Debt repayment & Net worth projection tool

I created a new tool, which was a pain in the butt to create, but I think it’s pretty nifty.

Key inputs (all in yellow):

  • Assets
  • Liabilities (including interest rates)
  • Income
  • Desired annual funding of each account (in green; put $0 if you don’t care to fund the particular type of account, like a 529 if you have no/grown kids)
  • Desired retirement age

Key outputs:

  • Wealth over time
  • Automated optimal debt repayment schedule (shown in blue, but you can override if you’d like)
    • I hard-coded $0 extra repayments towards mortgage in row 118 for now, but feel free to override by copying down the blue row above it.

Let me know what you think. As with any model, it is very sensitive to the assumptions. I assumed a 3% real return, which is probably somewhat conservative. If you change this number, of course, the output model will change considerably.

It’s downloadable here (link).

This spreadsheet, along with common sense, shows that the only way of accruing wealth (or getting out of debt) is to spend less than you earn. This is why I ruthlessly remove any expenditure from my life that doesn’t add value, which frankly is most expenditures other than the necessities of food, shelter, clothing, and my $15 3mpbs internet. I just spent a few days trouncing around the mountains with my family for a couple of bucks of gas and a couple of bucks in granola bars. The best things in life don’t cost much money.

Curious to see what your $100/month cell phone plan or is costing you over your lifetime? Play around with the model and see. With this model, it’s easy to visualize how your consumption decisions today will influence your future wealth (and thus your future ability to consume).

People who criticize me for being naively cheap fail to understand that I’m simply trading off consumption today for either consumption or free time later in life. When my broke peers are eating beans and rice out of necessity in their old age, I’ll be eating beans and rice (b/c it’s cheap, healthy, and environmentally responsible) when I’m older while being financially secure. Does this mean I’m crazy?

Let me know what you think of the sheet and whether you found it helpful.

Ask the Professor

I do a fair bit of financial mentoring for fun. I’d like to open this up to the readers of this blog. If you’d like me to publicly dissect and optimize your finances, send me an email at professorfrugal@gmail.com. I’ll make a blog post out of it so others can learn as well.

In order for me to properly assess your situation, I’d like you to provide the following info:

  • Fill out three-months worth of info on “financial update” spreadsheet
    • Balance Sheet
    • Income & Expenses
    • “Where Did Savings Go?”
    • Portfolio Allocation
    • Expense Ratio Analysis
  • Demographics
    • Age
    • Marital status
    • # kids at home
    • # kids 16 or younger

An example of the mentoring I did this past month was for a reader who is anticipating a large promotion next year. Her 2016 salary is $65k and her 2017 salary is projected to be $100k. She has 2 kids, both of which are younger than 16. Below are screenshots from my tax calculator tool.

 

 

At 65k of income, her EFFECTIVE marginal tax rate (EMTR) is 15%. Her main question was whether she should opt for a Traditional vs Roth 401k. Here is my general rule for Roth vs Not.

If your effective marginal tax rate is >= ~18%, do traditional 401k.

If your effective marginal tax rate is < ~18%, do Roth 401k.

 

As you can see from the chart and the table, her EMTR is 15% from $51k-$104k in income.

You can shelter $18k/year in a 401k. The first $14k of contributions would bring her taxable income from $65k to $51k. Over this region, her EMTR is 15%, (as confirmed by the table and chart above) so she would end up saving $2,100 in taxes on her first $14k in 401k contributions. This can be directly observed in the table, as the tax liability for $65k in income is $2,503 and the tax liability for $51k in income is $403, the difference between these two numbers is unsurprisingly the same as the $2,100 we had calculated earlier.

The tax code is not magic people, it can be learned and strategized around.

 

To get to the max contribution of $18k for the year, she could have contributed an additional $4k to the 401k, bringing her taxable wages to $47k and reducing her tax bill by an additional $1,265 since her average EMTR over this region is 31% ($4k * 31.4%).

If we managed to get her taxable income down from $65k to $47k, a natural question is whether we can further reduce her taxable income with traditional IRA contributions. After all, she is married so she could contribute $11k total to TIRAs. And if you look at the tax table above, this is precisely where her EMTR is highest at around 31%. If you continue to naively use my spreadsheet as we have above with the 401ks, you will be sorely disappointed because TIRA contributions are treated different from 401k contributions.

401k contributions reduce your earned income, and thus can be used to hack the EITC. TIRA contributions, on the other hand do nothing to lower your earned income. As a result, to understand properly the effects of the $11k TIRA contribution, you enter the $11k TIRA contribution into my spreadsheet.

Once you do so, you will see that at $47k of taxable wages, this only reduces the tax burden by $1,100, or a mere 10% of the contribution, from a refund of $2,096 to a refund of $3,196. The picture on the left (top if viewing on mobile) is with $0 TIRA contributions (as we had before), whereas the picture on the right (bottom if viewing on mobile) is with $11k TIRA contributions.

Thus, while a naive analysis would assume that the TIRA contribution would be extremely lucrative due to high EMTR, a more sophisticated analysis reveals that the TIRA contributions only reduced taxes by 10% of the contribution amount, which fails my rule of thumb of 18%.

So after performing the above analysis, my prescription for the reader was:

  1. Contribute to Roth 401k up to company match
  2. Max out HSA
  3. Max out limited purpose FSA up to what you will use this year
  4. Max out 11k of Roth IRAs (why? b/c Roth IRAs are more versatile than Roth 401k)
  5. Max out remaining Roth 401k contributions
  6. Stick the rest of it in a taxable brokerage account (though a 529 might be an interesting option as well)

For the following tax year, I redid the above analysis with the full year’s income of $100k and nothing changed. EMTR remained at 15%, so the decision to do Roth now remained.

For those unfamiliar with the Roth vs Traditional debate, it all comes down to one simple calculation. Do Roth if your EMTR today is less than your guess of EMTR when you retire. Do Trad otherwise. If the two EMTR are identical, it doesn’t matter, as shown below.

FV of $1 contributed to 401k = FV of $1 contributed to Roth 401k

(1-EMTR_in_retirement)*[$1 labor income today] * (1+R)^N = [$1 labor income today * (1-EMTR_today)] * (1+R)^N

The two are equal if EMTR’s are the same. If EMTR_in_retirement > EMTR_today, do Roth. If EMTR_today > EMTR_in_retirement do Trad.

The decision of Roth vs Traditional is among the most important decisions someone can make in their financial lives, and can amount to hundreds of thousands of dollars difference in wealth in retirement due to tax savings. It’s not hard to think about this decision strategically, as shown above. There is no magic. It’s just a straight-forward application of my tax analyzing tool or Turbotax’s TaxCaster.

Financial Update May 2017

Another month, another update. A few random comments.

Good Reads/Listens/Watches

  • Wisdom from Warren Buffett and Bill Gates:
  • A WSJ reporter shares her infuriating experience of calling her financial advisor to figure out how much she was paying in fees (link). After a series of calls to different people (including company headquarters) with little success, she finally arrived at the number. 0.55% in mutual fund fees + 0.85% in advisory fees for a total fee of 1.4%.

    After a series of phone calls that elicited the kind of confusion and frustration I have rarely experienced outside of interactions with cable-company customer-service representatives, I think I have an idea. Barely.

    Describing the fee disclosures of my adviser as opaque would be generous. The experience left me wondering whether someone even less savvy than me, a Wall Street Journal reporter, would be able to navigate this system, to ferret out the good information from the bad.

    • This is absurd on so many levels. Most importantly, it is absurd that this woman was pissing away 1.4% of her portfolio on an annual basis in fees by listening to a financial advisor. I’ve said it before, but I’ll say it again. If the stock market will produce a nominal return of 5% over our lifetimes (a completely arbitrary number I pulled out of thin air but seems reasonable to me), and inflation runs 2% over our lifetimes (a number which again I pulled out of thin air but seems reasonable to me), we will all experience a real return of 3% in the stock market. This woman was pissing away 1.4% of this 3% return in fees, or 47% of her potential upside.
    • I played dumb on a call to Personal Capital a few years back when they were trying to sell me on their 1% advisory services. After listening to their spiel for about an hour, they essentially claimed that they could beat my current returns by 1% but would charge almost 1% in fees for the right to do so. I am sure they were wrong with the former claim, but even if they were right, on an after-fee basis I’d be no better off with them. This whole industry is absurd. The only thing perpetuating the industry is people’s vast financial ignorance. Once the financial ignorance is solved (easier said than done), the industry will implode. Hence the huge migration to Vanguard I mentioned last month.
  • Warren Buffett on tax reform and healthcare during his recent Berkshire meeting (link).

    Today’s corporate tax rates, Mr. Buffett seemed to suggest, are a distraction, not a true impediment to growth.

    “If you go back to 1960 or thereabouts, corporate taxes were about 4 percent of G.D.P.,” Mr. Buffett said. “I mean, they bounced around some. And now, they’re about 2 percent of G.D.P.”

    By contrast, he said, while tax rates have fallen as a share of gross domestic product, health care costs have ballooned. About 50 years ago, he said, “health care was 5 percent of G.D.P., and now it’s about 17 percent.”

    Mr. Buffett said our global competitiveness had fallen largely because our businesses were paying far more for health care — a tax by another name — than those in other countries.

    • Buffett is spot on. I have a healthcare rant coming later in this blog post.
  • Speaking of interesting facts, every US citizen should be informed of the following:
    • Sources of U.S. revenue and how it is spent: https://www.cbo.gov/publication/52408. We are basically a welfare state.
      • The vast majority of our expenditures being spent on Social Security (24%), Medicare (15%), Medicaid (10%), Unemployment + Food Stamps + Federal Retirement + ETIC (16%), etc. 15% of budget goes to military (does not include VA benefits), 6% to interest. 16% goes to a bunch of other welfare programs including housing assistance.
      • Income primarily comes from payroll taxes (34%) and individual income taxes (47%). The ladder is extremely progressive, with the lion’s share of the tax revenue coming from the very top of the income distribution. The former is much less progressive, as payroll taxation is largely a flat tax (with the exception of social security being phased out above $120k in income). Only 9% of federal revenue comes from corporate income tax. The remaining 10% comes from estate and gift taxes, etc.
    • Largest tax breaks for individuals and corporations:
      •  The largest break by a mile is the subsidy for employer sponsored health care plans. This should be removed, as discussed later.
      • Mortgage interest is only #3 on the list because not everyone who has a mortgage benefits from the deductibility of the interest (mort int + state  income tax + property tax < $12,600 if MFJ).
    • It boggles my mind that we can’t balance our budget at the federal level. It’s not rocket science. It’s ensuring that expenditures are below income receipts (or alternatively said that our income exceeds our expenditures). Almost all budgetary problems are spending problems, not income problems. Our debt burden has been relatively painless thanks to historically low interest rates, but interest rates will rise and we’ll soon feel the hurt. The great folly of government is that it’s too easy to spend other people’s money. And it’s too easy to over-promise on spending when the burden of paying for it falls to future generations.

 

How to Fix Healthcare Rant (feel free to skip, of course)

  • Remove the healthcare premium tax subsidy. It is the largest tax break that the US offers. It is utter nonsense that we have this. It creates a huge incentive for companies to offer bloated, Cadillac policies and it’s very regressive….it disproportionately helps those who are well off and have juicy employer-provided plans.
  • Make consumers price-conscious through exclusive use of high deductible plans. High deductible plans will produce many benefits.
    • Create incentives for price-conscious consumers.
    • Reduce overhead from running insurance companies.
    • Given that we have a high deductible plan, I feel 100% of the hurt every time we go to the doctor, up to the deductible which I hope we never hit. As a result, we’ve innovated and come up with less costly options such as telemedicine and minute clinics, which are anywhere from 40% to 95% less costly than going to our primary care physician. Do you think we would have invested the time to figure out lower cost options if we didn’t have the financial incentive? Not a chance in hell. Five months into 2017, we’ve only reached $375 of our deductible, thanks in part to our innovativeness (not to mention good luck avoiding accidents thus far).
  • Divorce employers from health insurance. Remove that nonsensical distortion – an unintended consequence of wage caps during WWII. A competitive market for health insurance will arise (like in all other aspects of insurance (life, car, home, etc))
    • https://www.ebri.org/publications/facts/index.cfm?fa=0302fact
    • During World War II, the number of persons with employment-based health insurance coverage started to increase for several reasons. When wages were frozen by the National War Labor Board and a shortage of workers occurred, employers sought ways to get around the wage controls in order to attract scarce workers, and offering health insurance was one option.
  • Further incentivize good health by allowing for price discrimination in health insurance markets (just like how life insurance charges more for smokers with high cholesterol).
    • How is it that I’m penalized for being obese or a smoker for life insurance, but it’s not Kosher to do this in healthcare?
    • How is it that I pay the same amount for health insurance as my colleagues? I have 5 kids and some of my colleagues have none. They are subsidizing me, and it’s not necessary. I should bear this cost of having more kids, but I’m rewarded with a subsidy from my colleagues.
  • Require that doctors post prices for all procedures. One article I just read suggested that our healthcare woes will go away once consumers start asking “how much does this test cost?” and “is this test really necessary?”
    • With a more streamlined health insurance industry, there is no need for the nonsense battle between what doctors charge and what insurance companies reimburse. Again, this further drives down the overhead costs of insurance companies.
    • Require a certain percentage of the medical expense to be collected at the time of service, just like any other service on the planet. My preference would be full payment at time of service with all reimbursement handled on the back end between the individual and the insurance company.
      • I spent an hour this morning calling a half dozen dermatologists to inquire about pricing for a a basic preventative skin cancer screening exam. Receptionist #1 said $75+whatever your insurance doesn’t pay. Receptionist #2 said $120-$180. Receptionist #3 said $80-$121. Receptionist #4 said $150-$250. It is absurdly difficult to find out medical prices before incurring the expense. Under the current system, neither patients nor doctors care about costs. Only 3 months after the service is provided, when the insurance company decides it won’t cover all of the procedure, will the consumer care about pricing. By then, it’s 3 months too late and the consumer can’t choose a lower-cost provider.
  • Reform malpractice litigation of doctors, who are required to carry expensive liability insurance which costs are naturally passed down to consumers.

I shared the above points with some colleagues over lunch. One of them retorted “it makes sense for the fraction of spending on healthcare to go up as countries get richer, after all, health is priceless.” I understand where my colleague was coming from, but I reject the premise entirely that doctors make us healthy. In general, good lifestyle choices make us healthy, not doctors. Exercise, veggies, avoiding excessive salt & sugar (i.e. processed foods), sleep, washing hands, and sunscreen make us healthy. Doctors are generally there to clean up our mess when we fail to do what we know we should. I understand there are many conditions that are outside of our control (cancer, horrible birth defects, etc), but I’d suspect that the vast majority of healthcare expenditures are a result of poor lifestyle choices.

My former employer (the MegaCorp) offered free screening to employees every year. We would dutifully stand in line for 5 minutes to get our fingers pricked, to hop on a scale, and have our blood pressure checked. I would always marvel at the supposed insights learned during these exams. My colleagues would come back from these exams surprised to learn that they were 100 lbs overweight, had high cholesterol, and had high blood pressure, and were at risk for a series of horrible diseases. Really, you needed a doctor to tell you this?

Sorry about the rant. I’ve been teaching my oldest daughter economics lately and the idea of externalities. Externalities abound in the context of health insurance markets and it’s interesting to think through the implications of our current system and how one might fix it.

 

Life

  • I forgot to blog about this last month, but I took our family to the spring football game last month. It cost $17 for the 7 of us total. We have a strict no-buying-snacks policy at entertainment events like this so my kids resort to foraging. We stuck around until the end of the practice game and my kids were elated to see all of the half-eaten popcorn containers left behind by people.
  • We mulched. We had a truckload of mulch dropped off on our driveway. I had no idea how much mulch we’d need, so I gave it some thought and picked a random number out. 10 cubic yards. Then I went to Home Depot to buy a wheel barrow and realized that we needed less than that. Probably 8. The truck arrives with 12 (2 “free bonus ones”). Crap. I spent three days in the heat shoveling that stuff around. The joys of home ownership. That and removing bushes from hell littered with thorns and planting a garden. $364 down the drain.
  • The kids have tired of taking care of their guinea pig after 3 months of owning it. My wife or I don’t want to take care of the thing so we put the thing on Craigslist and it was gone in 3 days. If we were stronger-willed parents we’d probably force our kids to take care of the thing for the next 4 years of life the thing has left, but I hate the daily battle with the kids. Lost $300 or so on the deal, but we got the pet ownership bug out of our system. Best investment I ever made. Goodbye Thumper.

  • Sleep still eludes me, as it has for the past decade or two of life.
  • Exercise went well. Biked to campus every day. Did my workout routine. Took a few days off to recover from the mulching fiasco.

 

This month’s finances

  • Dumped $6,750 into Saturna HSA. It turns out they recently removed the lower trading expense for Fidelity mutual funds, so I opted instead for the ETF equivalent of the Vanguard Total Stock Market Index (VTI).
    • This was my first ETF purchase in my life, and I’m not a fan. ETF’s are a pain to own relative to holding index funds directly. You have to deal with bid-ask spreads as well as the inability to buy partial shares. With a simple index fund, you don’t have to deal with either of these issues.
  • I dumped $2k into a 529 account just to test the waters. Relatively high cost funds (0.32% after management overhead relative to the 0.04% expense I could achieve on my own). But I live in a relatively high taxed state, with marginal rates of 7%. If I lived in TX, WA, NV, etc, I don’t think I’d touch a 529 plan with a 10 foot pole. I guess I still need to give it some more thought, but I think the $10k/year (the state deductibility max) is a no-brainer.
  • It turns out that Vanguard lowered its expense ratios by 1bp (0.01%) for all funds I’m invested in. I hadn’t seen any other blogger/news article mention this. I love that company. It’s relatively commonplace, with expense ratios adjusting roughly annually.
  • Investors talk a whole bunch about alpha, which is a essentially fancy way of saying any excess return above the market. I’m convinced there is basically no alpha out there to be had from stock picking, which is why I advocate low-cost investing. However, I think there is substantial tax alpha to be gained through the efficient management of one’s taxes. Fully funding HSA, 401k, IRA, 529 plans are ways I achieve positive tax alpha. Further, tax loss harvesting, which I’ll expound on in subsequent months, is another source of tax alpha. I think this tax alpha is the lowest hanging fruit out there, and I’m absolutely shocked others don’t see the wisdom and follow suit.
    • I had a recent conversation with a colleague of mine, who is a brilliant man in his mid-forties. He has been employed by the university for a while (10Y or so). We got talking about effective marginal tax rates and tax sheltering. It turns out it never had occurred to him in is life to calculate his effective marginal tax rate. I showed him how to do it (and I shared my spreadsheet with him), and it turns out that his effective marginal tax rate was over 50%. Mine is 45% but his is over because he hits AMT like me but he also loses the refundable education credits with a kid in college, which leads to a 5.5% higher effective marginal rate than me. He and I determined that he could save $20k in federal and state taxes annually by sheltering $36k of income in a 403b + 457, which he validated in Turbotax himself by running scenario analyses. His mind was blown. In exchange for saving him $200k in taxes over the next 10 years, he promised to buy me a Chipotle burrito. I consider it a fair trade. Tax alpha people. It is unbelievably powerful.
  • After reading a series of good posts about umbrella insurance on Bogleheads, I finally succumbed. I detest recurring expenditures. I detest over-insuring. However, my one rule of thumb that guides my insurance choices is to not insure anything that I can easily afford to replace. Well, if I’m at fault in a horrible accident, or if someone slips and breaks their neck on my driveway, I’m exposed to huge litigation risk. Umbrella insurance protects me. I understand retirement assets to be protected from litigation, which is a huge shadow benefit of sheltering money in these accounts. I struggled to know how much coverage I should get but finally converged on a $1M policy for $143/year through Geico. I know it’s cheap, but I’m frugal and it kills me to sign up for a new recurring expenditure. I’ll probably allocate this to my auto expenses since it is primarily driven by auto risk. In addition to the countless Bogleheads posts on the topic, I found this blog post informative: http://www.financialsamurai.com/how-does-an-umbrella-policy-work-and-how-much-does-it-cost/. If you are not a reader of the Bogleheads forums (in particular their personal finance one), I’d encourage you to do so. There is no better source of financial wisdom on the planet than the collective brainpower there.
  • I paid $164 for car insurance this month (6 month premium) and $439 for annual homeowner’s insurance premium.

An extended of version of the table is available here (link).

 

Footnotes:

  1. Don’t lend money to friends/family.
  2. I lazily approximate home value using Yodlee’s embedded SmartZip estimator.
  3. I have a 15Y mortgage; which results in a faster rate of repayment. The true cost of the mortgage should exclude repayment of principal, which I show above.
  4. $15 internet and $0 cell phones as described here.
  5. All expenditures at Costco & Walmart are classified as “Food at home” for simplicity (even if it’s laundry detergent, clothing, etc).
  6. I prefer Vanguard funds but my employer offers Fidelity instead.
  7. Nobody knows the perfect asset allocation. Just pick one and run with it. Use a target date retirement fund as a benchmark if you want some guidance (link).
  8. My low portfolio expense ratio is the primary reason why I don’t hold target-date funds, which have expense ratios anywhere from 0.16% to 1%. I can achieve a much lower expense ratio on my own due to Admiral shares, etc. And it’s not hard. Plus, a DIY portfolio allows one to tax-loss-harvest more easily.
  9. ETF’s are a pain to own relative to holding index funds directly. You have to deal with bid-ask spreads as well as the inability to buy partial shares. With a simple index fund, you don’t have to deal with either of these issues. I am currently invested in VTI b/c it’s $10/year cheaper than VTSAX in my Saturna HSA.
  10. The one blight in my expense ratio analysis is my 529 plan. The underlying Vanguard fund is almost free to hold (0.02%), but the high administrative fees bring the total cost of holding the fund to 0.32%. I abhor fees and would likely avoid 529 plans if I didn’t get to deduct up to $10k of contributions per year on my state return, saving myself $700/year in state income taxes.
  11. The only other administrative cost not captured by my expense ratios is a $19/year administrative fee for my HSA at Saturna Capital ($15 per transaction + 4*$1/dividend reinvestment).

Disclaimer:
This site is for entertainment purposes only, as disclosed here: http://www.frugalprofessor.com/disclaimers/