Free Money Finance

Two Questions on Tax Refunds

Here are two questions about tax refunds:

• Are you going to get one this year?
• If so, what are you going to do with it?

I have not yet received my final tax return, so I'm not sure whether or not I will get one. My guess is that I will since I overpaid Social Security taxes (because I changed jobs). If I do, I'll simply save/invest the amount. I don't look at it as "extra" money and won't plan on going on a spending spree.

How about you? What are your answers to the questions above?

FYI, the average refund this year is over $3,000.

Reader Profile: GL

The following is the latest post in my "Reader Profiles" series. Each post in this series details the financial situation and challenges of an FMF reader. The purpose of this series is to help us all identify with people like us (in similar situations -- not all will be, of course, but eventually I'm sure you will find someone like you here), get to know the frequent commenters on the site, and hear some financial wisdom/challenges from people other than me.

If you're interested in contributing to this series, then drop me an email. The series seems to be very popular with readers and I need a steady stream of new ones to keep it going.

Also, please leave constructive comments, questions, and so forth. Simply telling someone what a mess they have, how they have made poor decisions, and so forth is not helpful. There is a way to say, "That was a mistake, but here's what you can do to correct it" that both acknowledges the problem and offers a solution. It's this sort of feedback that this series is intended to solicit.

Next in the series is FMF reader GL. She answered my questions (in bold italics below) as follows:

Tell us a bit about yourself.

I am a 20-something personal finance enthusiast, who makes no secret of her love for food, reading, and Pinterest. I work as an accountant at a hotel and live in St. Louis, MO. I am married to an awesome guy, who happens to stay home with out 5 month old, and we have a three-legged dog named Max!  My blog, Retired by 40!, tracks my progress towards retiring by 40.

Describe your financial situation.

I work as an accountant, my husband stays home with our daughter, but he attends school and drills with the Illinois National Guard, so he bring in money for going to school and drills.  I am not shy about sharing everything on my blog, so I'll do the same here!  Our after-tax income is $3,800 per month, and we break down our budget this way:

• Mortgage - $635
• Utilities (including phone & internet) - $300
• Vehicle Payments - $920
• Gas - $300 Insurance - $80
• Health/Life Insurance/Doc Bills - $313.33
• Anything bought at Walmart - $300
• Haircut - $20
• Entertainment - $8
• Savings - $150
• Student/Personal Loans - $620
• Total = $3,646.33

This leaves a bit of wiggle room for a meal out every other month or so, as well as small home maintenance issues and other things that inevitably pop up.

What are the current financial issues you face?

We have a personal loan that we are paying $500 per month on right now.  The balance is sitting right around $9,000, but because it is from family, we would like to get it paid off sooner rather than later.  Next on the list will be the huge car payment.  $670 of it is for our SUV (bought after the baby was born....) and $250 is for my husband's ATV.  Don't just me too bad on these!  They were impulse purchases that I made while swimming in hormones, and now we're paying the price :-)

Right now - even with our debt, our Net Worth is sitting at $51,025, give or take depending on the day, so when you consider that we're only 23, I feel that we're doing pretty well.  We bought a HUD home valued at 3x what we paid for it, so I feel that we did pretty well there!

Phase 1 is paying off debt and we're plowing through that as much as possible right now.

Phase 2 is moving out of our current home and turning it into rental property - yay passive income!

Phase 3 is saving and retirement - Hopefully by 40!  Right now we're on track, but who knows what the future holds!

What financial advice do you have for FMF readers?

Use the future value of money method to help stop spending money.  For example, $20.00 at McDonald's on a quick meal is the same as $300 in retirement!  Makes you want to go eat at home, right?

Also, it is never too late to start!  Just because you partied away your college years that doesn't mean that you have no chance of retiring early.  All it takes is some creativity and hard work!

Finally, be aware of your impact on future generations.  Are we setting a good example for our children and grandchildren?

Help a Reader: Partnership with a Family Member?

Here's an email I recently received from a reader:

One of my family  members offered me to start a business - 4 relatives would be involved.

Do you think it's a good idea?

Entrepreneur.com gives some reasons why it's difficult:

• You know so much about the other person--you've been privy to intimate information about them.
• You've most likely had arguments or negative conflicts with them.
• You have years of experiences with them, both positive and negative.
• You know the other person's "hot and cold buttons," the thoughts, feelings and behaviors that reward, cajole and pacify, or punish, threaten and dismiss the other person.
• Maybe you don't like your relative or, conversely, you're very close with that person, which means you could either be overly critical or overly protective of them.
• You may provide too much supervision or teamwork--or you may provide too little.

There is interesting comment at the bottom of the piece.

I would like to see your opinion about it and FMF readers' comments.

What are your thoughts for him?

What is the Ideal Retirement?

Here's an interesting article from Time that talks about redefining the ideal retirement.

Not that there ever was ONE ideal retirement, but the generally accepted retirement a generation ago was one where you worked until 65, lived it up for 5 to 10 years, then died.

As a contrast, here's what more and more people are thinking of these days:

Once common and easily defined, the ideal retirement is now highly individualized and increasingly difficult to achieve because of our longevity, retirement savings shortfall, and the financial setbacks of the past six years. But if you embrace the new model and can find satisfaction with your extra years on the job, it’s still possible to retire in style.

For the financially prepared, this is an exciting time with many options. Sometimes the ideal retirement involves working full time—but at something completely different. It might mean volunteering, teaching, mentoring, consulting, getting into politics, writing a novel, or going back to school—for the fun of it.

The piece goes on to list five factors that make a great retirement as follows:

• Financial freedom
• Purpose
• Good Health
• Close Relationships
• Giving Back

I'm still thinking about what my retirement will look like as it's at least a decade away. That said, all five of these are issues I thinking now as they all seem important in having a great retirement. My current thoughts on each:

• Financial freedom - Obviously I'm working on this one as I've been documenting my thoughts/progress for years here at FMF. :)
• Purpose - I can see taking some time off in "retirement" and traveling/relaxing, but I don't think I could do that for 10 to 30 years. I'd go crazy!! So what am I going to do in retirement that has meaning?
• Good Health - I swim a mile three to four times a week but don't eat like I should. If I want to be healthy in my golden years, something's going to have to change.
• Close Relationships - I would LOVE to live somewhere near my kids when I retire. Just not sure where they are going to end up.
• Giving Back - Perhaps this is the answer to the "purpose" question above. Can I find a cause I believe in and work for free/reduced salary to help it? Maybe.

Anyway, retirement isn't as simple as quitting your job and hitting the beach. We used to think it was (though it never was IMO) but now we're wising up. There are many more issues to take into consideration and they need to be thought through well before your last day of work.

What's your take on the items above? Have you considered any of them as part of your retirement planning?

What is the Best Free Retirement Calculator?

I recently ran into a post that highlights the three best retirement calculators. It does a great job of detailing what the author considers to be the best options, including strengths and weaknesses, and summarizing the situation as follows:

Free retirement calculators are plentiful on the web. These are three of the best, in my opinion. Try them. Try more than one. But use them all with caution!

Understand that retirement calculators aren’t giving you the answer to a simple mathematical equation. They are actually attempting to model the future. That’s a tough assignment. One that is actually impossible, in any precise sense.

I don’t recommend relying on any of these tools, and then resting on your laurels. Consult them, at least annually, to optimize your near-term financial decision making, while understanding that the future will inevitably turn out different than planned.

Lots of thoughts on this one. Here goes:

• I have heard of two of the three options he highlights, so I guess I'm fairly in the know. :)
• One of the options is from Vanguard, a company I use and trust. It's a very easy calculator to use. I plugged in 40 years, $1.7 million, $50,000 spent each year, and a stock/bond/cash mix of 20%-50%-30% and it gave me a 96% probability that my portfolio lasts 40 years. Given that I could easily live off $50k plus what my rental units generate, I guess I'm ready to retire now!!! :)
• The second is from Todd Tresidder who wrote the best book I've read on retirement titled How Much Money Do I Need to Retire?. It's a bit more complicated, but worth the time. I went through it a year or so ago in updating my own retirement plan.
• I don't know much about the third option, but I am going to check it out. It looks like a more complicated version of what Vanguard offers, but that's just my first impression.
• Two key points of the article are 1) there's no perfect calculator as you're trying to predict too many future variables, and nothing can do that and 2) any calculator should be used simply as a guide and combined with your own judgment, experience, personal life preferences, and so forth. Couldn't agree more.
• The fact that these are the three best FREE retirement calculators begs the questions, "Is there a better calculator than these that you can pay for?"

Anyone have anything else to add? Have you used a retirement calculator recently? If so, what did you think of it? 

How Many Americans Live Paycheck-to-Paycheck?

Time recently posted that nearly half of Americans live paycheck-to-paycheck. Their summary:

Too many of us are living paycheck to paycheck. The CFED calls these folks “liquid asset poor,” and its report finds that 44% of Americans are living with less than $5,887 in savings for a family of four.

A few thoughts on this:

• I'm not sure how they got "living paycheck-to-paycheck" from "44% of Americans are living with less than $5,887 in savings for a family of four" but that looks like the leap they made.
• If it is actually 44% living paycheck-to-paycheck, that's better than I thought it was. The book The Difference: How Anyone Can Prosper in Even The Toughest Times by Jean Chatzky lists 54% of people as living paycheck-to-paychecks plus another 15% actually spending more each month than they bring in. Details can be seen on my post titled The Difference Between the Wealthy and Everyone Else.
• My personal opinion is that at least 50% of people are living paycheck-to-paycheck, but I have nothing to back that up other than my own gut feeling.

What's your take? Anyone want to venture a guess how many Americans are living on their most recent paycheck (based on those you know)?

Money Expectations

The Motley Fool has a great piece titled How to Get Rich, Feel Rich, and Stay Rich. The piece contrasts those who make a lot of money and are unhappy with those who make relatively little and are joyful. Here's a summary of their thinking:

Wealth is relative. Those are probably the three most important words in personal finance. Gary makes $25,000 a week and feels inadequate. Pete makes $25,000 a year and feels so rich that he retired eight years out of college. How rich you are has very little to do with how much money you have in the bank and a lot to do with your expectations of what you need that money to do for you. It's a two-part equation, and a lot of people become miserable ignoring the second part.

The article then goes on to look at various expectations-versus-reality scenarios with the conclusion being this: the higher your financial reality is above your expectations, the happier/more satisfied you are. It's a very interesting piece and one I mostly agree with.

The article spurred a couple thoughts I wanted to share with you:

• The difficulty seems to be maintaining your expectations in light of success and the success (or apparent success) of those around you. When you're starting out, you may have high hopes of making a good income, but probably not a lot of expectations as to whether or not that will actually happen. Then, as you become more successful and make more, your expectations grow, many times surpassing the rate at which your success/income grows. Pile on top of that the "success" you can see from neighbors, friends, family members, etc. (like new cars, big homes, expensive vacations, etc.) and it's easy for most people to have expectations much higher than reality, which in turn makes them unhappy.
• I think it also matters a lot what you value. Personally, I'd rather have a $1 million net worth than a big salary, a huge home, the appearance of living it up big, and so forth. Since I value the creation of wealth more than the appearance of wealth and/or "having stuff", it's much easier to accumulate wealth by doing the simple, basic, mostly unglamorous things that grow wealth. Most people seem to value possessions and their expectations are "just a bit more than I have now." But when they get there their expectations aren't satisfied, so they simply increase what they expect to surpass the new normal. And as a result, happiness is never achieved.

Let me know what you think on this subject. Should be an interesting conversation...

Millionaire Interviews 22

Here's the latest in my series of millionaire interviews, discussions with everyday people who have practical tips and insights into growing and managing wealth.

My questions are in bold italics and their responses follow in black.

Let's get started...

How old are you (and spouse if applicable, plus how long you've been married)?

I am 58 and my wife is 56. We have been married 14 years, a second marriage for both of us.

Do you have kids/family (if so, how old are they)?

I have two grown children from my previous marriage ages 35 and 33.

What area of the country do you live in (and urban or rural)?

My wife and I live in the Northeast in a suburban area of a mid-size city.

What is your current net worth?

$2.25 million

What are the main assets that make up your net worth (stocks, real estate, business, home, retirement accounts, etc.) and any debt that offsets part of these?

• Savings & Investments-52%
• Tax Deferred Retirement Accounts-38%
• Personal Property-10%

We live in a region where housing is very affordable (but not property taxes). We own a modest 1860 square foot home built in 1928 with a market value of $175,000 (regional average market value is $115,000) with a low interest rate mortgage balance of $26,000. We also have a 1/3rd partial equity interest in a 2nd generation family cottage valued at $100,000 and clear of debt. We own 2 vehicles valued at $20,000 each that are also clear of debt. The modest outstanding mortgage is our only debt.

What is your job (type of work and level)?

I am a healthcare executive and my wife is a public sector attorney

What is your annual income?

My income is $172,000/yr and my wife is $86,000/yr

How did you grow your income so high?

With only a BA degree in accounting, I used my leadership and financial skills to rapidly advance up the management ladder in a medium size healthcare organization. I made a key decision at age 33 to work towards achieving a healthcare administrator license, which I received at age 35. From there I advanced into administration and eventually president/CEO of the organization at the age of 45.

What is your main source of income? What is your annual spending?

Our employment compensation is the only real source of household income other than investment income, which we allow to accumulate within our investment funds and currently don’t use as a source of household income. Against a 2013 household income of $258,000, our annual expenses for 2013 were $150,000 allowing us to add to our investments approximately $100,000, which computes to about a 40% household surplus margin.

Our 2013 expense category spending breakdown was as follows: 49% payroll taxes, 7.5% general merchandise, 7% charitable donations, 6% groceries, 4% gas & auto, 4% property taxes, 4% ATM cash withdrawals, 4% utilities & services, 3% vacations, 3% major household purchases or improvements, 2.5% dining out, 2% mortgage interest & insurance, 1% medical & health insurance, 3% misc. & other

What have you learned in the process of becoming wealthy that others can learn from?

For me it was a process of 4 steps.

First, “Work the Income”. Obviously, the more you earn, the more opportunities to save. In the early stages of net worth growth, the primary source of equity will be your income. So work long and hard to maximize your household income.

Second, “Manage the Margin”. A household with $80,000 of income and $50,000 of expenses is no further behind a household with $250,000 of income and $220,000 of expenses. Live well within your means by managing your expenses in a way that results in a healthy net surplus margin.

Third, “Save the Surplus”. Don’t be tempted to spend more because you have more. Make regular direct deposits to your retirement and other investment accounts in addition to periodic transfers from any additional household surplus.

Fourth, “Ride the Market”. As your investments grow from your household surplus, establish an investment portfolio using low cost, index mutual funds consistent with your personal risk & reward comfort level. It takes money to make money, so while your portfolio growth from income will start out slow, in the later years you’ll be amazed at how rapidly it will grow.

At the risk of sounding like every other financial pundit, my biggest regret is that I didn’t start earlier. When I re-married at the age of 44, our combined net worth was less than $200,000 with personal property representing about half of that amount. I shared that fact with my daughter recently to give her encouragement as her own household struggles with the financial challenges faced by a young, growing family.

Another mistake I made was thinking that I could self-invest my way to wealth. I started buying individual stocks in the early 2000s after everyone had run the market up making easy money, but learned pretty quickly it wasn’t that easy. I lost ground early before I figured out that I should leave the investing to professionals and invest in low cost, diverse index funds with excellent long-term performance results.

What are you currently doing to maintain/grow your net worth?

I’m sticking to my 4-step game plan. I try to keep it very simple and turn-key. As we approach early retirement, our compensation has leveled off but we continue to manage our margin rather easily. Don’t get me wrong, I don’t like to live within a budget or want for anything anymore than I like to diet or exercise. However, I’m a naturally frugal guy who likes to eat healthy and live an active lifestyle. So for me, working the margin, saving the surplus and riding the market come naturally and never feel like dieting or exercise. I’m well into my wealth accumulation journey so now I am reaping the benefits of making money off my money. Just last year on the wave of a very bull stock market, our net worth increased $600,000 with $100,000 coming from our margin surplus and $500,000 coming from investment growth.

Do you have a target net worth you are trying to attain?

I’m a fanatic planner and my wife and I are approaching what I call the first stage of retirement (semi-retirement). My target investment goal from several years back was 2 million dollars, but now that I have reached that goal the sky is the limit. That is the benefit of disciplined financial planning I guess. We have many options open to us and we can decide which we desire without worry or financial constraints.

What are your plans for the future regarding lifestyle?

Semi-retirement at age 60-62. Do something different from a career perspective. For my wife that might be running for town judge. For myself that might be consulting or part-time work in a line-staff position where I can sit around and complain about management for a change. We are also looking to purchase a waterfront retirement home in a warmer climate region where we can enjoy visitations with our 5 grandsons and family.

Is there any advice you have for FMF readers regarding wealth accumulation?

Follow the 4-step process, keep your investments simple and stay disciplined.

From 2000 to 2005, our net worth grew from $187,000 to $600,000 with 80% of that growth funded by our margin surplus (33% average) and 20% investment earnings.

From 2005 to 2010, our net worth grew from $600,000 to 1.325 million with 67% of that growth funded by our margin surplus (40% average) and 33% investment earnings.

From 2010 to 2013, our net worth has grown to 2.25 million with 33% of that growth funded by margin surplus (41% average) and 67% investment earnings. 

I would also say that I am a believer in the equity market over the long run and invest 100% in a diverse array of equity mutual funds. I ride the market (ups and downs) but over my 15 year plus time horizon that strategy has worked out fine. I would also suggest that a household’s wealth accumulation plan is only as strong as the weakest household member. My spouse and I share similar financial and spending philosophies (to an extent) and that is key. I once gave my wife a written quiz on our finances. To this day I’m not sure which is more remarkable to me; the fact that she aced it or the fact that she actually agreed to take it.

2013 Net Worth Review

Each year on FMF I post a review of my net worth and detail the ups and downs of the previous year. Here are my 2013 net worth highlights:

• Net worth ended 2013 at another all-time high, up 19.5% versus the previous year. This was well below the S&P 500 return of 29.6% because a good portion of my net worth is in investments or categories that are not designed to grow quickly (or even at all.) For instance, my real estate holdings are designed for income, not growth. I could assign them an appreciation amount (based on current market conditions, they are up 20-40% since I purchased/improved them), but have chosen not to. And assets like my house, cars, and cash investments either don't gain value (at least any I recognize) or lose it (I have one car completely depreciated and the other will be done this year).
• In addition, I continued to add a liability to my net worth. My kids are in high school and college isn't that far off. I have always included the value of their 529s in my net worth, but now that those dollars will be spent within the next several years, it's time for me to recognize the expense side. So I created a liability for college costs in 2012. I added $60,000 in "debt" in 2013, dragging my net worth down further.
• On the plus side, I am a strong saver and the index fund investments I did have performed very well. And a 20% gain on what is now a fairly sizable net worth is a substantial amount of money in itself.
• I had record net worth highs for eleven of the twelve months in 2013. That certainly made for a nice year. :)
• This year's performance brings the compound annual growth rate of my net worth to 14.79% over the past 17 years (I started tracking it in 1996).
• I should hit my crossover point in a year or two. That said, I have re-done my retirement plan and upped my goal significantly. My current plan is to work for 10 more years (I like my job, so why not?) and retire at 60. That said, I may get there and decide to work another 10 years. :)
• My rental income was low as I made substantial investments in the properties. I also had several months where units were not rented because they were being remodeled. I should have all the major efforts completed by the end of May and all units at their max earning capacity by summer. I will give a more-detailed update once the smoke clears, but first I need a post on the third property I have purchased.
• At the end of the year, I bought a new (literally) house in my new city for roughly twice what my old one cost. It wasn't my preference to sink so much into a non-performing asset, but it was the best option we had given our location, preferences, etc. FYI, we paid cash for it and continue to have no debt.
• I've already shared many of my resolutions for 2014, but I'll add a couple more: 1) invest all the cash from my 401k rollover into appropriate index funds (I'm about half way done) and 2) Add another $60k in "debt" for college costs -- which should get me "fully funded."

In addition to the information above, here are a few fun facts I thought you might enjoy:

• 88% of my 2013 income was from my career (which this year was two jobs split almost in half.) I expect this percentage to go down as my rental units come up to speed.
• Of my income, 39.6% went to taxes. This includes payments for 2012 taxes in April, payment of quarterly estimated taxes in 2014, and "regular" deductions from my paycheck. I'm expecting a refund this year as I paid Social Security taxes twice at two different jobs (and paid the max on each of them.) In addition, I sold some securities last year to buy rental units and that drove my income artificially high, so I'll actually have a lower income this year.
• 25.7% of my income went to giving. This was split between my church and three major charities we support. We used to give a small bit to 25 or 30 charities and now we give a lot to three.
• The remaining 34.7% went to spending and saving. There was roughly an equal split between the two.

That's it for this year! How did your net worth perform on 2013?

The Retirement We're All Trying to Avoid

When I read this piece from MSN Money it made me think of one word: yikes!

Here's the part that made me squirm:

At the height of his corporate career, Tom Palome was pulling in a salary in the low six-figures and flying first class on business trips to Europe.

Today, the 77-year-old former vice president of marketing for Oral-B juggles two part-time jobs: one as a $10-an-hour food demonstrator at Sam’s Club, the other flipping burgers and serving drinks at a golf club grill for slightly more than minimum wage.

While Palome worked hard his entire career, paid off his mortgage and put his kids through college, like most Americans he didn’t save enough for retirement. Even many affluent baby boomers who are approaching the end of their careers haven’t come close to saving the 10 to 20 times their annual working income that investment experts say they’ll need to maintain their standard of living in old age.

When the 2008 financial crisis hit, what little Palome had saved -- $90,000 -- took a beating and he suddenly found himself in need of cash to maintain his lifestyle. With years if not decades of life ahead of him, Palome took the jobs he could find.

A few thoughts on this:

• First of all, kudos to him for being willing to work at any job to make ends meet. I know it must be hard but the article shows that he has a great attitude about his situation.
• What a nightmare! This is would be a terrible result IMO and the exact opposite of the retirement I'm planning for.
• The key issue: he simply spent too much. He made six figures for at least part of his working life which means he likely had an above-average salary throughout his career. And yet he managed to save only $90k -- a number BELOW his final annual salary level.

I can't help but both feel sorry for his situation and be reminded that this could be me if I don't stick with my plan (through I'm way past $90k in savings). Hopefully it will encourage you in the same way.

Help a Reader: Buying a Home

Here's an email I recently received from a reader:

I have been a long-time renter, but now married with 2 small kids I’m considering buying my first home. I’ve done some research and talked to some banks, but the thing that’s making me hesitate is that I’m worried that houses are overpriced because of the current low interest rates.

The way I’ve approached the home buying process, and the way I think most people do, is to see what kind of mortgage I qualify for, and then use that to figure out what kind of house I can buy. Currently I qualify for about a $500K mortgage at a 4.25% interest rate.  However, if the rate goes up to 6.25%, which is still very low by historical standards, I’d only qualify for about a $400K mortgage, which would mean that the prices of the houses that I could buy would decrease by 20%.

If this is the approach that most home buyers use, if rates went up to 6.25% home prices would fall 20% as everyone would only get a mortgage that’s 20% smaller. I know that if incomes rise along with the interest rates that wouldn’t necessarily happen, but I’m not optimistic that incomes will rise that quickly.

I really haven’t had much experience with this, so I’d appreciate you could point out any faults in my thinking.

What are your thoughts for him?