Amanda: I'm not sure we can have a gym, nursery, and office all in one. We had a baby shower a couple weeks ago and our house is full of hundreds of small items.
Jamie: Meet Amanda and her husband, Gavin.
Gavin: My parents are very excited, but they are back in Scotland. So they're not going to be around as much to help with some of the baby stuff.
Jamie: They're about to embark on the journey of a lifetime, parenthood. And with that exciting news means some big decisions ahead.
Gavin: We like to think of ourselves as minimalist, but the reality is to both work from home and have a child, we need a minimum of three bedrooms and a little bit more space.
Jamie: They're currently in a two bedroom apartment, but will need more space soon. Gavin and Amanda work in the San Francisco Bay Area, and don't want to move too far away because Amanda's parents live close by and in the coming years, they'll need childcare. They think they need to buy a home, but they're not sure they can or even want to.
Gavin: When we talk to maybe our parents about things like a mortgage, they've always thought of buying property as an investment. And I'm not sure that I necessarily agree with that anymore. I think that it's just such a heavy financial burden compared to maybe what it was a few decades ago.
Amanda: My parents bought in the 80s in the Bay Area when things were much lower, and you could have a blue collar job and still live your life, travel and have disposable income. That reality is much different today.
Jamie: Being able to travel, have adventure, even retire early is important to Amanda and Gavin. They’ve got a combined income of $300,000. But, big change is coming and they want to have a financial plan to be ready for that.
Amanda: Bringing a child into the world means thinking about childcare costs, balancing that against my net income and figuring out what budgetary changes we'll need to make, to make this work for us.
Gavin: Amanda and I are actually really good at communicating and generally being on the same page about things, being pretty open and transparent, but I think there's just things neither of us know. And it's hard to have a conversation when you don't have that vocabulary.
Intro:
Jamie: And that's where we'll start today. I'm Jamie Roo and welcome to, What Should I Do With My Money, an original podcast from Morgan Stanley. We match real people asking real questions about their money with experienced financial advisors. Here at Morgan Stanley, we work with a range of clients. Some, are experienced investors. Others, are new to working with a financial advisor. On this show, you get a front row seat to hear what these initial conversations are like. And get answers to some of the questions you might have yourself. The arrival of a first child often prompts people to start rethinking everything that you need. I know it did for me, more space that your household budget needs to extend, to include big items like childcare, but also all the little things that add up like food and clothes and diapers. So many diapers.
Couples like Amanda and Gavin are wondering if their savings are enough, can they afford to buy a house or will that choice leave them stretched too thin? If they buy, where do they start with mortgages and how do they budget for the unexpected? What if one of them couldn't work all of a sudden?
These are questions, Eric from our Oakbrook Illinois Office gets a lot. Eric is a financial advisor and senior portfolio management director. He remembers having these same questions when he and his wife were expecting their firstborn.
Eric: I remember those early days, those early weeks, those early months, very well. And thinking about finances and thinking what was about to change.
Jamie: 18 years later, Eric offers clients guidance from a professional standpoint, but also from his personal experience, this helps him navigate conflicts, couples may be experiencing when they don't necessarily agree.
Eric: I have worked more with couples than not. I have certainly witnessed, I will term them, mild arguments. I have certainly witnessed what almost feels like a very heated battle, but I would say in the vast majority of those cases, by the time you work through that, the understanding that each one of them have for each other, how they feel about money, it's really amazing to witness. And then you watch them come together and they create a long-term plan that best suits them both and they become fully committed to it. It's really an amazing process to watch.
Jamie: Coming together and making a plan is what Gavin and Amanda are here for today.
Conversation:
Jamie: Well, first of all, Amanda and Gavin, congratulations on the baby. This must be a very exciting time for both of you. Yeah.
Amanda: Excited, nervous, and everything in between.
Jamie: Understandable. So Eric's been briefed on some of what you'd like to ask today, and he has many years of experience as a financial advisor, as well as a parent himself. I'll let him take it from here.
Eric: Thank you, Jamie. Gavin, Amanda. So nice to meet you both. And first of all, to echo Jaime's comments. Congratulations.
Gavin: Thank you. We're excited.
Eric: One of the questions that I've often asked clients through so many years is to tell me a little bit about what keeps you up at night?
Gavin: The thing I'm really grateful for is we've worked really hard to build up savings. And it's the first time in my life where I felt like we have a cushion. If something was to go wrong, if one of us was to lose our jobs or circumstances changed, we have a little bit of a safety net there, but the thing I don't like is now thinking, well, if we give that up for a down payment or some other investment, then suddenly we're back to square one.
Amanda: That's the same anxiety that I carry that keeps me up at night is weighing that decision and wanting to know that, say if one of us was unhappy in our role or something was happening, that was challenging with our child and needed to take a step back and focusing there. If we were to make a big investment and lose that safety net, we'd have to make a tough decision.
Eric: Sure, absolutely. One of the items that you both mentioned is you would like to, and feel you need to, to move into a bigger place. You're expecting your first child here soon. Tell me a little bit about that goal.
Gavin: I think space is maybe one of the biggest issues. We literally both work from home and need quiet space to do that and bringing a child into the home, we're going to need another bedroom. So there's a very like pragmatic aspect to that.
Amanda: Um hm, additionally, we live in a complex, and have wonderful neighbors, but we don't have our own yard where our child could play and explore and learn. And that's something that is a high priority for me.
Eric: Have you had the opportunity to look in the area to see what housing prices are for the type of real estate that you would like to own? Have you found the prices to be what you've expected?
Gavin: I think we knew it was going to be expensive in the Bay Area. And it definitely is. We probably had a little bit of sticker shock in the sense that we figured if we moved a little bit further out, the prices would drop down significantly. And I don't think we've really experienced that. And then we start to get caught up thinking about things like closing fees and the cost over and above, the literal cost of the home. And that's, I think where we get a little bit frozen.
Amanda: Yeah. I really have no clear understanding at how to break those costs down, what that would look like in terms of the down payment and applying that to a monthly budget, what would we have to cut out of our lives to make that really feasible? And how can we live the same quality of life we're living now, when we add those expenses in?
Eric: I learned actually from a colleague and I think it's a fantastic idea, maybe you have a date night, it's a money date night and you spend some time talking about finances, financial goals. And we start to talk a bit about a budget, because it really does not have to be horrible.
Amanda: We sat down this winter and went through granularly, line by line six months of expenses and then grouped those into categories. So we could do a test budget, that we're now applying and have been since March.
Gavin: Yeah, there was a lot of sit down with bank statements and credit card statements, just trying to work out where the money went.
Eric: Were there any surprises, anything that you looked at and said, oh my gosh, I had no idea we were spending that much money there.
Amanda: A lot on groceries. We prioritize eating healthy and we both work hard. On the weekends we tend to sit back and get delivery and there is definitely a good amount of money going out on that.
Gavin: Yeah. A lot of money spent on food in general.
Eric: It hasn't been uncommon in my career when I go through this process with a couple that they will come back to me after six months and say, oh my gosh, Eric, we discovered that we were spending a lot more money, for example, eating out than we realized we were, and it's not even important to us. We don't even really care about that. We were just doing that because that's what we did. That's the habit we fell into. When we think about budgeting techniques, it's my personal belief that there's no right or wrong answer here.
Jamie: Eric recommends dividing up a budget into three categories. Category one is needs, things like rent, utilities, food, car payments. Those should be about 50% of your budget. Category two, is wants, things that contribute to your quality of life, that might be vacations, concert tickets or costs related to your hobby. Give this category 30%. The rest is for the third category, savings and investments. Use this also for paying off debt that doesn't make good financial sense.
The percentages might change – things come up, like maybe saving for something big. Or investing in yourself during a career change. It will depend on your unique circumstances but this is a good framework for thinking about a budget.
Now to Gavin and Amanda's next question about using everything they have, savings and emergency fund, toward the purchase of their home.
Gavin: I think top of mind for me is how we should quantify throwing our savings at a down payment. Should we hold more back as a safety net or is it a better judgment call to put that down and secure a mortgage?
Eric: The tendency, I think sometimes is to say my gosh, we've got this large amount set aside for a down payment and let's commit all of that right now so we can have the lowest monthly payment, that lowest mortgage payment possible. Certainly understand that. You both are working, you're dependent on both incomes to make the household budget work at this point. If something were to change either by your own design or something that is out of your control, having some money set aside to cover those expenses is incredibly important.
The tendency may be let's commit all that to the mortgage, but I would really encourage you to think about making sure you have got three months, four months, five months worth of bills. I truly believe it will not only provide you financial security. I believe the emotional comfort you'll get from that, will be well worth it.
Gavin: It's really reassuring for me to hear that because I think we've had a lack of clarity around, is it stupid to hold back savings for something that might never happen when we could be putting it to more active use, but like hearing that from a financial advisor is helpful.
Eric: What concerns me from an advisory standpoint is if I see a client has committed all of their money, they don't have any cash to cover those short-term needs. Not only do I think about the stress that brings you in the near term, but I also think about how does that derail other goals? Are you now forced to liquidate long-term investments to cover a short-term need?
Gavin: Right.
Eric: Are you forced to go out and maybe apply for that credit card at 17 or 18% interest to cover that short term need? And now you have yet another line item on the budget, another worry.
Gavin: Yeah. We want to avoid that downward spiral, but you mentioned, I think three, four or five months of saving or like comfort zone. Is that an industry recommendation?
Eric: There is no right or wrong answer. Well, let me take that back. I believe the wrong answer is to have nothing. The right answer is maybe we shoot for the minimum, but find what's comfortable. And by the way, that may change, now as you start your family, you've got a new baby coming. You may naturally say we want that emergency fund to be higher, that's okay. Five years down the road, 10 years down the road, that very well may change. That's okay.
Gavin: That's helpful.So with that information, I think that helps to maybe set a benchmark of like, this is the amount of money that we should definitely be holding back, and we should remove that from anything that we are considering as a down payment, but then that raises lots more questions about how to actually choose a mortgage and what a down payment looks like. I feel like I have a lot of questions around that.
Eric: Well, expand on those both a little, tell me what you're thinking.
Gavin: Well, I've plugged some numbers into a mortgage calculator, for an example, and it will typically look at it from the perspective of what can you afford to borrow? And when I think about that, I'm less concerned about how much can I borrow as like, what can I expect as a reasonable monthly payment. I'd rather start with what I can afford monthly and then scale that up. And when I think about variabilities, like how credit score adjusts that, how a down payment adjusts that, how 15 years versus 30 years, about interest rates. There's so many variables, I don't know where to start.
Eric: I understand there’s a lot for you to consider here right now. The very first step – you need to understand what you’re comfortable spending each month.
Then you’ll want to start talking to lenders – and they may come back with quotes for different lengths of time, loan and payment schedules – and we can lay those out and take a look for you together on what will make the most sense given your budget and other long term goals you’d like to achieve.
You’ll likely be presented with different options that you can “afford” – but it comes down to your comfort level each month, and your other long term goals.
I would really, really encourage you to pay attention to the numbers, but to also pay attention to the emotion around it. On the surface, let’s spend the time, let’s do the homework, let’s understand each one of these programs – the pros and cons – really get the education you need prior to making that decision.
Gavin: That's helpful. And when you talk about reaching out to multiple lenders, do you offer your clients guidance on where to start with that? Because I think beyond our bank, I'm kind of at a loss as to like how to differentiate one over the other.
Amanda: Same
Eric: Great question. The first thing I would say is look to the relationships that you already have. So you do have a banking relationship, that bank understands who you both are to some degree, they understand a bit about your finances. Certainly I think it does make sense to talk to them, ask your friends, ask your colleagues, ask those that you know that own homes and that have gone through this process, if they have a relationship with a lender and a lending professional that they really trust.
Amanda: That's a great point. And I feel lucky that I have a large network of folks in the Bay Area who have purchased a home recently that I can start the conversation with.
Gavin: Yeah, it's a complicated process, but I think we just need to do some leg work up front that maybe we haven't done so far.
Jamie: Shopping around for a mortgage can be incredibly important. The mortgage market is definitely not one size fits all. Different companies offer different products and some may work better for you than others, depending on your situation.
Eric recommends looking to your existing relationships for guidance. A financial advisor can also be a guide here. They can also introduce you to a private banker who can further explain and explore different lending options. The private banker is then an extension of your financial advisor relationship, and can offer guidance and advise alongside your financial advisor throughout the process. At Morgan Stanley, private bankers can present options including fixed rate mortgages or adjustable rate mortgages, based on your individual needs. And depending on your unique situation, you may be able to reduce the need for a down payment on a home by using eligible securities in your brokerage account as collateral.
Once Gavin and Amanda have a better idea of what might be available to them, they'll have more information to help answer this next question.
Gavin: It seems like there's never a perfect time to buy a house much like having a kid. But right now it feels like everything's working against us. How do you advise us to factor in those big picture things when we think about our budget?
Eric: Are you thinking along the lines of my gosh is the real estate market just too expensive right now? Would it serve us better to wait a little bit and let prices calm down a bit?
Gavin: Yeah, there's a lot of information around interest rates going up, the stock market going down, the housing market just being a bubble. And when I think about that, I definitely get overwhelmed. But then maybe when it comes down to our personal budget, I just think, does someone need to give us the hard truth that we can't afford a house?
Eric: I think you will help answer that question as you work through that budgeting process, you're going to start to understand what can you comfortably spend on, on a house. And as you go out to start and shop, you may realize that there are homes that fit your needs that are in that price range, and that allows you to be comfortable making that commitment. You may also find that, no, my gosh, what we really, really want to own, it feels like too much of a stretch for us. Maybe we need to wait a little bit. I do not believe personally that there's any shame and I do not think you should feel bad about hitting the pause button a little bit.
Gavin: The situation we are in at the moment of maybe just trying to think a little bit further ahead, because we're expecting a child, is creating an urgency around this, which we don't necessarily have to adhere to.
Eric: Absolutely. It's creating a lot of urgency. Oh my gosh, what are we going to do? We need to have this solved, but I don't know. And I get the sense from you, both that rushing into a decision will ultimately not lead you to the comfort and the success that you're looking for.
Gavin: Do you have like general guidance on what a good down payment is for a mortgage or is that just different for every person?
Eric: I sense that you are probably people that will gravitate more toward that 20% rule of thumb. While there are some drawbacks to consider with a less than 20% down payment – like a higher rate on your loan, possibly. At the end of the day, let’s make sure we don't commit too much, that we've now thrown the rest of our financial life, the rest of our financial plan into an area of discomfort.
Gavin: That's helpful. Thank you.
Amanda: It does relieve the pressure. I appreciate that.
Jamie:
Pressure. Anxiety. These words come up a lot for people when it comes to their finances. For Gavin and Amanda, this initial conversation is just the beginning. A more detailed, financial plan – made just for them – will go even further in helping them feel less stressed, and more secure with where they’re at and what is possible.
With that, one last question about their budget.
Gavin: There's things that will change in our budget in the near future when we think about childcare and we think about cost of things that we've just never had to think about before, like diapers. I don't know how you would advise us to start planning a budget based on numbers that we don't yet know.
Eric: It is a great question, and as you were talking I was thinking about all of the additional expenses I incurred with my first child – diapers, car seats, strollers, etc. that I wasn’t prepared for. This is part of what your emergency savings is for, but to plan for it, I’d suggest committing more to your savings for the time being, to be sure you are prepared for the unknown changes. I mentioned money dates, be sure to set those more frequently in the coming months. A budget is not something you write once, it will continue to evolve. So set a healthy margin over what your needs are now, and then start setting a goal to save for that. Once your baby is here, you may find you need to adjust that up or down. In time, you’ll find the right place, and then can allocate any excess savings to your emergency fund or investing for long term goals.
Amanda: Right. I think that taking a step back and seeing and adjusting to what those costs might be before we make that larger decision would make a big impact on how we move forward in the real estate market.
Eric: And in hearing that you've taken the time to do that budget exercise is fantastic. You're just not launching into this completely uncharted. You're spending the time to understand what does money really mean to the both of you, that will help you make well thought out, well educated decisions that I truly believe will serve you very well. Not only today, not only as you make these decisions over the next year or two, but thinking about retirement at some point, for example, it will help you be best prepared for that.
Gavin: I think we definitely have some sleepless nights ahead, but I don't think it's going to be as often about money.
Eric: Good news. Good news.
Wrap up and recap
Jamie: You two make money dates sounds so romantic. How'd you find this experience today of talking to Eric? Was it what you expected?
Amanda: Absolutely. I've been looking forward to it for a long time. It's something that's been on my mind and on my heart for probably the last year. So when this was presented to me, I was elated that I'd be able to tap into someone who really understands.
Gavin: Yeah. And I think it was a lot more human and personal than I expected. I think that was the bonus for me that, we actually got to talk a little bit about our lives and who we are as people and not just numbers on the spreadsheet.
Jamie: Which parts of Eric's advice really stood out to you?
Amanda: For me, it was the part about there's no specific type of lender we should be reaching out to just to have conversations with multiple lenders and to reach out to your network, to find out what your peers are doing.
Gavin: Yeah. And sometimes I'm hesitant to reach out to friends and family on this kind of stuff, because everyone has strong opinions and they're always very different and you don't know where to start, but sometimes you just got to hear those things and then make decisions for yourself. So it was good to hear a financial advisor say that too.
Jamie: If you had a crystal ball and could look a year, 18 months into the future, where do you think you'll be living?
Gavin: If I look a year into the future, based on this conversation, I think we might be still in this apartment, but I think we'll be much further along in our planning and we'll have a much more concrete idea of what our expenses look like with the child and hopefully in a better position to make a decision for the next few years.
Amanda: I agree. I think my crystal ball is more when he's in kindergarten or at least in preschool, and we'll have at that point gotten to a good place where we've established ourselves in a home, and in a community, and kind of have created a village for our family.
Jamie: That sounds nice. This has really been a pleasure getting to meet you and know you both a little bit.
Amanda: It's been a real pleasure. I'm so inspired to take the next step. Take care.
Gavin: This was great. I appreciate the opportunity.
Jamie: That's it. For this episode of, What Should I Do With My Money, an original podcast from Morgan Stanley. If you enjoyed the show, follow us wherever you listen to your favorite shows. If you would like a deeper dive on what was discussed today – or to learn about our Spending & Budgeting tool – come see us at morganstanley.com/mymoney. I'm Jamie. Talk to you soon.
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