Should Frank go into business with his father? Will Carol quit her job after the baby is born? Can they afford to move out of their trailer into a house?
No, this is not a teaser for a soap opera; it is the basic scenario of financial planning.
Professional assistance in charting individuals' financial futures is taking hold on Main Street, thanks to runaway inflation. It no longer is just a rich man's game: how to avoid strangulation at the hands of the tax collector or make sure the surviving spouse doesn't have to sell the family jewels. "It's a lie-awake-at-night fear not of losing a potential profit, but of losing whay you've got," said Ferd Nauheim, former chairman of the board of the College of Financial Planning in Denver, and author of "Move Your Assets to Beat Inflation."
In what has become a semiannual exercise, stock brokers, insurance agents, bankers, real estate brokers and others members of the D.C. Metro chapter of the International Association of Financial Planners assembled in teams last weekend to plan the financial future of Frank and Carol McNab. After 90 minutes of discussion and calculation, test results were compared with those offered by the Certified Financial Planners who had worked on the actual case. There were more variables in the script than in "As the World Turns."
One former Air Force officer turned financial planner sentimentally thought Frank should spend a few more years in the service, where he now earns $24,000 annually, including housing allowances, but later conceded he really should become a civilian physician next year. Most but not all the planners bowed to this economic reality. Frank's father, also an obstetrician-gynecologist, earns $200,000 a year in private practice and is willing to make his son a partner at $35,000 annually. With only $15,000 in savings, no one thought Frank could afford to set up a practice himself.
Carol contributes one-third of the family income through her $12,000-a-year part-time job as a nurse. She has a two-year-old son and is expecting another baby in six months.Most seminar participants felt Carol should go back to work after the birth, even though a housekeeper would cost the family $3,000 a year. The experts decided Carol should stay home with the children and do Frank's bookkeeping from there because any salary she continued to earn would be offset not only by the cost of domestic help but by the salary of the bookkeeper Frank would have to hire in his office.
The McNabs now live off base in a $10,000 trailer on which they have an $8,500 mortgage. While he is still in the service, they could move to a larger house on base (and lose their housing allowance), or they could buy a house prior to getting out. They have found a $65,000 house and a $115,000 house with office space.
The panelist split widely on housing: One said to move back on base for a year and sell the trailer; another said to rent a house because purchase is not a good investment at this time; still others advised them to buy the cheaper house but were divided on whether Frank should ask his parents for a loan. Those arguing against said psychological complications outweigh the economic advantages.
The proffessional wisdom was that the couple could and should buy the $65,000 house now and probably could afford it on their own without dad's help.
Buying the house would cost about $200 to $225 more a month than trailer living, assuming a VA loan with no down payment and a 10 percent and 30-year mortgage. This could be financed by tightening their budget. Together Frank and Carol earn $3,000 a month. Their expenses amount to $2,680. Although the experts could not identify 11 percent of those expenditures, certain items were found clearly out of line. For example, the McNabs cited monthly contributions of $150, $125 for "gifts" and $180 for vacations.
There was unanimous agreement that Frank and Carol should pay off their $875 credit balance with Sears, costing them 18 percent interest a year, and pay future charges promptly at each billing period. Also they should convert their savings and loan, credit union accounts and Series E bonds, yielding between 5.5 percent and 6.5 percent, into money market mutual fund shares, now paying about 12 percent.
The McNabs save $240 a month. A college education fund for their children would require a savings of $275 per month invested at 9 percent yield. cYet most planners felt they should hold off on this investment program until after Frank begins private practice.
All panelists found the McNabs woefully underinsured with only $20,000 in life insurance of Frank. (The average American male has $29,000 worth of life insurance.) The experts recommended Frank pruchase $235,000 of term insurance on his life, which along with military benefits would provide $1,800-a-month income for Carol and the children. A term policy of $50,000 should be purchased on Carol's life. Liability on both auto and home should be at least $300,000 per person/$500,000 per accident. A $1 million umbrella policy also should be added as soon as Frank leaves the service. Auto property damage coverage should be raised from $25,000 to $100,000, and medical payments from $1,000 to $5,000.
The McNabs currently pay $45 a month in insurance premiums. The increased coverage would cost them about $54 more a month. It should be noted that two of the experts making the recommendations are insurance agents. First-year commissions for an agent writing this additonal coverage would amount to between $400 and $600, according to David S. Dondero, a Certified Financial Planner who works on a fee-plus-commission basis.
Without the commission, his upfront $220 fee would not cover the cost of taking Frank and Carol's case, Dondero said. The 12 to 14 hours effort required to do a complete analysis for the McNabs, whose case is relatively simple, would cost a minimum fee of $600. At that, Dondero added, he was interested in taking Frank's case only because he recongized his potential for high earnings as a private physician. Another planner would take Frank in hopes of getting his father as a client. (A comprehensive analysis of Frank Sr.'s finances was also done during the seminar.) "People tend to stick with (a financial doctor) for a lifetime," said Dondero. Subsequent annual updatings tend to cost one half the original fee.
Conflict of interest continues to plague the financial planning profession. A recent survey by the Stanford Research Institute found that one in four persons questioned had confidence in financial planners and their firms to do a thorough, disinterested analysis.
Yet a mere 10 percent of those calling themselves financial planners -- even recipients of the Certified Financial Planner degree -- do not depend on commissions from the sale of stocks or other investments to pay for all or part of the analysis. The reason is the high cost of planning: an average of $50 to $75 a hour after an initial free consultation, or one-half to one percent of net worth. Thus a typical work-up costs anywhere from $600 to $2,000.