Assignment: Risk, Insurance & Financial Planning
Case Studies
1) Planning for the future
Mary and Peter are 21 and just starting grad school. When they emerge two years hence as software engineers, they plan to marry and buy a small house or condo, and a car.
In the meantime, they are living together and bringing in a combined $75,000 a year from scholarships, research grants and work, he is a research assistant, and she is a teaching assistant. When they graduate, they expect to earn a starting salary of $55,000 each.
What distinguishes them from many other 21-year-old students is that they have $60,000 in the bank, savings Mary set aside from working during her undergraduate years. This year and next, they will each contribute $5,000 to their tax-free savings accounts. When they start working, they plan to live on one salary and take full advantage of the registered retirement savings plan.
They plan a simple wedding costing about $4,000 followed by a "shoestring" trip to Europe for $4,000 or $5,000.
Mary wants to put her savings to work for the next few years "so that I will have enough money to deal with the expenses of becoming an adult, whatever they may be and if they decide to have children" she writes in an e-mail.
We asked a financial planner/advisor what the analysis and recommendations are for the two entering grad school.
Mary and Peter plan to draw on their savings in two or three years - perhaps to tide them over until they find work, to cover the cost of moving to a new city, to buy a car or some furniture or even as a down payment for their home.
First, the investment question; with such a short time horizon, what should they do with their funds?
How should they invest in the longer term for retirement once they are established in their careers?
Mary and Peter figure they'll have to pay about $240,000 for a small house or condo, preferably in their hometown of Halifax if they can find work there. Estimate their monthly mortgage payments with $20,000 down, 5-per-cent interest and a 25-year amortization pay back period.
If they work for a while before they buy, as they plan, they can stash away some money in their RRSPs.
They will have additional costs for insurance, utilities, maintenance and property taxes, so their living expenses will be higher. What other financial considerations do they have with plans for children?
The People: Mary and Peter, both 21
The Problem: How to invest $60,000 in savings and set finances on course for marriage, careers and the purchase of a home.
The Plan:
The Payoff: Lifelong financial security and the peace of mind it brings.
Monthly net income: $4,500
Assets: Bank accounts $15,000; GICs and term deposits $42,000; TFSA (mutual funds) $5,000. Total: $62,000.
Monthly Disbursements: Groceries, dining out $600; clothing $50; medical, drugs, dental $50; rent $1,100; telecom, TV $110; furniture, appliances $50; entertainment $50; tuition $1,260; bus $20; gifts $20; miscellaneous $100. Total: $3,410. Savings Capacity: $1,090.
Liabilities: None
2) Planning for House and Baby
Danielle and Brad haven't been married a year and already they're on sound financial footing.
They each owned a condo in downtown Vancouver, so when they moved in together, they sold one and paid off the mortgage on the other. Now they own their $310,000 apartment outright.
Brad, 37, earns a little more than $60,000, Danielle, who is 34, earns about $55,000. They both work in the media.
Like most people their age, they have great plans.
"We want to have a comfortable life, be able to afford to raise our children properly, save for their education, move up from our condo to a house in Vancouver and have enough money to retire at 60 with a vacation property," Danielle writes in an e-mail.
Their short-term plans are to have children and buy a house to live in that can also generate some rental income. Danielle also hopes to quit her job and go freelance (self employed) in the next two to three years.
We asked a financial planner to look at this young couple's situation.
Danielle and Brad are currently saving about $675 a month outside of their company savings and pension plans after expenses. What are the challenges in meeting the financial goals given their financial resources and plans?
The couple's search for ways to generate an income stream, either by renting their condo when they buy a house or renting out part of the house, would involve taking on more debt.
Another income source is their company savings and pension plans. Brad's employer matches his stock purchase savings plan contributions by 50 per cent, making for a "pretty nice return," "It's like buying a GIC [guaranteed investment certificate] paying 50 per cent interest."
"When evaluating the guaranteed investment return from a defined benefit pension, the rates are often quite compelling." Both Brad and Danielle currently have defined benefits pension plans.
What are financial implications if Danielle decides to work freelance instead of employed with a company?
Looking further into the future, Danielle and Brad are on track to retire in their early 60s - "assuming they continue to live in their current condo." If they buy a house, how will this potentially change and what will they need to do to retire as planned?
Client Situation
The People: Danielle, 34, and Brad, 37
The Problem: How to start a family, buy a house in Vancouver and save for the children's education without running into cash flow problems.
The Plan:
The Payoff: Achieving at least most of their goals and ultimately, financial security.
Monthly net income: $7,338.61
Assets: Bank accounts $12,700; Tax-Free Savings Account $14,101, mutual funds $33,725; company stock $3,500; condo $310,000: Total $374,026.
Monthly disbursements:
Union dues $70.65; savings $675; RRSP $375; employer savings plan $472; employer pension plans $395.08; food and eating out $1,150; clothing $460; medical, drugs, dental $10; dog $150; storage locker $160; gym $53; property taxes, utilities, condo fees $570; house insurance $20; telephone, cable, Internet, cellphone $237; painting, repairs and maintenance $120; furniture and appliances $500; vacations $500; entertainment, music, books $150; auto expenses $550; other transportation $200; life insurance $38.86; group insurance, disability, dental $145.75; donations $20.83; gifts $200. Total: $7,223.17
Liabilities: None
3) Managing Goals and Priorities
At 23 and fresh out of university, Katheryn has the world by the tail. She's just started her first full-time job, in Edmonton, and already she has $5,000 in mutual funds, $4,000 in a tax-free savings account and $10,000 to invest.
Before starting her new job, she had been working at two part-time jobs and saving money.
Like most young people, Katheryn has grand ambitions. First, she wants to buy a car, travel, and build an investment portfolio. Over three years, she aims to save three years' worth of living expenses plus tuition so she can get her MBA.
That's just the beginning.
In four years, she wants to buy a house, which she will rent out while she is studying, and live in later. Over four to eight years, she hopes to accumulate a large, diversified investment portfolio. Then she plans to buy a second property for rental.
Katheryn figures she'll be earning $80,000 a year to start when she gets her MBA. Can she do it all?
We ask a senior financial adviser to take a look at Katheryn's situation.
Because Katheryn clearly is eager to become a successful investor, she might want to start by taking an investment course and reading up on personal finance or taking the Canadian Securities Course, offered by the Canadian Securities Institute.
"It's great to see a young person caring about their finances. Often, this line of thinking doesn't occur until age 35 when a baby is on the way. My overall tip to a young person out of school is to get knowledgeable about financial planning and investing."
Katheryn's desire to start saving now for her many goals is "noble," "but I am concerned that she is biting off more than she can chew."
What and how should she invest her funds in given her goals, priorities and timelines?
Client situation
The Person: Katheryn, 23
The Problem: How to save for grad school, buy a car, travel, buy a house and build an investment portfolio all in the next few years.
The Plan:
The Payoff: Successfully achieving the most important goals, one by one.
Monthly net
income: About $4,200.
Assets: Bank accounts $13,150; TFSA $4,000; mutual funds $5,000. Total $22,150.
Food and eating out $250; clothing $100; medical, drugs, dental $50;
Monthly disbursements:
miscellaneous $300; rent $750; telephone, cable, Internet $60; replacement of furniture, appliances $50; vacations $200; entertainment, music, books $20; transportation $60; donations $20; gifts $20. Total: $1,880. Monthly saving capacity: $2,320.
Liabilities: None
4) Life After University
Carmen and John admit that while they're "book-smart" - they have six degrees between them - they lack even a basic understanding of money and investing.
Carmen, 28, is a librarian. "I just graduated in April and for the first time have a real job making enough money to cover the bills," she writes in an e-mail. John, 31, is working on his PhD in archaeology, living on government grants and university scholarships.
"We would both really appreciate some advice on how to start saving and investing money now that we both pull in a salary and our student loans are almost paid off," Carmen writes. Their goals include buying a house, starting a family and landing a professorship for John after he graduates next year. "We aren't sure where to start." We asked an adviser at a financial planning and investment counsel firm.
Carmen and John should be proud of their accomplishments. "Many people in their situation, with such a long pursuit of post-secondary education, would still be burdened with huge student loans, car loans, credit card balances for many years."
Carmen estimates their savings capacity at $2,100 a month, about a third of their net income.
The main obstacle to planning at this point is the couple's uncertain future. When John graduates, he will look for a teaching job, which could take him anywhere.
Carmen and John have been investing some of their savings in stock mutual funds. Is this appropriate given purpose and timelines?
If they move, Carmen will have to give up her job. Indeed, they may have to move more than once if John has to take short-term teaching jobs before he lands a permanent post.
Their target house price is up to $300,000 some time in the next two or three years. How should they plan for this home purchase with 10 percent down payment? Assuming 5% interest rate and 25-year amortization, what is their approximate monthly mortgage payment? How much are monthly payments with 20% down?
Carmen and John face a number of challenges. When they move, Carmen will have to give up her secure government job with its pension and benefits. It may take time for her to find another job in a new city and she may have to settle for less income. How will this affect their plan for home purchase?
Starting a family, another of their near-term goals, will add to the challenges - "and of course the rewards" - because Carmen will likely take time off for maternity leave.
Carmen wonders if they are saving enough for retirement.
Client Situation
The People: Carmen, 28, and John, 31
The Problem: How to allocate their money given that Carmen has graduated and has her first job, John may have to move to find work, and they have long-term plans to buy a home and raise a family.
The Plan:
The Payoff: Peace of mind and financial stability in face of an uncertain but bright future.
Monthly after- tax income: $6,300
Assets: $11,020; tax-free savings account $10,015; mutual funds $22,500. Total: $43,535
Monthly disbursements:
Food and eating out $500; clothing $200; haircuts, cosmetics $25; miscellaneous $485; rent $1,348; tenants' insurance $22; utilities, phone, cable, Internet $125; vacations and other travel $975; entertainment $300; books and magazines $20; public transit $30; donations $20; gifts $50; pet care $100 Total: $4,200. Savings Capacity: $2,100
Liabilities: None
5) Time to Rethink Retirement strategy
Harry and Sally are in the enviable position of working for themselves as employees of their own corporation.
They've been successful, amassing $1.8-million in investments. Their Vancouver home is valued at $500,000.
Even so, their goals differ little from those of other working people. They want to retire early - in their case in two or three years - work part-time, fix up their house a bit and arrange things so they can live comfortably from their investments for the rest of their lives. He's 59, she's 53.
They have no children, so they hope to leave a financial legacy to their favourite charities.
They invest through a discount stockbroker in individual stocks and keep a cash reserve of 10 per cent to 25 per cent of their portfolio. They've done well, chalking up a return of 8.5 per cent a year over the past dozen or so years.
"Therefore, I hope to compound 8 per cent, including inflation, in retirement," Harry writes in an e-mail. They figure they'll need about $100,000 a year after tax when they retire because they expect to spend about the same amount of money then as they do now. "We would appreciate feedback about our budget and plan."
Harry fancies himself a good stock-picker, the couple's portfolio is risky and poorly diversified among asset classes.
"They have 84 per cent in equities with the balance in cash." Nearly 40 per cent of the stocks are in small-capitalization companies, many of them penny stocks. Roughly 40 per cent of the portfolio is in the industrial sector, which comprises only 8 per cent of the S&P/TSX composite index.
Part of the problem is that Harry believes they need to earn an average annual return of 8 per cent to meet their spending goals. In truth, they can likely get by with a return of 5 per cent because they will spend less when they are retired than they do now. What should they do?
As well, an 8-per-cent return is very difficult to achieve year in and year out.
"It is very easy to plug a higher return into a financial plan; it is considerably more difficult to achieve it."
What options are available to the couple in seeking professional investment advisors?
Finally, $480,000 of their capital is held in their jointly owned corporation, which will become a holding company when they retire.
They "should speak to an insurance agent about the possibility of using corporate-owned insurance to reduce the tax bite that will be triggered as this money comes out of the company and is spent by the surviving spouse."
Client situation
The People: Harry, 59, Sally, 53
The Problem: How to retire in two or three years with enough money from their savings to live comfortably for the rest of their lives and leave a financial legacy to charity.
The Plan: Because they rely almost solely on their investments, they should shift their portfolio from high risk to one that focuses on preserving their capital and cut their spending if necessary.
The Payoff: Financial security and a legacy.
Monthly net income: $7,200.
Assets: Home $500,000; non-registered stock portfolio $730,000; registered investment portfolio $850,000; cash in investment accounts $240,000. Total $2.32-million.
Monthly disbursements:
Food and eating out $1,000; clothing $200; medical, drugs, dental $400; pets $150; personal allowance $350; miscellaneous $400; property taxes $320; house insurance $70; heating, hydro, water $325; telephone, cable, Internet, cellphone $350; painting, repair and maintenance $200; replacement of furniture, appliances $150; vacations $1,800; entertainment, music, books $450; auto expenses $400; subway, bus $85; donations $300; gifts $250. Total $7,200.
Liabilities: None.