our goals were soft and pliable. We thought we could always change them. Now, we realize that we have to make concrete decisions and take action. This blueprint should help us."

 

A retirement investment portfolio

This retirement portfolio assumes a time horizon of at least 15 years and is expected to bring after-tax returns of at least 7 percent.

FundType% of portfolioTotal return*
1 year5 years (annualized)
Pimco Real Return–Class D  
(888-877-4626)Short-term bond15%5.9%N.A.
Pimco High Yield–Class D  
(888-877-4626)High-yield bond100.9N.A.
Dodge & Cox Stock  
(800-621-3979)Large-cap155.114.2%
State Street Research Mid-Cap Value–Class A  
(800-882-0052)Mid-cap value2015.5N.A.
n/i Numeric Investors Small Cap Value  
(800-686-3742)Small-cap value3040.4N.A.
Tweedy Browne Global Value  
(800-432-4789)International equity102.012.1

 

 

Leslie Kane. Financial Makeover: Scrambling to catch up. Medical Economics 2002;11:84.