CASE STUDY: Soon to receive tax-free 137% what I made last year

[misstache]

Hi, all 'Stachians!

Because of a car accident I was in a couple years ago, I will soon be receiving more money than I make in a year. To some of you, what I make in a year would not be that big a windfall, as I live fiscally well below poverty line, but otherwise I live a very rich life (lots of friends, lots of organic food in my garden, lots of time to do lots of interesting projects... living on a dreamy island in the semi-wilds of remote British Columbia, and with enough money for my basic needs met).

To be specific, what I expect to receive is around $12,500 in USD, but I live in Canada. The dollar rate right now is 1 USD to 1.1 CAD.

Other than that, my current financial situation is as follows:

Expenses per Month
My rent is CAD$260/month. I have no utility bills save my phone bill, maybe CAD$50/month. I spend anywhere from CAD$200-400/month on groceries, which I could for sure whittle down. The island I live on basically has nothing around for me to spend money on, except groceries and rent.

Total CAD $600 - 800/Month

In the 2013 tax year I earned just over $9000 CAD.

Current CAD checking account balance     $450

Debt

Owe on consolidated USD student loan @ 6.5%     $17,880 (currently accruing interest and principal being paid by US government)

Owe on defaulted USD credit card @ 0%       ~$5,000, but they will mark it on my credit score as paid in full for about ~$2,200 if payment in full

Owe to family member in USD @ 0%        $4,935

Total Debt USD $25,015 - 27,850

Have LendingClub account w/ USD $30 total value, and less than that in my savings account.

I have no emergency fund.

Two years ago I started taking responsibility as best I knew how for examining my money beliefs and taking my financial situation more seriously and responsibly. I've been using YNAB religiously since then, tracking my expenses, usually using a budget, and reading more about money. I am in the process of starting my own business so I don't have to rely nearly as much on the rather weak and seasonal local economy here, while still enjoying what I love about living here. I also have started freelancing @$25/hour, so that helps when I have any of that work coming in.

This is a serious amount of money for me, and I'd like to use it as a jumpstart to really turn-around my financial situation and habits. I'm really grateful that it is coming into my life, and I want to honor the opportunity it represents. I have some thoughts about how to use it, but would love to hear your thoughts and feedback.

My thoughts on it right now are:

• Pay off the credit card entirely at their reduced rate, so I can start building my credit again
• Make a $200-500 contribution to a local charity I care about, and as a way to energetically honor the money coming in Suze-Orman and Personal-Integrity style
• Pay my family member $1000 to show goodwill and that I continue take the loan seriously
• Buy two inexpensive but currently out-of-reach items... rainboots that I need for the winter, as mine currently have holes, and a used iphone that I will soon need for my business (these would be the yay-I-got-money celebration items)
• Set up an emergency fund and/or set aside $800 to use as a "buffer" in the YNAB system, so I'm using my current income next month instead of now
• Invest the rest, with the plan of switching each month between reinvesting whatever I earn in interest and pulling out what I earn in interest to continue paying off debt

What do you think? Thanks for any feedback!!!

[misstache]

Oh, and if it helps, I'm 32, so I still have time to aim for earl(ier) retirement, if I can turn my situation around now. :)

[Hotstreak]

If I were you, I would pay the Credit Card, pay the family loan in full, buy yourself some gently used boots and an I-phone, put 1,000 cash aside for emergencies, and invest the remaining 4,000.  More details about your loan repayment program (student loan) might change things a bit.

I would also take a good look at income sources, and try to make more money.  That's what's holding you back.

[misstache]

Hi, RobbyJ -

Thanks for the reply and your input. Yeah, the income piece is definitely what is missing. Where I live is where I want to live, but there are almost no 40-hour-week year-round jobs, and the few there are, are already taken. The plus side is that my part-time work leaves me just enough income that I can rely on, while having a lot of free time to devote to starting my business. Another major plus is that I have no temptation to spend, as there is nothing much to spend it on here.

I will go work on my next-business-steps right now, as I have a meeting with my business mentor in the morning, and have some tasks to finish before then.

Thanks again!

[Chrissy]

I think this is about right except that you qualify FOR charity, so don't give anything TO charity.  I admire the sentiment, but your first responsibility to ensure that no one else has to take care of you.  You can make it up to charity down the road when you're earning more money.

Also, an emergency fund is usually 3-6 months of expenses.  Here's what I suggest:

$4,935 to family
$2,200 to credit card
$1,000 personal items
$2,190 US/$2,400 CAD emergency fund (3 months of expenses)

This leaves $2,175 USD to invest.  If you ever intend to return/retire in the U.S., then I suggest you put that money in a ROTH.  Otherwise, look for a Canadian retirement account that would suit you.

[Retired To Win]

We don't know what your intended business idea might be, but in the context of your semi-remote living context to me the obvious income-making solution would be an internet-based business.  Become a web developer, or virtual blog assistant, or something else that will make your isolation irrelevant as far as income generating is concerned.

So, what is your new business idea?

[DocHolliday]

I have to agree with the other posters on the board.

First, pay off the credit card immediately.  If you can pay it off for less than you actually owe on it, so be it.

Second--Please note that everyone who has responded has said that you should pay your family member's loan back in the entirety.  In this case (coming into an adequate sum of money) paying the loan back in full is showing true good will.  Please remember to properly thank them for helping you when you needed it.  Paying the loan back in full without prompting will show that you honor your agreements and that family member will remember this and will likely be willing to help you again in the future if needed.

Third--Buy your shoes and work equipment as needed.  Try to not blow your budget and stay frugal.

Fourth--I don't understand your 6.5% loan which you stated "(currently accruing interest and principal being paid by US government)".  Is the interest being paid by the US government?  Are loan payments due yet and if not, when?  You need to have a plan to work on paying this off in an active way as the interest can eat you alive if you don't stay on top of it.

Fifth--Shout out to Chrissy on not making the charity contribution.  She is completely correct, your first priority is making sure no one has to take care of you.  If it helps, imaging Suze O. sitting in a room listening to you talk about giving to charity when you are just barely staying afloat yourself--I'm visualizing it and she is shouting "GIRLFRIEND........".  Perhaps a donation of your time (which is not being overutilized by a full time job) would be a more valuable and reasonable thing for you to donate.

Finally, my feeling is (with possible loan obligations, etc) that perhaps keeping your funds liquid (and not locked up in retirement funds or hard-to-access investment vehicles) might be a better fit for your current financial situation.  The only thing that you will have to watch out for here, though, is that you don't dip into these funds and begin to work on increasing them instead.  One way you can do that would be to open both free checking and savings accounts and try to add to the savings as much as possible.  Now, this would give up the possibility of a return on your money but really, we are talking about fairly small amounts here ($200 per year assuming an 8% return on 2500 invested).  Given how close you currently are to the bone, I feel that sacrificing this potential gain is worth the added flexibility you will have.

Good luck and I hope that the proposed business starts to take off.

[SunshineGirl]

I agree that in your case, you should not "invest" money, but rather "save" it in a liquid account that is not subject to the ups and downs of the market.

I also agree that you should pay your family member in full.

[RichMoose]

I think this is about right except that you qualify FOR charity, so don't give anything TO charity.  I admire the sentiment, but your first responsibility to ensure that no one else has to take care of you.  You can make it up to charity down the road when you're earning more money.

Also, an emergency fund is usually 3-6 months of expenses.  Here's what I suggest:

$4,935 to family
$2,200 to credit card
$1,000 personal items
$2,190 US/$2,400 CAD emergency fund (3 months of expenses)

This leaves $2,175 USD to invest.  If you ever intend to return/retire in the U.S., then I suggest you put that money in a ROTH.  Otherwise, look for a Canadian retirement account that would suit you.

This is bang on advice. If you are planning to stay in Canada, open a self-directed TFSA account with Questrade. Put your Emergency Fund & Investment amount (about $4500 if my math is right) in the TFSA and purchase a low-cost ETF such as ZCN.TO, the BMO TSX Capped Composite Index. If you ever need to withdraw from a TFSA, you can do that without penalty. At your current income levels you should not open an RRSP.

[SwordGuy]

$4935 of that money belong to your family.  Pay them back in full.  If they want to make a charitable contribution with the money that you pay them back with, that's their business.

You have no business giving away your family's money to charity.

[Catbert]

Another vote for paying off the family member in full. 

I disagree with others regarding charitable contribution.  I think it's great that you want to donate from what for you is a large lump sum. 

I don't really understand your SL situation.  Is interest accruing to you or not?  Unless the loan is going to magically disappear you'll need to deal with it at some point.  (Not that I think this windfall is necessarily the time, but sometime.) 

[misstache]

Hi, all -

Thanks for all the great advice. I really appreciate what you said, Chrissy and DocHolliday about my first responsibility being to not be dependant on anyone else financially. I do already volunteer my time in various ways around the community, and serve on two boards. There are three small contributions I've been meaning to make that total less than $50, so I will make those.

Thanks everyone for asking me about the student loan info. I just called the bank the loan is under, and asked them more about it so I would understand it better and could report back here better. I said it rather incorrectly and vaguely in my original post. By asking, it gave me more info to make a better decision, I think. Part of what I say below I understood, but some of the figures I didn't, and it will make a big difference! So thank you all for urging me to be more clear.

So, it is currently in repayment under an income-based repayment plan. I pay what it is deemed I can afford based on my last-year's tax info, and the US government makes up the difference. No principal currently gets paid off by the government. It is deemed I can afford $0 for now, so my payment is $0, the government pays part of the interest due each month, but interest continues to accumulate as it doesn't pay the interest in full. As long as I am still in the income-based repayment plan (IBR), the accrued interest does not get added to my principal. If I were in the IBR plan for a total of 25 years (I've been in it 1.5 years), the entire debt would be cancelled. I do not plan to be in that situation, and would plan to pay it off in full much sooner than that!

Right now, the principal is just over $17,000 and the accrued interest is just over $800. If I got out of the IBR plan tomorrow, it would add the $800 to my principal. Right now, it basically is adding $1.77 per day to my interest, that the government is not paying off. ($54 a month or $648 a year)

So it probably would make sense to pay off the $800 interest now, with the new money coming in soon, so I'm back down to just the principal. From there, I could really aim to always pay at least $60 per month, so I am paying off the interest in full (along with the government's help for now), plus paying $4 measly dollars off the principal each month.

With all of that all in mind, my new set of goals for what to do with the money coming:

$12,500 total

• Pay off SL interest   –   $800
• Spend on three small charity donations I've wanted to do for awhile   –   $50
• Pay off my family member in full   –   $4935
• Pay off credit card "in full" at their reduced offer. They will accept what they'd offered in their last letter, which was actually   –   $1715
• Set aside $1200 for an emergency fund. I feel this is well more than sufficient, as I live in the kind of community that really looks out for its own. This level of emergency fund is still basically 5x my month's rent, and I know when I first got to this island, I only had about $800 and lasted fine for 2 months on that without any more income. So I think $1200 is reasonable to start with, and I will plan on adding to it as I increase my income. This could go in the TFSA I already have open with my current credit union. TuxedoEagle, any reason to go with Questrade rather than the TFSA I already have?  –   $1200
• Do not buy rainboots, but instead patch the ones i have with some sugru stuff my mom gave me   –   $0
• Wait on the iPhone until I actually "need" it for my business, which isn't until February, or even later   –   $0
• Have the yay-I-got-money celebration be being as responsible and aware as I can about how I spend and save the money   –   Priceless

That would leave me $3800 to invest/save. My inclination with this right now is to put in my LendingClub account, and be very specific about which loans I'd fund, with a range of risk. It's not so big an amount that I feel it's essential to diversify it broadly, especially as it is "free money," and I feel that is safer for me than putting it in an easily accessible liquid account, where I've traditionally so far only been able to save $200-300 dollars at a time, for two months ish at the most, before I transfer it back to my checking account to pay bills with. If it is somewhat out of reach, I will find another way to pay the bills (take on more side work, hustle, etc.) while it still accumulates some interest. Then, whatever interest it does add, I can alternate reinvesting or cashing out to pay off principal on my student loan, or help pay interest if I'm having a hard time paying the $60/month interest.

As to remote living on this island, yes, my new business is internet and phone based, so the remoteness will not be a major factor. I will also be able to travel with the business if I ever decide to move, or am visiting family elsewhere. The business itself I'm not quite ready to talk about on here, but my set date to launch it is January 28th, 2015, and I'm working at it steadily, working with beta testers, and making good progress. A psychologist/successful serial entrepreneur (she started a company you've heard of) I know professionally is mentoring me, and she is very optimistic, as are my beta testers. So I feel I am in good hands and being guided well, and need to keep going at it.

And yeah, I will tell you all about my business when I'm ready to launch! :)

Thanks again for all your wonderful feedback! Reading it has helped me clarify my thoughts and find out more about my own situation. Very empowering!

[BigRed]

If you are going to have your money invested in only one thing, I don't think Lending Club is a very good choice.  That's a high risk allocation for money you really aren't likely to replace quickly.  If the important thing is to prevent easy access, there are lots of other options for savings accounts that are harder to access or mutual funds or ETFs that have a lot less risk than Lending Club.

Can you explain why you have chosen Lending Club for all of your excess funds.  I haven't seen anyone on these boards use Lending Club as their primary investment, only as an extra.

[RichMoose]

• Set aside $1200 for an emergency fund. I feel this is well more than sufficient, as I live in the kind of community that really looks out for its own. This level of emergency fund is still basically 5x my month's rent, and I know when I first got to this island, I only had about $800 and lasted fine for 2 months on that without any more income. So I think $1200 is reasonable to start with, and I will plan on adding to it as I increase my income. This could go in the TFSA I already have open with my current credit union. TuxedoEagle, any reason to go with Questrade rather than the TFSA I already have?  –   $1200

I guess this would depend on how it's invested with your credit union. If it's in one of their 1.5 - 2% "savings accounts" I would say get it out ASAP because you're barely earning enough to cover the cost of inflation. If it's with Credential Direct (the discount brokerage most C.U. use), I would still advise you to remove it because Credential Direct is easily one of the worst brokerages in Canada. If it's with Qtrade (the discount brokerage some C.U. use) then stick with them. Use the money to purchase low-cost index ETF's. With the amount you have saved, I wouldn't worry too much about diversification, you're young enough to have a long investing period. So pick one ETF and stick with it. My gut says go with ZCN.to or XIC.to. They both track a diversified Canadian index for a ridiculous low cost.

Also, Lending Club is probably not the best choice for someone in your situation for many reasons (risk, taxable gains, liquidity, etc.). I would say put all your investment into TFSA if you have the room.

[misstache]

Thanks for your input, BigRed and TuxedoEagle.

My inclination towards LendingClub has been based on:

• Noticing that my ridiculously small amount of $25 invested with them since I opened my account in May 2013 has earned 20.41%, so even after their fees, there is $5.12 in interest which is more than I've ever earned in any other kind of account in interest, ever. I've looked at their graphs about how to expect the percentage to go down after awhile, especially as you have more invested there, and still the percentage rates seem really good on average.

• My limited understanding of when to invest in risky investments (like LendingClub) is that it should happen when I am young. I'm still relatively young, so now seemed like a good time. If I can be earning a very high to highish percentage rate, and then partially reinvesting back into LendingClub, partly into less-risky options, and partly using the interest earned to pay off debt, it seems like a pretty decent scenario.

• I really like and feel comfortable with being able to very carefully choose who I want to loan the money to, with LendingClub, and what level of risk I feel good about, and look at the borrower's credit score and past history of payments, and make a reasonably educated decision on how well I think that particular note would do. In the case of the $25 I invested there two Mays ago, I chose a D-rated investment (so about as middle risk as I could get), with a woman who had a good history of payments but a poor credit rating. I felt good about what she wanted to use the money towards, etc. I don't have that same level of comfort or understanding with a diversified index, nor do I feel good about investing in companies that I know nothing about, which a diversified index would be doing (unless I researched a ton of companies, and then there would probably be a lot of them that I didn't agree with their practices, products, or motivations in the marketplace).

• As to taxable gains, I assume that means that whatever I earn in interest from LendingClub in USD (which is what my account is in), I would at some point need to pay taxes on it. I think for where I am at currently, that point is still a ways away. I am currently not required to pay any US or Canadian tax, as my income is far too low. I usually get money back from Canada at tax time, even though I haven't been paying anything throughout the year. So, I think for now with this relatively-small (but large for me) sum that I could invest in anything I want, I probably won't have to pay taxes on it anytime soon, as my total income will still be low until I get the make-more-income piece figured. So until then, I don't think it would matter if I have taxable gains, and after that point of starting to get the more-income piece dealt with, I could look into reconfiguring where I had investments in what.

• As for the liquidity, I think it is better if I can't touch it for awhile, which LendingClub and plenty other investments would offer.

I'd love your thoughts, and know very little about all of this, so welcome any continued input. It's helping me greatly!

[Chrissy]

You live a very unconventional life, so the place for being conservative and taking the conventional path is with the money that shores up that life.  It's great that you've had one tiny loan work out well with Lending Club, but that doesn't mean every loan will turn a profit.  Diversify by investing in an index fund in a Traditional IRA.  The money will be out of reach.

Don't go with Lending Club just because that's what you know.  You say you're interested in being responsible, well, responsibility means continuing to educate yourself; there's a whole world of investing out there.  Start with this:  http://jlcollinsnh.com/2012/05/12/stocks-part-vi-portfolio-ideas-to-build-and-keep-your-wealth/

Then, read 'em all:  http://jlcollinsnh.com/stock-series/

Feel free to loan money through Lending Club once your business is off the ground and paying you.  In my opinion, THIS windfall should be invested conventionally and for the long term.

[Catbert]

P2P lending is pretty much the same as buying a junk bond.  Crappy credit is why someone needs to borrow money at 20% interest.  When it works out its great to get 20% interest.  But people get crappy credit because they didn't pay their bills in the past.  The likelihood that the borrower won't pay consistently is pretty great. You're become the CC company which give YOU a credit card...think how well that worked out for them.

[misstache]

Hi, Chrissy and mary w -

Thanks for your good advice and, Chrissy, thanks for the links. I will read them, as I'm sure a large part of the inclination towards LendingClub is simply familiarity and understanding, whereas I don't know anything about traditional IRAs.

I'll read the links and do more research to get a better feel for all of my options.

Thanks again!