Author Topic: Reader Case Study - pay down student loans or build cash to start a business?  (Read 2764 times)

hodge

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After discovering MMM over the summer and making some initial changes in how I think about money, I figured it was time to join the forum and get some guidance on the next steps.

Iím a 26 years old single guy with a masterís degree in the humanities, and have been working for a year and a half as an admissions counselor at a selective liberal arts college. It's a fun job with lots of opportunities to travel, but it's not something I'm likely going to be doing for too much longer, so I'm trying to figure out how best to position myself financially to move forward. My gross salary is currently $35,000/year.

Monthly Take Home Pay: $1,850

Monthly Expenses

Groceries              $150
Prepaid cell           $10
Electricity              $40
Gas Heat              $44 *
Internet                $45
Haircut                 $14
Laundry                $6
Rent                     $650
Avg car maint.       $7
Avg car taxes/fees  $3
Fuel                     $70 **
Car Insurance       $82
      Includes:
         -bodily injury to others 20k/40k
         -optional injury to others 100k/300k
         -damage to property 100k
         -personal injury protection
         -bodily injury from uninsured 100k/300k
         -bodily injury from underinsured 100k/300k
         -comprehensive deductible, $300
         -collision deductible, $300
         -towing and labor
         -rental reimbursement 30/day max 900
         -medical up to 10k/person
   AAA memb.         $7
   Renterís Insur.     $10
   Life Insur. (20k)   $10
   Student Loans   $119 (see below)

   SUBTOTAL:       -$1,267/month

Debts
   Student Loans   $8,600 at 6%

   SUBTOTAL:       -$8,600
 
Assets
   2002 Saturn SL1, owned outright    $2,100
   TIAA-CREF retirement acct***       $5,500
   Cash, at 1.5% in credit union         $8,700
   H.S.A. from previous job              $942
   Whole Life Insurance cash value    $1,300
   
   SUBTOTAL: $18,542

Question #1: Does any part of the car insurance coverage look ridiculous, given the value and age of the car? What other cuts would you suggest? Commute to work is 10 miles/day roundtrip. Rent for apartments nearer to employer is usually $200-300 more per month (my current landlord hasn't raised rent on anyone in years, even though he could probably get closer to $900/month for the place where I'm currently living if he rented it at a market rate). I thought about bicycling to work, but taking a route without a major highway would double the distance, and I don't think I'm quite there yet physically (though I'd like to be!).

Question #2: Whatís the best use for the $8,600 currently sitting in my checking account at 1.5%? Over the past year, Iíve paid down about $7,000 in student loans, starting with the ones that were 7% and 8%, so I was considering paying the rest of the loans off as quickly as possible. However, itís likely that in the next year and a half to three years, Iíll probably want to make the switch to working as an independent college consultant/tutor, and so the idea of having enough cash on hand to cover expenses while I build up a client base is attractive as well. If I did that, I would likely be moving closer to family, where rent for a comparable apartment would be closer to $550/month.

Question #3: Speaking of which, what sorts of additional expenses should I be planning for if I do decide to start a consulting business in the next few years? What books would you recommend for learning more about the legal and accounting aspects of starting a small business? When it comes to health insurance, my state hasnít expanded Medicaid as part of the ACA, and it appears that subsidies donít kick in until youíre making a certain amount of money above the poverty line. If I donít have significant income for the first few months (or more) of the business, what are my health insurance options?

Thanks in advance!


*utility expenses are for December. In the summers, electric is closer to 35, gas is closer to 18.
**I drive regularly for work and get reimbursed at $0.55/mile, which helps to offset fuel and maintenance costs somewhat, though it does mean the car has 95k miles on it.
***Iím currently contributing 5% of each paycheck, pretax, to VIFSX; employer will begin matching 10% in March.

Another Reader

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Your car insurance is insane.  You do not need full coverage anyway, but even with it the cost is very high.

Whole life insurance is a terrible investment.  You have no dependents, so you don't need life insurance.  In your shoes, I would drop it.

At 6 percent, I would pay off the student loans ASAP.

What are your investment choices in TIAA-CREF?  Is this a 403b plan?  Do you have a pension plan with this employer? 

In your shoes, I would look at a Roth IRA.  You have until April 15 to fund the 2013 IRA.

Start your business as a side business.  If it pans out, then consider going full time.

hodge

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Thanks for confirming my suspicions about the car insurance and whole life insurance. I just left the car insurance coverage at the same levels that my parents had when the policy split off into my name, assuming it was a normal amount until recently. They also bought the life insurance for me back in the early 90s; I didn't realize I had it until I turned 25 last year. I'm strongly considering dropping it.

I think you make a good point about considering consulting as a side business first. I don't think I'd be able to do it in the current position because of conflict of interest, but it's a fairly common route for admissions counselors to switch over to working as college counselors at private high schools after a few years, and I know of a few who do consulting on the side.

Yes, the retirement plan is 403(b); no pension plan. Investment choices with TIAA CREF are:

Equities:
CREF stock
Vanguard 500 Index Fund - signal shares
American Funds EuroPacific Growth Fund R4
Vanguard Extended Market Index Fund Signal Class
Oppenheimer Developing Markets Fund - Class Y
T.Rowe Price Equity Income Fund
Vanguard Total International Stock Index Fund Signal Class
Eaton Vance Atlanta Capital SMID Cap Fund Class I
Diamond Hill Small Mid Cap Fund Class I
Harbor Capital Appreciation Fund Administrative Class

Real Estate:
TIAA Real Estate

Fixed Income:
Vanguard Total Bond Market Index Fund - Signal Shares
Vanguard Inflation Protected Securities Fund Admiral Class
Metropolitan West Total Return Bond Fund Class M
Legg Mason BW Global Opportunities Bond Fund Class I

Money Market:
CREF Money Market

Multi-Asset:
CREF Social Choice
T.Rowe Price Retirement Income Fund
T.Rowe Price various target date funds

My current allocations are:
$3605.05 in Vanguard 500 Index Fund
$1600.73 in T.Rowe Price Blue Chip Growth
$266.24 in TIAA Real Estate
$98.68 in Vanguard Total Bond Market Index Fund

FrugalSpendthrift

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You can lower your car insurance liability limits, until you have more assets to protect.  And also consider dropping comprehensive and collision.

Another Reader

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What are the expense ratios on the Vanguard index funds?  "Signal class" is not something you see on the retail side of Vanguard.  The T Rowe Price funds they offer are ok, but not their best funds and my guess is the expenses cancel most of any benefit of active management over the index funds offered by Vanguard.  I'm not a fan of their Blue Chip Growth fund at all and their version of Equity Income is focused on large cap dividend stocks.  I think you can probably build an easy to manage index portfolio from the Vanguard offerings.  At your age, I would be focused on stocks for growth, as you can tolerate market fluctuations.

Can you do the tutoring part of your proposed business without creating a conflict of interest?  Some side income could go to an IRA or to paying off those student loans.

lackofstache

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I'd definitely look into the auto insurance. One thing to consider on the life insurance, though, is that you may not always be able to purchase it. Since my wife (at 25 yrs old) was diagnosed with cancer she can no longer get any. I'd probably get a larger 20 or 30 yr term, though, instead of the whole life. It's cheap while you're young & healthy.

Rebecca Stapler

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    • Stapler Confessions

Question #2: Whatís the best use for the $8,600 currently sitting in my checking account at 1.5%? Over the past year, Iíve paid down about $7,000 in student loans, starting with the ones that were 7% and 8%, so I was considering paying the rest of the loans off as quickly as possible. However, itís likely that in the next year and a half to three years, Iíll probably want to make the switch to working as an independent college consultant/tutor, and so the idea of having enough cash on hand to cover expenses while I build up a client base is attractive as well. If I did that, I would likely be moving closer to family, where rent for a comparable apartment would be closer to $550/month.


I would be extremely tempted to dump your savings into that student loan and wipe it out for good. Start 2014 off cleanly, with zero debt.

And because I think that whole life insurance is generally a waste of money, especially if you don't have any dependents, I would cash out that policy and make it your emergency fund.

At your current income, I would put your emergency fund into a Roth IRA because your tax bracket is so low. Of course you don't want to ever tap into your emergency fund, but you can withdraw principal from a Roth without penalty, so it is a way to put money aside for a "just in case" scenario while taking advantage of the annual maximum IRA contributions. (you can only contribute $5,500/year)

In that vein, I would continue to use the Roth as a savings vehicle for the $119/month you're saving in not paying your student loan bill. You might want to tap into it in a few years when you start your consulting practice, but you also might find that you've cut your lifestyle expenses so much by then that you can sustain yourself pretty easily with your consulting income.

Good luck!

Another Reader

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Using a Roth IRA for an emergency fund is extremely foolish in my book.  An emergency fund is for unexpected car repairs, a flight to see a very sick family member, or a couple of months of living expenses after a job loss where you are not eligible for unemployment.  We all experience emergencies and handling them without taking money from tax advantaged investment accounts with the capacity to compound untouched for 40 years or longer is the smart way to do it.  Set aside at least a couple of months of expenses and a little extra to cover this stuff in a high yield savings account.  Then take everything else beyond your living expenses, pay off the debt, and invest the rest.

Everything in your savings account above the emergency fund is fair game to pay off debt or invest in your 2013 Roth.  That's how I would play it.  Once the debt is gone, the emergency fund is in place, and the IRA is funded, I would turn my attention to the side business.  If you can start tutoring today, there's little or no start up cost for that. 

You have shown you have the discipline to save.  That's 90 percent of the battle.