BUSI 352 Week 5 Case Study 1 Example

The Morales Family: Statements, Ratios and an Investment Plan

Case Facts

Daniel and Ana Morales, ages 36 and 34, live in Charlotte, North Carolina, with two children, ages 6 and 3. Their goals are to retire around 65, help pay for their children's college and stop feeling one emergency away from trouble.

Ratio Analysis

Dalton et al. (2016) treat these ratios as the starting point for any plan. Two results are healthy: the Moraleses' housing and debt costs fall within the standard limits, so their debt load is not the problem. Two are serious gaps. Their emergency fund would cover barely five weeks of essential expenses, and their retirement savings rate is less than a third of the 10 to 13 percent of gross pay the textbook suggests for someone hoping to retire with adequate income. At 3.9 percent, they are saving $4,320 a year, including the employer match, when the benchmark implies at least $11,200.

Investment Analysis

Three problems stand out. First, Daniel contributes 3 percent of pay while his employer matches up to 5 percent, so the family forgoes $1,440 a year of matching money, a guaranteed return before any market gain. Research on automatic enrollment shows how strongly defaults shape behavior: Madrian and Shea (2001) studied a company that began enrolling new hires automatically and found that most of them stayed with the preset contribution rate and fund, even when that rate sat below what they would probably have picked on their own. Daniel's 3 percent looks like such a default left untouched.

Second, 40 percent of the 401(k) is in his employer's stock. His paycheck and a large share of his savings therefore depend on one employer, and a single bad year could hit both at once. Benartzi and Thaler (2001) showed that many plan participants allocate their savings by simple rules of thumb, such as spreading money evenly across whatever options are offered, rather than by deliberate risk choices, which suggests the allocation may not reflect a real decision.

Third, Daniel trades the brokerage account actively. Barber and Odean (2000) studied tens of thousands of household brokerage accounts and found that the households that traded most earned net returns well below the market, largely because of trading costs. French (2008) estimated that investors collectively spend a substantial fraction of a percent of the market's value each year trying to beat it, money that passive investors keep. The Moraleses do not need a better stock picker; they need fewer trades and lower costs.

A Quick Risk Management Check

Before adding to investments, a planner should confirm that a single event could not undo the plan. The case notes that Daniel has employer group life coverage of about one year's pay and that Ana has none, and neither has disability coverage beyond a short-term employer plan. With two young children and a mortgage, the death or long disability of either parent would leave the survivor unable to keep the house and the savings plan. Dalton et al. (2016) place risk management alongside investment planning in the planning process for this reason: investment growth means little if an uninsured loss forces the family to liquidate it. A level term policy on each parent, sized to replace income until the younger child finishes school, would cost relatively little at their ages and protect every other recommendation in this case.

Recommendations

• 1. Build the emergency fund to three months, about $15,600, by moving $9,600 from the brokerage account to a high-yield savings account, selling positions with losses or the smallest gains first to limit taxes.
• 2. Raise Daniel's 401(k) contribution from 3 to 5 percent immediately to capture the full match, adding $1,440 of employer money and $1,440 of his own.
• 3. Open a Roth IRA for Ana and contribute $250 a month, raising the household savings rate toward 10 percent within two years, with further increases timed to raises.
• 4. Reduce employer stock in the 401(k) to no more than 10 percent and move the rest to a low-cost target-date or broad index fund.
• 5. Hold the remaining brokerage funds in a broad, low-cost index fund and stop frequent trading.
• 6. Within the next quarter, buy level term life insurance on both parents and review long-term disability coverage, since the family depends on two incomes.
• 7. Once the emergency fund is complete, open a 529 plan for each child with modest monthly contributions, keeping retirement savings ahead of college savings, since a student can borrow for college but no one can borrow for retirement.

A Biblical Perspective on Diversification

The Preacher advised giving a portion to seven, or even to eight, because no one knows what disaster may happen on earth (English Standard Version Bible, 2001/2016, Ecclesiastes 11:2). Holding 40 percent of retirement savings in one company ignores that counsel. Diversification is a form of humility about the future, and a careful steward does not stake a family's security on a single outcome.

Conclusion

The Moraleses are not in crisis. Their housing and debt are manageable. But their thin emergency fund, low savings rate, concentrated stock position and costly trading leave them vulnerable and behind on their goals. The seven steps above, taken in order, would give them a cushion, capture free money, protect their income, diversify their risk and lower their costs, putting them on a path toward the retirement and college goals they described.

References

Barber, B. M., & Odean, T. (2000). Trading is hazardous to your wealth: The common stock investment performance of individual investors. The Journal of Finance, 55(2), 773-806. https://doi.org/10.1111/0022-1082.00226

Benartzi, S., & Thaler, R. H. (2001). Naive diversification strategies in defined contribution saving plans. American Economic Review, 91(1), 79-98. https://doi.org/10.1257/aer.91.1.79

Dalton, M. A., Dalton, J. F., Gillice, J. M., & Langdon, T. P. (2016). Fundamentals of financial planning (5th ed.). Money Education.

English Standard Version Bible. (2016). Crossway. (Original work published 2001)

French, K. R. (2008). Presidential address: The cost of active investing. The Journal of Finance, 63(4), 1537-1573. https://doi.org/10.1111/j.1540-6261.2008.01368.x

Madrian, B. C., & Shea, D. F. (2001). The power of suggestion: Inertia in 401(k) participation and savings behavior. The Quarterly Journal of Economics, 116(4), 1149-1187. https://doi.org/10.1162/003355301753265543