I have been talking to a couple about their finances over the last year. He works in a consulting firm and she stays at home with their daughter. We first started talking about the priorities in their financial life: student loans, emergency fund, new house and retirement. Before this discussion started, they were paying off their student loans as quickly as possible, yet they had only a small amount of money in ready cash in case something happens. They came to me because they wanted to look into increasing their retirement contributions. In discussing their situation, they also wanted to look for a bigger house because they were planning on having another child in the near future. However, they had fear around buying a new home and having two mortgages if they could not sell their current home quickly.
It was important for them to understand what their goals were and in which order to handle them. He had recently changed jobs and had some extra income to allocate to different goals. We discussed how some of the logic out there can seem to place certain priorities on goals (e.g., the rush to become debt free or save early for retirement). They had student loans, yet at favorable interest rates where it was not financially adverse if they slowed down their accelerated repayment plan. They also wanted to put in the full 401(k) contribution. Yet, in looking at their situation (both around age 30 and having some money saved for retirement already), taking one year off was not that big of deal if other goals needed to be addressed.
One of their questions was what kind of home could they afford? He had received a nice raise so that they could afford a bigger home. So we discussed the price range that they could comfortably afford and discussed the tools they could use to avoid being pinched by two mortgages at once (including saving up a few months for dual mortgage payments and buying on a contingent basis on selling their current home). We also discussed how he may work in a different city in a year if the new venture he and his company were working on did not work out. Thus, they put off buying a home for a year. They were still going to look around and save some money for the down payment to be ready when his job outlook was more secure. They also decided to slow down their student loan repayments, to put just enough money in their retirement plan to max out their 401(k) match and to save the rest for a healthy emergency fund and for a down payment on house and/or bigger car for their second child.
During that year timeframe, they were told that the new venture was working out, so they could buy a new home without the fear of relocating. In looking for their homes (in planning for the upcoming year), they found most of the homes they wanted where just outside their upper price range by 5 percent to 15 percent. Instead of settling for a cheaper home or buying a house outside their comfort zone, they decided to wait a couple more years to see if he was able to become partner at his company to afford the type of house they wanted.
After this decision, they had a large emergency fund from the money that they were going to use for a down payment for a new house. Thus, they were able to increase their 401(k) contribution to max it out. They also decided to make a Roth IRA contribution with the extra money. The wife also asked if they should lock some of the extra money away in a CD for a better return. We reviewed their current risks. She was 6 months pregnant at the time and his job was relatively secure for at least a few years. They had a good catastrophic medical plan that would cover at 100% of anything above a certain level in case something happened. They were also thinking about a new car, yet had not decided to buy one yet. So there were some risks, yet nothing that their emergency fund couldn’t handle. However, the money they could earn in a longer term CD was only going to be $100 greater compared to leaving it in their savings plan after taxes. Thus, was it worth the loss of flexibility? She decided that it wasn’t.
The decisions that they made turned out to be wise moves. A few weeks after our discussion on CDs, she went had some complications and was rushed to the hospital. Luckily, the hospital was able to help her out of immediate danger and put her on bed rest. They still had several weeks of worry about what would happen if something else happened before the baby was delivered.
From a financial standpoint, this situation was not going to have too much of an adverse impact on them because their health insurance was going to cover everything over a certain limit at 100 percent and because they had an ample emergency fund to handle the deductibles and other costs. If they kept to their accelerated student loan repayment to become debt free or if they bought a house outside their price range or if they put their extra savings into their retirement savings through out the year, they would not have had such a large emergency fund and may have had even more financial stress, on top of the stress of worrying about the health of their baby.
Morale of the story: Thinking through financial decisions before having a major life event is critical. And, sometimes, the wise financial advice to earn a higher return (in CDs or 401(k)) may not make the best sense in the short-term. I am sure my clients would agree. Even if he needs to work 3 more months past his planned retirement age because he did not max out his 401(k) for one year or they turned down a higher return in a CD, it was worth the peace of mind of focusing on the health of their son knowing their short-term finances are handled. The added financial stress of a bigger home outside their means or not having an ample emergency fund would have just added to an already stressful situation. Their lives were stressful enough during this time, let alone adding a financial stress because they cut their finances too tight.
They were also lucky in having a good catastrophic health care plan. It would have been different if they had to cover 20% of their costs. In addition, she was already a stay-at-home mom, so there is no loss of income which some may have depending on their disability plan.