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!

Insights from Mint.com

Going over my Mint.com trends for the past couple years, I noticed a few things I thought were somewhat cool. In no particular order:

• 75% of my out-of-pocket expenses are for housing and communications - mortgage, property taxes, insurance, and all utilities including TV, Internet, and phone.
• I spend more for Verizon Wireless than I spend at Walmart. To be fair, my Verizon bill covers five people. To be unfair, Walmart covers the majority of my grocery expenses and cat food and litter. To be fair again, I eat out quite a bit, so groceries are cheap.
• I will also spend more for Verizon Wireless than I spend on eating out, once figures include a full 24 months of Verizon bills.
• I spend a lot at Chili's ($800), and it is probably worth getting any discounted gift cards I see.
• My expenses have actually gone up since I've started paying attention to them. Every month, I've spent more in 2010 than 2009. I've also had more cash on hand.
• It's very important to set up renaming rules right when the name of a merchant changes for whatever reason. From that point on, it becomes automatic.
• Rollover budgets are great in theory, but end up making the overall totals meaningless as they drift way negative or way over budget. Really, the budget feature itself is not as informative as the Trends tab.
• "In the past 30 days, you spent $309.62 on Clothing. Usually you spend $9." That $9/month is inflated because it includes a tuxedo rental and a bunch of clothes that weren't actually mine. In other words, I spend very little on clothes.
• It is also important to realize tax refunds are income that the government held for you, and not taxes. Assigning tax refunds to the 'Taxes' category can result in negative spending for the month, which looks awkward.

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: 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.

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!

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!

Multiple E*TRADE accounts

A couple posts ago, I commented on my spending discipline. I just took a step to help me maintain that discipline. I opened up a separate bank account just for emergency funds.

I used to have a E*TRADE Bank Complete Savings account. It has solid features and a high yield - beating Bank of America CDs, for example. The interest rate applies to every dollar in the account - it's not tiered. Now I have two! E*TRADE is kind enough to allow people to open as many as they want, it would seem. The interesting thing is that this basically eliminates the limit of 6 withdrawals a month because you can always transfer money over to another savings account and withdraw from that.

I have never hit the withdrawal limit, so that didn't enter into my thinking when I set up the account. I was just thankful to have the option to create a separate bank account with just as high of an interest rate. I can rename it to "Do not touch" or "Emergency Funds" or whatever else will make sure I'm not tempted to spend it. I then set up an automatic transfer from my old savings account (which gets my direct deposits) to my new one. Now I'll always have enough cash on hand in case I otherwise forget to set aside cash (say, for property taxes or insurance). Thanks, E*TRADE!

Managing debt

I grew up thinking that debt was a bad thing. Why buy a car when you can't afford it outright? I understood that houses required mortgages, but why put things on credit cards when you can pay cash? Managed properly, debt, even in credit card form, can be a good thing.

Spending

A lot of proper debt management depends on a realistic assessment of your spending habits. I, for example, don't tend to buy things. Or, I didn't until I bought a house and needed to put things in it. I have no expensive hobbies (compared to my brother who buys guitars and related equipment quite often) and I keep my monthly spending constant within a couple hundred dollars, in general.

In short, my spending habits are well defined and I track them informally. I also have a pretty stable job. IBM is a $160B company and people seem to like what I do there. Thus, I have a demonstrated discipline when it comes to spending and a pretty solid income. The risk of me not being able to pay my monthly bills is fairly low, so debt shouldn't be an undue emotional burden.

Interest Rates

The rest of debt management is interest rates. Most debt is pretty simple, actually. The interest rate is advertised directly. Some interest is tax deductible, though, in which case you need to multiply the advertised interest rate by (1 - your tax rate). For example, if you're in the 25% tax bracket and have a 6% mortgage, you're effectively only paying 4.5%.

If you can beat the interest rate determined above through investing, you can actually make money by going into debt. Even with the recent downturn, The S&P500 index has seen annualized growth of 9.516% over the last 5 years. That pesky tax rate works against us a bit, here, though. Interest income and short term capital gains are taxed as regular income, while long term capital gains are taxed at a 15% flat rate. For a worst case scenario, we can assume everything will be taxed as regular income. We need to now divide our effective interest rate from above by (1 - your tax rate) to get an rate of return goal. That 4.5% becomes 6% again. An 18% credit card interest rate becomes a 24% goal. Whatever we invest in, we need to beat this final rate in order for the debt to be profitable.

Over the long term, an 8% annualized return is fairly achievable. If you can invest money borrowed at 6% (effective) or lower, it is likely that you will be able to make money on money you don't actually have. This whole argument only applies if you have the money available to invest, though. If you borrow money to buy things, then that money isn't working for you.

Credit Cards

When there is something you need to buy, credit card debt can still be a good thing (even a card with an 18% interest rate!). The key is to not keep an interest-bearing balance. Pay the credit card off completely each month and you've basically borrowed money for 30-50 days interest free. You can keep that money in a high interest savings account and earn an extra few dollars by using a credit card instead of cash. Even better, you can get a credit card with additional cash back like the Chase Freedom card and/or Citi Dividends card.

Keep in mind that interest-free financing isn't a free pass to go on a spending spree. You still have to pay the purchase price. However, a store's 0% financing credit line can actually be better than cash back credit cards. I'll leave it as an exercise for the reader to determine a formula based on bank account savings rate, b, financing period, t, and cash back bonus, c, that calculates the break-even surface.