Putting a Family's Finances to the Test
Banks have undergone stress tests; now it's a Michigan family's turn.
April 29, 2009 — -- As big U.S. banks undergo financial stress tests, many American families are surely wondering how they would hold up to such a test.
They've seen many of their neighbors fall victim to foreclosure, bankruptcy or some other financial calamity. They want to be sure the same does not happen to them.
With that in mind, ABCNews.com decided to put one middle-class family's finances to the test by offering a no-cost financial checkup.
Steven and Vickie Randel of Royal Oak, Mich., agreed to participate, hoping to gain a second opinion on their family finances and advice on changes they might make.
In many ways, the Randels are ideal candidates for a financial stress test. They hold down good, middle-class jobs, but living outside of Detroit puts them at the geographic center of the nation's economic downturn.
The Randels do not work for automakers, but both of their jobs are tied closely to the fortunes of the U.S. automotive business. The possibility of job loss is a major concern.
"We're both working now, but that could change tomorrow around here," explained Steven Randel, 54, a senior cost estimator for a marketing services company. Vickie Randel, 49, is a project accountant for a company that provides training services to industries, including automotive. Both companies rely on the U.S. automakers for a good share of business, which explains Steven and Vickie's job worries.
Steven's annual salary is $59,000; Vickie's is $53,000.
The Randel family finances feature several strengths, but there are also weaknesses that need to be addressed.
The family's financial strengths include a strong head start on saving for college for two sons, ages 16 and 11. (A third son is an adult who is out on his own.)
Back in 2007 and 2008, Steven and Vickie contributed to a prepaid tuition program run by the state of Michigan that allows participants to buy credits toward future tuition payments at current rates. The credits can applied toward tuition at a public college or university in Michigan. The $60,000 they contributed to the plan should be enough to pay for seven full-time semesters for their younger son and six full-time semesters for the 16-year-old.
Saving for Retirement: The 401(k) Question
A second financial strength for the Randels is the size of their retirement accounts. Between IRAs and 401(k) accounts, Steven and Vickie currently hold about $575,000 in retirement funds. Without doubt, they need to save more, but given the collapse in stock prices over the past year, that's not a bad retirement portfolio. Should stock prices recover over the next decade, the Randels could be in pretty good shape with their retirement nest egg.
There is one problem in the retirement area that should be corrected. In March, Steven stopped contributing to his employer's 401(k) plan after the company stopped its contributions and cut employee salaries. Steven felt he could not afford the 401(k) contributions after taking the pay cut. I would advise he look to cut spending elsewhere in the budget and resume contributing even if it's just 2 or 3 percent to start. That may be the only way he's going to be able to achieve his goal of retiring by 65, particularly if there's a period of unemployment down the road.
Part of the reason the Randels' retirement portfolio held up is that they are conservative investors. IRA accounts held with a large financial services company they work with held no more than 50 percent stocks when late summer or early fall last year they directed their advisor to cut back even further on their stock allocation.
Currently, these IRA accounts hold about 80 percent in bonds, according to Steven Randel.
In my view, that's too conservative for the long haul, but I can see where a huge move into stocks is not the right move for them. Something in the 40 percent to 50 percent range seems right to me for the Randels.
Despite their financial strengths, the Randels, like many American families, also have their weaknesses. These include high credit card debt, insufficient life insurance and inadequate emergency funds.
Steven Randel calls the family's $27,000 credit card debt his number one worry. The family is making a concerted effort to pay that amount down with monthly payments totaling about $1,200.
But it's that credit card debt that is holding back Steven Randel from addressing a second major issue: insufficient life insurance. He feels he should be paying down the credit cards before buying more life insurance.
He carries just $178,000 in term life insurance bought through his employer plus a minimal amount from an old policy. Vickie Randel carries $150,000 in coverage, with $100,000 in a private policy and the rest through her employer.
Life Insurance vs. Credit Card Debt?
Given they have two children at home and total family debt of about $130,000, that's not really enough. Steven Randel, in particular, needs more coverage given his only significant policy is tied to his job.
If he does lose his job, he could be without any meaningful life insurance. My advice to him is that he look to obtain a private term life insurance policy to at least cover the family's total debt in the event he died.
He says he feels like he should pay off the family's credit card debt before buying more life insurance. His determination to pay down the debt is admirable, but what would his family do if he lost his job tomorrow and then died the following day?
That's a financial stress test his family may not pass. He needs more life insurance. I recommend a term life policy that at least covers the family's total debt load.
One more point about the life insurance issue: I told Steven that in the event he did lose his job before securing a private policy, he should carefully review his employer-sponsored plan. Many times these plans allow participants to convert a group policy to an individual policy within a certain period, such as 30 days after leaving a job.
A converted plan like this often is not the most cost effective type of life insurance, but no medical checkup is required and it can provide stop-gap coverage until a private policy can be secured.
The one other area where I see a need for the Randels to improve their family finances is an inadequate emergency fund. Their overall savings level is very good, but most of these funds are tied up in the college and retirement accounts. They need to add to the $6,500 they now hold in bank savings accounts.
It won't happen overnight, but they should start working on direct deposit of a small amount into bank savings with each paycheck. The first target should be three months of living expenses and then, over time, shoot for six months worth.
One place to find savings in the family budget is the mortgage payments on their home. The Randels carry two mortgages totaling about $103,000 on their home that are above current interest rates. They should look into refinancing into a single, 15-year mortgage for the home they value at about $150,000.
Saving on the Mortgage
Based on a 4.6 percent interest rate, they could cut their monthly total mortgage payments by about $500 a month and save more than $80,000 in total interest payments. With their combined income and substantial equity in their home, they should be serious candidates for a new mortgage, but, of course, qualifying for a mortgage is a lot tougher than it used to be.
If they are able to refinance, they should be able to devote more to retirement and emergency fund savings.
For the Randels and every American family, there's a balancing act between building up savings and paying down debt. There's no magic answer on which should be done first. The reality is they need to try do both. Even a little bit at a time will help should their finances ever get put to the test.
This work is the opinion of the columnist and in no way reflects the opinion of ABC News.
David McPherson is founder and principal of Four Ponds Financial Planning in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at david@fourpondsfinancial.com.