Financial Strategy for Christopher and Anne - Case Study Example

Financial Strategy for Christopher and Anne 1. Financial Issues and Objectives The financial issues and goals for Christopher and Anne can be briefly summarised. Their immediate concerns are the payment of school tuition and fees next month for their three younger children and reducing their credit card debt. They also want to maintain a healthy program of saving for retirement, and they are currently maintaining this through superannuation contributions and investments. Although they have not indicated any concern about their oldest son’s college-related expenses, it is reasonable to assume that they would like to maintain the ability to provide him financial assistance not covered by his relatively small salary. They have three outstanding loans and a mortgage for a rental property that must be maintained, as well as normal household expenses such as the mortgage for their primary residence, utility payments, and living expenses. Finally, they must unfortunately face the eventuality of Anne’s mother’s death; while there is a will in place and Anne has been named her mother’s executor, it would be prudent to assume some expenses may arise. In order to develop an effective financial management plan, it is important to prioritise Christopher and Anne’s financial needs and responsibilities. Putting their various concerns in order of importance: School tuition for the three younger children is an immediate need, as the fees for the term are due next month. Reducing their credit card debt, which will free up credit that can be used for unexpected expenses as well as reduce their present monthly expenses. Reducing other credit debts, in the following order: personal loans, mortgage on rental property, mortgage on their home. Maintaining growth of retirement savings. Having sufficient resources on hand or sourced to cover possible expenses related to Anne’s mother’s health problems and eventual death. Having funds available to assist with the expenses of their oldest child, if needed. Maintaining an amount of savings available as ready cash for emergencies. 2. Step One: Outline Monthly Income and Expenditures Because most of the couple’s large expenses are paid out on a monthly basis, it is necessary to outline their income and expenses in the same fashion, in order to provide a clearer picture of their available resources. Note: figures have been rounded to the nearest dollar for the sake of convenience. Income From salaries, Christopher’s annual take-home pay is $82,417 per annum, while Anne’s net salary is $88,048 (paycalculator.com, 2013); this provides a combined monthly net income of $14, 205. From the rental property they receive a weekly income of $500, which translates to a monthly income of $2,167. Christopher will receive income from his $35,000 listed debenture in 12 months’ time, but that amount ($37,731 at maturity) is not currently available, and so will be disregarded for the time being. Thus, the couple has a grand total of $16,372 of monthly net income to apply to their expenses. Expenses Home mortgage expenses are $7,491 per month. On a monthly basis, the school fees for the younger children are $5,000. Assuming a standard mortgage term for the rental property (25 years, interest compounded annually), this has a monthly payment of $2,781. The monthly loan payments for the three personal loans are $726 (4-year loan), $539 (2-year loan), and $585 (one-year loan) for a combined total of $1,851 per month for the next 12 months. The credit card payment based on their current repayment habit starts at $1,245 per month, and then will progressively decrease as the balance is paid off. The $1,245 figure will be used here for income-expenditure calculations. The balance of the couple’s income and expenses before accounting for ordinary household expenses (food, utilities, transportation, personal expenses, home maintenance, entertainment, and other incidentals) is a deficit of $1,996 per month. This is obviously an intolerable state of affairs, because a significant number of expenses are not even included in that amount. Although no information as to the couple’s daily budget has been provided, the assumption will be made that these additional expenses will approximately double the shortfall to $4,000. 3. Short- and Long-Term Objectives The immediate short-term objective is to produce $15,000, payable next month as school fees for the younger children, without falling behind in other payment obligations. Long-term, the objective is to reduce the monthly deficit, now $4,000, to zero as a minimum goal, and ideally to produce a monthly surplus. The most readily-available source of extra funds is the $15,000 bonus Anne will be receiving next month. If she retains this bonus rather than making it a superannuation contribution, however, it will be attenuated by tax and deductions, and will net approximately $10,917. That amount is nevertheless two-thirds of the immediate cash need; given that Anne has a relatively robust regular superannuation planning program, the loss can be compensated through other measures in the future. Having owned the rental property for four years, the couple has paid-up equity of $26,576 in the property, against its reported total value of $585,000. They should obtain a loan against this equity; assuming the terms are similar to the $29,000 personal loan they are now paying, that will create an additional loan payment of $661 per month. However, the loan amount will be sufficient to cover the immediate expenses, and eliminate some of the other loan payments. Plus it provides the option of allowing Anne to make her bonus a superannuation contribution as originally planned. With the bonus retained, the balance after paying the school fees is $22,493. This balance can be used to eliminate the two shorter-term personal loans, and leaves a balance of $3,336 after the early-payment penalty for the one-year loan. A one-time credit card payment for this amount reduces next month’s minimum payment to $1,171. With the new loan payment, the monthly combined loan and credit card payment amount is reduced from $3,096 to $2,559, a savings of $537. Without the bonus (i.e., with the bonus contributed to superannuation), the balance after paying school fees is $11,576. After paying off the shortest-term loan, the balance remaining would be $4,321. Applying that amount as a one-time credit card payment reduces the minimum payment amount next month to $1,137. With the new loan payment, the combined monthly loan and credit card payment amount is reduced from $3,096 to $3,063, a savings of $33. Taking the step of obtaining an equity loan against the rental property solves the immediate financial problem, and eases the monthly obligation for credit and loan payments. If the bonus due Anne is retained and applied, the monthly deficit is reduced by a significant amount, but at the expense of losing some of the bonus amount to taxes and deductions, and of course not having the bonus amount to apply as additional superannuation savings. The equity loan is a necessary step; using the bonus is a judgment call the couple will have to make. Long-term much of the problem still remains if no other steps are taken. Assuming the couple will not want to sacrifice Anne’s bonus – which would be a reasonable decision – the monthly deficit is now reduced to $3,967, which is hardly any gain at all. Therefore, other avenues must be explored. The two obvious ones that need closer examination are the share account and the rental property. Both these are producing a loss at this point. The share account is currently worth a total of $126,000, which is $9,000 short of the margin loan amount used to purchase them. The rental property, on the other hand, is producing a monthly deficit (mortgage amount less rental income) of $617, and will likely continue to do so until the mortgage is paid. The mining shares may increase in value again, and since there has apparently been no margin call, taking no action on the shares at this point will have no immediate effect. The rental property does have an immediate effect, and does not appear likely to become a profitable investment any time soon, therefore as a long-term solution it should be sold. Selling the property at its current $585,000 value results in a profit of $161,576: The sale price minus the purchase price plus the equity already paid. That sale will also result in the loss of $2,166 of monthly net income, but can be applied to pay all outstanding debts. The couples’ balance sheet would then show a monthly surplus of $1,714, which can be budgeted appropriately to meet regular living expenses, they would have no debt, and they would have a one-time surplus of $61,418. To bolster their monthly income, the profit from Christopher’s listed debenture should be placed in an annuity account that pays on a monthly basis, which would provide a before-tax income addition of $228; the debenture amount of $35,000 can be rolled into a new listing with similar terms to provide income for subsequent years. With the surplus from the sale of the rental property, purchasing a second listed debenture for $50,000 at 5.75% p.a. will create a second additional income stream of $244 per month in one year’s time; altogether, these new investments virtually make up for the loss of rental revenue from the now-disposed investment property. The remaining $11,418 can be spent as the couple deems appropriate; it would be completely understandable if they feel they deserve to reward themselves and their family with a nice vacation, something for the house, or even just to add to their everyday savings account. 4. Summary and Remaining Issues To briefly summarise, Christopher and Anne face an immediate, short-term problem of covering the quarterly tuition and fees for their three younger children, and a longer-term problem of reversing a monthly income deficit. The solution to the immediate problem is to obtain a loan against the paid-up equity of their rental property, which provides funding for school fees due next month and reduces some loan obligations; the $15,000 bonus due to Anne next month can also be applied to this, which would create even more financial “breathing room”, though not without penalty. Longer-term, the solution is for the couple to rid themselves of what has turned out to be a losing proposition, the rental property. Sale of the property halts the monthly loss they are suffering from it, and will allow the elimination of all debt as well as creating a monthly income surplus. Reinvesting a significant part of the remaining proceeds from the property sale will permit the establishment of a small additional monthly income stream in the near future. This solution still leaves two important problems, the eventuality of Anne’s mother’s death and the unknown expenses that may arise from that, and the underperforming mining shares account. For the latter situation, there is not much that can be done unless the couple is willing and able to absorb at least a $9,000 loss on the shares; at this point, it is better to hold them and hope the share price improves. For the unfortunate, yet inevitable, circumstances of Anne’s mother, not knowing the financial implications presents a bit of a handicap. To cover any possible eventualities, such as funeral costs, maintaining a reasonable amount in ready savings is probably a prudent idea. It also helps that the sale of the rental property will allow the credit card to be paid and its full $40,000 credit limit restored; the couple should be mindful not to use any more of this credit line than they need to, so that a useful amount is available for the future. Read More