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April 20, 2012

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Health Care Insurance? Now is a great time to purchase a home! Check your credit scores for errors now so that everything is ironed out before you shop for loans. Look into what you can do to increase your current home's curb appeal. One bath homes are harder to sell. You say you pay PMI but hope you have some play to lower your asking price to speed the sale. Be willing to pay closing when you get a decent offer, most buyer's are short on cash these days.

You are doing really well. Have you and your wife decided whether to help children with college? Also, you didn't mention Roth at all. If you qualify, Roths are way better to contribute first before exceeding the match in your 401k.

Others to do life insurance, wills, living revocable trusts, etc.

I would pay off the student loans and the car before buying a bigger home. A bigger home is more expensive to maintain and insure and also has higher property taxes. Also, I suspect you need to save up more money for a downpayment on the new home as I see you now have PMI. You should have at least 20% down on the next home purchase as PMI is a waste of money.

I'll second Luis' suggestion to look at life insurance. I suspect you have a 1x or 2x salary policy through your employer but is that enough? At your age a 10 year term would be inexpensive.

I'd stay in your present home for now. Start contributing to Roth IRA's; you and your wife are young and have time on your side. Pay off your car, and put aside that payment for the next car. Pay off your colleage loans. Please consider only having two children. Frankly, with your income you should plan to put aside something for the child(ren)'s education; you don't have to pay it all. I don't agree with you statement about no ceiling to what you can earn. There are limits. What's important is that you send less than what you earn. You're on a good path--stay the course and good luck to you and your wife!

You are off to a great start, but I agree with JimL that you should have 20% down on your next home to avoid PMI.

I'd choose these priorities:
- Postpone buying a new home as long as you can stand it. Among other things, rates are unlikely to rise significantly soon, and home prices may well fall further in your area.
- Dedicate more money to retirement accounts. Personally I'd boost the 401k contribution for now and hold off on the Roths until your non-mortgage debts are paid off. Since 401k contributions are pre-tax, you can get more retirement saving 'bang for your buck' while impacting your budget less (vis-a-vis a Roth), leaving more money to attack the debt.
- I'd rank paying off your non-mortgage debt ahead of starting to fund a 529. (But set up the 529 and tell your family about it--others can choose to contribute to it as a gift to their grandkid/niece/nephew/etc., so there's no harm in making it available now!)
- For the car and student loans: Sit down with a spreadsheet and your budget and make a plan to pay these off by a date certain.
Good luck!

I'm impressed! You're definitely on track!

Personally, I'd stay in the home and refinance. I didn't see how long you've been in the home, but after what I guess has been a few years of home ownership, you have probably built enough equity cut your PMI if you were to refinance. You might also get a lower payment amount for the same loan term (like do a 25 year loan rather than a 30). Then, you could put a couple hundred dollars extra per month toward your student loans.

Eventually, when you're ready to move, you'll have a lot more room to go into a loan without a PMI payment.

Good luck!!

Just for comparison purposes let me tell you about my comparable experience back in the old days.

I was an aerospace engineer, had married at 21 in England and in 1963 at the age of 28 we bought our first home in what is now called Silicon Valley, CA. It was a 4br, 3ba, brand new, ranch style home in a nice tract that was only 7 miles from work. At the time I had just obtained my MS in engineering, paid for by employer while taking 3 classes/week and making up the time by working late.

My salary was $225/week and my wife stayed home to look after our 3 and 5 year old daughters and she was also expecting our son who was born that same year. The home was $26,950 and we put 20% down to qualify for a low interest conventional 25 year loan. Our monthly payment was $185. Our car was a '55 Chevy that we had bought used in 1958 for $1,300.

The neighborhood was ideal, it was all young couples just like us, and none of the other wives worked. The children could all walk back and forth to the nearby school and it was a happy place where every July 4th. we obtained permission to close off the street and have a huge party. A few years later the neighborhood gave us a big party to celebrate obtaining our US citizenship along with our first Stars & Stripes that we proudly fly on national holidays.

There were no 401K plans in those early days but there was a non-contributory pension plan. We stayed in that home until 1977 when we sold it for $89,950 and moved about a mile away to a much nicer and larger home for $107,000 in a tract where every home was different.

My wife went back to work as a pre-school teacher when the children were older and we saved her income as well as a lot of my own. I ended up working 32 years before retiring at age 58. My wife retired the following year.

It seems to me that my journey from being a young engineer, first to retirement, and now after 20 years of retirement has been a lot smoother and easier that comparable couples in current times.

I thought that in America life kept getting better every year but lately that doesn't seem to be holding true. What's happened?

I read past your Roth and 529 idea the first time, i'm sorry. If the type of home you want to buy is priced so that your gap between income and expenses is tight, then I agree with others that you should stay put. In the meantime start a home fund and keep working up the career ladder.

I'd definitely increase the retirement savings. You're only saving 3% + 3% match right now. 6% total savings is really not enough.

Their spending and savings is not very clear. 6 figure income in the midwest should go far. I see a $1550 mortgage, a car loan and some student loans. Where is the rest of your money going? Maybe they have a fair amount of discretionary money they'r saving. But I'm concerned about how they felt a need to cut the retirement. That sounds like someone who lives paycheck to paycheck more than not.

IF your spending is such that you're only able to put 3% into retirement and you're making 6 figures then you definitely need to cut your spending.

I appreciate you prefer to make more money than control spending but you need to spend less than you earn while saving enough for retirement first. I'm not saying to count your TP squares, but 6 figures should be ample money to have a nice life and save a lot.

I agree with Kurts priorities.

It sounds like you have a lot of different priorities getting a new house, paying off debt, semi-retirement at 52, college savings, having your wife be a stay at home mom. That is a lot of different priorities. I would focus on a few that are the most important to you and do them well.

Getting a new bigger house will involve a lot of new costs, is that a good idea right now? My thought is that there are better investments.

Since you are paying PMI I assume you don't have 20% equity on your current home.

On increasing retirement contributions- 3% 3% match isn’t much at all. It would be sense to increase your contributions. I like Roth IRAs because you have control over the investments and with a bit of effect can get very low costs as some brokerages offer no commission EFT funds and index ETFs can have very low expenses for example VOO (SP500) has an expense ratio of 0.06%/year I suspect your 401K has higher expenses. If you don’t mind managing it yourself the savings in fees will increase your investment returns, and when compounding over many years a 1% difference is huge.

Since your debt is all at fairly low rates I wouldn’t forgo retirement savings to repay the debt. I especially wouldn’t pay off a 2% debt early- that is probably lower than inflation is going to be. Even 5.5% isn’t that high of a rate- investing should do better.

>Once we take care of our most pressing issues I described, we’d like to be able to have my wife stay at >home and take care of the family. If I can continue on my path and get a couple promotions, I think
>this is possible in 5-7 years. This is contingent on being able to continue saving a large portion of my >income for investments/retirement and hopefully retire or semi-retire in ~25 years.

At 27 you’ve saved up $50K- while it is great to have that much savings it isn’t a huge % of your family income (100K+), assuming you have been working for 5 years that is ~10% a year including the company match. It should be enough for a good retirement since you started early, but it would not be enough to retire in 25 years without a radical decrease in your costs. Here is a quick projection:

Starting with $50,00 adding 13K per year with 7% CAGR: gives you $1.15 million, with an 8% CAGR you get to: $1.37 million with 9% CAGR $1.63 million. While that is a fair amount of money- if inflation averaged 3.5% over that 25 years the purchasing power of those dollars would be reduced by 2.36 so it would be like having 500-690K today. At most you could take out 4%, although less would be very prudent since you could have a 50 year long retirement. You would have less than the equivalent of $20-28K in today’s dollars to live on.
Possible if you owned your home and had a very frugal lifestyle but it would be a pretty big change in lifestyle. Semi retirement would be more viable, waiting a few more years would also make a big difference. NOTE: If you did want to retire early or semi-retire early you will need savings you can spend without penalties before 59.5- like the contributions to a Roth IRA or investments outside of a retirement account.

-Rick Francis

Hello everybody, PD here.
Thanks for all your comments!

I thought the common theme would be to stay in our current home. A couple things I should add:
--In addition to the savings I outlined, we also have ~$1500/month in cash savings. The reason we're not doing anything with it right now are the decisions I wrote about.
--We currently have life insurance @ 3x my salary.
--The early retirement/semi-retirement option is the lowest priority and would only be seriously considered in the best case scenario.

@JimL - PMI is currently ~0.5%. When rates go up by more than that amount, any saving from having 20% down are wiped out. Would you still pursue the 20% down in that scenario? I expect them to go up by more than that within 2 years.

@Carol - The car loan would be the last to pay off at such a low rate. Any other loan or investment should vastly outperform 2%. Same with college loans, but they would be next I think as the mortgage interest is tax deductible. I'm curious, why do you think we should consider having only 2 children? We are certainly planning on helping with their college, but they'll be expected to contribute in some form or fashion (jobs, loans, savings, etc). It disappoints that you think there are limits to how much someone can earn. Frankly, I think that's the very mindset that holds people back. Of course spending less than you earn is the most important, but what's wrong with earning much more and spending more also?

@Kurt - Does the tax-free growth and withdrawl of a Roth make a difference for someone my age? In terms of the non-mortgage debt (student & car), I'm thinking the 2% rate (or even 5.5%) is going to be hard to beat and investments should beat that over the long term, right? Does that change the consideration with retirement, non-retirement investments, and 529?

@Rick - You are correct, we don't have 20% equity yet. We should be able to sell and cover commissions and closing costs and take away a small amount of cash, but not much. Who knows with the market, but our local market was not hit hard at all compared to some places. Do you prefer the Roth IRA or Roth 401(k) as that is an option I have through work? The 401(k) option also has a self-management option. The standard 401(k) is currently in an auto-pilot 2050 retirement target date fund, but I'm starting to think of self-management of that also. Like I said, the early retirement/semi-retirement option is only best case scenario and a lot of things need to fall into place before seriously considering it.

PD,

Just to follow up, I would try and get together enough money to get rid of the PMI and refinance all at the same time. Rates are under 4%. Add to that the PMI savings, and it will be a nice monthly savings. Once you do that, tackle the debt and then move on to maximizing your retirement contributions.

@ Old Limey Yes, as a gen Xer, I also feel "gone are the old days." Lifestyle has deteriorated. It is a net loss in my eyes even after you take into account the cable, internet, and other luxuries not available back then. Your first home would be like a $400 mortgage payment in today's dollars. If we could have that more of us in the middle class would be able to keep a parent at home no problem (with or without cable). Really, can anyone explain what happened?

@PD

There is always a bigger or nicer house for more $$, ultimately you and your family need to be happy with where you are living. Still- I suspect the “small” the house you are in would have been considered a normal size for three kids in the 60es. Is it really too small or do you just perceive it as too small because a lot of newer homes are bigger (and more expensive)?

When my wife and I were first married in 2001 we lived in a ~1000 sq foot 3br 1 bath home and then moved to a ~2000 sq foot 3 br 2.5 bath home just before our first child was born. While the extra space is nice, the old layout made great use of the space, the new house is a two story which doesn’t feel as large- so the extra space isn’t as much of a difference as you might think.

There are some disadvantages to the size- it cost about twice as much, it is about twice the work to keep clean, the heating and cooling costs are a lot more and both taxes and insurance are a lot more too. We had 20% down so we need had to worry about PMI payments.

The real value of the new home is that we like this neighborhood better and it cut my commute from > 45min to less than 15min. Knowing what I know now I think a ~1500sq foot home with 2 baths would have been a better size, I’m sure we could have gotten one in the same neighborhood.

I max out Roth IRAs for myself and my wife and contribute to a 401K and Roth 401K. If the IRAs had much higher limits I wouldn’t use the Roth 401K as my company’s plan has higher fund costs and fewer options. I also think it makes sense to have both types of 401K accounts so that in retirement I can decide what tax bracket I fall into by how much I pull from each account.

A target date fund is a good default option- if you do manage it yourself you may not want to make the asset allocation radically different- but decreases the expenses as much as you can.

>The early retirement/semi-retirement option is only best case scenario and a lot of things need to fall into place before seriously considering it.

As long as you can contribute a significant amount toward
retirement for the next 25 years then semi-retirement is a realistic option. I’ll write an article on that as some of the math works out to be quite surprising.

-Rick Francis

Good to know you've got $1500/mo surplus.

I would definitely start a higher retirement contribution. It can make a substantial difference in the long run. If you short change retirement saving now you'll end up playing a difficult catch up game later.

3x salary isn't really a lot of life insurance. That wouldn't last long if you were gone. I'd consider spending a few hundred more and getting a 20 year term policy for another $500k-$1M. Also make sure your wife has life insurance.

How expensive of a house are you looking at? You sound like saving a couple years won't get you a 20% down and you say if you pursue the house you want you won't have money left for other priorities (retirement, college, debt repayment).

You definitely need to ensure you have a decent retirement savings set aside as a higher priority than buying a big house.

You've got a good start with the 6% but you really need another 5-10% to have a safe retirement. And that amount needs to be budgeted in before you decide how much house you can afford.

I assume you don't have any kind of pension benefit right? If you do then thats a different matter.

Steps:
1) Re-fi your current house to a 15 year mortgage with a 3.5% or thereabout rate. This will pay for itself in 2 years. You can afford it, based on your monthly savings.
2) Focus your excess cash on paying down your 5.5% student loan. Based on your income, you are already being phased out of that deduction.
3) Save your extra cash for your new downpayment. Get aggressive with expenses - cut out cable, take your lunch, and eat out 1x per week max.
4) Consider contributing more to your 401(k) on a pre-tax basis. Notwithstanding the tax free growth of Roth vehicles, you need to maximize cash flow. Don't forget that you our highly progressive tax code will let you earn decent coin ($50K) from investments with hardly any consequences.

Do NOT:
1) Establish a 529 with your own contributions. Your expected family contribution (EFC) does not include your home equity. So funding a 529 prior to paying off your house doesn't make a whole lot of sense since the 529 will be counted.
2) Overestimate your ability to get a return in the market. Unless you want to be a pro money manager (and the time commitment that comes with it), put your money in index funds.

@Rick & Luis
I was telling my wife about my recent post and she reminded me of many of the differences from 1960 such as no Internet, no e-mails, no cable TV, no cell phones, no Facebook, and in my own case "The Cold War" which was a boon to aerospace companies. TV was also very different back them, it was primarily family shows such as "Father knows best", "My three sons", "Bonanza", "Lassie come home", "The Waltons", "I Love Lucy", "Perry Mason", "Ed Sullivan" etc. and a few Quiz shows.

Education was pretty cheap, tuition at the private university I attended to get my MS was $30/semester unit and paid for by my company. My daughter paid for her education at San Jose State just by working odd jobs, it was that cheap. Junior Colleges were free.

The salaried workforce was pretty much white males, zero black and hispanic, and a very small number of Chinese, and most engineers need a "Secret" clearance that involved an FBI background check.

The gulf between the richest and the poorest of society has also widened substantially. There was a huge amount of land available in the Santa Clara Valley and my company was the largest employer, peaking at 35,000 but now down to 5,000. As newcomers arrived the subdivisions started appearing and a typical weekend activity was checking out the model homes that were available all over the valley. Today the orchards, farmland and canneries have all but disappeared and replaced with homes, and an acre lot in a prestigious area goes for $2M. Even with my $1M home, built in '72 on 1/3 acre the majority of the value is in the land, and in adjacent streets I have seen homes similar to mine razed to the ground and replaced with a newer and fancier one, primarily because of the great location. Fortunately the hard to build upon land in the 2,200ft mountains surrounding the valley have mostly been turned into open space preserves for hiking, mountain biking, and horse riding, thanks to the generosity of some of the valley's wealthiest individuals with names you know such as Hewlett, Packard, & Varian.

Our Hi-Tech companies, of which Apple is the most valuable, used to employ many production workers but all of those jobs were outsourced long ago. Since we came here both a large GM and a large Ford factory have closed down and yesterday was the groundbreaking for the new 49'er football stadium to be open for play in 2014.

The Santa Clara Valley, often called "The Valley of Heart's Delight" because in the Spring it was covered with the blossoms of its many apricot, prune, and cherry orchards, is now Silicon Valley and the only blossom trees are in people's back yards.
That's why life here is a lot more expensive for young working people.

Please consider the environment and the world before you have 3-4 kids. Its selfish. 2 may be fine - replacing yourselves on the earth, More than that is really shortsighted. Do you really want your kids to suffer in a world where there are not enough resources? Please please think, research and consider. The choices you make now will affect future generations and it will be your grandkids that suffer (if not your kids). David Attenbough, respected eminent UK scientist believes we can sustain 15b people - if we want to live like the poorest in Africa. We are approx 7b now and increasing exponentially. In David's time on this earth (around 80 years) our population has doubled.

Please consider your family and the people already here on this planet before you have 3-4 children.

@PD, regarding your questions:
- I think, yes, the Roth may be a superior (vs. 401k) option for you because withdrawals are tax-free, while you'll pay tax on your 401k withdrawal. This is a fine point, but my thought is by focusing now on the 401k, you can better attack the debt. Every $1 you put in the 401k cuts your available cash by only (say) 80 cents, but every $1 you put in a Roth cuts your available cash by $1, leaving you less to dedicate to debt repayment. Once the non-mortgage debts are paid off, you may want to fully fund Roth IRAs each year, scaling back on the 401k contribution (if you have to) to make that possible.
- Yes, you do have pretty good rates on your non-mortgage debts. I think you should devote more money to retirement saving before paying extra on these debts. But I think you should get the debts paid off before putting serious money of your own into a 529. Now with respect to non-retirement investments vs. paying the debt: Making extra payments on a loan with a 5.5% interest rate is exactly the same as making an investment with a GUARANTEED 5.5% pre-tax return. Everybody has a different opinion on this topic, but for my money I'll take a guaranteed return of 5.5% vs. investing in stocks, bonds, gold, etc., especially in today's interest rate environment, and especially considering the intangible benefits of paying off debt: more freedom and flexibility, and you're likely to improve your credit score and get a better rate on a future mortgage when you do move.

A couple of points on the "Please consider the environment and the world before you have 3-4 kids. It's selfish" meme.
1. Every other decade, we see studies showing the planet's limited ability to support more people. The following decade proves the prognosticators wrong.
2. Supporters of population control typically advocate for government intervention (aka force) to limit growth of populations.
3. Population control is usually focused on our poorest, least educated, and least capable of self-advocacy, population groups.
4. Government force to control population leads to eugenics (Germany), partial birth abortions (China), and the use of AIDS and malaria to control the poorest populations (Africa).
5. The irony is that you are encouraging the highly educated, affluent, and responsible people to not have more children. PD and his wife are exactly the kind of people you want having more children. Hopefully, because they are concerned about frugality, saving, and having a SAHM, they will also teach their children about minimizing waste and stewarding resources.
6. Finally, a SAHM that homeschools their kids(they don't necessarily coincide, but sometimes do), should be encouraged. The government schools get their taxes through taxation and the kids have been removed from said schools, reducing the "burden" on society.

@Carol and @Melanie, lay off your self-righteousness over the number of kids he has. I know families who have 4-5 kids and are doing a much better job (regardless of finances) raising men and women than many with only one or two. The number does not matter; the parenting approach does. "Children are a heritage from the Lord; they are a reward from Him." I have three and know that to be true. You will find far more reward in family than in finances.

@PD, Regardless of how many kids you have, fill them with truth and not with the tripe espoused by the ilk of Carol and Melanie, who view human life as equal to that of a housefly.

^+ to Bruin's comments. Agreed.

Population is not growing exponentially. Its generally been linear growth for a few decades but growth rates have been declining across most of the world. Europe and Japan are seeing declining population and North America is in balance. Most of the rest of the world is slowing to the point that soon they'll hit a balance or start to decline. Africa is the one area that is still growing most but their growth rate has been declining too. It is quite likely that within 50 or 100 years the world population will peak and decline.


Carol, Melanie, Nobody needs your permission nor criticism if they decide to have more than 2 kids.

I thought that's where the "please consider only having 2 kids" comments were going, but I didn't want to assume before knowing. It's nice to know that some people aren't Malthusians who think that humans are a plague on "Mother Nature." But that isn't to say that we should go ahead and pollute without regard to the future either. As a country's GDP increases, so does its ability to dedicate more resources to things like environmentalism. The same principle applies to individuals.

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