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Handling a $100K windfall
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June 9, 2000: 12:30 p.m. ET
A hospital case manager and part-time musician deals with an inheritance
By Staff Writer Alex Frew McMillan
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NEW YORK (CNNfn) - Checks & Balances runs weekly on CNNfn.com. People with questions about financial planning are invited to write in explaining their financial picture and short- and long-term goals. See the bottom of this article for specifics. For those selected, financial planners will review the details and suggest ways to meet those goals.
Ever since Bob DeMarco's wife, Diane Dressler, quit her full-time job as a teacher's assistant to have children, the family has made do on his salary.
DeMarco, 50, makes $42,000 as a case manager at Springfield Hospital in Springfield, Vt. He coordinates with the hospital staff to make sure patients are getting the care they need. He also arranges for their discharge when they're ready.
 So DeMarco's paycheck covers the expenses for a family of four -- just.
"When we had the kids, we decided one of us would stay home, and we'd live poor," DeMarco explained. "The quality of the homecare was important to us, so that's what we chose to do."
Not that poor, of course. They bump up their annual income to $50,000 with help from Dressler's part-time job at the local post office, in Florence, Vt.
"Florence is just a post office, basically," Dressler, 52, joked. The family lives in next-door Pittsford, Vt., which is about an hour's commute from Springfield and DeMarco's job.
Hay -- or barley -- Mr. Tambourine Man
DeMarco also makes a little money now and then playing in a band, Wind that Shakes the Barley. The four-person folk-music group plays about 25 gigs a year around New England.
DeMarco, who founded the group in 1980, sings a few of the Scottish and Irish tunes they play. He also plays a variety of instruments, including guitar, fiddle, mandolin and bouzouki.
He jokes that it's his full-time hospital job that's the hobby. But the band doesn't bring in much money and in fact often runs at a loss. Fortunately, a well-off band member covers those costs and gets paid back from the gates.
Dressler and DeMarco have a son and a daughter now and have lived off DeMarco's pay for around 15 years. "We live check to check," he said, and they have saved nothing toward retirement. "We save enough to pay taxes, then its gone, and we save again."
What to do with a decent-size inheritance?
But he recently inherited around $110,000 from his mother. He's keeping $10,000 to use for some household repairs and other unexpected expenses.
He put the rest of the money in a Certificate of Deposit, which is earning 5.25 percent until it matures in January 2001.
He has contacted a couple of financial advisers trying to work out what to do with the money then. DeMarco is torn because all the advice seems good when he hears it.
 He has 20 years left on a 30-year mortgage. He pays $650 a month toward that, at 8.9 percent interest.
Given those monthly payments, he's tempted to use some of the inheritance to pay off part or all of the $70,000 balance on the family's house, which is worth $88,000.
DeMarco also went to see the brokerage company Edward Jones. He said the brokerage salesman suggested he invest $70,000 of the money in mutual funds. He could then draw $650 a month in profit off the mutual-fund returns to cover his mortgage.
Then, DeMarco continued, instead of paying $650 a month out of his paycheck toward his mortgage, he could put $200 a month into a retirement fund, Edward Jones pointed out. DeMarco said the salesman recommended he invest the $30,000 left from the inheritance in four individual stocks.
A second opinion
But another financial adviser had a completely different take. "He said, 'Decide when you want your mortgage paid off,' " DeMarco continued. DeMarco told him 10 years. "So he said, 'Why don't you pay off half the mortgage, and invest the rest.' "
Put $35,000 down toward the mortgage, keep the payments at $650 a month, and you'll have it paid off in no time, he heard. "Which is true. But the other guys said you'd lose the tax advantage if you pay the mortgage off."
Now he isn't sure what to do. He also has around $8,000 in car loans and car repairs to pay off, between 11 percent and 12 percent interest. He pays $430 a month on those.
Ultimately he wants to buy the family a new car. He's been looking at a Subaru Outback that would run him $17,000.
So many goalposts
And there are numerous other concerns. With no retirement savings, he needs to save for him and his wife and their future. But he also wants to save for his children, Brian, 14, and Erin, 10, and their college education.
"Both are very smart and well motivated at school," he wrote. They're in public school right now, but the family doesn't know if they'll end up in private or public college.
If he takes the Edward Jones plan, DeMarco figures he could fund their college out of the $30,000 he'd invest in individual stocks. But DeMarco would also like to take the family on the occasional vacation.
Basically he feels confused about the variety of options of what he could do with his inheritance, the range of advice he has received, and the list of things he'd like to accomplish.
"What is your perspective on all this? Do you have better advice?" he asks. "I am financially unsavvy but want to invest this windfall soon."
What the planners say
"Bob has been smart to shop his situation around to several planners," said Marc Freedman, president of Freedman Financial Associates in Peabody, Mass. "Yet in doing so, he has become further confused in realizing that financial planning is more an art than a science."
He has worked hard to support a family of four on $50,000, Freedman, who is also a certified financial planner, continued. That "takes perseverance, a sharpened pencil and commitment to maximizing each dollar earned and spent."
The inheritance is no chump change, the planner points out. At 50, DeMarco likely feels he needs to get the biggest bang for the buck out of the money. "But we would advise him to take baby steps."
Emergency fund first
The first priority is to establish an emergency fund, according to Freedman. DeMarco should skim cash equal to at least three to six months of his fixed expenses from the inheritance. The $10,000 that DeMarco plans to use for household repairs seems an appropriate amount to Freedman. But DeMarco will be spending that money on the house.
Put another $10,000 in a money-market account at a mutual fund company or brokerage, Freedman said. Most even offer check-writing privileges for purchases of more than $100, the planner says.
Peggy Tracy, a certified financial planner with Lincoln Financial Advisors in Wheaton, Ill., agreed. Take 10 percent of the inheritance, or around $10,000, for an emergency fund, she said. DeMarco should put it in a high-yield money market account, she added.
If possible, DeMarco should try and put $25 per paycheck into savings bonds, Tracy added, and $25 per paycheck into a fund. That's important because they have no savings.
"Sometimes by breaking things down into very small chunks, clients are able to begin the process of learning to save without incurring too much pain," Tracy explained.
Look into retirement plan
But Tracy believes that DeMarco's first priority should be retirement planning. Depending on his hospital's status as a for-profit or non-profit, he is likely eligible for a 401(k) plan or a 403 (b) plan.
"I would strongly suggest that he begin contributing to the maximum as soon as possible," Tracy explains. He may be able to contribute up to 15 percent-to-20 percent of his salary pretax.
Dressler's job at the post office qualifies her for a Section 457 plan, according to Tracy, that will also allow her to contribute part of her salary toward retirement. She should do that, Tracy said.
"Even if they need all their pay for living expenses, they can still reimburse themselves from the earnings on the inheritance," Tracy said. If they are able to put away $7,500 a year, at a 10 percent return they will accumulate $265,000 in 15 years, the planner pointed out.
They can also afford to invest the money quite aggressively, she said, because they won't need it for at least 10 years.
Pay off the car debt
Freedman has some other steps he thinks DeMarco should take. He should pay off the $8,000 in consumer debt that is costing him $430 a month, Freedman said. Though he will finish his payments in 21 months, he should pay it all off now and reallocate the $430, according to the planner.
In fact, DeMarco could take that money and pay for the Subaru Outback, Freedman said. At the very worst, he should be able to lease the car for $423 a month on a four-year plan, with 9 percent interest, Freedman continued.
But instead of leasing the car, Freedman believes DeMarco should buy it, with any luck paying $430 a month over five years. That way, he will have an asset that has some value. He should hold it for at least seven or eight years, according to Freedman.
Next, Freedman said, DeMarco should go with his second opinion on the mortgage. Pay $20,000 toward the principal, he said, leaving roughly $50,000 on the mortgage. Continue the $650 payment and he will have the home paid off in nine and a half years.
"Don't let the temptation of deductible mortgage interest steer you away from paying down your mortgage," Freedman said. The mortgage deduction only benefits you when you itemize your taxes on Schedule A, the planner pointed out.
Freedman estimated DeMarco's deductible mortgage interest in 2000 will be $6,000. He would have to have substantial other deductions -- from costs like property, state and excise taxes, and charitable donations -- to make it worth his while itemizing, Freedman said.
"We don't suspect that you will be using your itemized deductions and thus, the deductibility of your mortgage interest is negligible," he said.
Now you get to invest
Finally, DeMarco and Dressler get to invest some money, following Freedman's plan. After devoting $10,000 to the emergency fund, $10,000 to home repairs, $8,000 to paying off the car loans, and $20,000 to the mortgage, there is $62,000 left.
Split it into three accounts, Freedman encouraged. For 2000 and 20001, both DeMarco and Dressler should fully fund Roth IRAs, the planner said. With a max of $2,000 a year per person, that accounts for $8,000.
Freedman recommended that they both split their Roth IRA money equally between an S&P 500 index fund, a small-cap growth fund and a large cap international fund.
DeMarco should not be buying any individual stocks, according to Freedman. The other $54,000 -- the $62,000 less the Roth IRA money -- should go into a broad array of mutual funds, Freedman said. Focus on long-term growth, he says. If the account earns even a conservative 9 percent a year, the money will grow to $124,000 in 10 years.
Funds to think about
Tracy concurred that DeMarco should forget individual stocks. She believes he should invest the leftover money in the inheritance in a similar mix as Freedman picked for the Roth IRAs.
Specifically, Tracy recommended a blend with around half the money in large cap growth or value funds, and the rest split between international and small- to mid-cap funds. Some funds to think about in those areas are the Vanguard Extended Market Index fund (VEXMX), the Janus Worldwide fund (JAWWX), the Weitz Value fund (WVALX), the T. Rowe Price Science & Technology fund (PRSCX), the White Oak Growth Stock fund (WOGSX), and the Vanguard Health Care fund (VGHCX), Tracy said.
After five years, DeMarco will be faced with his first kid heading off to college. But he will also have finished paying off the Subaru Outback by then. He could take the $430 a month, which amounts to a little over $5,000 a year, to help pay for the tuition, Freedman said.
Following Freedman's plan, after 10 years, DeMarco will then own his house outright and have another $650 a month to add to his mutual-fund savings. Freedman hopes DeMarco will find a way to continue funding the Roth IRAs at $2,000 a year, too. If they do, they will have $30,000 in the Roths after 10 years, Freedman calculated.
Freedman recommended that DeMarco consider hiring a certified financial planner, rather than a broker. That "will certainly curtail the emotional hills and valleys and help him maintain a rational focus," Freedman wrote.
* Disclaimer
Got questions about financial planning? Need some advice? CNNfn.com has organized a panel of outside experts to answer your questions. If you want to be considered for the "Checks & Balances" column, where professional planners suggest ways you can manage your money, send us an e-mail at checksandbalances@cnnfn.com. Include information about your age, occupation, income, assets and monthly expenses -- imagine you're providing a full income statement and balance sheet. Also, share with us any short-term and long-term financial goals you may have. And don't forget to leave your phone number. 
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