Author Topic: New, looking for some opinions  (Read 4541 times)

tamahime

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New, looking for some opinions
« on: June 14, 2012, 01:37:30 PM »
Hi all,

Recently found this site, from a link about long-range wifi of all things, and after curiously reading the first post just started poring through all the articles. Really intriguing stuff, especially since it's so practical and not the kind of "I got rich flipping properties and so can you!" hokum you see so often. I intend to keep reading post by post, but in the meantime there were a couple of things I specifically wondered about.

By way of background, I guess, I'll say that we're probably right in the sweet spot of the target audience here. My wife and I together make about $140k per year, in an expensive city. We're in our early 30's, no kids but want to start a family soon. We're still stuck in the renting treadmill, perpetually unable to get together a down payment. When we met 7 years ago, my wife (who's always been very spendy) had $26k in credit card debt. By adopting a (what we thought then) extremely Spartan lifestyle, making about $75k per year we paid this off in a little over a year.

After that the reins (which nearly caused the end of our relationship many times - spending continues to be our big sticking point to this day) were loosened. And while we've weathered job losses, moves, surgeries, and other events that have contributed to eroding our attempts at savings, we've avoided debt as well. We've been stuck in a limbo, always spending as much as we make.

Currently, we have no debt outside of the $27k I have been dragging around in student loans forever (at 3%). We have a couple thousand in savings. I contribute 5% to my 401k, to get my full company contribution of 7%. My wife doesn't have retirement benefits. So, my questions are:


1. What are the general thoughts around student loan debt? Couldn't find any specific articles on that here. Is it something to be paid off ASAP, or something to just let ride and pay according to the full schedule?

2. Where would buying a house rank in terms of priorities (vs. paying off student loans, increasing my 401k contribution, contributing to an IRA or index fund for my wife)

3. Any general advice other than "read the site, stupid?" I will be doing that for sure! I know we will never be able to make all of the sacrifices necessary to be a world-burning saver and early retiree like Mr. Money Mustache, but I am confident that we have plenty of room for improvement.


Thanks for your thoughts!
« Last Edit: June 14, 2012, 01:44:07 PM by tamahime »

grantmeaname

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Re: New, looking for some opinions
« Reply #1 on: June 14, 2012, 02:58:09 PM »
1. To calculate your effective interest rate on student loans, see if the loan is deductible. If so, it depends on if you're taking the standard deduction or not. If the loan isn't deductible or you take the standard deduction, it's just the printed rate. Otherwise, it's the stated interest rate times (1-t), where t is your marginal tax rate. So if you pay deductible loans at 7% and you're in the 25% bracket, you're really paying 5.25% interest on it, with the rest being chipped in by Uncle Sam.
Now, paying off your loans is like investing for a guaranteed return of your effective interest rate. If your loans are costing you 9%, paying them off is terrific. If they're costing you 2%, they're the cheapest money you will ever borrow and it's better to keep them around. The 5-7% range is more iffy: you could make that by investing the difference, or you could prefer to pay it all off and guarantee the return. Of course, that's just the mathematical angle. If you're psychologically debt-averse, it may be better to pay them off even if you could do a little better in the market.

2. The priority of buying a house is really more about your life than your money. If you're not totally sure when you want to start, you could open a Roth IRA and contribute the max for you and your wife each year. It's nice to have money in the Roth IRA invested, but if you change your mind you can use any money in the Roth for a first downpayment, penalty free. In general, you want to be contributing very heavily to your 401k and Roth IRA (but, it's great that you're already contributing 5% and getting 7%, as that's much better than the national average), but many people are eager to buy a house and are willing to slow down retirement contributions in order to get a downpayment. There are several good buy vs rent calculators, maps, and discussions that can help you track the money side of your considerations, though.

3. Other important bits of advice: I would read the MMM articles about convincing your SO to sign on to your lifestyle (Having "the talk" and the hilariously named How much is that bitch costin' ya?). As MMM and Your Money and Your Life emphasize, it's not really about the money, it's deeper. What is it that your wife actually has a problem with? Feeling deprived? Feeling controlled? Feeling respected for spending money? If you two can get to the point where you can have that discussion, you've got a much better chance of negotiating something you're both happy with. If she doesn't go for that, there are lots of ways you can be smarter about your consumption that will make doing the same old things the same old ways cheaper -- from grocery shopping to internet, cable, and phones. Even if you can't downgrade your lifestyle and you want to continually live in luxury, you can do so on the cheap!

gooki

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Re: New, looking for some opinions
« Reply #2 on: June 14, 2012, 03:22:31 PM »
grantmeaname's advice is spot on.

In you situation to get ahead, you're going to have to make a plan. And not just a financial plan of reducing expenses, and building capital, but a life goal plan. When do you want to reach financial independence, how do you want to raise your potential children (one parent stay at home, two parents etc), how much is home ownership a priority - and does it make financial sense (crunch the numbers) etc.

Getting ahead will take some sacrifice, but now's the time to do it. Starting a family is a great driver for getting ones finances in control.

PS good to see you're doing the 401k contributions, and getting maximum match.

skyrefuge

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Re: New, looking for some opinions
« Reply #3 on: June 14, 2012, 09:32:06 PM »
In general, you want to be contributing very heavily to your 401k and Roth IRA

This only has a little to do with the OP, so sorry, but I'm going to go on a bit of a tangent here;  tamahime, unless you're really interested you can stop reading now, and just go re-read grantmeaname's excellent post.  :-)

Anyway, I feel like I've seen "Roth IRA Roth IRA!" mentioned around here a bit too robotically lately.   For most Mustachians, a Traditional (deductible) IRA probably makes more sense than a Roth IRA, because the Mustachian paradigm has the income-earner in a lower tax bracket in retirement than they were during their working career, and the Traditional IRA allows you to pay those lower tax rates later rather than the higher tax rates you'd pay now with a Roth.

There IS a good reason that the Traditional IRA is rarely mentioned here, and why we "settle" for a Roth IRA: you aren't allowed to contribute to a Traditional IRA if you're covered by a 401(k) at work (and have sufficiently high income).  But that doesn't apply to everyone, including the wife in this case, so I kind of like to point out these "lucky" cases where someone is able to contribute to a Traditional IRA and avoid paying taxes now.

Of course it still only makes sense if the OP expects their income to be lower in retirement than it is now, and if he's already maxing out his 401(k), and if the other advantages of a Roth IRA (withdrawable contributions) aren't a big selling factor.  So probably not too applicable in this case, but who knows, maybe the idea of the wife contributing to her own "Individual" Retirement Account would be a helpful psychological boost or something like that.

arebelspy

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Re: New, looking for some opinions
« Reply #4 on: June 14, 2012, 10:00:59 PM »
I like the Roth because I don't know future tax rates.

Yes, maybe my tax rates will be lower in the future.  Maybe they won't.  Maybe I'll make less money in retirement.  (Probably?  Though a lot of my income is sheltered right now due to depreciation that I won't have then.)  But tax rates could well go up.

The Roth limit is so tiny anyways (5k) compared to the amount that a Mustachian will save, that it makes sense to me to contribute to it to diversify a little, tax-wise.

If you have 17k to invest, 12k in 401k and 5k in Roth doesn't seem like a bad plan to me, even if you think the full 17k in the 401 is slightly more optimal mathematically.
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grantmeaname

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Re: New, looking for some opinions
« Reply #5 on: June 15, 2012, 06:42:19 AM »
The traditional IRA is almost certainly going to be better for tax purposes. However, that is only a little portion of the issue.
  • The Roth IRA allows withdrawal of principal penalty free at any time, which is superb for early retirement, and you can withdraw earnings for many qualifying events as well (home downpayment, high medical expenses, going back to college). To use your 401k money when young you nearly have to put it in a Roth IRA, because 72t distributions are tiny, and it would be stupid to need to convert both traditional IRA money and traditional 401k money into your Roth.
  • It provides tax diversification if you're contributing to a traditional (i.e., non-Roth) 401k, such that part of your savings will be advantaged if tax rates rise, and the other part if they fall.
  • It allows you to contribute more than a traditional IRA, because $5k after tax is more than $5k before tax.
  • If you're planning on leaving money to your descendants or being survived by your spouse, the Roth IRA is also superior there, because it is a tax-free vehicle and there are no forced distributions starting at age 70.5.
My recommendation is not just a knee-jerk reaction because I can't do math (although that seems to be common in the broader personal finance community). The advantages of the Roth IRA for early retirement seem to be well worth the costs, especially since the OP is thinking about a house down payment in the near future.

Edit:
There IS a good reason that the Traditional IRA is rarely mentioned here, and why we "settle" for a Roth IRA: you aren't allowed to contribute to a Traditional IRA if you're covered by a 401(k) at work (and have sufficiently high income). But that doesn't apply to everyone, including the wife in this case, so I kind of like to point out these "lucky" cases where someone is able to contribute to a Traditional IRA and avoid paying taxes now.
Interesting, I hadn't thought about the specific case of a married couple with only one partner covered by a 401k. The income limits are way, way higher!
« Last Edit: June 15, 2012, 07:28:23 AM by grantmeaname »

James

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Re: New, looking for some opinions
« Reply #6 on: June 15, 2012, 07:52:30 AM »
1. What are the general thoughts around student loan debt? Couldn't find any specific articles on that here. Is it something to be paid off ASAP, or something to just let ride and pay according to the full schedule?

2. Where would buying a house rank in terms of priorities (vs. paying off student loans, increasing my 401k contribution, contributing to an IRA or index fund for my wife)

3. Any general advice other than "read the site, stupid?" I will be doing that for sure! I know we will never be able to make all of the sacrifices necessary to be a world-burning saver and early retiree like Mr. Money Mustache, but I am confident that we have plenty of room for improvement.

Welcome!  Glad you are asking questions, that is where things really start.  Of course, asking questions is always easier than the follow up actions, but get excited because you can really make a huge difference with changes you make today despite missing out on the benefits of starting early.  Lots of us around here didn't start mustachian, most of us have made all the same mistakes you have to various degrees.  Nor do we all have spouses who started on the same page or are even on the same page now.

First the general advice.  Instead of spending based on your income, create a lifestyle at a lower price point that you can live at and be comfortable.  That is your new budget, regardless of your income.  Everything above that goes to saving, investment, loans, etc.  As inflation works its magic it applies a downward pressure on your consumption rather than a reason to increase spending, and the exciting realization is that it doesn't mean less enjoyment of life.  If you can keep your budget locked at a nominal number (or even dropping) over the years your spending in inflation adjusted dollars drops naturally while your income increases.  Make inflation work for you instead of against you.  And yes, reading sites like MMM will help maintain your spine and keep you on the narrow path, it's hard to fight the constant pressures of consumerism without help and company.

Regarding priorities, you will get mixed opinions on your questions.  There are two aspects to these decisions, objective and subjective.  Objectively your student loan interest rate is low enough that you should be able to beat that with market investments.  Subjectively you may choose to pay off the student loan because it works better for you.  For example, it could be a big goal that is worth skipping nights out, vacations, etc.  You can put a goal on the wall for each month and celebrate your successes.  And for many people paying of their debt is worth more "pain" than investing, so it becomes a psychological advantage that makes paying off debt a better than investing.  Only you can weigh these issues.

Regarding buying a house, there are some objective issues at play also.  Your particular location affect the decision.  For some locations the finances for renting versus purchasing a house leans dramatically one way or the other.  If there is a big financial advantage then it might be a reason to delay certain investments and loan repayments to expedite a house purchase.  But in general I wouldn't advocate the house purchase as a first priority. 

I would focus at this point in the lifestyle change.  Decide what you choose to live on, whether that is $35, 55, 75 thousand or whatever.  Once you have made those changes and have settled into them, you will start to build up some savings.  Then you can direct the flow of those savings into your priorities.  Saving for a down payment might very well be one of those, but I don't think you need to decide that up front at this point.  Get a good growth on your mustache first then tackle those decisions.

tamahime

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Re: New, looking for some opinions
« Reply #7 on: June 15, 2012, 11:30:28 AM »
Thanks, guys, for the great responses!

My loan is deductible, and it's an adjustment to income that you can take regardless of whether you itemize deductions (we don't, not having a mortgage and all.) It gets phased out depending on your income, though, so I might not get much of a credit this year, if any. So that puts the loan at its true rate I guess (3.875%, I looked it up).

Roth IRA may be a good idea. Also, we each have a small (~$3000) rollover IRA from previous jobs. Any thoughts on whether to just leave them alone or to try to combine them? Doesn't seem ideal to have 4 different retirement accounts active...

We're not great at "crunching the numbers," as you say. The many available calculators rely on you being able to estimate so many variables we couldn't begin to guess, that we end up throwing up our hands.

For the Mrs. - we have had many, many talks about financial goals and issues over the years. She wants to save for the future, and is on board with having goals in general. However, she's a very instant-gratification, spontaneous kind of person, so her immediate desires easily overwhelm a less tangible idea like "we can retire in 10 years if you don't go to the spa/buy this coffee/take that trip." What you said about feeling deprived or controlled rings true as well. For her, it's all internal - she values creature comforts, things that make her feel beautiful, indulgences. She doesn't go crazy, by modern American standards, but is certainly the driver for our spending (I'm still wearing clothes I had in college!)

So having the conversation isn't a problem, but reaching an agreement tends to be. She is more comfortable with very modest goals like "We need to get $10,000 in ING."

I like James' suggestion about picking a level to live on - we kind of started that by saying one of my paychecks each month will go straight to savings. That's where my initial question came in - do I pay off that student loan, try to buy a house, or start pumping investment vehicles? Sounds like there's not one right answer to that question. (At least from reading other posts it looks like my previous assumption that we needed to build up a sizeable "emergency fund" isn't necessary).

It's funny, I don't feel like we live in luxury. We rent a pretty nice apartment in a sketchier part of town, so it's reasonable for the city. We drive a 10 year old car that we own, take 1 vacation a year, eat out a couple times a month. We shop at Target and Costco, and only buy a couple of things for Christmas and birthdays. We don't throw big parties or go out drinking. But somehow it's always one thing or another (new tires here, medical bill there, etc.) Definitely want to get off this wheel!

James

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Re: New, looking for some opinions
« Reply #8 on: June 15, 2012, 11:55:13 AM »
I would suggest putting that money you save where you can't touch it in the weak moments.  Maybe make a challenge of paying off the student loan in some difficult but attainable time period.  The other big key is to automate your cash flow.  What worked for my wife and I was to create an ING checking account where all income is deposited.  We then have an automatic transfer to the checking account we actually use (you could set that weekly, biweekly, monthly, whatever)  We don't have checks from the ING account, but being a checking account means we can transfer money from that account more frequently than a savings account.  Then we simply live off of the transfer to our local checking account, for you this would be everything but the one paycheck to start with.  From that ING account you start an automatic deposit to your student loan, Roth, or whatever else you decide on based on your priorities.  But you make a firm commitment to not touch that money for anything else, and have a separate "emergency account" if needed to make sure you are not tempted by circumstances.

I also suggest small automatic funds for each of you for the individual spending choices.  That way you both can decide your own priorities for splurges without going to the main account.

The benefits of automation are huge, it's amazing how much less we spent back when we started it.  Our individual spending for personal things dropped off quickly when we realized not spending meant we had thing nice chunk of cash to spend as we see fit later.  And we finally started following through with our plans to spend less since we never "saw" the money that stayed at ING.  We also created separate account for known expenses like clothing, auto repair, etc.  That way those accounts build up over time and you don't see that money sitting in your main account wanting to be spent.

A few years later we are in less need of that "forced" savings.  We have new habits and in general we make better choices without the need for those tricks.  But don't underestimate the power of tricking yourself in order to create a new way of thinking and new habits.

I can totally sympathize with your final paragraph, that was exactly where we were three years ago.  Getting off that wheel is an excellent feeling.
« Last Edit: June 15, 2012, 11:58:54 AM by James »

MrChanticleer

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Re: New, looking for some opinions
« Reply #9 on: June 15, 2012, 01:28:08 PM »
...We also created separate account for known expenses like clothing, auto repair, etc.  That way those accounts build up over time and you don't see that money sitting in your main account wanting to be spent.

This sounds like a great plan. I have been hesitant to do this sort of thing because I have been worried about overcomplicating things. How easy is it to manage all those accounts, and how many do you have open at one time (if you don't mind me asking)?

gooki

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Re: New, looking for some opinions
« Reply #10 on: June 15, 2012, 05:00:20 PM »
It's funny, I don't feel like we live in luxury. We rent a pretty nice apartment in a sketchier part of town, so it's reasonable for the city. We drive a 10 year old car that we own, take 1 vacation a year, eat out a couple times a month. We shop at Target and Costco, and only buy a couple of things for Christmas and birthdays. We don't throw big parties or go out drinking. But somehow it's always one thing or another (new tires here, medical bill there, etc.) Definitely want to get off this wheel!

Sounds like a pretty normal middle class lifestyle. Which is why it's surprising to see you are struggling to save given the income levels.

My wife and I managed out finances similar to James. One joint account which all income went into. Then two separate checking accounts (one each) for our personal spending. Each week a set amount gets transferred into the personal checking accounts, and we're free to do as we please with this money, but we don't dip into the savings account for personal expenses, only joint expenses, and only with agreement.  The weekly amount has varied over time, as our priorities and income level has changed.

It sounds like your both debt adverse for general spending, so buying a house on a 15 year term may well be the catalyst you need to lock more money away.

James

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Re: New, looking for some opinions
« Reply #11 on: June 17, 2012, 03:04:23 PM »
...We also created separate account for known expenses like clothing, auto repair, etc.  That way those accounts build up over time and you don't see that money sitting in your main account wanting to be spent.

This sounds like a great plan. I have been hesitant to do this sort of thing because I have been worried about overcomplicating things. How easy is it to manage all those accounts, and how many do you have open at one time (if you don't mind me asking)?


We started by making accounts at ING for all the main things, like auto, home repair/improvement, emergency, each of our accounts, vacation, etc.  My wife also used Quicken so she kept track of one of the ING accounts in Quicken which was further broken down into groceries, household, clothing, etc.  Start by just making a master list on scrap paper of all the possible accounts you might need to spend from, and possible numbers.  Then over a week or two adjust numbers and determine what you want to dump into each account each month.  Then set up the checking account at ING with the direct deposits and then set that same account up with all the transfers to the various other accounts.  It can get complicated, and there aren't any set rules for this sort of thing, just make a system that works for you. (we use a google spreadsheet now to keep track of some of the accounts, which works better for us than quicken)  Obviously since you don't have a firm grasp on where all your money is going right now you will have to change some things as you go along.  But the key is that it is a hassle and you start having to think about money.  Making it a hassle to spend money is a feature not a bug!  Just the very act of checking the accounts and watching the system influences your spending, even if there is plenty of money in the accounts.  You are forced to keep track of your spending so you can move the right amount of money into your checking account from the other accounts, so there is a feedback system to give you a gut check when reviewing your spending.  If you spend $120 on clothing and then later you go to move that money over from the clothing account, you get to thinking "Wow, we really didn't get that much for spending $120, how could we do that differently".  Which is much better than spending the money and never thinking back over the purchase, it just flows from paycheck to checking to credit card payment without actually realizing what is being spent.


Anyway, if you have specific questions I can talk more, but just because we did it a certain way doesn't mean it will work great for you.  Our system has changed along the way, as we get more and more mustachian we find the need for budgets decreasing.  We have built better habits and a better lifestyle that doesn't depend on outside forces to control spending.  But just starting that way doesn't work (we tried), it takes a designed system for many people to change things that have been developed in their lifestyles over many years.