Determining Short and Long Term Financial Goals

By Frances Nikki Reve M. Estorninos, CSS, RFP Candidate (Batch 21)

Mr. and Mrs. Bobby and Cara Alvarez, both 31 years old, are government employees. They receive a monthly net income of P14,000 each. They have a four-year-old daughter named Karen. Bobby’s tenure in office is permanent while his wife is a contractual worker. Although they can both avail of GSIS, SSS, and Philhealth benefits, the two have no other kinds of insurance or any active will.

The Alvarez’s short term goals include Cara stopping work for a few months so she can review for the Bar exam. Meanwhile, her family will provide financial support at par with Cara’s current compensation during the time of her review. Cara’s parents also pledged support for Karen’s preschool tuition fees.

Bobby plans to take the Bar after a year. He wants to secure funds first for Karen’s elementary education as Cara’s parents promised to take care of Karen’s Nursery II tuition fees. The Alvarez’s also want to buy a new car and weighing the following housing options: (1) buy a rent-to-own condo, (2) build a house on a lot that will be part of Bobby’s inheritance or (3) continue to stay in Bobby’s family’s home.

Their long term goals (in five years’ time until they retire) include securing their daughter’s high school and college education. Bobby considers retiring at age 55 with a monthly income of P50,000 (in today’s money).

Current Financial Situation

Bobby and Cara were able to set aside some savings and invested them. Bobby’s cooperative in his government office has a strong and consistent record of dividend repayments to all members. The cooperative allows members to deposit a maximum of P5,000 monthly which earns 3% interest per month. At the end of each calendar year, all the members must withdraw the interest for the year. The Alvarez’s has also put up a P150,000 fund where they were able to receive P51,788 in December.

Their statement of assets and liabilities as of December is as follows:

Making Goals

1. Determine areas with potential

   Although the Alvarez’s have no current liabilities, most of their money was spent during the Christmas season for shopping and debt payment. The couple also has a history of extravagant shopping during holidays and even uses their bonuses to pay for things. These need to be adjusted so they can get nearer their goals. It is wise though that they have not applied for a credit card to avoid possible impulsive buying and were able to pay all their liabilities (e.g. personal loans) the past year.

   Bobby started contributing to the cooperative fund with Karen’s education in mind. If he can consistently contribute P5,000 monthly, there will be dividends of P77,588.95 for this year. However, this needs to be evaluated if the fund will be enough for the child’s tuition fees. Nevertheless, the consistent 3% monthly return is unparalleled in other investment instruments. It is important though for the couple to learn how to diversify their investment basket for the family’s welfare.

2. Determine if the support pledged by Cara’s parents will be enough for the family’s needs

   Bobby and Cara both earn compensation so their taxes are withheld and they need not pay additional taxes when their Income Tax Returns are filed. At the moment, the couple and their daughter live in the home of Bobby’s father. For the past months, the Alvarez patriarch has been paying for the household utilities,

   Karen’s milk and part of the groceries, totaling P6,850 per month. Since Cara’s parents pledged support, projections of projected cash needs of the household were made assuming a monthly P14,000 allowance throughout her review. With this, all the basic necessities can be covered and the P5,000 a month coop contribution can be continued. The latter is necessary to better prepare the family’s finances when Bobby also starts reviewing for the Bar next year.

   Almost 94% of the family’s expenses are non-discretionary thus, their regular weekend mall outings must be adjusted and a minimal monthly allocation of P1,500 for leisure is recommended instead. The savings can be channeled for Karen’s clothing needs as well as P3000 monthly allowance for the child’s schooling, school projects, and transportation fees.

3. Anticipate major income and expense changes that may happen

   Bobby’s intention to take the Bar will coincide with a paid study leave for two months. He has requested that his current income be used as the basis. If Cara passes the Bar, the current family income will significantly increase. By then, a comprehensive review of this financial plan is suggested.

   Using a 5% inflation rate in computing for expenses, all the projected dividends from the cooperative in the next twelve months amounting to P77,588.95 will be used to cover the needs of the following year, including Karen’s tuition fee. In addition, a P30,000 per semester subsidy from Cara’s parents is also expected. However, this financial plan will have to be revised if another child is conceived.

4. Determine emergency funds needed

   Based on the Alvarez’s cash flow statement, the family’s average monthly expenses roughly comes to P40,000. With the available funds in their ATM savings accounts intended for the needs of the family for the year, it is suggested that Bobby and Cara set aside P120,000 of stocks fund as their contingency to be kept in a money market fund.

5. Determine if current employment conditions can sustain the family after the Bar exams

   Based on projections, the Alvarez’s will live with ease for the most part of the year. However, they may need to tap their emergency fund come November which can be replenished by December. Their current annual income only totals P534,000 while expenses are at P631,020 when Karen’s tuition fees will no longer be subsidized by relatives.

   Thus, the couple’s income must increase by at least 20% in three years’ time and at least 5% annually onwards to cover for inflation, else the dividends from the coop will not be enough for its intended use which is to pay for Karen’s schooling.

Recommendations on educational planning

Karen’s preschool education is projected to cost around P70,000 annually while elementary, high school, and college education will cost P100,000 yearly in today’s value. Even if she is enrolled in a state university for college, the fees may still increase by 10% each year.

The couple is encouraged to consistently add P5,000 to their coop fund. Dividends in December 2013 must automatically be set aside for the tuition fees in June and November 2014. Fees for Nursery I and II will be subsidized by Karen’s parents in consideration of her Bar examinations. Dividends for December 2012 will be used to cover for other expenses in 2013. Starting 2015, excess funds can be re-invested in other instruments that pay 15% per annum return, which can be used for the family’s other goals.

Recommendations on retirement planning

Bobby and Cara want to retire by age 55 with a monthly income of P50,000 (in today’s value). Assuming an inflation rate of 5%, they will need P161,255 per month by that time. They both expect to live up to their 80s, with the assumption that all assets have been disposed by then. Returns during retirement will average 8% per annum as compared to the current expected rate until retirement of 15%.

As their current investments in stocks were reduced to P45,000 to give way to an emergency fund, this will translate to only P1,288,132.93 in Year 24. They also have set their contributions to the cooperative for retirement, provided that they consistently add P5,000 monthly to it until then. This will total to P1,650,000 by Year 24 and leave a lump sum gap of P34,989,896.45. This can be attained by saving at least an additional P15,823.43 per month earning 15% per year for the next 24 years.

If the couple’s retirement age will be adjusted to 60 (29 years from now), required monthly savings needed until Year 29 is P8,498.39. This can be further halved if the retirement age will be adjusted to 65 (34 years from now), which only entails P4,293.45 in monthly savings.

Considering the family’s current situation that they will need support from Cara’s family to weather through the BAR exam reviews, even an additional P4,293.45 to be allotted for retirement savings will result in negative cashflows for 2012 and 2013. Thus, it is advised that they start adding investments for retirement right after their respective BAR exams. This will mean that if they start saving for retirement two years from now, they will have to set aside P19240.87, P10314.27 and P5248.04 to retire comfortably by 55, 60 or 65, respectively.

Another potential source of retirement savings is the excess funds generated from the coop deposits which shall be invested in instruments that pay 15% per annum return. This way, the required savings needed for retirement will be lighter.

Bobby and Cara are also advised to resume pooling funds for retirement after their BAR exams at age 33. This plan reinvests the excess dividends from their coop deposits in investment funds earning 15% per annum. They will only need to save P12,062.46 to retire at 55 or P433.47 at 60. The option to retire at 65 does not require additional savings for retirement and even yields excess funds of P36,195,025.05 at Year 64 or 2045. Among the choices, the best plan is to target age 60 for retirement so that they can still enjoy their retirement benefits.

Another scenario is to (1) adjust the monthly retirement income making it only P45,000 from their desired P50,000 and (2) instead of allotting all excess coop dividends for retirement, only half will be invested while the rest will be spent for the family’s special needs. The latter will result to a P14.5 M projected amount by retirement year, which will help lower the lump sum gap.

If the retirement plan monthly income is reduced to P45,000, it will only require a P4904.19 monthly savings for the couple which will start two years from now, when it is assumed the family’s finances will be more stable after they have both taken the Bar exams. This retirement plan is best recommended for the couple.

Recommendations on special needs planning

Based on the current state of the family’s finances, the decision to buy a condo or build a house on a lot that Bobby will inherit eventually, will postpone their retirement goals if they will seek to pay for mortgage using the excess dividends (amount left from the tuition allotment) from the coop. Unless the family’s income will be augmented, the family may not yet be ready for these goals in five (5) years.

Five years from now, by 2016, only P14,801.87 will be available if the excess dividends in 2015 and 2016 can generate 15% interest when invested. Thus, this fund may not be ready for purchase of house or car by 2016, but it can supplement their budget if substantial increases in their income happen.

Recommendations on insurance planning

The protection needs of the family must also be considered should untimely demise happen. This will be best prepared for through life insurance. To compute for Bobby’s and Cara’s coverage necessitates the following steps:

1. Determine the immediate cash needs for living expenses – Immediate cash needs cover expenses up to six (6) months after death with the assumption that the widow(er) will resume work afterwards.
2. Determine the present value needed for education fund – The family must have P907,460.28 invested today at 15% per year to cover for Karen’s education.
3. Determine funeral expenses, medical expenses (net of Philhealth), emergency fund, present value of the retirement shortfall needed and insurance coverage needed – insurance coverage for Bobby should be P2,086,825.36; while, Cara needs P1,932,134.4. It is recommended that they subscribe to Permanent Insurance Life Policies with the respective face amount. These have cash values that can supplement their retirement income needs. They can choose to pay for it for a fixed number of years. This is the best way to protect their family’s welfare.

This financial plan is to be implemented effective January 1, 2012.