Author Topic: Optimize my savings/debt pay-off? First world problems.  (Read 2492 times)

theflyingpenguin

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Optimize my savings/debt pay-off? First world problems.
« on: January 08, 2018, 06:06:28 PM »
Hello Mustachians!

Longtime lurker, first-time poster.

Background: I'm quite risk adverse. I was raised to be debt-phobic, and went to grad school on what I thought were bare minimums. So now, I have the following buckets of money:

-$5,053 in student loan debt (with SoFi!) at 4.75% interest

$1,212 in checking surplus (I draw from this about every other month)

$4,029 emergency fund in Vanguard Brokerage account (all in VFSTX)

$29,922 in Traditional IRA (all in VFIAX)

Variable: I walk to work, but must maintain a car for occasional work trips. The car is nearing the end of its lifespan. I may need to buy a car in the next month. I'll follow Mustachian principles in the purchase.

My current savings rate (not including tax benefit of a traditional IRA, and pretending as if debt-payoff is counted as savings) is 34.6%, and I will increase that percentage. I  know that this is my #1 area to improve/my personal vices to vanquish.

My current gameplan: continue automated maxing out of my IRA, and prioritize my student debt payoff until it reaches $3,000. At that point, increase my cash reserves until they reach 3x my monthly spending. At that point, transfer money into a more risk neutral investment (VFINX), and begin 401k contributions (VOYA, no employer match. My employer contributes 3% of my salary with delayed vesting--I do not include that amount in my FI calculus until it vests).

My gameplan if the P/E ratio dips below 16: switch my emergency fund to VFINX, increase those reserves to the desired longterm amount (3x monthly spending), then to max out the Vanguard IRA, then to the VOYA 401k.

I appreciate all input!
« Last Edit: January 08, 2018, 06:18:07 PM by theflyingpenguin »

Laura33

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Re: Optimize my savings/debt pay-off? First world problems.
« Reply #1 on: January 09, 2018, 08:25:31 AM »
Three main comments:

1.  Your last paragraph is called market timing.  Stay away from it.  You will not succeed, and it will hurt you in the end.  This is coming from your loss aversion: if you wait until the market crashes, you think you will feel "safe" to invest, and you won't have to worry about losing money.  This is entirely false.  Take it from someone who has been doing this a lot longer than you:  when the market is falling, it never feels "safe" to invest; then you tell yourself, well, you'll wait until it's heading back up; and then you end up missing the bulk of the next upswing.*  And don't forget:  if you want to time the market, you also then have to know when to sell again.  And no one gets both ends of that right -- if you're too aggressive, you hold on too long; if you're too scared, you bail too soon (that would be you, btw).  It just doesn't work.  For anyone.  Think about it:  there are thousands of extremely high-IQ, genius-level talents with Ph.Ds and years of training who go to work on Wall Street to make gazillions of dollars by timing the market better than everyone else.  What is it about your background, talents, and abilities that leads you to believe you are going to call the peak and the trough more accurately than they do?  Either you are totally in the wrong line of work and need to head to Manhattan immediately, or it's hubris, pure and simple.

I am sympathetic, though -- believe me, I know the feeling.  I really started investing in the early- to mid-90s, when (despite several crashes) the market had been on an overall upwards run for over a decade.  Oh, the drama -- P/E ratios are at such highs, the Dow is ridiculous, this is just guaranteed to crash!  But what do I do?  What are my other alternatives?  I couldn't think of any, so I gritted my teeth and kept throwing my money in.  Lived through the first tech crash.  Lived through the 2008 crash.  Lived through a variety of other short-term crises that all said This Time It's Different.  And guess what?  I have buttloads more money than I did back then.  And a metric shit-ton more than I'd have had if I had waited for some metric to hit my desired target before I started (because it never did).

2.  I don't care much about the debt-vs.-investing thing given the size of your debt, but don't wait too long to get going in your 401(k).  The power of compounding is amazing -- and it is at its most powerful early in your career, when whatever you invest has the most time to grow.  You have seen the stories about "if you started at 25 vs. 35" -- they're all true.  But it's even more important to start getting that growth soon if you want to FIRE.  Say you're 25 and you want to retire at 65; the rule of 72 says that at 7% average returns, the money you put in at 25 will double 4 times over -- so $10K at 25 will be around $20K by 35, $40K by 45, $80K by 55, and $160K by 65.  But if you want to FIRE at say 45, you lose the final two doublings.  And note that that is not 2x, it's two doublings, or 4x -- so instead of $160K, you have $40K.  So the more important an early FIRE date is to you, the more important it is to get investing as much as you can, as soon as you can.

And the 401(k) is, of course, a double-bonus, because not only do you get tax-deferred growth, but you also get a tax deduction from your current taxes, which means you can invest more without actually losing as much out of your paycheck.  Run some tax calculators and see for yourself -- you may be able to sock away noticeable amounts without seeing much of a hit to your paycheck.

3.  Most people who say they are risk-averse are really risk-blind.  You are averse to the immediate pain of seeing a big loss in your investment accounts.  But what you're not seeing is that if you keep your money in cash and out of the market, you are guaranteeing that you are losing money to inflation every year.  Sure, it's not as painful, but it will do more to damage your chances of FIRE than any market upheaval -- it's death by 1000 cuts.  It's not as obvious to people today, but the ridiculously low inflation rates of the past decade or so are not normal.  If inflation reverts back to 4% (closer to its historic average), and bank accounts and money market funds increase the interest they pay all the way up to 2%, your purchasing power will be cut in half over 36 years -- so if you have $100K in savings now, in 36 years it would be worth the equivalent of $50K.  It will eat you alive, and you won't even notice it.  Meanwhile -- reverting back to 1 above -- the market has never lost 50% over 36 years; in fact, it's never even lost money over that period of time.  And if the market were to suffer that kind of long-term loss, well, I can only assume that the whole country would be in so much trouble (or no longer existent) that none of us would be worrying about FIRE anyway.

So, tl;dr:  figure out how to manage your fear, and make decisions based on math.  Which means throwing as much as you can manage into the market as quickly as you can, and then just holding on tight.

*Historically, much of the market gains have occurred suddenly and over a short period of time, which means even if you get back in in time for some of the gains, you will still miss out big-time if you are not in the market when the change happens.  Do some research on how your returns change if you miss the 5 or 10 or 20 biggest days.

theflyingpenguin

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Re: Optimize my savings/debt pay-off? First world problems.
« Reply #2 on: January 10, 2018, 07:28:05 PM »
@Laura33 : Thank you!!

Here's my thought before reading your comment: I don't have traditional insurance (part of a co-op), have a big (for me) purchase on the near horizon with the dying car, and so my potential need for an extra $5k within one week is at a (hopefully historic) high. I wasn't thinking of the $4k + $1.2k as an investment so much as a recognition that I'll need to make a $5k purchase with fairly little forewarning... but, if stock went on sale suddenly, my risk calculus changes even if I needed to cut back on regular investing to make a car purchase work. Conversely, if the market crashes and my total flex money reduces to $3k, I'd need to reduce my regular IRA investing (at the time of a stock sale!) in order to make avoid a car loan.
Student loan debt isn't springy debt, and is a guaranteed 4.5% loss. At $3k, I could knock that debt out in about two months if I needed to improve my cashflow for some reason.

After clarifying my thoughts and re-reading your post, my new thoughts:
So what? I have great credit and growing financial discipline. Even if the world ends and I need to take shortterm credit for a sub $2k car loan (do they make those?) or put doctor bills on a credit card, I'll probably come out ahead. Transferring all but $300 cash into VFINX now.

SwordGuy

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Re: Optimize my savings/debt pay-off? First world problems.
« Reply #3 on: January 10, 2018, 09:30:29 PM »
You're in a great starting position, you've gotten some solid advice and you're taking it.  Bravo!

Have you read JL Collin's Stock Series?   http://jlcollinsnh.com/stock-series/

It's a really straightforward introduction to what we, as regular folks, need to know in order to invest successfully.

I think after you finish reading it and absorb the material, you'll find you have a better handle on risk - and realize that the layman's intuitive wisdom on finance and the risks involved is often wrong.


Laura33

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Re: Optimize my savings/debt pay-off? First world problems.
« Reply #4 on: January 11, 2018, 07:42:30 AM »
@Laura33 : Thank you!!

Here's my thought before reading your comment: I don't have traditional insurance (part of a co-op), have a big (for me) purchase on the near horizon with the dying car, and so my potential need for an extra $5k within one week is at a (hopefully historic) high. I wasn't thinking of the $4k + $1.2k as an investment so much as a recognition that I'll need to make a $5k purchase with fairly little forewarning... but, if stock went on sale suddenly, my risk calculus changes even if I needed to cut back on regular investing to make a car purchase work. Conversely, if the market crashes and my total flex money reduces to $3k, I'd need to reduce my regular IRA investing (at the time of a stock sale!) in order to make avoid a car loan.
Student loan debt isn't springy debt, and is a guaranteed 4.5% loss. At $3k, I could knock that debt out in about two months if I needed to improve my cashflow for some reason.

After clarifying my thoughts and re-reading your post, my new thoughts:
So what? I have great credit and growing financial discipline. Even if the world ends and I need to take shortterm credit for a sub $2k car loan (do they make those?) or put doctor bills on a credit card, I'll probably come out ahead. Transferring all but $300 cash into VFINX now.

Glad to help!  But I didn't mean deprive yourself of an emergency fund.  :-)  I meant more along the lines of don't focus on debt so much that you miss the benefits of investments, and don't try to time the market.  So more like "figure out what asset allocation is going to work for you for the long term -- how much do you need in an EF; do you want to pay cash for a car or take out a loan, and if the former how much do you need and how are you going to get it; how much do you want to invest, and how do you want to divide that between stocks vs. bonds vs. real estate vs. other classes, etc. -- and then set up a program to implement that.  And stick to it!"  :-)  It was the second part of what you just said above (the "but" part) that I was responding to, the idea that your strategy would change based on whether the market did well or poorly (well, plus prioritizing the loans above all else).  And I am very pleased that I was able to help reframe your thoughts on shifting your strategy based on shifts in the market -- that will serve you very well in the long run. 

In terms of your "new" plan:  your approach is one I have seen used here successfully, and I am impressed with your new insight into your "real" downside risk (vs. the worst-case "awfulizing" that is easy to fall into).  You are right, low-interest debt is not a problem (unless you are using it to buy crap you don't need, of course, but that's not you), and a small car loan is not the end of the world.  And in fact, many people here do keep very little in cash and rely on available low-interest credit as their EF.  But at the same time, that is a big swing from "ALL DEBT MUST DIE ASAP!!!" -- so I just want to make sure you're really comfortable with that much more aggressive approach. 

I think your post resonated with me because I too tend toward the "desire security above all else" mindset, which makes it easy to focus so much on the fear of losing money that you miss the growth you actually need to FIRE.  The way I manage my fear is to keep a cash reserve (money market fund) that covers anything I am likely to need within the next year or two -- I intentionally give up the potential growth for the security of knowing I don't have to worry about market returns.  But that then allows me to be completely comfortable throwing everything else I have into the market, because I know for sure I won't need that other money for a long time, so there's no panic when the market drops. 

Again: not saying you need to do exactly what I do; like I said, there are many people here who do the "low-interest-debt-as-EF" route very successfully.  The point is to make sure that you have an approach that allows you to manage your fears and make smart financial decisions that you can stick with over time, as the market goes up and down.  Not just do what some stranger on the internet does (because, really, I could be totally looney tunes, and how would you know?).  :-)

theflyingpenguin

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Re: Optimize my savings/debt pay-off? First world problems.
« Reply #5 on: January 11, 2018, 07:01:26 PM »
@SwordGuy --I have, but it's been a year or so since reviewing it. I'll take a look again!

@Laura33 -- Despite your potential lunacy, your post was the lightbulb moment for a lot of prior reading/number crunching. :) Automating accounts in a moment of logic has helped me ignore occasional, illogical panic. Also, I lied; I didn't transfer all of my EF, but did immediately redirect my above-and-beyond loan payments into my 401k.
After thinking a bit more, I wonder about putting the Vanguard brokerage fund into a Roth IRA. I need to do some more research, but *think* that's my gameplan now to help me sleep easier, since I'm not yet on target to max out all of my tax-advantaged accounts.