Tags: money

hat

financial planning (2)

Well, after a lot of number wrangling I think I have a mostly workable plan. It's a little hard to make the numbers work out. I'm currently aiming for saving1 20% of our income (on top of the 8% that gets put into the university mandatory retirement plan), which seems workable. But if you add children into the picture (which we want to do in the near future), it all goes to hell, since my best estimates are that 10-15% of our income will go towards child care. That only leaves 5-10% free for savings; combined with the university plan, we can manage retirement on that, but I'm not sure what we're going to do about having a second child, or paying for school or university tuition. My current plan is to ignore this issue for now and get back to it in my next round of planning, which is due in February once I get to work out our taxes and see how big an adjustment to our figures I need to make.

1 By "saving" I mean putting money towards increasing our net worth; in the near term, this will really be paying off some loans.

Poll #875629 financial planning

What's in your financial plan?

Retirement projection
1(4.2%)
Long-term life events
1(4.2%)
Short-term life events (3-10 years)
2(8.3%)
Other
0(0.0%)
I have no plan
10(41.7%)

How much do you save? Include any retirement plan at work, but exclude employer contributions.

< 5%
1(4.2%)
5% of income
0(0.0%)
10%
1(4.2%)
15%
2(8.3%)
20%
6(25.0%)
25%
3(12.5%)
30%
2(8.3%)
35%
1(4.2%)
> 35%
3(12.5%)
less than 0 (spending exceeds income)
1(4.2%)
I don't know
4(16.7%)

How much does your employer contribute towards your retirement?

0%
17(73.9%)
1%
0(0.0%)
2%
0(0.0%)
3%
0(0.0%)
4%
1(4.3%)
5%
0(0.0%)
6%
2(8.7%)
7%
0(0.0%)
8%
0(0.0%)
9%
0(0.0%)
10%
3(13.0%)
> 10%
0(0.0%)
hat

retirement planning

One of my goals for today has been to do some retirement planning. We've gone to a couple of financial planners recently, and they've been good about helping to make high-level choices: what kind of income to aim for at retirement; what kind of return to expect, etc. But they've been less helpful about making low-level decisions. One question that's particularly relevant to us is whether money should be used to pay off loans at a faster than normal rate, or to invest it into IRAs or other retirement plans. The first planner suggested that it's wrong not to max out your IRA, without any real explanation why. (Even if I believed this, it's not 100% helpful, since we also have a 403b plan allowing for a large amount of income to go tax-deferred, and I doubt we will max this out.) The second was even worse, saying "well, you want to put some money into loans, some into IRAs, some into ...". So I've had to sit down with spreadsheets to figure this out myself, and I think I have the answer now.

I compared two scenarios having a budget of $1000 each year for two years. The first scenario involves putting money towards a loan in the first year and putting it into a (tax-deferred) retirement fund the next. The second one is switched around, putting money into the IRA the first year and paying for the loan the second. Here's what it looks like:

Scenario 1Scenario 2
Year 1
Budget10001000
Paid to loan10000
Loan interest072.50
Paid to IRA01344.20
IRA return0107.54
Year 2
Budget10001000
Paid to loan01000
Paid to IRA1449.270
IRA balance1449.271451.74

The "Paid to IRA" columns require a bit of explanation. In scenario 2, we have $1000-72.50 to invest in the IRA. (The $72.50 goes to pay the extra loan interest not present in scenario 2.) However, that's $927.50 post-tax dollars, which at our tax bracket (31%) is the same as $1344.20 in pre-tax dollars. Similarly, in scenario 1, we invest $1000 post-tax, which is $1449.27 pre-tax. This tax break gives the second scenario a slight advantage at the given interest and return rates (7.25% for the loan, 8% return on the IRA.) So it makes sense to put any "extra" money you have into the IRA first, and overpay on the loan the next year. And since you can make the same argument for the following year, you should in fact put as much money into your IRA as you can and pay off your loans as slowly as possible.

In fact, we will probably pay off our student loans first before putting money into retirement, since the 8% return is only an estimate and it carries with it some form of risk. As return in scenario 1 is nearly the same, and it's risk free, it seems overall a better strategy. All our other loans are at significantly lower rates (except the second loan on the house, but even that's at a lower effective rate once you take the tax deduction into account), so it makes sense to put money towards retirement first and pay those loans off slowly.

Curiously, the break-even point between the two strategies doesn't depend on the tax bracket:

IRA return = 1/(1-loan rate) - 1

Next step: Roth vs. traditional IRAs.

hat

dollars in flight

I realized today that I nearly forgot to initiate a transfer from ING to my checking account. I would have felt pretty silly if I had gone to the bank Thursday to write the cheque and realized that the money was in the wrong account, inaccessible for the next two days. As it is, it should arrive just in the nick of time.

The cheque will be by far the largest one I ever wrote — bigger than my yearly pre-tax income when I was a grad student. And it strikes me that I don't yet know how much (exactly) it will be, and to whom I should make it. Well, I'm sure one of my agents knows the answer and will be able to tell me in the next three days. *fingers crossed*
hat

budgeting

I think I'm starting to get the hang of budgeting. I've finally cajoled Quicken into giving me a report that makes sense. The bad news is that we went overbudget for April, and we're a little overbudget this month. The good news is that the main culprit is unplanned wedding expenses, which will disappear in the long term.

Other than wedding, our biggest areas where we are overbudget seem to be groceries and dining out. I've started changing my eating out habits, so hopefully that will help. I'm not sure how to spend less on groceries; my current thinking is to try to track grocery spending more precisely, but I'm not sure if I'm up to keeping such detailed track.

My biggest breakthrough in budgeting was something that happened a few weeks ago, when I started making long-term plans. I realized that what matters is not how much you earn, or how much you spend, but the difference between the two. (And, most importantly, the sign of it.) This means that amounts that seem inconsequential when compared to our household income can still have a significant impact on our financial well-being. I stopped buying lattes after I figured this out!
hat

financial musings

Mutual Funds


I got some statements from fanlain's IRA earlier, with a listing of the mutual funds she's invested in. So I spent some time looking up various stats on the funds, including their overhead rates. I'd heard a fair bit in the past about how mutual fund performance over the long term is worse than an index fund, because most fund managers can't beat the market by much, and when they do, it's eaten up by overhead fees. I spent some time trying to find evidence of this fact. Of course, as I would expect, all the funds on the list are less than 5 years old, so it was hard to think about long-term performance. But the bulk of money is in a fund of funds, and the constituents have been around for longer. Looking at the history of one of them, it underperforms the S&P for some periods (e.g. the last 8 years), but going back to the start of the fund, about 15 years ago, the annualized return is nearly a percent higher than the S&P. So that's somewhat reassuring.

Of course, seeing as "past performance is not an indicator of future results," this whole exercise was meaningless. Assuming I believe (and correctly understand) the efficient market hypothesis, the most likely reason that this return has been better over this time period is pure luck, and it doesn't make it any more likely that over the next, say, 30 years, the returns will be better than S&P. So it stands to reason we should move that money into an S&P index fund instead.

On the other hand, the mutual fund does seem to be performing relatively well. And then there's the fact that if everyone moved their money to index funds instead of mutual funds, the market would cease to be efficient. So part of me just wants to let the money be. Have any of you faced this dilemma? And which way did you go?

Mortgages


Another thing I've been thinking about is mortgages. And here's something I found confusing. Interest rates these days are low — not as low as a year ago, but still quite small by historical levels. So let's say that I have a mortgage at a 6% interest rate. Since mortgage interest is tax deductible, the effective rate (in my tax bracket for this year) is only 4.32%. On the other hand, a CD with ING Direct can pay up to 4.70%. So if I have any cash surplus, thought I, it would be to my advantage to put it into a CD, rather than pay off the mortgage, since the interest I'd be gaining from the CD is more than I'd be paying for the mortgage.

As I was writing this, I realized a small kink in this plan, since the 4.70% interest I'd be earning would itself be taxed, and I'd only see a 3.42% return. But if I were to invest in something slightly more risky, it's not hard to envision a higher than 4.32% rate of post-tax returns, especially if I can manage to have the investment taxed as capital gains instead of income.

So by this calculation, a 6% fixed-rate mortgage seems like a very good deal for me. And so my winning strategy would be to get the longest-term loan possible and pay it off as slowly as possible (at least as long as the mortgage tax deduction exists.) But I'm wondering if there's something else I'm missing.
hat

credit report logic

UIECU: You'd like us to buy you a new car? Sure!

Toyota Financial: Wait, we'd rather buy the car for you! We'll give you a better offer!

US Bank: You want a credit card that gives you airline miles and no preset credit limit? No problem!

Verizon: You want to get a cellphone? That will be a $400 deposit. (And another $400 for a second line for fanlain.)

I guess I got overly excited by the fact that other companies treat me like I exist. We could order the phones in fanlain's name (or at least I think we could), but then we wouldn't get the discount they give to UofI employees, costing us a couple hundred dollars more in the long run. Grr...

Poll #588249 Cell phone hell

What would you do?

Pay Verizon $800
7(41.2%)
Get the phones in fanlain's name
2(11.8%)
Stick with Cingular
8(47.1%)


Update: For reference, the monthly costs of the three options are roughly $60, $70, and $80/month respectively. The (non-refundable) start up costs are cheapest with option 3 ($0), about $50 with option 1, and some complicated amount more with option 2, but probably about $150.