Things I've Learned in Angel Investing

I've helped friends start three companies so far, and helped another continue on for a bit before losing everything I put in. Here's a few things I've learned in my informal angel investing adventures.

1. Only invest what you can afford to lose.

   As with all investing, really. Investing in a single company is very risky; it's putting all your eggs in one basket. Investing in a startup is like putting all your eggs in a basket made of a new experimental material with properties unknown. It might be a nice titanium alloy, or it might end up being a new origami pattern that disintegrates in a bit of rain. It can be a decent place to put truly spare cash, though.

2. Put the terms in writing.

   There will be confusion on anything not in writing, and even then there could be some. Think the arrangement is trivial? Someone will remember it as an investment, and someone else will remember it as a loan. The small business owner is going to forget the need to pay out quarterly for estimated taxes (though, this isn't a problem until you are in a position to have to pay them -- earning so much on the side that you surpass your regular employment's withholding, or retired and not withholding anything). Questions will arise when new investors want to join. Does the owner get a salary paid off the top? Better to just write it down and amend things when new issues come up and are decided.

   Do as I say, not as I do, on this one.

3. Be wary of replacing a departing investor.

   If you are being approached to provide capital to replace some that a departing investor pulled out, extra caution is warranted. Investors can cash out for plenty of legitimate reasons (retiring and buying a summer home, for example). But, it could also be a sign that they saw something wrong. If it's been long enough for an investor to pull out, it's probably an established business. That means they've been in business for awhile and have not built up enough reserve capital in all that time. It's an increased risk, for sure.

4. Be wary of contributing only a portion of initial startup costs.

   Let's say a company needs $100,000 to start up, but you can only afford to invest $50,000. Include a clause to cover the possibilities. Either they don't raise enough to start at all, in which case you want to make sure you get back whatever money you've already given them, or they find a cheaper way to start up. But in this latter scenario, the likelihood of needing to raise more capital increases, and you need to make sure you're fine with the consequences. You're going to have your share diluted, or you need to include a clause about where that dilution comes from, up to their initial capital raise goal, as an example. Or they fail to raise more capital and go out of business.

5. Be prepared to do your taxes late.

   K-1s almost always arrive late. The more businesses that you invest in, the higher the probability you will have to file an extension. Pretty much always, in my experience.

6. Feel good about it.

   This has two parts. Before you pull the trigger, have a generally good feeling about the investment. Trust your gut to whatever extent you normally do. Afterward, don't stress too much. If all else fails, you helped employ one or more people, and you helped someone try to achieve their dream. And since you followed #1, you can afford to fail economically. Silver linings!

Third Refinance

Yesterday, I closed on my third refinance. This is my fourth loan for the house in just over 6 years of owning it (http://eis271828.blogspot.com/2007/05/house-closing.html). I opted for a 15-year loan at 3.000% interest, which was the no-cost refinance rate. My out-of-pocket costs were #3115.86, which included $1549.21 in principal reduction, because I wanted the new loan to be a nice round $200K, and the customary prepaid interest and escrow pre-funding. I should get $1,433.34 refunded from my old escrow in awhile. Not too bad.

The 3% interest rate is lower than my estimated long-term rate of inflation (http://eis271828.blogspot.com/2010/08/annualized-inflation.html), which means I am borrowing money for free! The principal portion of my payment is also hugely higher than the interest portion, which makes me all kinds of happy inside. Because I was paying slightly extra on my old loan, my new payment is only about $20 more per month. I will not be paying anything extra toward this mortgage. Except, I am guessing that as I approach the end of the term, I will want to get rid of the monthly payment and still pay it off early.

I also have a nice happy feeling because I just helped the economy! For the most part, mortgages are owned by wealthy companies/individuals, and I lowered the interest rate they're earning from 4% to 3%. My local broker got some extra income, the state of Kansas got some extra fees, and everyone came out ahead!

Refinance, Round 2

I refinanced my mortgage back in May of 2009, and it's apparently time to do so again. I'm going about things a bit differently, this time. I'm using the same mortgage broker as last time, though he's with a different company now: First Trust Mortgage. I guess I'm just listening to his advice more now.

Currently, I pay $1400/month, which includes a decent pre-payment amount, and I would currently pay off my mortgage in 230 more months. I decided to formalize that this time around and get a 20-year mortgage, which lowered my rate 0.25% compared to a new 30-year. This puts my required payment at just under $1300/month, which means I'll round up to $1300, of course. So, I'll increase my projected term by 8 months, but save $100/month and pay less in interest.

Another change is that I've opted for a no-cost refinance. Here, the lender pays my closing costs in exchange for an increased rate of 0.25%. I crunched the numbers again, and paying the costs myself for the 0.25% would save me 2 months off the end of my loan. If I refinance again, or pay it off early (likely once I get down to the last few 10,000s in principal), paying the extra money out of pocket now does me little to no good. I don't plan on refinancing again, but I didn't think rates would drop when I refinanced two years ago, yet here I am.

I'm quickly realizing that no-cost refinances don't mean there are no out-of-pocket expenses. I still have to pay the prepaid interest that accumulates between my closing date and the date of my first payment on the new loan. And I have to pay the accumulated interest on my current loan between my last payment and the closing date. I've also opted NOT to waive escrow this time. So, I'm shifting some expenses from December up to now, to the tune of roughly $3300. Add the interest payments, and it'll be more than $4000 out of pocket. It's all money I would be paying this year anyway, though.

One of the main reasons I decided to not waive escrow (I still think this is one of the stupidest terms - you aren't waiving escrow, you're paying in order to not do it) is that I was told you can often call your lender after awhile and request to waive escrow then - with no costs. They don't have to let you do it, but it sounds like they often do. I also have the spare cash now, whereas I didn't have nearly the reserves in 2009. So, I can shift my payments from December to now in order to save $500 or so. And again, if I do refinance again, that money would either be paid to waive escrow again, or I'd be back where I am now.

Another interesting tidbit came from my credit scores. Back in 2009, I averaged around 796, I'm pretty sure. Now, I'm averaging just above the top tier cutoff of 740. I'm pretty sure most of the loss is from getting a credit card back in December that I've been regularly putting large balances on and then paying off again. The combination of the recent credit application, high utilization on that card, and some randomly high activity on a credit card of my parents' that they included me on long ago in order to build my credit history, has resulted in a slight ding on my credit. It still seems to be OK, since I'm over 740 on all three. However, it would be quite annoying to have problems because of these otherwise irrelevant credit score fluctuations. I'll find out within the month!

Dropping DirecTV

My friend Brian called to cancel DirecTV a long while ago and was given an awesome deal for some basic HD package for roughly $25/month. I called to cancel my service and was offered a basic non-HD package for $35/month. I declined that offer, but not before the customer service representative tried to compare DirecTV with what I said I would be using. Netflix only offers older movies, apparently, and this would somehow matter to a person who doesn't have any movie channels in their plan....

She also didn't know things start playing on Netflix virtually instantaneously. She claimed I wouldn't get my local channels even though I explained that I would get more local channels, and in digital HD, for free using an antenna. I had to explain that TheDailyShow.com and ColbertNation.com make their episodes available, I have access to tons of Comedy Central stand-up through Netflix, and can watch Rachel Maddow online, too. I can even watch tennis in HD on espn.com. She didn't seem to have a good reason to stick with DirecTV, other than my stated entertainment sources being different.

So, I wasn't offered a sweetheart deal. The cancellation went through, at which point I was informed that I would owe a $180 early-termination fee for nine months of a contract I was apparently under. Three months ago, I had called AT&T to combine the billing of my internet and DirecTV, thereby saving $5/month (which only just started getting applied to my bill). I was informed by the AT&T representative that if I had any contract term, then I would be under a new 12-month contract. However, if I was not under any contract, then I would still not be under a contract. I fear all commitment other than marriage, so naturally I double checked that with the AT&T representative.

After about ten minutes arguing with the DirecTV lady, she agreed to ask her supervisor/manager whether she could waive the cancellation fee. Even through the frustration I was feeling, I was interested to note that she asked via instant message, and in the end the fee was waived. I'm still not happy about that situation, and I'm sad that my last experience with DirecTV reinforced the overall feeling I had that they took advantage of their long-time customers (or tried to). DirecTV service will stop at the end of the month, though, and that's the important thing.

Trade Deficits and Trading

There's been a lot of talk over the years about the trade deficit as concerns imports and exports. I understand that concept - we buy more than we sell, so money is leaving the country. I also understand, roughly, that that's a bad thing. Well, I used to understand that. Looking at a section of the previous link, there seem to be a lot of smart people that think trade deficits could be a good thing. That may be a topic for later.

I've been curious as to whether money is actually leaving the country, overall. This balance of trade really only covers the import and export of physical goods and real services, as near as I can tell. I can find no indication that the portion of treasury auctions purchased by foreign entities counts as either an export or import. This statistic also doesn't count profits and losses from stock trades, bonds, forex trades, etc.

Awesomely enough, some of that data can be found. It looks like I could spend a few years sifting through the data at the Treasury International Capital (TIC) site. It took me most of a day to read the FAQ! But, there's some absolutely great data, such as this grand total table of foreign transactions. And these grand total tables of foreign liabilities and foreign claims. And this other table of derivatives contracts stuff. There's a lot of information to read on how to use all this information. Then there's this table of everything (Flow of Funds Accounts) over at the Federal Reserve statistics site.

Perhaps you can see why I said I found a lot more information than I expected to. I still don't think this covers everything. For one, the FAQ says there are a lot of errors due to a variety of factors. And even with all these statistics being complete, I don't think they would be able to answer my question. I'm still not sure if these show any profitability in all these trades, and I'm almost positive they don't cover forex transactions, since that has an average daily volume of $3.98 trillion, and I don't see any figures with large enough values to cover that. I have to admit that I'm tired of looking into it at the moment. However, if anyone has the answer, or even just another piece of the puzzle, please do let me know in the comments!

Q&A: How Many More Topics Do You Have?

Zero! The answer is zero! Wow, that was a quick blog post. Want more? If so, let me know what you want me to talk about! It can be about anything. Just because most of my recent posts have been financial in nature doesn't mean that's all I will discuss. So, give me some ideas!

Q&A: Should I Buy a Bigger House for Roommates?

Following last week's post on the ROI of rental properties, another interesting question is whether you should buy a small one-bedroom condo (for example) to keep expenses low, or a three- or four-bedroom house to gain some rental income. There are two main considerations: ROI and overall financial safety.

As far as ROI is concerned, I think it's very similar to last week's calculations. There are some differences in the details, though. Your principal and interest (P&I) payment will be higher, but when determining the ROI on the rental portion of your property, I think it should be specified as the difference between the large house's payment and the small home's P&I. You would have had the base P&I payment anyway, so it's not really a cost associated with the renters. Similarly for most of the expenses. Property taxes and insurance will be higher for a larger house, usually. Maintenance costs will be higher with the increased wear and tear, and you'll need a larger refrigerator, but maintenance costs haven't risen that much for me. Utilities will be higher, but probably not terribly so.

Your investment amount should be the increase in down payment, or the difference in overall home value. In this scenario, I am strongly inclined to use the overall home value in my calculations. This gets into the overall financial safety aspect. A pure rental property can be abandoned and sold off if you don't want to deal with renters anymore. If you get tired of having roommates, you can kick them out, but you still have to pay for the entire house. Lowering your expenses requires moving and the house-buying-and-selling process and headaches associated with it.

Consequently, I think it is very important to buy a house with many financial cushions included, even when you plan on having roommates. As I mentioned ages ago, I bought my home knowing I could afford the payments and other costs using just my base salary after all my preferred expenses had been taken out - 401(k) contributions, IRA contributions, miscellaneous spending money. Each of these expenses was a cushion, and any rental income was a nice bonus.

And there are other reasons why you may not have roommates anymore. I would guess that most people are single when they contemplate having roommates in a house they are buying. It's possible you meet that special someone that thinks you're a special someone, too. Roommates may get in the way then. It's possible that special someone comes with a second income that's much higher than that provided by roommates, but they might also be going (back) to school, or you might be having kids right away and one of you will be staying home. Either way, it'd be nice to be able to spend your first year together in wedded bliss, rather than struggling to downgrade your home.

For me, it seemed to make sense to buy a bit bigger. It's definitely worked out so far. On the other hand, I'd have a much lower debt than I have now, and might have purchased a standalone rental property already. It's hard to know exactly how things would have been different, but I can't say I've had any major regrets with my house and/or roommate situation.

Q&A: What's a good down payment size?

This is actually quite a complicated question. For one, things can change rapidly. For example, the interest rate penalties for high loan to value (LTV) ratios used to be higher. I believe they have been reduced in many cases as part of the effort to improve the housing market. On the other hand, a lot of loan regulations have gotten stricter to avoid bad loans entering the market again. Basically, rate changes related to your LTV need to be discussed with your lender.

Private Mortgage Insurance (PMI) still needs to be purchased when your LTV is greater than 80%. PMI is typically equivalent to a 0.50% to 0.75% interest rate hike for the period it needs to be paid. Some lenders advertise PMI-free loans even when your LTV is greater than 80%. The PMI still has to be purchased, but for these loans the lender buys it. They will pass this cost on to you via a higher interest rate - there is no such thing as a free lunch. Because your interest rate won't change for the life of a standard 30-year fixed rate mortgage, this interest rate, even if it results in lower monthly costs than buying PMI, could very well cost you more in the long run. Again, go over the details with your lender.

When it comes to deciding between making a larger down payment and buying PMI (or accepting a higher interest rate to cover PMI expenses), you have to look at the best use of your money. My previous post on whether or not to prepay your mortgage could be helpful in evaluating your options. Personally, I would rather avoid PMI than invest a few thousand dollars, say. Whatever you invest that money in would have to earn you more than the PMI payments and extra principal and interest payment amount (minus taxes on the interest and PMI, since PMI is tax deductible like mortgage interest). In fact, this should be considered an addendum to my previous post: The return needed to overcome PMI probably warrants paying extra principal at least until you reach 80% LTV. Psychologically, I just hate the idea of paying private mortgage insurance because it only benefits the lender.

Paying extra principal at the beginning such that you have less than 80% LTV ratio mostly follows my previous post's recommendations. The only difference is that the extra principal in this case does reduce your minimum monthly payment. When determining the terms of your loan, though, you have another option to reduce your payment: you can pay points to reduce your interest rate. As you can see using my refinancing calculator, reducing your interest rate can reduce the interest portion of your payment more than the total monthly payment amount in some cases. You have a choice in which number you use in determining your break even point, but obviously the total monthly payment might be all you care about.

I would make a point-paying calculator, but the cost of each interest rate reduction isn't always the same. For example, it may cost you half a point to move from 5.000% to 4.750%, but another half a point to move from 4.750% to just 4.625%. The user interface of such a calculator would be clunky at best. You can use the refinancing calculator fairly easily to get individual values and compile your own table of break-even times, though. Just find a payment amount for a 0-point loan and plug that into the current loan information fields. Then zero out the closing costs and adjust the points value and find the resulting interest rate entry.

Overall, I would tend toward a 20% down payment if you can afford it so you can avoid PMI. After that 20%, paying points will usually reduce your monthly payments more than extra principal. I paid half a point on my first loan, I think, and zero points on my refinance, other than the quarter-point fee I paid to waive escrow. For the most part, it comes down to what you feel comfortable paying up front versus owing later. I'm not sure there's ever a clearly wrong decision!

Q&A: Should I Pay Down Extra Principal Each Month?

Whether or not to pay down extra principal each month is a complicated question, and one that doesn't have a universal answer by any means. For the purposes of this discussion, we'll assume that an extra payment fits in your budget. Otherwise, the question is a bit moot.

Paying down principal has two primary effects. First, it takes money out of your pocket. Second, it increases your equity. Increasing your equity has the effects of reducing the interest you pay over the life of your loan and increasing your borrowing power. We'll go backwards through these effects this time around.

The borrowing power I'm referring to here will usually take the form of a home equity line of credit (HELOC). If you make a larger down payment, your monthly expenses can be lower, which can increase your borrowing power for a new loan, but if you're just getting a mortgage, chances are you're not looking for many other new loans. (Indeed, you shouldn't be, as new loan credit inquiries can negatively affect your credit score! Wait for your mortgage to be finalized before looking at car loans, for example.) The only thing I would use a HELOC for is an emergency fund. It's a great way to be able to pay down principal and still have access to that money in a pinch. If the pinch comes and you don't already have a HELOC, you're unlikely to be able to get a HELOC, so it's important to plan ahead. HELOCs are usually restricted to whatever equity you've built beyond 20%, so that your combined LTV remains at 80% or less. They also usually require a recent appraisal, so even the no-fee HELOCs aren't entirely cost-free to set up.

To me, though, this benefit of paying down principal isn't a major selling point, as evidenced by the fact that I do not have a HELOC. For emergency funds beyond my cash on hand, I would rely on loans from my family. I haven't formalized that line of credit in any way, and maybe I should do so rather than taking it for granted. At the same time, I can make sure my family knows that I would be there for them, too.

I view principal reduction as an investment that returns a savings in interest payments. Unfortunately, the rate of return on that investment isn't always just the interest rate of your mortgage. I included a simple calculator in my post on your effective mortgage interest rate, but that doesn't give a complete picture of your investment.

First, just as in my discussion on S&P 500 growth, values were not inflation adjusted. When it comes to the returns of the S&P 500, you have to subtract the inflation rate to get an inflation-adjusted return (approximately, anyway). Your mortgage works much the same way except that inflation helps debt, so you get to subtract the inflation rate from the interest rate you pay and get an inflation-adjusted interest rate. You get a benefit now (the home) and pay for it with less and less valuable dollars. Not a bad deal for the purchase, but it lowers the rate of return on principal payments. For the default values in the calculator above, the effective interest rate is 3.75%. After adjusting for inflation by subtracting 3.3% (though recent inflation has been lower), you're left with a nice low 0.45% inflation-adjusted effective interest rate.

Second, paying down principal now takes off interest from the very end of the loan. Your minimum payment doesn't go down and you can't readily access that money except through a HELOC. It is definitely a long-term investment, and the rate of return is locked for that entire period. It's similar to buying a multi-year CD with a rather - even ridiculously - low rate, given the current interest rate environment.

Third, paying down principal really shows the nature of compounding. Every payment that goes by, the principal you pay down saves you one fewer compounding of interest. Take a look at a monthly amortization schedule (my favorite calculator). You'll notice that the principal you pay goes up each month, while the interest paid goes down. Where you are in the schedule depends entirely on the principal outstanding, so to move up the schedule by a month (and in effect take a payment off the back end), you just have to pay the principal for the next month ahead of time. Thus, the extra payment required to gain a month goes up each time. The rate of return doesn't go down, but the time horizon is shortened and the compounding reduced. If that shortening of the time horizon is your goal, there are definitely diminishing returns.

As mentioned above, paying principal takes money out of your pocket. Whether or not paying principal is a good investment really depends on which pocket the money comes from. If it's coming from a cash account, chances are good that you will get a larger return by eliminating interest. If you are paying extra principal instead of making an IRA or 401(k) contribution or otherwise investing, then you are missing out on what is very likely to be a higher return in the stock market. Remember that it is important to compare inflation-adjusted rates to each other, and non-inflation-adjusted rates to each other. Mixing and matching is not a valid comparison.

Basically, as near as I can tell, prepaying principal doesn't make financial sense unless mortgage interest rates are over ten percent or so. I don't think many people today would pay down their mortgage if it weren't for the psychological benefits. Being in debt just doesn't feel very good - especially when it's tens or hundreds of thousands of dollars and can result in being homeless. Conversely, there's no feeling quite like knocking another month off the end of your mortgage. It's also a lot of fun to reduce your principal by the first $1,000; the first $10,000; the first $100,000 (I imagine). I'm also really looking forward to the day (soon, I think!) when my various investment and cash accounts could pay off my mortgage if I liquidated them. That would mean I could pay off the house if I had to, significantly lowering my monthly expenses so that I could live off a minimum wage job, for example. However, when I get close to the end of my mortgage, I imagine that I will pay it off simply for the monthly cash flow improvement, whether I need it or not.

In the end, I pay a couple hundred extra each month despite the logic behind investing it instead. I guess that's the price I put on the psychological benefits above. Pretty cheap therapy, actually.

Infinite Retirement Calculator

As you may know, I plan on living forever. Dying just seems so wasteful, so I think I'll skip that part of life. Living forever requires some planning, though. It'd be rather annoying to retire and then be forced back into the workforce at age 2718 because I ran out of money. Every retirement calculator I've ever found requires you to choose how long you will be retired. The longest option I've seen is 120 years, but even that's rather pessimistic. So then, I need to know how much money I need to save up in order to retire - forever. Alternatively, I'd like to know how much I can take out every year given my current investments.

I tried to be as conservative as possible in my planning. I assumed I would take out the entire year's spending money at the beginning of the year, i.e., I was pessimistic about how much of my net worth would grow each year. Of course, this pesky little recession has shown that I'm being ridiculously optimistic by assuming any sort of consistent growth during my retirement. Still, this is for planning purposes only, and certain assumptions have to be made in order to make the math at all reasonable.

So, without further ado, the calculator!

• Modify either the "Net worth" or the "Max sustainable income" field and the other will be calculated.
• "Growth rate" and "Inflation rate" are configurable as well.
• The bold label indicates the calculated value.

Net worth ($):
Growth rate (%):
Inflation rate (%):
Max sustainable income ($):
Monthly values?

For every $0.00 you save, your eternal retirement income increases by $1.00.

Some following ado is in order. It should be noted that the "Net worth" and "Max sustainable income" values are in current dollars. The amount you withdraw is assumed to adjust for inflation each year; your infinite retirement should maintain a consistent quality of life. Since money equals happiness, this means your purchasing power should remain the same no matter how long you live. Similarly, the "Net worth" (when calculated) is how much you would need today in order to retire. The amount you need goes up each year, since your income requirements get larger as you postpone your retirement, but most of the difference should be accounted for in the principal growth that would be occurring. It should also be noted that the amount you have to save per dollar is entirely dependent on the growth and inflation rates, so these are rather important to estimate right (and/or conservatively).

Observant readers may have noticed that the default inflation rate of 3.3% closely matches the annualized inflation rate discussed previously. They may have also noticed that the default growth rate of 7% does NOT match any of the numbers in my discussion on the annualized growth rate. I chose 7% because this calculator models retirement, and people tend to be more conservative in their retirement. I think 7% is a better reflection of a portfolio with a significant percentage allocated to bonds, for example.

The "Net worth" label is probably a bit misleading, but it gives you a good place to start. I would probably not include my home equity in these calculations because I don't plan on using that for income in any way. Similarly, cash accounts won't come close to the average growth most people assume in their models, and would probably best be ignored. I would have used "Retirement savings" except that term is usually used to refer to 401(k) and IRA accounts, and regular taxable accounts can grow and produce income, too.

Growth and inflation rates are APY values. The default values reflect yearly budgeting, and for yearly values, APR=APY and things are simple. When the "Monthly values?" checkbox is checked, the growth and inflation rates are adjusted such that the APY remains the same as for the yearly case, other than rounding errors. When looking at monthly values, your overall income will still be higher (or your net worth needed lower) because you are leaving your money growing a few months longer.

Q&A: When and Where to Save

Now that we've made a decision on where to put our money, generally speaking (and it's okay if your decision is different than mine), it's time to decide on when to put it there. First, we'll look at which accounts get priority when allocating contributions. Then, we'll look at the timing of those contributions throughout the year.

Where

The highest priority for your money is definitely 401(k) contributions that qualify for employer matching contributions. This is typically an instant 50-100% return, depending on your employer's plan. Once you've passed the match cutoff, deciding between 401(k) contributions and IRA contributions depends on a number of factors. Hey, it sounds like we need yet another bulleted list!

• Maxing out contributions? - If you plan to max out both 401(k) and IRA contributions, keep in mind that the only way to contribute to your 401(k) is through salary deferrals. It is important to contribute enough to your 401(k) early in the year to make maximizing your contributions possible. There is more flexibility in contributing to an IRA. You have all year to contribute, plus until tax filing of the following year. Your 401(k) is more time-sensitive, and therefore may have a higher priority.


• Investment options - 401(k)s typically have a very limited number of investment options. For example, IBM offers mutual funds that follow large sector indexes. Additional mutual funds are available for a small administration fee, though even these choices are limited. By contrast, my IRA through E*TRADE has access to over 7000 mutual funds, 1000 ETFs, plus stocks, bonds, and options, of course. The nice thing about 401(k) investment options is that they usually (but not always) have very low expense ratios. Still, it's important to look at net returns, and IRAs often have many more investment options than 401(k) plans, which means more opportunities for better overall returns.


• Roth vs Traditional - If your employer doesn't offer a Roth 401(k), but you've decided that Roth is a better option for you, prioritizing contributions to a Roth IRA before additional 401(k) deferrals makes sense.


• IRA vs Nothing - Of course, if your employer doesn't offer a 401(k) at all, an IRA is your only option. I would strongly suggest taking the issue up with management or HR!

Naturally, tax-advantaged accounts have received the priority. When you have extra money and no tax-advantaged accounts left to put it in, a regular brokerage account finally comes into the picture.

When

Generally speaking, trying to time the market is not recommended. It is possible, perhaps likely, that you will miss out on significant gains. I'll admit to some attempts at timing the market, though. I think the important thing is to be careful not to try to time the market too much. It would probably be bad to hold your $5000 IRA contribution waiting for a low point in the market, but I don't think it's bad to alter your 401(k) deferral percentage based on large market trends. For example, I lowered my my 401(k) deferral percentage at the beginning of 2008 and 2009, then raised it about halfway through so that I would contribute more during the latter half of the year, while still maxing out my contributions. For 2006 and 2007, when the market was good, I maxed out my 401(k) contributions in little more than 6-8 months. The economy shows some signs of improving, so I might set my deferral percentage to max out my 2010 contributions around August. This is different than the usual definition of timing the market, too - I still have all previous contributions invested, and I am still making regularly timed contributions. Basically, I don't feel bad about my 401(k) deferral adjustments. In all years, I contributed to my IRA fully in the first quarter. As discussed previously, I am using my Roth IRA for more aggressive stock and option trading through E*TRADE. This year, I didn't try to time the market with my IRA contribution(s), but I did not make a contribution until I had a specific trade I wanted to make. It just so happened that there were trades I wanted to make in February and March.

There are, of course, some other things to consider than how to best time the market without trying to time it too precisely. For example, it is very important to maximize your employer match, as it is highly unlikely that market gains will be as high as 50-100%. When I max out my contributions early in the year, IBM will continue to make their matching contributions with each paycheck. Basically, as long as I've contributed up to the match cutoff, IBM will match fully, no matter what the timing of my contributions. Some employers may not have a match maximizer program. In this case, it is important to spread out your 401(k) contributions so that you get your full matching contributions each paycheck. This isn't always ideal from a budgeting standpoint, however. It can be nice to max out your contributions (and here I don't necessarily mean the yearly contribution limit, but whatever amount you plan on contributing) a bit before the end of the year so you have more spending money for the holiday season.

One nice thing about 401(k) contributions is that they are usually added to your portfolio without transaction fees. In regular brokerage accounts and IRAs, investing money can often be subject to transaction fees, immediately reducing your return. You can get around this by choosing to invest in no-load, no-transaction fee mutual funds, for example. Another option involves the timing of your contributions - making fewer but larger individual investments will result in lower overall transaction fees. If your IRA is not readily accessible online, it can also be a hassle to write multiple checks throughout the year. Before I moved my IRA to E*TRADE, I made my IRA contribution in one or two payments just because I am that lazy when it comes to check writing.

Finally, I'd like to mention a more technical note on mutual funds and taxes as it relates to timing investments. As we discussed earlier, mutual funds are required to pass on gains to share owners. They usually do this at the end of the year, but the actual timing can vary. As I mentioned before, as an owner of the mutual fund, you own a portion of the profits and those count as income, even when reinvesting them in the mutual fund. When buying mutual funds in a taxed account, it can be beneficial to wait until after this distribution so that you avoid the tax liability on profits you didn't actually receive. (More information on mutual fund NAV pricing and distribution tax consequences.) Similarly, it can be beneficial to sell a mutual fund from a taxable account before this profit distribution. If you read the second link in the preceding parenthetical statement, this may sound counter-intuitive. If the distribution lowers the NAV, wouldn't the gain from the sale be reduced accordingly, making the tax burden the same? The difference is that the distribution likely contains significant short term gains, while a sale is more likely to be long term gains. Of course, how much of this sale is long term gains depends on your transaction history, but you should be able to estimate the upcoming gains distribution's short term percentage based on prior years' distributions.

Q&A: Investment and Tax Strategies Across Accounts

The different tax structures of the various account types - traditional, Roth, and regular taxed brokerage accounts - should be taken into consideration when planning your investment strategies. How do we take advantage of these different account types, all while maintaining a balanced portfolio? The answer is to break up your asset classes into each type of account, rather than trying to make each one roughly balanced. It can be advantageous to hold certain asset types in each account type. I'm going to keep things relatively simple and talk just about stocks, bonds, mutual funds, and ETFs (and a bit about options, I suppose, but not commodities or specifics on market capitalizations and whatnot).

• Stocks - Your basic stock has dividends and stock price appreciation. While some stocks are chosen for their dividend yield, when we talk about stocks, we usually are focused on stock price appreciation as a goal. For stocks that are held longer than a year, we expect/hope that the majority of our profits are the result of stock price appreciation. This will result in long term capital gains, which is always taxed at a lower rate than regular income tax.


• Bonds - Bonds have coupons and price, which taken together produce a yield. Because the coupon (the interest rate) doesn't change, price and yield are inversely proportional. While the price may go up and down while you hold the bond, your yield is locked in when you buy the bond. We are usually focused on this yield, which provides a steady stream of income (and is taxed as such). Bonds are a more conservative investment, where yields are expected to be lower than the average return of stocks, but with less risk.


• Mutual funds - Mutual funds provide a convenient way of diversification. Owning a share of a mutual fund gives you an ownership stake in all assets the fund holds. You also own a share of the profits, and the taxes due on those profits. The form of those profits - short term or long term - are mostly under the control of the fund manager, and may not be ideal for your current tax situation. Some funds are actively managed and change their assets often (have high turnover). These funds tend to have a lot of realized gains every year, and behave more like bonds, tax-wise. Other funds are passively managed, or tax managed, and do their best to avoid gains that have to be passed on to the shareholders. These funds tend to have fewer realized gains per year, and behave more like stocks, tax-wise. The performance of mutual funds depends on the assets it invests in.


• ETFs - Exchange-traded funds (ETFs) are like mutual funds, but all ETFs follow an index, and so are like passively managed mutual funds. They also don't have to buy or sell their underlying stocks as often as mutual funds, and instead do in-kind trades, which the IRS doesn't tax. So, ETFs generally behave more like stocks, tax-wise, than mutual funds, but there are a few ETFs that aren't as tax-efficient as their mutual fund peers, but these tend to be mutual funds that themselves already behave as stocks. More information, for anyone who wants it.


• Options - Options include your two basic types of options contracts - puts and calls. A put option is merely a contract to buy a block of shares (usually 100) at a given price. Similarly, a call option is a contract to sell a block of shares at a given price. Most options trades are for short term contracts, and are therefore short term gains taxed at high rates. For example, so far all of my options profits and losses have been short term. Options can be used to add extra value to owned stocks, insure an equity position, or put cash to use, but either way, gains (and/or losses) are expected to be relatively large.

With our asset types defined, we can now match them with their ideal account type. First, let's take a quick look at how much of your portfolio each should be. Unfortunately, there's no single answer. Each investor has to decide for themselves what level of risk they are willing to accept in their pursuit of returns. Common stock/bond ratios are 80/20, 70/30, and 60/40. This can be achieved through mutual funds and/or ETFs, or directly through individual stocks and bonds - with individual stocks and bonds being more risky. The percentage of your portfolio invested in bonds usually increases as you approach retirement, as well. Because I am young and have time to make up any losses I might suffer, I have decided to be risky and have nearly 100% stocks, including some individual stocks. I also use some options trading, which has definitely been risky.

• Brokerage accounts - Regular brokerage accounts are taxed as often as possible. Every trade in the account is subject to income or capital gains taxes, as applicable. They are not tax advantaged at all. Consequently, brokerage accounts lend themselves to few trades that result in long term gain. From above, that would be ETFs and stocks - specifically stocks that are good buy-and-hold stocks.


• Traditional accounts - Traditional retirement accounts are taxed as regular income when you take the money out, but grow tax free. I think traditional accounts are ideal for the bond portion of your portfolio. Bonds are full of short term gains that we can avoid the tax on, and aren't expected to produce returns as large as other investment types, which means our tax at retirement will be lower. Perfect!


• Roth accounts - Since Roth accounts grow tax free and end tax free, I find them to be ideal for my more aggressive investments. As I said, most of my portfolio is made up of stocks, but if I did have bonds, I would try to keep them out of my Roth accounts. Also whenever possible, I do my options trading in a Roth account.

So, to summarize, I would like my Roth accounts to contain mostly aggressive stocks and mutual funds, my traditional accounts to hold mostly bonds and bond-like mutual funds, and my brokerage accounts to contain mostly stable stocks and ETFs, or tax-exempt bonds/mutual funds. Of course, it's not always easy to allocate things between traditional and Roth accounts. For example, my 401(k) plan has a limited number of investment options - all mutual funds (or IBM stock). To make things more challenging, my 401(k) does not make it easy to consolidate information on which assets are in traditional versus Roth accounts, and managing separate investment allocations between pre and post-tax accounts is not automatic. Thus, I have not implemented any special treatment for the traditional side of my 401(k) as of yet. If your IRA account is through a financial planner, they may only offer mutual funds, or hands-on trading may be impractical. It was for the latter reason that I transferred my Roth IRA to E*TRADE. This gave me access to thousands of mutual funds and ETFs, along with individual stocks and bonds. It also let me take advantage of options trading opportunities tax free.

In my next post, I will take a look at the relative priority of each type of account, and my thoughts on spacing contributions throughout the year.

Q&A: Roth Versus Traditional

I was recently asked a few interesting (to me) financial questions about 401(k)s, IRAs, and contribution strategies. I've decided to answer those questions in a few Q&A blog posts so everyone can benefit (or get screwed if my strategies aren't sound).

The primary difference of concern between Roth and traditional IRAs and 401(k)s is taxes. Traditional contributions are pre-tax (they are tax deductible), but the distributions are considered as regular income and taxed accordingly. Roth contributions are post-tax, but the distributions are tax-free. So, traditional contributions lower our tax burden now, but increase it later, and Roth contributions raise (or don't benefit) our tax burden today, but lower it later. Another way of looking at it is that traditional contributions are tax-deferred, and Roth contributions include prepaid tax. This gives us two things to think about: our tax bracket now and our expected tax bracket when we start taking distributions.

The general wisdom is that if you expect your income tax bracket to be higher in the future, you should choose Roth retirement accounts. Determining if your tax bracket will be higher can be a complicated question. Personally, I took the following items into consideration when trying to evaluate my future tax bracket:

• Current income - For IRAs, traditional contributions are only tax deductible for those earning less than $53,000 (phased out through $63,000). This made my decision for IRA contributions easy - Roth is still allowed until you make $105,000-$120,000. Traditional 401(k) vs Roth 401(k) still required the following bullet points, too.


• Future income - I've been maxing out my 401(k) and IRA contribution limits since I've been working at IBM. I am on track to have more money coming in than I really know what to do with. I expect my future income to be quite high.


• Current vs. future tax deductions - I can currently deduct mortgage interest, but when I retire, I will not have a mortgage. That's actually my only major deduction at the moment. But, does your employer only offer a traditional 401(k) plan, or have you already decided against the Roth 401(k)? Have children? Taking classes? More deductions that might not apply in retirement!


• Historical tax bracket trends - As you can see from the graph in the link, we are enjoying relatively low tax rates (especially for the rich, which we all hope to be). Does this mean tax rates will rise in the future? Not necessarily, but it wouldn't surprise me.


• National sales tax - I like a lot of the features of a national sales tax instead of an income tax. However, if we go to a national sales tax, our future tax brackets will all be zero percent. After George W. Bush got torn apart for merely suggesting that we look at the plan, I decided a national sales tax isn't too likely to happen, but it's still something to consider.


• Alternative Minimum Tax - The AMT is one of the most complicated set of tax laws out there. It was designed to ensure the wealthy can't deduct their way out of too many taxes, basically. There is some fear that an AMT-like system will be implemented to tax some ROTH distributions that are currently promised to be tax-free. As much as the government loves to tax, I think this, too, is unlikely.

Another thing to consider is how much you will contribute. When you contribute fully, there is an advantage to Roth accounts. Each dollar contributed into a Roth account is equivalent to a pretax contribution plus taxes. Thus, you can make a larger (pre-tax equivalent) retirement contribution via a Roth account. This assumes the same tax bracket now and at retirement, and is definitely not the only consideration. This same type of idea is relevant to estate planning, too. Roth accounts are more valuable, dollar for dollar, than traditional retirement accounts. Retirement accounts are assessed at their account value, not at their after-tax value. A traditional and a Roth account of the same value will be taxed the same amount as part of the estate tax, but the traditional IRA will then have additional income taxes taken out when your heirs take their mandatory distributions.

There are a couple of features that really sold Roth IRAs to me. Because Roth 401(k)s can be converted to a Roth IRA without having to pay taxes when you leave the company, these also end up applying indirectly to Roth 401(k)s! The first feature is that there are no forced distributions from a Roth IRA. You can keep compounding those returns as long as you don't need the money. This gives you a lot more flexibility in your tax and estate planning. The second feature is that Roth IRAs allow you to withdraw the contributions at any time. This makes Roth IRAs a sort of emergency fund - but definitely an emergency fund of near-last resort. Once withdrawn, there is no way of putting that money back in, and you will lose future compounding returns. A better option is probably a 401(k) loan, and a better option than that is probably a home-equity loan (HELOC). Still, it's a nice feature.

As I mentioned in the current income bullet above, only the Roth IRA made sense for me at all. For 401(k)s, there are no income limitations for the vast majority of people. When deciding between a traditional 401(k) and Roth 401(k), or a mix between the two, I looked at the above points and decided that my income is likely to be greater in the future, my tax rate is likely to be higher, and the Roth variety gives me more flexibility later. Still, it is tempting to hedge your future-tax-bracket bet by splitting 401(k) contributions between traditional and Roth 401(k)s. Splitting contributions is allowed, but I have decided against it for the time being for two reasons. First, the Roth 401(k) option has only been offered at IBM as of the beginning of 2008. This means I've already bet two years worth of contributions on traditional 401(k) being better because there was no other bet to make. This year will mark two years of Roth 401(k) betting. Second, employer match contributions have to sit in a traditional 401(k) account. I view these matching contributions as an additional bet on traditional 401(k). Even if you don't view it as a bet, it is at least going to affect your future income levels at retirement and/or when forced distributions kick in at 70.5. Thus, I am maxing out my Roth 401(k) contributions, for the time being.

[For anyone curious, as of the time of this writing, Roth contributions make up 47.19% of my 401(k), and 100% of my IRA.]

In my next post, I will take a look at how tax-advantaged accounts can affect investment choices and how I (plan to) balance my portfolio across my varying accounts to better utilize that tax advantage.

Favorite Time of the Month

I look forward to the beginning of the month. It's a very special time for me. My mortgage payment goes out at the beginning of the month. This prompts me to... wait for it... update my spreadsheet!

My budget spreadsheet is the first I created with multiple worksheets. It has nine (one of which goes unused, and the other just has information used in calculations on other sheets)! I've always been a long-term thinking/planner. While I like the idea of tracking things monthly, like Jonathon does over at MyMoneyBlog, I think I'm content with updating things monthly but tracking things on a yearly basis. You can look at my spreadsheet as a long term planning item, and Mint.com as my monthly tracking place. Alternatively, you can look at Mint.com as my monthly history, and my spreadsheet as my yearly outlook. It's really not much of a budget, I guess.

Recently, I haven't been using much of the spreadsheet besides the Retirement Planning tab. (I may have to look at what this says about my current job satisfaction at a later time.) This tab isn't so much of a plan of how to get to retirement - my 401(k), Roth IRA, other savings, and house are my retirement plan already being taken care of. The Retirement Planning tab lets me know when I can retire and live forever off of my accrued savings. I compute the live forever part of that by determining if the growth of my investments will outpace inflation.

By my current assumptions of 3% inflation, 7% retirement portfolio return, and $70,000 (in 2006 dollars) yearly withdrawals, I can retire permanently at age 56. Now, $70,000 seems like a ridiculously large amount of money to spend in a year, to me. However, I would like to have a wife, and I don't want to underestimate those associated expenses... Seriously, though, that should allow for most travel plans I can think of, charitable giving, and regular living expenses, with hopefully enough left over to handle unexpected expenses, or temporary-ish ones like college costs for children.

Even though I don't use most of the parts that I programmed into it, updating the spreadsheet is still a very fun activity. Very few things are better than a large table of numbers.

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This was supposed to be posted nearer to the beginning of the month, but my main computer was having issues. Chkdsk seems to have sorted them out, though. It took a few hours, but it completed. I was fooled a few times by long periods of no screen updates and the keyboard not working. That is, I restarted the process more times than necessary, I think. For future reference, the Num Lock and Caps Lock keys don't work when chkdsk is running, and it's apparently normal for some operations to take an hour without updating the screen.

One-Time Expenses

A couple of days ago, my friend and I were talking about many things. One of these things included a comment about one-time expenses and how there seems to be one every month. I decided to analyze my one-time expenses over the past year and see what I can learn about my budget (as informal as it is). So:

• December: Living room TV: ~$800, second 24" monitor: ~$300.
• January: Video games: ~$100. Not too bad...
• February: Ladder to fix the roof: ~200, paying some guy to fix the roof: ~$60.
• March: No big expenses. Go me!
• April: Nothing again!
• May: Fiona died, and I took Apple in to get tests and shots: $130.
• June: Adopted Mac & Cheese: ~$100, initial vet visit for Mac & Cheese: $110
• July: Apple's eye infection: ~$50, Mac & Cheese declawed: ~$260, new tennis racquets: ~$230, video games: ~$100.
• August: I did good again!
• September: Video games: ~$75, miscellaneous family expenses: ~$200.
• October: File server parts & digital camera: ~$400.
• November: Planned car repairs: ~$400

This puts me at just about $300 per month for one-time expenses. I also want to get a new bed at some point, a storm door for the front, a new car eventually, and probably a few other things I have forgotten about while compiling the above list. The storm door will improve the heating/cooling efficiency of the house. The bed, at least, will likely be purchased at Nebraska Furniture Mart (can you believe I used to be anti-NFM at one point?) and therefore be spread out over the following 24-30 months...

I think the video games will also be a less frequent expense for awhile, since a lot of the video game purchases were large packs of games, and should keep me busy for quite a long time, really. There are still at least 10-20 games I haven't even installed/tried. I really hope my pet expenses (one-time, that is - food and litter are frequent purchases) are very low going forward. Regular check-ups only, please! My file server is running much smoother now (see future post), so that will hopefully truly be a one-time expense for the year or more. I remember justifying my living room TV as roommate retention. It's at least getting use. Some car repairs are definitely necessary - I worry about every strange noise I hear when I drive right now, which is not pleasant at all.

...I think what I learned is that even after compiling a list of one-time expenses while expecting a ridiculously high total, I still went into justification-mode after seeing it. I do keep my regular expenses fairly low, and I'm not at all worried about my cash flow. As I discussed previously, I save $200 each month, and that's after maxing out my 401(k) and Roth IRA contributions every year. I save a lot of money each year, and have multiple layers of financial cushions should I ever need to cut back on expenses. However, even if it's not strictly necessary, I think an occasional analysis of spending patterns is helpful.

Update: Speaking of Nebraska Furniture Mart, I forgot about my living room couch. It was purchased on my NFM card, though, and I technically haven't started paying that off yet - I'm still working on my dining room furniture. Or maybe it is my downstairs TV. I love 0% interest! Also, I think it important to mention my new furnace, since it was almost a full year's worth of one-time expenses by itself. Things happen.

Reserve Cash vs Investing

As I discussed awhile back, here, I have a primary E*TRADE Complete Savings account, and a reserve E*TRADE Complete Savings account. I set up a $200/month automatic transfer from my Complete Savings account to my Reserve Cash account quite awhile ago. This was in addition to a sizable initial funding.

So far, this has worked very well at keeping me from investing this cash in (riskier) stocks. For the most part, I think this has worked because the balance of each account is relatively small, so it doesn't feel like I have that much extra to invest. You'll notice that I don't say spend - I have an automatic transfer of $1200/month to my checking account, which covers all credit card transactions plus those utilities not charged to the credit card. This has been more than enough to cover my limited expenses so far. It also helps me keep the few bigger purchases I make, such as buying a new camera, well spaced throughout the year. My main problem in keeping a cash reserve is that I feel that money is wasted just sitting there, when it could be averaging 8% per year sitting in the stock market.

I think this feeling will become a larger issue very soon, when my Reserve Cash account will surpass my Complete Savings account. At that point, I fear it will suddenly appear to be a much larger chunk of money than it is. To combat this feeling, I think I need a specific goal. For example, MyMoneyBlog's author keeps $100K in reserve, which is way too much cash to have on hand (at least for me). If I take my $1200 spending money plus $1400 mortgage payment, I get monthly expenses of $2600. In an emergency, I can take off more than $100 from my mortgage payment, and can easily cut down spending. But, to be conservative, let's leave one month's expenses at $2500 (a small adjustment for nice round numbers).

My first thought is to keep $10K in my reserve account. This would be at least 4 months of expenses, and is a nice round number. Combined with the fact that I always keep at least $3K in my Complete Savings account just in case there's a problem with my direct deposit for a month, this seems like a more than adequate cash reserve. However, never having had an emergency in my life, I'd be interested to hear other perspectives. Is 4 months of expenses a stupidly low cushion, despite most places recommending 3-6 months? How many months expenses do you keep on hand?

New Car On the Horizon

A few days ago, I was driving home on the highway and may car starting making a noise somewhere between a screech and a whine. It was a constant sort of noise, but once I got off the highway, I found that it varied depending on the speed of the wheel - I assume it was once per revolution. It also sounded worse when I applied the brake. I pulled into the gas station, but did not see anything wrong with the wheel right off.

As I continued to drive home, the noise stopped abruptly with a little *plink* sound, and it looked like a washer or something similar was bouncing around behind my car. This was not a comforting development, even though the noise went away.

I took my car in on Monday, and they charged me $50 or so to diagnose the problem. They didn't actually find anything that would result in the noise and missing part that I described, but they found plenty of other problems:

• Air dam deflector - $151.00 - This is apparently a piece of plastic that scoops air into the engine area. I see no reason to spend $151.00 on a piece of plastic.


• Front brake pads and resurface rotors - $180.00 - I knew I needed new brakes soon, but I think they are now likely to find something else wrong with the brake assembly when they get around to putting new ones in.


• Transmission side cover gasket leaks - $274.00 - This one makes me a bit nervous. It evidently isn't leaking horribly, but a leak of transmission fluid is bad. I am clearly an auto maintenance expert, you can tell.


• Rear sway bar links - $244.00 - I knew about this one from awhile back, and they said it wasn't critical. The sway bar distributes load from side to side, so the fact that mine is broken makes my handling worse on turns, and I'm more likely to slide around. It hasn't been a problem yet.


• Left/Rear strut with spring - $531.00 - They skipped this in their haste to go over the list before closing. It's expensive and sounds important. At the moment, I have to plan on fixing it.


• Serpentine belt - $92.00 - The main belt, apparently. They said it has major cracks and they found part of it wrapped around the axle, so it's already falling apart. This is the most pressing issue.


• Muffler strap - $99.00 - This is just a simple bracket that helps hold the muffler on. There is no reason this should cost $99.00, and I refuse to fix it.

All told, the things that aren't completely trivial would cost $1321 to fix. I also need an oil change soon. Thus, I entered into a cost analysis to see if getting a new car was a better investment than continued maintenance.

Car:	Civic	Corolla	Focus	Prius
Price1:	18225	16750	15995	22000
Monthly cost2,5:	$285.94	$255.21	$239.48	$364.58
Monthly Insurance3:	$25.5	$26.00	$24.83	$21.83
Monthly Total:	$311.44	$281.21	$264.31	$386.42
Months to recoup4,5:	18.69	20.69	22.02	15.06

1. Price is base price of a model, not including any packages. I don't need any packages or options, but dealers rarely have plain cars in stock, so this price will probably be an underestimate. It also doesn't include fees, taxes, charges, whathaveyou.


2. Monthly cost is based on a 48-month 0% loan. I probably can't get that rate at the moment, but it also doesn't account for any down payment or trade-in money, and so shouldn't be too terribly far off.


3. Monthly insurance is the cost to insure the new vehicle minus my current monthly rate on my old car.


4. Months to recoup is how long I would have to keep driving my current car to make the repairs worthwhile.


5. Figures reflect a $4500 price reduction corresponding to a CARS trade-in (my family has an old van that is rapidly dying). This represents an opportunity cost associated with repairing my current vehicle as opposed to buying a new one.

At this point, I find it unlikely that I can drive my car for another year or two without the need for further repairs. The bonus of a $4500 price reduction makes getting a new car very practical!

UPDATE (08.22.2009-1019): It would appear that we cannot get into the safe deposit box that contains our car titles, so there can be no trade-ins. With the $4500 bonus out of the picture, the recoup time becomes just 2-4 months, making the repairs far more practical. No new car for me!

Mortgage Refinance Completed

On Wednesday, May 20, 2009, I completed my first mortgage refinance using United Home Loans. I stayed with a 30-year fixed mortgage, but was able to reduce my interest rate down to 4.625% and save $176.51/month on my monthly payment. The process will have increased my principal by ~$5000, but a lot of that is the interest for the month of May that I rolled into the new loan, a quarter point for waiving escrow, plus some money back to ensure that I didn't have to mess with getting a cashier's check. The closing costs were comparable to the other places I looked, and the rates were quite competitive.

Most importantly, yesterday marked one of the worst days in the MBS (mortgage-backed securities) market, which resulted in rates climbing into the 5.25%-5.5% range. I timed my closing pretty well! The site I follow, Mortgage News Daily, seems to think rates will come down again this year, but it's a whole different feeling to follow the MBS market when I have no direct financial stake in the matter.

A couple people have expressed surprise that I decided to waive escrow, seeing how it cost me .25% of my loan amount. I did some number crunching before coming to this decision, and in my case it definitely made sense. First, I had just paid property taxes, and my insurance doesn't have to be renewed until December, yet they were going to collect 6 months worth up front, or about $3000. I don't think I'd like to pay $3000 out of pocket now if I don't have to, which means I probably would have rolled that cost into the new loan amount. A $3000 loan equates to $15.42/month in extra payments, which means I will recoup my escrow payment in about 3 years directly. That .25% is listed as a discount point, though, which means its tax-deductible. I also get some interest on the $3000 that can stay in my savings account (I actually used it to max out my Roth IRA for the year, so hopefully that will result in even better returns). I also keep the flexibility of scheduling my property tax payments. This gives me the opportunity to shift my tax burden between years a bit by paying either half or all my property taxes in December. Mostly, I don't like the idea of giving my money to somebody and getting nothing out of it, so there is psychological value for me in waiving escrow.

Some of the closing costs are offset by not making a payment in the beginning of June (at the cost of increased principal, of course). This will mean $1500 extra into my pocket this month. I think I will lower my payment to $1400/month on my new loan, however. This will mean an extra $100/month for me, but still be prepaying my mortgage faster than I was on my old loan. Here, I'm fighting the strong psychological benefit of paying off debt with the intellectual knowledge that prepaying on a 4.625% (tax-deductible) loan almost certainly is not the best use of my money. I just love seeing the balance jump down!

401(k) Surpasses Merrill Lynch

Friday marked the first time my 401(k) account was worth more than my Merrill Lynch investment account. Before the recession, this was a milestone I wasn't expecting to happen for another couple of years yet. Since my Merrill account has been halved by the economic downturn, though, my regular 401(k) contributions have a larger relative effect. Of course my 401(k) was halved, too - I don't mean to badmouth Merrill Lynch.

There's nothing more to say on this topic, really. I just found it interesting how the economy tanking altered my various accounts relative value. For example, my Roth IRA is not roughly half of my Merrill or 401(k) account, which is far higher than originally projected. Fun times!

Taxes 2008

This post is analogous to last year's tax post.

Taxes for 2008 turned out to be much simpler than last year for the following reasons:

• I only lived in one state, and so did not need to split my income.


• I closed one of my accounts to pay for the down payment on my house in 2007, so I no longer have to worry about all those forms and trades. That account had tons of trading activity.


• I was familiar with which sites I needed to log in to in order to get various 1099 forms - mainly Countrywide.


• TurboTax imported last year's return so I didn't have as much data entry on my personal information.

I was actually fairly pleased with TurboTax. It still had a few problems (there was no official way to enter short sales [such as cash-secured puts], so I'm not sure I did that right, but the total profits/losses are correct), but was improved from last year overall.

In addition to TurboTax, I used Kansas' WebFile page to e-file my Kansas return. I basically just entered things in line by line from the form TurboTax generated, but didn't have to print it out or mail it. I think that will be the more environmentally friendly route, plus get me my refund sooner.

Speaking of refunds, I get big refunds! From the federal government, I get $5397 back, and I get $854 from Kansas. Governments, you're welcome for the 0% loans over the last year! Please place money in my savings account soon.

What will I do with all that money? Well, you should read this post on things I want to buy, and this post on mortgage refinancing, all while keeping in mind that a cash reserve is nice to have and build.

Why was my refund so large when I owed so much last year? Another list:

• This was my first full year of paying my mortgage, which means a full year of mortgage interest deducted.


• This year sucked for investments, so I had no realized capital gains. I'd rather pay taxes than not be building wealth, though.


• This was my first full year of paying property taxes, which are deductible.