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 $9500, and $6500 of it is in a 2.5% savings account at the credit union where Phil works. They have about $3,000 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 $6,500 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. Given the current economic conditions, Marcia thinks this plan might be too risky, but she does agree that the 2.5% 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 4.5% 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, considering your readings for this week, answer the following questions.
1.Do you feel the Helms' $9500 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? In other words, considering the options available to them, what action should they take?
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1. In determining whether the Helms' $9500 liquid balance is adequate, it is important to consider their financial situation and their goals. While the Helms have promising careers, their income protection in the event of a layoff is not strong. Additionally, they have no other investments besides their life insurance policies. Given these factors, it is advisable for the Helms to have a larger emergency fund to cover at least 3-6 months of living expenses. A good rule of thumb is to have a liquid balance that can cover unexpected expenses and sustain them in case of job loss. Therefore, the Helms' current liquid balance of $9500 may not be sufficient for their needs, and they should consider building it up further.
2. Certificates of deposit (CDs) may be a suitable option for the Helms depending on their risk tolerance and financial goals. CDs are financial products offered by banks and credit unions with specific maturity dates and fixed interest rates. The relative risk of CDs is lower compared to investing in the stock market as they provide a guaranteed return of principal and interest if held until maturity. The potential advantages of CDs include stable and predictable returns, and they can be a good choice for individuals who prioritize capital preservation over higher growth potential.
I would recommend CDs for the Helms if they have a low risk tolerance and if they want a safe investment option with a fixed interest rate and a guaranteed return in the short to medium term.
3. Whether the Helms should invest some of their funds in the stock market depends on their risk tolerance, investment goals, and time horizon. Investing in the stock market can provide higher potential returns over the long term but comes with higher risk and volatility. Given that the Helms' careers have promising futures and they have some savings, it may make sense for them to consider investing a portion of their funds in the stock market if they have a moderate to high risk tolerance and are willing to accept potential fluctuations in their investment value. However, they should also ensure they have a sufficient emergency fund and a solid foundation of risk-free assets before considering stock market investments.
4. Based on the options available to them, the following cash management plan is recommended for the Helms:
- Build up their emergency fund: Given their limited income protection, it is advisable for the Helms to allocate a portion of their monthly income towards building an emergency fund that can cover at least 3-6 months of living expenses. They should aim to save more than their current liquid balance of $9500.
- Consider opening a super NOW account: This account offers a 3% interest rate and unlimited check writing privileges with minimal service charges. However, they would need to maintain a minimum balance of $2500 to avoid a reduced interest rate. If their balance goes below the minimum, they would earn 2% interest.
- Assess their risk tolerance and long-term goals for investing: The Helms should evaluate their risk tolerance and long-term investment goals to determine whether investing in the stock market is appropriate for them. They may want to explore other investment options such as mutual funds or retirement accounts for long-term growth.
- Diversify their savings: It is important for the Helms to diversify their savings across different types of accounts and investment options to manage risk and potentially earn higher returns. This includes considering CDs for a portion of their funds, especially if they prioritize capital preservation and have a shorter time horizon for that money.