Investment Strategy Recommendations for a Young Married Couple

Case Overview

Chris and Faith are a young married couple, both with regular salaried jobs and a fair amount of job security, as well as stability in their income and expected expenses over the next several years. Expenses are fairly standard, including rent and utilities, child support payments Chris makes to his previous wife for his two children, auto and renters insurance, and miscellaneous expenses such as credit card debt, food, and clothing. Chris, a corrections officer, earns $26,000 per year and has an employer-sponsored 401(k) plan that his employer will match annually up to six percent of his income. Faith earns $20,000 without additional benefits. Both salaries are expected to grow by five percent annually.

Inflation of four percent annually will erode some of this salary increase; however, many costs — rent, insurance, child support payments, and others — are expected to remain at the same dollar value for at least the next five years. The fact that revenue will be increasing over the next five years without major increases in expenditure makes this an excellent time for Chris and Faith to begin considering their investment options and financial goals seriously, as they will have increasing amounts of income available for investment and other objectives.

A set of general recommendations for their financial and investment strategy is provided below, with a focus on the five-year period beginning in 2008, though long-term recommendations are also included. The primary goals are purchasing a home and establishing a six-month emergency fund to cover all monthly expenses should their income suddenly be cut off or dramatically reduced — for example, due to job loss or injury. Although Chris and Faith have a good amount of health insurance and Chris has disability insurance, the emergency fund remains a priority. This focus on security over gain is taken into careful consideration throughout all recommendations.

Spending and Saving Habits

It is impossible to discuss investment strategy without addressing spending habits, since the balance between income and spending determines how much can be saved or invested each year — and that amount, in turn, helps determine which strategy will be most effective in meeting specified goals. Because Chris and Faith appear to be especially security-minded, with the purchase of a modest ($100,000 current value) home and a six-month emergency fund as their only stated goals, a comprehensive financial plan should address certain spending habits and suggest ways to improve investment amounts, reach goals faster, and establish greater financial security.

It is recommended that they not add at all to their current credit card debt. At annual payments of $1,800, this debt is not crippling, but it still represents money paid toward interest that could be redirected elsewhere. The same logic applies to the furniture purchased at 18% interest with a three-year repayment period; buying less expensive furniture or waiting until cash was available would have created significant savings. The projections in the accompanying spreadsheet assume that credit card payments continue at the same level for the next five years and that the furniture loan will not be paid off early. However, any additional savings that Chris and Faith are willing to direct toward discharging these debts sooner will increase their capacity to save and invest in later years. It is strongly recommended that they take on no further consumer or other debt, and even that they reduce their food and clothing budgets where possible. The spreadsheet assumes a ten percent reduction in food costs and a twenty percent reduction in clothing costs, adjusted upward annually for inflation, and it eliminates vacation expenses entirely to illustrate the potential savings the couple can create.

General Investment Strategy

In addition to the recommended changes in spending habits, Chris should increase his 401(k) contributions to the maximum amount matched by his employer — namely, six percent of his annual compensation. Failing to contribute the full amount is, in effect, giving up free money. By doubling his current contribution from three percent to six percent, Chris would actually triple the total amount added to the 401(k) each year, thanks to the employer's matching policy. This account is also earning an estimated eight percent annually, not far behind the 9.5% the stock market is expected to earn, and the money in the 401(k) remains relatively liquid: up to 50% of its value can be borrowed at any time at a rate lower than a mortgage and significantly lower than a standard personal loan, though borrowed funds must be repaid within five years. This strategy will build both short- and long-term growth to a much higher level without compromising the ability to maintain an emergency fund or purchase a home.

Because Chris and Faith have short-term goals focused on stability — the emergency fund and the home purchase — an aggressive growth strategy through increased stock market investment, even in mutual funds, is not recommended at this stage. The spreadsheet is currently optimized for 401(k) contributions maxed out at six percent, with the remainder devoted to savings. Although more substantial contributions to the 401(k) would produce faster growth due to the account's interest earnings — Chris is permitted to contribute up to 20% of his earnings annually — those funds would not be as liquid as a savings account, given the requirement to repay any borrowed amounts within five years. While it makes sense to consider the 401(k) as part of the emergency fund, it would not be wise to rely on it as a substantial portion of a home down payment. Maximizing savings contributions is therefore recommended in the near term.