Marcia and Phil Helm, a couple in their thirties, have been married for several years. They have no children, and each has a professional career. Marcia is a trainee for a management position at a large department store, and Phil is an engineer at an electronics firm. Their careers have promising futures, but neither has exceptionally good income protection in the event of a layoff. The Helms have saved around $8000, and $7400 of it is in a 3.5% savings account at the credit union where Phil works. They have about $600 in a regular checking account (with Mid-City Bank) that doesn't pay any interest. The Helms' combined take home pay is about $5000/month, and Phil thinks they should take the $7400 out of their savings and invest in the stock market to earn a better return. He points out that, excluding their life insurance policies, they have no other investments. Marcia thinks this plan might be too risky, but she does agree that the 3.5% yield is not very good.
Recently, at a party, a friend suggested they take out certificates of deposit (CDs) with long maturities because the CDs were paying around 6% in interest. The Helms liked her advice and stopped at Phil's credit union to get more information on the CDs. After talking with the office manager for a while, though, they became more confused. He didn't favor CDs; although, the union had them available. He pointed out that interest rates on the new money market accounts were around 4% and didn't require "freezing" your money for a year or more. He also indicated that the union could offer a super NOW account that would allow the Helms to close their current unproductive checking account with Mid-City. This account would give them unlimited check writing privileges with no service charges and would pay 3% interest; however, it would require a minimum balance of $2500. If their balance went below the minimum in a month, interest would be only 2%.
The Helms left the credit union without taking any action. They have asked you for advice on managing their liquid deposits.
In 3-4 paragraphs, answer the following questions.
1. Do you feel the Helms' $8000 liquid balance is adequate? Explain.
2. Explain the relative risks and potential advantages of CDs. Explain under what condition(s) you would recommend them for the Helms.
3. Do you agree with Phil that some of their funds should be invested in the stock market? Explain.
4. What are your recommendations for a cash management plan for the Helms?
Please answer all questions in detail!
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1. In assessing the adequacy of the Helms' $8000 liquid balance, several factors should be considered. Firstly, it's important to consider their monthly expenses and how long their savings would need to last in the event of a job loss or emergency. If their combined take-home pay is $5000 per month and they have no other significant sources of income, an $8000 balance would cover less than two months of expenses. This might not be adequate as it leaves them vulnerable if they face an extended period of financial uncertainty. Additionally, it's worth considering their risk tolerances and comfort levels with relying solely on their current liquid balance.
2. Certificates of Deposit (CDs) have relatively lower risks compared to stocks and potentially higher returns than regular savings accounts. CDs are time deposits, which means that the money is locked in for a specific period, typically ranging from a few months to several years. The interest rate on CDs is typically fixed and higher than that of regular savings accounts. The main advantage of CDs is that they offer guaranteed returns, regardless of the stock market's performance. However, the downside is that the funds are inaccessible until the CD matures, which means they cannot be easily withdrawn without penalty. I would recommend CDs for the Helms if they have a specific financial goal in mind for a longer time horizon and are comfortable with the funds being locked up for that period.
3. Investing in the stock market carries higher risks compared to other options like CDs or savings accounts. While the potential returns can be higher, the market is inherently volatile, and there is no guarantee of positive returns. Given that the Helms mentioned they do not have strong income protection in the event of a layoff, it might be prudent for them to prioritize building an emergency fund with sufficient liquid savings, rather than immediately investing in the stock market. Once they have a more robust financial safety net, they can consider gradually investing a portion of their funds in the market if they are comfortable with the associated risks.
4. Based on the information provided, here are my recommendations for the Helms' cash management plan:
- Keep a portion of their liquid deposits, such as the $600 in the regular checking account, as readily accessible cash for day-to-day expenses and immediate emergencies.
- Consider transferring the majority of their funds to a money market account, which offers a higher interest rate than their current savings account. This would provide a better return while maintaining liquid access to their money.
- Evaluate the option of opening a super NOW account at the credit union if they can comfortably maintain the minimum required balance. This account would offer the benefits of unlimited check writing and a competitive interest rate.
- If they have specific financial goals with longer time horizons, like buying a house or saving for retirement, they may consider allocating a portion of their funds to CDs with appropriate maturities. This would provide a fixed and guaranteed return, which could be beneficial for achieving their goals.
- Gradually increase their emergency fund by saving a portion of their monthly income until they have a cushion that covers at least three to six months of living expenses. Once this emergency fund is in place, they can consider exploring other investment options, such as the stock market, if they are comfortable with the associated risks.