John and Sally have been married 5 years. The 35-year-old computer programmer works at a major software company, while Sally, 32, works part-time as a freelance photographer and full-time as the mother of a 3-year-old son and a 5-year-old daughter.
The family rents a large apartment, but John and Sally would like to get on the property ladder and buy a house.
While both John and Sally have been busy with their careers and their children, they haven’t devoted much time to their financial affairs. John had done almost all his investing through his company’s 401(k) plan, while Sally had put savings into one major mutual fund. They had never really worked out any long-term financial planning, just paid the bills and let the savings accumulate slowly.
Now, with the prospect of making an important investment in a home, the couple decided they needed advice. They went first to their bank, which proposed a mortgage along with some stock market-linked index funds but they couldn’t decide if this was the best way to manage their savings.
John and Sally weren’t really sure that they could afford to invest in a home, pay the bills, and save for retirement and their children’s education at the same time. It was the first time in their lives that they were considering very important, long-term financial decisions.
So they sought the help of a financial advisor. The advisor, who earned a fee for his services and didn’t depend on commissions from specific investment vehicles, was able to help them establish a plan for the future.
The first thing the advisor did was to gather all of the requisite information needed to make decisions and to organize it. The advisor developed a balance sheet, listing their assets, liabilities, and net worth, as well as a detailed listing of household costs. The advisor also took a hard look at how the couple was spending money on extras like restaurants or entertainment.
The advisor asked the couple to set goals for their future. How much did they need to save for their children’s education? What amounts should be set for retirement, life insurance, and for the expenses of daily life, including discretionary spending like entertainment.
Then the advisor developed several long-term scenarios for the couple’s future. What would happen if they bought a home? How much of a mortgage should they take on? Were they getting the best return on their savings from the 401(k) investments and the mutual funds? The advisor explained how to adjust investment risks to potential rewards.
The long-term scenario allowed the couple to make intelligent choices about what kind of home to buy and how to achieve their other goals. The advisor helped the couple work out a portfolio strategy.
John hadn’t been actively managing his 401(k) plan, into which almost all of his savings were going. The advisor helped him change the investments inside the plan so that he got better returns and reduced investment costs. Some of the money in the fund was moved into IRAs, offering tax savings at low cost. Tax efficiency, which neither member of the couple had given any thought to previously, was introduced as a factor in how the couple invested.
The advisor helped Sally to diversify the investments she had made in the single mutual fund, which was not returning well, but which imposed high fees.
And the advisor completely reviewed the couple’s insurance plans, proposing lower-cost alternatives for life and property and casualty insurance.
Thanks to the advisor’s comprehensive long-term planning, John and Sally were able to choose a home they could afford, while saving for their most important goals for the future.