Hi everyone,
Longtime reader, first time poster. I feel like I’m pretty well-versed in the basics of personal finance since I started reading MMM and the forums (and some other key resources) about half a year ago, but today my girlfriend put a question to me that I wasn’t completely sure about how to answer, and I thought maybe the community could lend some wisdom. First, the necessary/unnecessary/miscellaneous background:
- I’m 28, she’s 26, we live together and are the most part both pretty frugal, or as much as you can be in a large, expensive American city. Our rent is just a little high for the area but we love our apartment and it’s perfect for us in all the ways that matter. We both hate moving and wanted a place we could “grow into” when we moved in together a few years back, and our landlord has raised the monthly rate a whopping $20 in the last three years. On the other side of things, we eat like royalty below the poverty level (according to the USDA, anyway) because the local ethnic grocery has amazing produce for cheap. Works for me.
- She makes more than I do ($44k, soon to be $48k once a recent raise kicks in, vs. $39k for me), but she has student loan debt, about $30k, and I don’t, so I’ve managed to save a lot lately while she often seems to be feeling the financial pinch. I’ve got an emergency fund (3 months of my own expenses at the moment, building that up to 6 months this year and ultimately to 12), while I’m not sure if she has any savings beyond a 401k. But her job is far more secure than mine (she’s been promoted twice in the last year, while my work is funded by grants), so maybe that evens out. I would also help her if times got really tough, as I know she would do for me.
- She also carries a small amount of credit card debt, maybe $500-$1k worth last she mentioned it — I don’t ask about it because I know she’s not thrilled about it either, but I also get the impression that she doesn’t feel like she’s in a position to pay it down given her student loans. If it were me, I’d find a way to do it anyway, but it’s not me, and I don’t go looking for conflict!
We differ in a few areas when it comes to money, namely that while she is pretty resourceful and tries not to be wasteful, she’d just rather not deal with the specifics of personal finance, and maintains that ultimately, “money is for spending.” (On what? Not sure — we often talk about how we already have pretty much everything we might need right now, but I know she appreciates going out on [reasonably priced] date nights and would like to travel more than we do now.) She’s been somewhat skeptical of my recent efforts to cut spending and sock away some loot, so I finally explained to her the other day that no, my ultimate aim is not to have a vault full of gold coins that I can go swimming in Scrooge McDuck-style, but rather to ensure personal freedom for myself and, ultimately, for her and any kids we might have down the road (been together 5 years, so this is serious longterm relationship stuff, and marriage is probably in the cards sooner than later). I guess she must have warmed to this explanation, because for the first time, she asked me some questions about her money situation this afternoon — “because I don’t know what this means and you understand this stuff,” which was a nice compliment for a budding Mustachian to hear!
Basically, she got a college graduation gift about 5 years ago from her now-late grandfather in the form of a $5k mutual fund investment in a taxable account in her name. As of today, the investment is at about $7300. She asked me what was going on with it because she has to report taxable income from it each year and she had thought it was a retirement account. Clearly, it’s not. I looked at it and saw that it had a 2% expense ratio, which, combined with annual taxes on the dividends, makes it less than ideal as far as I’m concerned. It pulled something like a 15% return last year, so it’s not doing terribly, but past results are not a predictor yada yada yada, and the MMM reader in me recognizes that there are a few possible strategies where she could be utilizing that money for a better return. I basically laid out a few options for her based on my understanding of the situation:
- She can leave it where it is and continue to let it grow, but she’ll continue to pay annual taxes on the dividends and the higher fees will definitely stunt its growth. On the upside, she doesn’t have to change anything. I guess in this way it would function as semi-liquid emergency fund of sorts (I wasn't going to recommend she sell it and put it in a bank account), but for reasons given above I think there are better ways for her to go about establishing an emergency fund.
- She can sell it, take the capital gains hit, and use most of it to fund an IRA for the tax deduction or a Roth IRA if she would rather go that way (I explained the difference, as well as the rollover technique, but I think choosing one or the other will take some further consideration on her part).
- She can sell it, take the capital gains hit, and plow the proceeds directly into her credit card debt and higher-interest student loans (most are at 4.5%, but there’s a chunk of about $5k divvied up between 5.5% and 6.5%, and then another $7k or so at 5%).
She was wary of parting with such a large sum all at once, but I did explain that if she used it to pay off those debts, she’d save a bunch of money on interest, and she could pretty quickly use those savings to build up an IRA at Vanguard, for instance, where the money could grow without taxes and fees — in other words, that she wouldn’t be parting with the money in the long run, just temporarily diverting it to knock out some debt and ending up in a better place retirement-fund-wise. This line of thinking definitely appealed to her.
The unspoken fourth option would be to sell it and buy a better fund elsewhere, i.e. VSTMX, but in another taxable account. However, I don’t think she intends to use this money for anything in the short term. I mean, she had already assumed it was a retirement account and was unable to touch it. Even if she did, would it be worth the tax hit to pull the money out of one taxable account just to put it in another?
So what do you think? My gut says knock out at least the credit card debt and the 6.5% loan and maybe start an IRA with the balance if she wants to hang on to some of the money, or maybe just take out as much of the student debt as possible and worry about the IRA later. But I have no experience selling off taxable investments, so I’m also saying this under the impression that the capital gains she’d pay would be based on the $2300 growth and not the original $5000 investment, minus any dividend reinvestments over the last few years, which by my count have already been taxed. I’m assuming that the capital gains tax in this case would work out to be a few hundred dollars. However, if I'm mistaken and it’s going to be a tax on the full amount, gift included, I’m less sure of how good an idea it is to sell it off all at once.
I’d rather not lead her in the wrong direction, given how hesitant she’s been to talk much about financial planning with me thus far — I’m hoping this is the start of something good and leads to more Mustachian conversations in the future, so I don’t want to mess up the opportunity! And at any rate, at the end of the day she’s going to make her own decision, because she’s tough and intelligent and fiercely independent (all great things about her as far as I’m concerned), so I’d at least like to provide her with the best possible information to make that choice.
For what it’s worth, she’s told me on more than one occasion that, if we were married, she’d be happy to put me in charge of our combined finances and be done with it, but I want her to be comfortable and confident about how all this stuff works. I’d hate to get to a point where she doesn’t see why we’re saving X amount here or investing Y amount there because we’re not on the same page yet. I want to get on that page starting right now if possible by showing her that we can work together on this stuff.
Thanks in advance for your feedback!
