FIN 250 Module 7 Project Two Example

Financial Plan, Part Two: Investments and Retirement

[Student Name]

Southern New Hampshire University

FIN 250: Personal Financial Planning

Project Two

[Instructor Name]

[Date]

The organization, setting and figures below are a composite written as a model document. No real employer, client, colleague or patient is described.

Financial Plan, Part Two: Investments and Retirement

Introduction

Project One gave the Dunbars a budget, a $5,000 starter fund and a schedule that pays off the card by next December, and Module Five protected that plan with insurance. This project completes the plan with the long-term half: how much they need for retirement, whether their current saving will get them there, which accounts and funds to use, how to begin saving for their child's education and when each step can start without breaking the budget.

The Retirement Goal

Kayla hopes to stop working at about 62 and Marcus at 64, about thirty years from now. All figures here are in today's dollars, so the target and the projections can be compared directly. With the debts paid, the child grown and no retirement saving to fund, they expect to need about $85,000 a year, roughly 63 percent of today's gross income. Their Social Security statements estimate combined benefits of about $36,600 a year if they claim at those ages; waiting to 67 would raise that substantially. That leaves $48,400 a year to come from savings. Using a 4 percent withdrawal rate, a common planning rule for a retirement of about thirty years, the target is about $1.21 million.

Where They Are Headed

Kayla contributes 5 percent of her salary, $3,700 a year, to her 401(k) and her employer matches 4 percent, $2,960. Since Project One, Marcus contributes 3 percent, $1,830, to his SIMPLE IRA with a matching $1,830. Together that is $10,320 a year on top of Kayla's $28,500 balance. Assuming a real return of 4.5 percent a year, roughly 7 percent before inflation for a mostly stock portfolio, the current path reaches about $736,000 in thirty years, short of the target by about $475,000.

Closing the Gap

The plan raises saving at moments when money frees up, so the budget never has to absorb a cut. Thaler and Benartzi (2004) showed that employees who committed in advance to raise their contribution rate with each pay increase saved far more than those asked to save more right away, because the increase never felt like a loss.

Contribution schedule (today's dollars)

Both partners will sign up for automatic annual increases where their plans allow it, timed to their raises. The first step comes when the card is paid at the end of next year, using part of the $465 a month that had been going to it; the rest builds the emergency fund toward three months of expenses. When the truck loan ends in late 2031, $250 of its $640 payment goes to a Roth IRA. With these changes, the projection reaches about $1.18 million, within about 3 percent of the target. Working one more year or claiming Social Security a year later would close the remaining gap.

Accounts

The employer plans come first because of the matches, which are an immediate 100 percent return on the matched amount. Contributions to both are traditional, pre-tax, because the couple is in the 22 percent federal bracket now and may well be lower in retirement, and the tax savings help the budget during the years of childcare. The Roth IRA added in 2031 provides money that can be withdrawn tax free, which gives them flexibility to manage taxable income in retirement. Washington has no state income tax, so state tax plays no part in the choice.

Investments

When Kayla started at her practice she put 60 percent of her 401(k) into the plan's stable value fund "to be safe." At 32, with thirty years to go, that choice carries a bigger risk: that her savings will grow too slowly. Benartzi and Thaler (2001) found that many plan participants spread money according to the menu or simple rules rather than their own time horizon. She will move the whole balance to the plan's 2055 target-date index fund, which holds about 90 percent stocks today and becomes more conservative as she nears retirement, at an expense ratio of 0.12 percent. Marcus's SIMPLE IRA will use the 2055 target-date index fund at his brokerage.

Fees matter more than they seem. French (2008) estimated that investors as a group give up a meaningful share of returns each year to the costs of trying to beat the market, and Barber and Odean (2000) found that individual investors who traded most earned the lowest net returns. Over thirty years, a difference of half a point a year in fees could cost the Dunbars more than $60,000 in today's dollars. The plan uses index funds and asks them to leave the allocation alone, reviewing it once a year.

Education

After the baby is born, the couple will open an account in Washington's DreamAhead 529 plan and contribute $50 a month, invested in an age-based portfolio. That will not pay for four years of college, but at a 4.5 percent real return it grows to about $16,100 in today's dollars by the child's eighteenth birthday, and grandparents can add to it. Retirement saving comes first because loans exist for college but not for retirement.

Risks

Lower returns than assumed are the main risk; at 3.5 percent real, the projection falls to roughly $900,000 before the Roth IRA, and the couple would need to work a few years longer or save more. A job loss could pause contributions; the emergency fund and disability coverage reduce that risk. A second child would raise costs and delay increases. Market drops will happen, and the plan's greatest danger is selling after one. The couple agreed in writing to make no changes to the allocation for twelve months after any fall of 20 percent or more.

Summary of the Whole Plan

Now: budget with $920 of cuts and a $640 irregular account, furniture plan paid in November, $5,000 starter fund in December, Marcus's match claimed, insurance gaps closed. Next year: card paid by December despite twelve weeks of leave and the start of childcare, 529 opened. From 2028: contributions rise a point a year, emergency fund grows to three months. Late 2031: truck paid, Roth IRA begins, house savings increase. Retirement target: about $1.21 million in today's dollars, on track at about $1.18 million.

Conclusion

The Dunbars started this plan with a net worth of minus $2,600 and a savings account that had not grown in a year. With the changes in this project, the same income takes them close to a secure retirement while they raise a child and pay off their debts, mainly by raising contributions when money frees up and by keeping costs low.

References

Barber, B. M., & Odean, T. (2000). Trading is hazardous to your wealth: The common stock investment performance of individual investors. The Journal of Finance, 55(2), 773-806. https://doi.org/10.1111/0022-1082.00226

Benartzi, S., & Thaler, R. H. (2001). Naive diversification strategies in defined contribution saving plans. American Economic Review, 91(1), 79-98. https://doi.org/10.1257/aer.91.1.79

French, K. R. (2008). Presidential address: The cost of active investing. The Journal of Finance, 63(4), 1537-1573. https://doi.org/10.1111/j.1540-6261.2008.01368.x

Thaler, R. H., & Benartzi, S. (2004). Save More Tomorrow: Using behavioral economics to increase employee saving. Journal of Political Economy, 112(S1), S164-S187. https://doi.org/10.1086/380085