Bob and Edna Smith had a dream — a rustic vacation home in Utah. When they learned that a lake house was for sale, they could not contain their excitement. Everything was exactly as they had imagined — swans floated across the pond as a gentle breeze rustled through the leaves. However, before inking the deal, Bob and Enda descended from their cloud of joy long enough to get cold feet. After a long discussion, they resolved to contact a financial planning firm for an objective opinion on what they could actually afford.
Bob and Edna, both 45, owned a flower shop in Las Vegas. In addition to paying off their current mortgage, they planned to fully fund college for their two children (Freddy, age 10 and June, age 13). They had spent 20 years in Nevada but longed to leave Las Vegas and purchase a vacation home in Utah. They were ready to realize their dream but wanted to ensure this purchase would not jeopardize their retirement living standard. They didn’t want to become “house poor”. Mostly, they worried about how their fluctuating income might impact their goals.
As an analysis ensued, one thing became clear. Despite Bob and Edna’s diligent saving, they simply could not support a vacation home of this size. In addition to a substantially lower living standard (from $68k to approximately $45k), Bob and Edna would not have access to adequate cash for ongoing expenses as most of their savings were in retirement accounts. The living standard or sustainable consumption is the amount someone can spend after they pay their committed expenses (rent, mortgage, insurance, etc.).
Bob and Edna were presented with several possible adjustments. They could either increase income or decrease spending. After illustrating the impact of the various changes to their plan on their sustainable living standard, Bob and Edna agreed they were willing to reduce the sizable budget for their favorite hobby, restoring classic cars. However, Bob and Edna were adamant they did not want to depend on earning more or working longer. They did reveal that they may be able to sell their flower shop after retirement. However, as the sale price could vary greatly, the Smiths did not feel comfortable relying on this income either. Bob and Edna asked if there were other alternatives.
After careful analysis, they determined postponing the vacation home purchase for ten years added substantial flexibility to the plan. Bob and Edna would have additional time to save for the down payment and ongoing housing expenses in more liquid taxable accounts. Waiting would also allow them to see how the various uncertainties in their plan unfolded. Freddy and June would be finished with college, they would be less reliant on future earnings, and their mortgage would be paid off. Although purchasing the vacation home would have to wait, the Smiths could still take vacations in Utah and even rent a home for a few weeks each year.
With the revised scenarios, Bob and Edna learned that if they earned more or profited significantly from the sale of the flower shop, they could comfortably afford to purchase their dream home. Waiting would enable Bob and Edna to maintain their standard of living even if they experienced financial setbacks. It would also decrease the amount the couple would need to spend over their lifetime on maintaining their vacation home.
Relying on unreasonably favorable events could be stressful. If Bob and Edna bought the vacation home now, they may have worried about how they would fund the ongoing maintenance costs. Illustrating the impact that each variable would have on Bob and Edna’s living standard provided them with the information necessary to make an informed and confident decision.
While the original plan sometimes falls short, small adjustments can make large differences.
The article listed above summarizes a hypothetical scenario developed to illustrate the kind of people we help and the problems we solve.