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November 19, 2013

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"We'd like to do a semi early retirement. I'd like for both my husband and I to be able to work part time when we have kids. I could work 2-3 days a week and he could work 4 days a week." -- For a family with young kids, this is far from semi-retirement but rather a very reasonable lifestyle goal. The key is less about saving and investing now and more about cutting expenses and figuring out the logistics. My wife stays home and I started a business and work from home. Your husband's income seems to already cover the expenses, so I'd say you're in great shape. The "move to a larger place" is obviously gonna be key, if by larger you mean much more expensive then you could greatly handicap your semi-retirement plans.

Thats a great gap between income and expenses even after current 401k deductions. Your benefits are amazing. At your age, IF you have a stomach for volatility but don't want to be picking stocks (this is me), just throw the rest at small cap index funds, and of course cram as much as you can in tax advantaged accounts unless they are awful.

Congrats. You're doing a GREAT job. (I don't think people get told that enough on these personal finance pages, but you're clearly doing very well).

If I were you (and this is totally subjective - other opinions may vary), I would:

1. Beef up the emergency fund to 6 months of expenses. You have 3 months ($9k, with about $3k a month in expenses), which is great, but you're young and you want to have children at some point in the future, correct? Get the emergency fund to 18k and you'll have a LOT of piece of mind in the event you get pregnant, or if one of you loses your job, or if that house needs a big repair, etc. No one has EVER regretted having a few more months in their emergency fund.

2. Continue maxing out the ROTHs. You mention semi-early retirement as a goal, and ROTHs are a great partial vehicle for that, since you can take out your contributions at anytime(but not your capital gains/dividends/earnings until you're 59.5). The ROTH contributions, therefore, can also be a nice emergency fund IF you need them (but it's always better to have a liquid emergency fund.) In 5 years (when you may want to have kids), by socking away $11k a year in ROTHs, you'll have $70k in contributions ($55k plus $15k you currently have) that you could pull out to help make ends meet for awhile.

3. Take the trip. Do it. You're in great shape financially...heck, using just one month of your surplus you could take a REALLY nice trip somewhere. Just do it - you won't regret it.

4. Reach to max out the 401k for whichever one of you has the better low cost index funds. Then, as you get raises, increase the other's 401k too.

5. Split everything else between paying down the mortgage and taxable accounts. You mention that you're "nervous committing large sums of money to individual stocks" -- you SHOULD be! If you're investing in a broad, low-cost index fund, though, you're buying HUNDREDS if not THOUSANDS of companies. Go to Vanguard and just do a Target Date fund (convenient for rebalancing and proper risk/diversification). If you like dividends, consider VIG (which is their Dividend ETF), or their REIT index ETF (I forget the name right now)...both offer relatively broad diversification (well, the REIT is all real estate, but at least it's MANY individual REITs), low costs, and decent dividends (although not 15%, which is probably unsustainable). As for the mortgage, I'd be a bit wary of the interest rate hike when the 10-1 ARM expires, which is why you could try to throw a little extra towards paying down the mortgage quicker now. That way, you can refinance later if you need, and/or get rid of the mortgage entirely so you don't need have that expense when you have kids/go part-time, etc.

My personal opinion is that you are not saving enough in your cash fund. I created a quick excel table of what your Income minus Expense list is which revealed that you lacked an Emergency Fund (should be in high interest cash account), a Vacation Fund (for that big trip you want), and a Kids Fund (for future children). I would allocate $600/month in an Emergency Fund; $200/month in a Vacation Fund; $500/month in a Kids Fund; and increase your Medical Fund to $125/month. According to a study done by the US Dept of Agriculture last year, it costs approx $241,080 to raise a child to age 18. You would be well on your way to prepare for your first child if you started saving now. The emergency fund is super important, because we live in a fast-changing world where even mothernature is more unpredictable than ever. You are lucky now that both you and your husband have good-paying jobs, so you should take the opportunity to save for that rainy day/month/year because nothing is certain in life. I like to use pre-tax retirement funds to help ease the burden of tax time as well as saving for retirement. Check with your tax specialist and she/he will calculate the best amount of retirement savings for you. Begin to search and develop a good relationship with an investment broker, build the trust, because it will help you in the long run. I've known my investment broker since my college years where I began my first college campus job (obviously not a lot of money then). Even though I've moved away since college, we still keep in touch and he will check on me throughout the year with updates on my investments and retirement funds. He even helps with my company retirement funds becuase he's a friend now. I would be careful of investment risks right now. Many banks would tell you to diversify at your age and that leads to higher risk stocks, but take a careful look at the economy in the US as well as the world. I've observed many co-workers lose 50% or more of their retirement investments in high-risk funds because they thought they could ride it out. Do you research and don't be greedy. I hope this helps :)

I would rethink holding REITs in a taxable account. Your Roth IRAs would be a better spot for it.

Here is a decent primer on tax efficiency:

http://www.bogleheads.org/wiki/Principles_of_tax-efficient_fund_placement

Well I certainly agree that you are doing well.

I have a couple of thoughts I will share with you.

Initially-- I would suggest you refinance out of the ARM as soon as you can. When interest rates are at historic lows as they are today--- I feel you should lock in the low interest rate. At the same time you can put 20% or more down and stop paying PMI. At your income you do not need PMI---its a waste of money.

I am surprised that your one investment ( at least that you mention) is a REIT fund. The 15% dividend is a red flag as well. That means that most likely the price of the REIT has dropped recently. REITS are considered an alternative asset class and probably should not constitute more than 5% or 10% of your portfolio. They can be quite volatile. I would go with a low cost vanguard total stock index fund and total bond index fund. The allocation is subjective based on your risk tolerance, but at your age 80% stocks is reasonable.

While giving to charity is always a wonderful thing to do-- I think of it like the oxygen advice you get ( in the event of an emergency) when flying commercial airlines with kids. They advise parents to secure their own oxygen line first and THEN help their children. In line with this thinking-- I would secure my own financial future first before giving large sums to charity. this will ensure that you are in good shape to be a lifetime benefactor to the charities of your choice in the future. In other words-- I want to make sure that YOU are never in line to be the beneficiary of an charity!

In a nutshell-- increase your emergency fund to 8 months, refi to a fixed rate, max out both 401k plans, save aggressively in a taxable account for yourselves, start saving for the kids education and give to charity more modestly until you have a net worth of substance.

Good luck-

JNEW - couldn't disagree more about the charity thing, by that logic, the only way charities are going to receive money is through people's wills. To me (admittedly, based on a Christian perspective and based on what the Bible teaches about giving, so it won't be this way for everyone), giving to others is just as important as saving, if not more so - not giving crippling amounts, but giving overall. If you can afford to save thousands every month for yourself, then you can afford to give a substantial amount to others as well. And that should be done up front, just like saving, to avoid it becoming just a left-over thing. Not necessarily a popular standpoint in the personal finance community, but it sounds more in line with this couple's philosophy, so congratulations to them for putting their money where their mouths are!

OP here,
Thanks everyone for your insightful advice. We really appreciate it!
I’m honestly surprised that our cash position is low. Our thought processes was that because we can live off of one income (either mine or my husbands) and we’re in unfavorable interest rate climate for savings that it would be better to invest then hoard cash. We’d both have to lose our jobs in the same month with no severance and neither of us be able to find another job in order to need the E-fund. However, cash is a hedge against uncertainty and we’re young, still figuring out what we want in life, want to travel, and do hope for kids in the future. It makes sense to increase our cash reserves now while we have the flexibility to do so.

@Steve, yes our benefits are great and we’re hoping they stay that way! Also, even though there are beautiful large houses in our area we do remind ourselves that we do not want a huge mortgage. If we spend all our time working and driving to pay for a big house we’re never in that’s a waste.

@Jeff, JNEW I completely agree that the RIET is in the wrong account. It’s something I bought in college to “learn” about the market. It did well for a while but you’re right it makes more sense to have an index fund in taxable accounts.

I absolutely agree with r_meister on giving, and congratulate this couple on their generosity. My wife and I are similar to the couple in question in that regard - while we have goals to gain financial independence as soon as possible, one of our primary motivators is to be able to give generously. While we always try to strike a balance between saving/investing and giving, we decided early on that in order to protect against our greedy nature, we'd better give generously from the start. At 29, we're able to save about 40% and give about 25% of our gross income while living comfortably. We'll reach our goals soon enough, and when we get there we won't find ourselves with deep pockets but hard hearts.

I agree with JNEW on all points. While you're doing good, you really should take the steps he outlined to be in the position to live the life you desire once kids arive, including you should both by maxing your 401ks now, while you're young and working full time. Charity is very important, but in my opinion you need to put yourself in the position to provide for yourselves in retirement and your future family so that you are not at risk of becoming a burden on society, then as you establish yourselves you will be in the position in the future to give generously. In the meantime, IMO, the greatest gift you can give people in need is your time.


I would make sure I was maxing out my retirement plans both employer and individual. Then I'd put more toward emergency fund. After than, I'd take some of the surplus and put in a new (different) car fund so when the time came to replace a vehicle, I would have a good down payment in addition to the trade in. If you ever have children extra expenses and college funds will eat up a big portion. After that, I would add money to a budget category that made me happy. Like eating out, or a mad money account for each of you to spend without having to report in a budget meeting. It sounds like you're doing a great job.

I'd beef up my cash savings first. I think 6 months expenses in cash is a fairly good amount to cover emergencies like extended unemployment or similar.

You should also probably refinance out of that ARM to lock in a low interest rate. That will also let you get out of PMI once you've got 20% equity. You may need to refi to get out of PMI anyway, as lenders aren't necessarily obligated to drop it if you pay down principal early.

After that I'd dump everything excess into retirement like others have mentioned.


Regarding that REIT, if the 15% is the current yield then that is quite likely one that invests in mortgages or a mortgage REIT. They then borrows at low interest. For that kind of REIT their profits are really just arbitrage. That high dividend will drop when interest goes up. Hopefully you're aware of how it works and you've read the financial statements. But for people who aren't aware they should be wary of REITs with very high dividends and read up a little on what they actually invest in. If a REIT buys mortgages then its really just using low interest shorter term borrowed money to finance buying mortgages then making profit on the % difference. They're dependent on being able to refinance their debts and profits depend on getting a low interest rate.

You are right to be nervous about investing in individual stocks. Keep your equity allocation in index funds from a company like Vanguard that has ultra low expenses. At your ages, you'd be shocked if you did the math on how big a hit even a 1% 'management' fee would put on your nest egg before you retire.

Yes, I'd max out the 401ks first. I'd also keep making extra mortgage principal payments. Think of these payments as exactly equivalent to making an investment with a guaranteed, risk-free, pre-tax return of 3.25%.

If you still have a surplus, then you start building diversified investments outside of your retirement accounts. You'll be paying tax on the income as you go, so that's a significant factor in the allocation. I'd favor tax-advantaged opportunities: capital gains and dividends. I also encourage you to think outside the equity box. Real estate, a small business, lending clubs, education or training to boost income--there are many options besides equities. You'll have to do some research and move methodically, but you'll have fun!

Agree with r_meister and Jonathan. It's always easy to say that you'll "give more once you're established." Somehow, that time never quite comes (and, by the way, anyone short of the 1% who thinks he can assure himself that he will never need charity is kidding himself). If you think charity is important, it needs to be a priority from day one. I'm not saying that those who are genuinely struggling need to make matters worse for themselves, but remember the widow's mite. This couple is CERTAINLY well enough off to make a meaningful contribution to charity. Perhaps that entails a bit of a lifestyle hit. Guess what? If charity weren't a sacrifice, everyone would do it.

Let me be a bit of a contrarian on the E-fund. We are a couple in our late 30s with one child. We use a combination of cash and a taxable stock portfolio as our e-fund. We made the calculus that putting money in the best online savings account is not even going to get us one percent interest, and that seems like a waste to us.

We are at about 35 days of current expenses, and are aiming for 6 months' worth over time. However, I expect us to get there with 70-80% in the stock portfolio and 20-30% in cash. We do intend to grow our cash position to 6 months expenses eventually, but right now we are taking this alternate path.

We also set up (but did not tap) a $40k HELOC on the house. (we have about $70k equity) This makes us feel like we don't have to go to credit cards, etc., in case we have a heating/ac unit die on us, etc.

If I had your cash flow (ours is much tighter) I would probably split the difference between our current strategy and the max-cash-to-e-fund strategy.

Having a strong cash position is great but you guys also have the earning power to generate that quickly.

I would say get the E-fund to $15,000, then save up for a two-week trip that includes both Venice and Prague, and no more than 1 other stop.

Along the lines of the Dave Ramsey baby steps, I would build your emergency fund to 6-8 months of expenses, max out all retirement and then focus on knocking out the mortgage. FMF posted a good piece on his strategy for paying the mortgage off early and the OP could benefit from this if he hasn't read it yet. I have hit a number of financial milestones over the years, but I cannot think of any milestone that has given me more satisfaction than to have the mortgage gone and to be totally debt free.

I would agree with PJ on the EFund approach. You have very good cash flow and could survive a hit to either of your jobs (based on your additional comment). My husband and I have a couple months of cash saved up in a savings account and keep the rest in investments. We count every dollar in the investments as $0.50 towards our EF. So if we were looking for $18k to get 6 months, we would have about $6k in cash and a minimum of $24k in investments*. This way we don't miss out on the higher possible gains, AND we protect ourselves in the event that 2008/9 happens again where layoffs and a 50% drop in the stock market coincide.

"Or should we continue to pay down the mortgage aggressively with the intention of keeping this house as a rental when we move to a larger place with kids (5+ years down the road)?"

I would just pay down the mortgage for the sole reason of having it paid off/down. You don't have to have a goal of renting it. You can have a nice paid off house, sell it and then move if you need to.

I agree totally with JNEW regarding giving $1,200/month to charity at your age. That's a lot of money. Over the next 30 years that works out to $432,000 without assuming any investment gains. If you add in the effect of market gains even in an index fund you're looking at several million dollars by the time you are in your mid 50's.

CNN has done investigations on a lot of charities over the years and there are many bogus ones out there. Personally I would leave the charitable work to very smart, super wealthy people like Bill Gates, Warren Buffet, and the large group of billionaires that they have assembled in their foundation. They know how to use it to get the biggest bang for the buck.

I agree with Sarah's point on charitable giving 100%. Charitable giving is like saving. If you're waiting for a time when it will be magically easy to do, you'll be waiting the rest of your life.

@Old Limey: Billionaires who give to charity may have not such pure or transparent motives. Even if they don't have ulterior motives, their goals and values may not align well with the goals and values of the rest of us.

Old Limey - "I would leave the charitable work to very smart, super wealthy people..."

I can't fathom how a retired engineer with 20% year-over-year portfolio growth for 20 years and a $7 million net worth doesn't consider himself smart enough or wealthy enough to give in a way that might make a difference in someone's life.

@ Jonathan et al

If you do give then keep this article in mind.

http://www.marottaonmoney.com/when-helping-hurts/

As you can see even some conservatives think Old Limey is right.

I agree with others that if you wait until you have enough to begin giving to charity, you will die waiting. My husband and I regularly set aside money for giving away every month. We are so blessed, and giving money away regularly is a great reminder. We get more enjoyment from giving money away than from any other way we spend money. Some we give to church and charities. But our favorite way to give money is to give to those we know who are going through a difficult time, such as unemployment. We once gave money anonymously to our hair stylist who was unable to work for an extended period of time due to illness. It was so much fun listening to her talk about this money and speculating about who it was from. If you are hesitant to give because of what a charity might do with the money, volunteer with a charity whose cause you believe in. Being involved with a charity's activities will give you a lot of insight into how responsible they are with donations. I serve on the board of a local charity, and have no qualms about donating money, because I know it will be spent wisely. I encourage everyone to be involved in giving. It's so much fun!

"Personally I would leave the charitable work to very smart, super wealthy people like Bill Gates, Warren Buffet, and the large group of billionaires that they have assembled in their foundation. They know how to use it to get the biggest bang for the buck."

-----

Like this?

http://www.bbc.co.uk/news/uk-england-manchester-25016994

The synopsis is that the Bill and Melinda Gates Foundation just awarded a $100,000 grant to scientists to create a thinner stronger condom using Graphene.

I guess that's one interpretation.

@Luis - that's quite a stretch ... Old Limey says you can't give effectively, so don't give at all. Or maybe (more charitably), look after yourself first, so you don't become a charity case. That article says to give, but be careful with your charity. Specifically, #4 directly contradicts the attitude of the anti-charity PF crowd: "I will put the interests of the poor above my own (or organizational) self-interest even when it may be costly."

I have to agree with Jonathan (even though he didn't put it this way) that Old Limey's standpoint is proof of Sarah's statement - if you don't give when you have very little, you won't give when you have a lot. Fortunately, I've found that if you can truly give in a sacrificial manner, then you can also truly save in a sacrificial manner - ie, being able to give effectively actually does make you better with your finances. The difference is that it also keeps things in perspective - in the end, all the money in the world isn't going to let you live forever, which we can forget if we focus exclusively on the dollars and cents ...

Anyways, sorry for hijacking the thread, but it's encouraging to see many people here put an emphasis on giving as well as saving!

@ r_meister

I agree with you for the most part on why to give, its just that giving 16.4% when you pay PMI and have little emergency savings is silly. Forbid something terrible happens? The giver then becomes the beggar? That makes no sense at all, hence the "give smartly" statement by Old Limey I back up 100%.

Luis:
Thanks for the support.
I plan to eventually give everything we have but it will go to our children and grandchildren.

Although I am in my early 40's, your family's goals are very similar to my family's goals.

Double that emergency fund and then go on that trip you've always dreamed of. Travel is harder when you have kids. I love your idea of working less when the kids arrive. We did the same and have never regretted it! Follow that gut feeling I know you have and pay down the house to at least 25% equity and refinance into a 10 or 15 year fixed rate. Those extra payments you're making might mean you have no mortgage payments when the kiddos arrive, or at least a small, low payment mortgage on a larger home.

KEEP UP THE GREAT WORK!

@Luis, if you're still reading this - 16.4% is based on the after-tax salary, they stated they make "low six figures", I'm guessing they're tithing their before-tax income. I agree that bulking up the emergency fund and continuing to save should be priorities, but I think the approach of "when our income changes we adjust this amount" works well for their situation. If one of them loses their job, they absolutely can and should legitimately cut the donations - in the meantime, they have more than enough space to take care of themselves and continue to save.

As far as the giver becoming the beggar ... others have pointed out that you really can't self-insure for everything. There is no shame in that - I help people out now who through no fault of their own need a hand up. If someday I need a hand up, hopefully they or someone else will provide it to me. Again, I think I come from a very different philosophical position than Old Limey (and possibly you) - but I think people were created as social, not as individual, beings (note: this doesn't mean I think the government should be socialist - I actually believe they're far outside of their sphere of responsibility when they pick up the charitable tasks that are required in any society). So yes, I as the giver may some day become the beggar (in fact, I may whether or not I'm a giver), and I sure hope that if that happens (and may God graciously prevent it!), someone will be there for me.

My personal approach is to decide on an amount to give at the beginning of each year, and give that - no matter what. The guideline of 10% (usually based on my pre-tax income) works well, but is just a guideline. And I adjust if necessary based on changing situations (which does NOT include based on wanting to buy something for myself). There's a lot more I could write on the philosophy of giving, on individualism, stewardship, and on who's really in control - but those are quite a bit outside the realm of this particular blog, so I'll try to resist ... :)

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