Financial Update Feb 2017

Another month, another update. A few random comments.

  • Tax refund finally came through. I denoted this as “other income”. As expected, EITC hacking / tax optimization proved to be wildly profitable this year. All low/middle income families with several kids should be doing this. I’ve drafted a guest post on the topic on GoCurryCracker which will be published in the coming weeks. It’s not rocket science.
  • We started two new forms of recurring expenditures this month:
    • We adopted a guinea pig, our first real pet. Yeah, it’s an over-sized rat but our kids love the stupid thing. We paid about $150 for a year’s supply of food for the thing. And we spent $100 or so on a new cage. Only after adopting the thing did I realize that I’m allergic to it. Brilliant planning on my end.
    • We started piano lessons for the three oldest kids. We have a teenager teaching them, but parting with the cash still pains me. Something like $100/month is what we’re doing. Ouch.
  • I maxed out 2016 Roth IRA contributions x 2.
  • I’m sitting on a lot of cash. I need to do 2017 (backdoor) Roth IRA contributions x 2, max out HSA, max out other retirement accounts (403b, 457), pay off mortgage early. Still trying to figure out optimal timing & sequencing.
  • I had a really interesting conversation with two of my friends this past month. Both of them know that I blog (and are two of the five readers I have) and that I am totally transparent with money. Talking about money doesn’t weird me out like it does many people. As a result, a these good friends have independently opened up to me about money. One of them is a friend from undergrad. The other is a friend from my master’s program. Both are 35. One told me that he hit $1M in net worth this past month. The other told me he’s worth several million dollars. A few things strike me as interesting about these conversations:
    • As a society, we don’t talk about money in a healthy way. We hide both our problems and successes, and as a result, we don’t learn from one another. As a result, we often suck at money.
    • My friends are truly “millionaire’s next door.” You wouldn’t know it from their consumption habits. They remain frugal. They drive crappy cars and live in modest homes/apartments. But this is precisely what enabled them to accumulate masses of wealth at a young age.
    • Not even their siblings or parents or other friends know about their wealth. I guess they don’t want to come across as bragging or whatever, but to me it’s kind of weird that these great successes are hidden from view for others to learn from.
  • My safe withdrawal analysis chart is slowly but surely climbing upwards. It is amazing to me how much savings is required to move the needle on this chart at all. I hope it is a reminder to us all of how much wealth and savings are actually required to retire.
  • We currently have high deductible health plans. Several of the members of my family got sick this month. In lieu of going to the doctor for a normal visit (and bill of $150-$200), we utilized a combination of minute clinics (in CVS) and telemedicine. It was our first experience with telemedicine and I was pretty encouraged. They treat simple stuff (sinus infections, allergies, etc). You may want to check it out if you have high deductible plans. Worst case scenario you’re out $10 if they tell you to see a physical doctor. My wife was prescribed antibiotics to treat a lingering sinus infection through one of these visits. Our daughter was told to go see a physical doctor for an ear infection. Again, I’m happy to pay $10 for a consultation which will likely save me a $200 visit. If it doesn’t work out that way, then I’m only out the $10. No big deal.
  • My wife is going on a cruise with her sister and parents, without me. The prepayment of that cruise showed up on this month’s finances as well. I’ll be left on my own with 5 kids for a few days. Heaven help me. I’ll try not to over-analyze the fact that my wife going on a cruise without me.
  • My water bill (below) shows my water usage relative to my home’s previous owner (I moved in over the past summer). I use about half the water as the previous owner. How did I accomplish this? Watering lawn less often (specifically, I turned all water off and saw which portions of lawn began to die, and only watered those portions). I also installed low-flow aerators on my sinks (0.5gpm, sold on Amazon here). I assume I use about half of the other utilities as well, despite having a large family. I assume I also spend about half on groceries, 80% less on restaurants, 90% less on entertainment, etc. As a result, my wealth will increase at a substantially higher rate than my peers. But I don’t feel deprived because we are gaining great value out of the relatively few resources we consume. This, to me, is the essence of frugality and wealth accumulation. We eat healthier than others (due to cooking our own food and eating lots of fruits, vegetables, legumes, and whole grains) at a fraction of the cost of what it would take to eat out at a restaurant. Libraries are free and expand our minds relative to rotting away watching TV. Etc, etc, etc. It doesn’t take a lot of money to enjoy an incredibly enriching and fulfilling lifestyle.
    • I think the process through which I figured out what areas of the lawn needed to be watered is somewhat symbolic of best practices in frugality. Addicted to your $150/month cell phone plan? Try cancelling it for a couple of months. If you die, then reinstate the plan. If you managed to survive just fine without it, then go ahead and transition to a cheaper plan. Similar strategies could work for TV payments, restaurant behavior, etc.  Life goes on without these expenditures. But only after breaking out of the automation of consumption do we consciously think about our consumption decisions. Again, I’m all for consumption that brings value to your life, but it’s often hard to isolate which of your many expenditures are bringing you happiness until you cut stuff away and see what hurts. If you cut and it doesn’t hurt, it means that it wasn’t bringing you happiness in the first place. When talking about this, I see a lot of similarities to this book (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: http://www.frugalprofessor.com/things-i-like/.
  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. Also, Fidelity mutual funds work better at my Saturna HSA.
  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: https://personal.vanguard.com/us/funds/snapshot?FundId=0306&FundIntExt=INT#tab=2.
  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 0.75%. 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. The only other administrative cost not captured by my expense ratios is a $19/year administrative fee for my HSA at Saturna Capital.

Financial Update Jan 2017

Another month, another update. A few random comments.

  • Thanks to aggressive tax sheltering in 2016, we’re getting a $8k refund in a few weeks. I filed taxes for free using Turbotax’s Freedom edition (turbotax.intuit.com/taxfreedom/), which is available to those with low incomes who qualify for EITC, etc. What’s nice about this edition is that it handles capital gains taxes, etc, which most other free versions don’t handle. Plus it covered two state returns free. Pretty good deal.
  • In 2016 we cashed out 90k of our Roth IRAs to fund our down payment for our home purchase. The principal, of course, is tax-free and penalty free. We were also able to use up to $10k each in interest for the purchase, penalty and tax free (which we didn’t need to do). Roth IRAs are incredibly powerful savings vehicles – especially when your effective marginal tax rate is relatively low today. I’m grateful to have maxed ours out since 2005. We’ll continue to do so indefinitely, but in 2017 and beyond we’ll be forced to do back-door roths.
  • I still need to fund 2016 Roth IRA contributions X 2. The deadline is ~April 15.
  • We had an anomalous $2.5k expenditure this month. Without this our monthly spending would have been around $3,500. Extrapolating a bit, I guess it takes about $50k/year for our family w/ 5 kids to live. One of our biggest expenses is mortgage interest, so once the house is paid off our yearly spend will fall significantly.
  • Financial priorities for 2017 (most important first):
    • 1.) Fully fund tax-deferred accounts (401a, $18k 457, $18k 403b, $6.75k HSA).
    • 2.) Fully fund back-door roths x 2 ($11k total).
    • 3.) Contribute to taxable accounts
    • 3.) Pay off mortgage debt early

I’m a bit torn between whether to pay off mortgage early or contribute to taxable accounts. Mortgage rate is 2.875% but I’m itemizing (and well above standard deduction this year), so the effective interest rate paid will be close to (1-45%)*2.875% = 1.6%. That’s pretty low rate at which to borrow, but I’m debt-averse.

What I’ll probably do is a mix of taxable accounts and mortgage repayments. Having a good chunk in taxable accounts would allow me to tax loss harvest every year and wipe a maximum of $3k/year off my taxable income. Seems like pretty low hanging fruit that everyone should be doing. If you harvest a loss greater than $3k in a given year, you can carry the unused losses forward for future years. For example, if you harvest a loss of $9k in 2017, you can reduce your taxable income by $3k/year for 2017, 2018, and 2019.

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: http://www.frugalprofessor.com/things-i-like/.
  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. Also, Fidelity mutual funds work better at my Saturna HSA.
  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: https://personal.vanguard.com/us/funds/snapshot?FundId=0306&FundIntExt=INT#tab=2.
  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 0.75%. 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. The only other administrative cost not captured by my expense ratios is a $19/year administrative fee for my HSA at Saturna Capital.

Financial Update Dec 2016

Another month, another update. Some random thoughts this month.

The humbling mathematics of retirement savings.

  • The mathematics of retirement are daunting. In order to retire, you can only withdraw 3-4% of your investments annually. This is known as the safe withdrawal rate. 3% is a more conservative number. 4% is less so. Good discussions on the topic are found here and here. In other words, $1 of investments should yield roughly $0.03-$0.04 in interest (through dividends and capital gains) indefinitely.
  • If it costs you $X/year to live, you will require $X/.03 (=33X) or $X/.04 (=25X) to retire.
  • Obviously, you’ll reach retirement much quicker if you can bring $X as close to zero as you can. It’s by far the most important thing you can focus on for your financial well-being.
  • Let’s put some numbers in. $50k is probably viewed by most as a relatively modest retirement budget. At that rate of spending, the above calculations indicate required investment balances of $1.66M and $1.25M, respectively. These are obviously large amounts of money that most people will never accumulate in their lifetimes.
  • If instead we can live on $25k, these required investment balances drop by 50% to $830k and $625k, respectively.
  • To me, this humbling exercise in arithmetic should be at the forefront of everyone’s minds.
  • When I brown bag a lunch instead of going out (which I do daily) and save $10 in the process, why do I do it? It’s to increase my investment balances by $10, which will generate $10*0.03 in interest forever, or 30 cents per year. Every dollar saved will generate 3 pennies in interest in perpetuity.
  • The above is why I save. So my savings can make babies – a few pennies at a time.
  • Retirement is certainly a daunting prospect when one is honest with himself and performs the above calculations.
  • As I’ve already said on the blog, the best thing you can possibly due to increase your net worth is to dramatically lower your recurring expenditures (housing, auto, health, food, entertainment, utilities, etc). This is most important as the gains to savings are amplified with each transaction (monthly food bill, etc).

A few notes on cash flow optimization:

  • You should do everything possible to not receive a large tax refund. The ideal refund is near-zero. Tax refund = stuff you’ve overpaid + free money from gov’t (EITC, etc). If you have low income, don’t withhold any federal taxes throughout the year by claiming exempt on your W4. This will help get you cash in Jan 2017 rather than in April 2018, a difference of 16 months. This cash flow management is especially important if you are in debt, where 16 months of high interest debt can be especially costly. Strive to predict within $100 what your federal tax liability is and change your W-4 withholding today to optimize your cash flow today. The math says having a near $0 refund is optimal. For tax year 2016 I claimed exempt from federal taxes, yet I’ll get a huge tax refund (thanks to large family and deliberate tax planning such as $36k of supplemental retirement contributions).
  • A nice thing I did this past month (which I’d never done before) was to ask my credit card company to shift the due date of my statement so that the bill is due on the 1st of the month. I’m paid at the end of the month, so it’s nice to immediately pay the credit card bill after receiving my income. After this bill is paid, I keep around $4k in the bank to pay for my mortgage (on the last day possible, the 15th) + a tiny emergency fund (around $1k) and immediately put the rest to work by investing it or paying of debt (in my case I only have mortgage debt). Having near zero cash rotting away at low interest is a good policy, particularly if you’re in debt. Historically I’ve banked at Ally which has of the best money market / online savings rates in the country (currently ~1%). I’d recommend Ally to anyone, as I have banked there for 10 years. Currently, however, I use a bank that has partnered with my employer to provide rewards checking yielding 2% for checking. Not a bad rate of return for idle cash in a checking account in today’s interest rate environment.
  • I pay utility bills, etc. with credit cards for a few reasons. 1st: free money with cash back rewards. 2nd: if I incur the expense at the beginning of my billing cycle, the credit card company gives me an interest free loan for 45 days or so. It’s a nice cash flow management tool, but only if you’re paying the credit card off in full every month.
  • I recently called up my mortgage company and asked for them to stop withholding property taxes (which are non-trivial in size) into escrow. I’d tried to do so before but they said no (not sure why, perhaps I didn’t have enough equity yet). Luckily, they obliged this time. Why did I do this? 2017 property taxes aren’t due for me until March and July of 2018. Similar to the federal tax witholdings logic above, why would I give my bank an interest-free loan for up to 19 months (Jan 2017 to July 2018)? I can put my money to better use today, and have the discipline to save enough myself to pay property taxes when they are due. The only time this strategy breaks down is when one lacks the discipline to save on his own. I do the same for home insurance, which I pay annually out of pocket rather than through escrow.

Investment thoughts:

  • I helped a friend this month lower his expense ratio from 0.67% to about 0.06% though the DIY alternative to target retirement funds (especially Fidelity’s which are expensive) that I advocate elsewhere on this blog. Doing so will easily save him a grand a year based on his current investment balances, and hopefully up to ten grand per year once his investments exceed $1M. Doing so took a couple of mouse clicks and will make him tens of thousands of dollars richer over the course of his life. But when I helped him make those mouse clicks, balloons didn’t fall from the ceiling. Nobody jumped out of a cake. They didn’t carry me out of their house on a throne. It was largely anti-climatic, and the full consequences the decision won’t be fully realized until 30-40 years from now. This is precisely how the actively managed mutual fund industry still exists (as well as AUM financial advisers). Small differences in investment performance are imperceptible over the short term and only visible after 10+ years. However, in 30-40 years, this will prove to be one of the wisest financial decisions this friend has ever made.

Comments on this month’s finances:

  • I had a large cash inflow as I cashed out the property tax escrow. This is mostly what accounts for “Other Income” this month. I now show $0 property taxes paid every month, though my “Property Taxes Payable” account (not shown on balance sheet) is growing at a rate of $576/month. So I’m understating my monthly expenditures now to optimize cash flow.
  • IRA and HSA funding deadlines is April 15, 2017 for 2016 contributions. With the extra cash we have on hand, we’ll be fully funding our 2016 IRAs (5,500X2) and 2016 HSA ($6,750) over the next several weeks.
  • Actively managing our taxable income this year will enable us to maximize the EITC this year and receive a ~$9k federal tax return. All moderate income households with (~50k-$75k) per year in income and lots of kids should actively be managing their retirement and HSA contributions to max out the EITC every year. I’ll be filing taxes for free using Turbotax’s Freedom Edition (turbotax.intuit.com/taxfreedom/) which is usually available at the end of January. I’ll have the federal tax return money in hand in mid-February.

 

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: http://www.frugalprofessor.com/things-i-like/.
  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. Also, Fidelity mutual funds work better at my Saturna HSA.
  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: https://personal.vanguard.com/us/funds/snapshot?FundId=0306&FundIntExt=INT#tab=2.
  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 0.75%. 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. The only other administrative cost not captured by my expense ratios is a $19/year administrative fee for my HSA at Saturna Capital.