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Personal Finance

The Queen Is in Her Counting House…

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So now that the Dow is closing on 11,000 again, I spent part of yesterday evening counting up my shekels.

Some time back, I figured the crash of the Bush economy (oh, how i luv bugging my rightie friends with that one! 😉 ) had drained my retirement savings of about $180,000.

Things are looking somewhat better today. Thanks to ten nontaxable grand available from a whole life policy, I contrived to set things up so I could pay my share of the downtown house’s mortgage without drawing down from the big, professionally managed IRA. Landing a temporary loan modification helped, too: the reduction in monthly payments will draw out the number of months the $10,000 lasts.

Despite partially drawing down the cash in that policy, total retirement savings are now down “only” $95,400 from the all-time high in October 2007.

We know, of course, that stocks were hugely overvalued in October of 2007. And some say they’re overvalued now. Seeking a more realistic measure, I compared total savings today with the figure that appeared in January 2001, when I first started tracking the various accounts in Excel. In that scenario, over 9.4 years my savings have grown by $18,211.

Looks like a pretty poor return on investment, eh?

However, it must be remembered that I used some of my savings to pay off the loan on my house. I also used about 30 grand to copurchase the downtown house with my son. So, it could be said that some of the funds were simply reinvested elsewhere

That notwithstanding, there’s no question the crash did some serious damage. If we look at the amount that was in savings in December 2006, before the run-up had built any momentum, we see that today’s bottom line is down $55,716 off what might be regarded as a reasonable figure.

Well, it’s better than a $180,000 loss, anyway. Just depends on how you look at it, eh?

Checking net worth: Respectable, though down about $400,000 from the 2007 estimate. Net worth sustained a huge loss when the mortgage on the downtown house went upside-down. Equity in that property is now negative…to the tune of about –$60,000. However, my own house, the one that’s paid for, retained its value and may even have crept up a little. So, even though M’hijito and I took a bath in real estate, it could have been worse. A lot worse.

My net worth is still significantly stronger than most Americans’. A calculator at CNN Money suggests the median net worth for Americans my age is $232,000; mine is about three times that. For 65-year-olds in my post-canning income bracket, median net worth is $34,375; mine is about twenty times that. For those in my pre-canning income bracket, median net worth would be $301,475; mine is 2.2 times that.

Despite the fact that I moved a fair amount of cash from equities into real estate, I’m still none too thrilled at the piddling $18,000 ten-year growth in liquid holdings.

But on reflection, my sense is that a free-and-clear house may be more valuable than smoke-and-mirrors money in stocks and bonds. While the sale price of a house may rise and fall, the value of a roof over your head is pretty immutable. It’s hard to evict a person from a house that has no mortgage.

To rent my house would cost between $800 and $1,200 a month. At 4.8 percent, principal and interest for a traditional 20 percent-down mortgage on this house would cost about $995. So I figure owning the house outright represents a return on investment of about $1,000 a month. Though that’s only a 5% annual return on the house’s present sale value, the fact is that if I had to pay $1,000 a month out of my much-reduced “retirement” income, I could not afford to stay in my home! And since my home is nothing very extravagant, that would mean that when I was laid off I would have had to move into some pretty downscale digs.

Another benefit to owning the house: when I shuffle off this mortal coil, the house will pass directly to my son, giving him a pleasant place to live with very little overhead. He then can rent the downtown house for the amount of the mortgage (or, if things are better, sell it) and end up with a solid basis to build his own retirement savings.

Both of these advantages, IMHO, are huge.

How are things in your money bin? Are you seeing any improvement?

Taxpayer confusion

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Damn, but I wish Congress and the IRS wouldn’t let corporate lobbyists make hash out of the tax code so the rich folks can get out of paying. If you have several different kinds of income, it is just flicking impossible to understand tax forms and what you’re supposed to do to pay fairly. What excuse is there for this mess?

This spring, for the first time since I started paying my own taxes (as opposed to the ex-husband doing it), I owe money: $770 to the IRS! This happened because, when ASU started jacking us around with furloughs, I added two allowances to my W-4 so as to minimize damage from the $480/month cut in pay. After six months, the furloughs went away but I didn’t change the withholding.

Meanwhile, I taught two classes in the fall, hustled a lot of freelance business, began to make money on FaM, and also withdrew $800 a month from an IRA to cover my share of the mortgage on the downtown house, yielding a pretty plump gross income. As a result, not enough was withheld to cover federal taxes. On the other hand, the state of Arizona owes me $1004.

It remains to be seen whether the state will issue refunds. Tax Lawyer says her understanding is that they will, but others have heard that we’ll be getting refunds in the form of useless IOUs. Meanwhile, TL charged me $476 to do my personal return and $442 for the corporate return.

Holy mackerel! She’s never charged more than about $350 before. I realize lawyers have to eat, too, but still… The state refund will not cover the federal income tax bill plus TL’s bills.

I can’t even begin to do my personal returns. With income from investments, freelance sources, jobs, Social Security, and limited partnerships offset by itemizing and mortgage interest deductions, the job is just too complicated, because the law is just too complex for me to follow. But I’m pretty sure I can manage the corporate return using Turbotax’s business edition. It’s $150, an amount that has to be ponied up every flickin’ year, but that’s a far cry from $442.

This year my income will drop to about $33,000. TL tells me I should be able to figure out what percentage I’ll owe at the IRS website. Problem is, although Social Security is taxed, it’s not considered earned income. If you add it in to the “earned income” line, the tool calculates an incorrect figure. But it’s not dividend income. It’s taxed in a bizarre way that’s linked to how much you make elsewhere. The complexity of that transaction renders the tool at the IRS site useless.

I think that if I teach only five classes this year (rather than the previously planned six), I may not owe any taxes on Social Security. The clinker is, though, that the RASL payments (sick-leave payout), even though they’re not considered 2010 income (they were earned while I was working at ASU), may push me above the threshhold. I just don’t know, and I don’t know how to prove to the IRS and Social Security that RASL is not 2010 earned or dividend income.

Meanwhile, I still have two allowances on my community college W-4, something I installed at TL’s advice last fall. So…is the District withholding enough? Who knows? It’s impossible to make an accurate guess.

There’s a tool at Money Chimp that sort of explains tax brackets (as best as one can: your tax is xx% but it’s really not; it’s really probably yy%… Yeah! makes sense).

So, if my teaching income is $12,000 and Social Security is $15,084 and the enforced drawdown from the 403(b) is $6,000, and I can keep the “salary” from The Copyeditor’s Desk down to $500 or $1,000 and I don’t withdraw dividends from CE Desk this year, then my total 2010 gross should come to something between $33,584 and $34,084. That will put me in the 15 percent bracket, with an actual tax of 13.73 percent. If I have to draw $1,000 from CE Desk (an S-corporation), then I’ll be in the 25 percent bracket, BUT my actual tax as percentage of income will still be only 13.8 percent.

Huh?

But then, if only half my Social Security is taxed (that’s one possible scenario), do I enter $26,042 into the calculator? If I’m lucky and none of it is taxed, then should I enter $18,500? And what about the RASL? How do I know? How do I find out?

See what I mean? It just doesn’t make any sense at all. And you can NOT arrive at a credible answer without hiring a tax professional (to the tune of $400+) to figure it out.

At any rate, I need the cash flow from my paychecks and am loath to get rid of the allowances. The fact is, with two allowances the community college district is withholding 15 percent. The feds are withholding 20 percent from Social Security. And Fidelity is withholding 23 percent from the $500 distribution the state is forcing me to take.

If the Money Chimp tool is correct, then I shouldn’t have to change my withholding, even though the college is not extracting enough to cover both federal and state taxes. If the calculator is wrong, I do have some money to pay taxes. Really, I’d prefer not to overpay, partly because of the need to buy groceries, but partly because, if the state is going to start issuing IOUs, I certainly don’t want those SOBs getting any more of my money in advance than I can avoid.

Social Security doesn’t issue anything that looks like a pay statement, so you can’t tell whether they’re sending money to the state. At 20 percent, they probably are, since I asked to have 15 percent withheld. The state gloms a percentage of your federal tax.

I’m thinking I should drop or maybe even eliminate the drawdown from Fidelity. Now that the General Accounting Office has approved my RASL payout, I may not need to keep taking that drawdown. However, RASL is paid out over three years. I don’t know whether the RASL Czar checks each year to be sure you’re still drawing down a so-called “pension” or whether once she’s approved it she just cuts a new check for each year. What would make sense would be to roll the ASU drawdown into my big IRA, which just now is cranking money. If I had, say, $250 paid out to me and then rolled the rest, I’d still have a little pocket change, my taxable income would drop by $3,000, and that would put me solidly in the 15 percent bracket.

The question is…can I get by on $3,000 less?

Financial Freedom: Building the bankroll, part 1

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In the quest for financial freedom—the search for a way off the day-job treadmill—it’s important to build the habit of living not just within your means but below your means.

When you live within your means, you spend no more than you earn. In living below your means, however, you spend less than you earn. This allows you to put money aside for future use; to wit, early retirement. The scheme is pretty simple:

• Live below your means;
• Save a specific amount each month;
• Also set aside whatever else you don’t spend;
• Stash your savings in investments and leave it there.

Saving is a strategy you can start at quite a young age, from the moment you begin to earn. My first full-time job paid a grandiose $300 a month. After paying the rent, I had $200 to live on. From that I budgeted $15 to buy myself some clothes or shoes and $20 to put into savings. Following the old adage, I always paid myself first. We didn’t have automatic electronic funds transfers in those days; I had to physically go into the bank to deposit my paycheck, and while I was there I had a share of it deposited to a savings account. If I hadn’t spent the previous month’s clothing budget, I transferred that or the amount remaining from it to savings, too. I still do the same today, only instead of $20 I put aside $200 plus anything else that doesn’t get spent.

It doesn’t sound like much, but over time it adds up. And when you’re young, your greatest financial asset is time. Twenty dollars a month invested at 8 percent starting in, say, 1967, when I began working, today would amount to $89,498.86. If you began investing $200 a month today and worked for twenty years, in 2030 you’d have $117,804. That’s a respectable amount, especially if you’re saving from after-tax income so that this is on top of your 401(k) or 403(b).

Yes. That’s what I’m talking about here: not only investing before-tax income in whatever savings plan your employer offers, but also setting aside something from take-home pay.

For most people, $200 a month is minimal. In fact, while I was still working I was setting aside about $370 a month, plus whatever was left over from my general operating expenses. Over 20 years at 8 percent, $370 a month would add up to $217,937.55—about as much as my 403(b) accrued in 15 years with matching contributions from my employer. In other words, the habit of saving and investing on your own can double your retirement savings…and at least some of it will be in instruments that you can access before age 59½, a crucial factor for those of us who do not intend to stay in the traces until we drop.

Even if your earnings are modest, it’s surprising how many ways you can find to unearth cash for savings and investment.

If you’ve recently succeeded in paying off debt, then you know that you can break loose a certain number of dollars from your income for purposes other than mere survival and indulgence. If that’s your case, instead of diddling away the newly freed-up income that you were having to use to service debt, put it into savings.

If you’re using the “snowball” approach to debt payoff, once you’re out from under the debt, put the snowballs into savings. If you’ve “snowflaked” debt away, keep on putting every little windfall aside, only put it into savings and investments.

Similarly, when you get a raise or move to a better-paying job, don’t change your standard of living. Put the increase into savings.

More proactively, start a side income stream and invest all the after-tax proceeds for the future. My freelance endeavors, for example, have earned around $8,000 to $10,000 a year. Eight grand amounts to about $666 a month; invested at 8 percent over our 20-year period, it would add up to $392,288.

Living below your means entails downsizing before you upsize. Instead of buying the biggest, most grandiose house you can afford, for example, buy a more modest but comfortable house. Or rent instead of buying and save the difference between the rent payment and mortgage payments for comparable digs. Refrain from buying the largest, fanciest vehicle your paycheck will support; get a car you can pay off quickly and use the amount you’d have to put into payments to build your Bumhood stash. Find better ways to entertain yourself than sitting in front of the boob tube, and then ditch the cable TV. Get rid of the land line. Learn to cook, and eat better for less by eating in instead of haunting restaurants.

If you never develop the habit of buying more than you need, you’ll never miss what you don’t have. Obviously you don’t have to live like an anchorite. But too many apparently middle-class Americans fail to distinguish between indulging their wants and providing for their needs. As a result, they’re really not in the financial middle class: they’re actually poor folks who are in way over their heads.

By April of 2009, the average household saving rate was only about 4 percent of disposable income. Let’s say you have $48,000 left after taxes from a $60,000 household  income: that would give you an annual savings rate of $1,920—significantly less than the rather modest $200/month we started with in this discussion. If your 4 percent includes your required contribution to an employer’s deferred saving plan, then you’re not even putting $160 a month ($1,920 ÷ 12) aside from take-home pay.

Meanwhile, economists at the Federal Reserve estimated (also in 2009) that despite the slight increase in U.S. households’ savings rate, most savings were going to pay off debt, which had accrued at a staggering rate during the recent boom, when consumption far exceeded income. To eliminate this household debt, the Fed observes,

Assuming an effective nominal interest rate on existing household debt of 7%, a future nominal growth rate of disposable income of 5%, and that 80% of future saving is used for debt repayment, the household saving rate would need to rise from around 4% currently to 10% by the end of 2018.

Clearly, if you start out with little or no debt and never accumulate debt, instead of pouring your savings into some already spectacularly wealthy banker’s pockets you can put your money to work for you. Living below your means is, then, the first stage of building your Bumhood bankroll.

The Financial Freedom Series

• An Overview
• Education
• Work
• Debt
• The Health Insurance Hurdle
• Own Your Roof
Building the Bankroll, Part 1
Building the Bankroll, Part 2

January outgo

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So, in the first month of unemployment, how did the budget fare?

Net income was $550.32.

Net outgo (including $325 to the self-escrow account for homeowner’s insurance, auto insurance, and property taxes, and $200 to monthly savings) was $1,636. Since that $200 to savings didn’t actually go away, we could say net outgo was really $1,436.

January’s cash flow: –$886

{sigh}

Well, it’s not as dire as it looks. First, I have a $10,000 cushion, so I’m not bouncing any checks yet. Second, I started with $$4,500, the amount accrued by December 31 from my last paycheck and vacation pay. So in terms of dollars that were actually in the account, we have $4500 + 550 – 1436, allowing us to argue with some plausibility that the actual cash flow was a positive $2,514.

The problem with that argument, of course, is that we now have used up almost half the original bankroll, and we still don’t know whether enough cash will come in to cover expenses.

I have yet to see a Social Security check. Because I have no accurate way of knowing what the tax gouge will be, I can only estimate that it will be around $1,000. But in every other case so far, the estimated tax bite of 20% has been a bit on the optimistic side.

And I still have no idea what a full paycheck from the community colleges will look like. January’s munificent net of $161 (!!) was for only two sections, since one started “late”—a week after the first day of classes. And it was, I think, for only one or two days of each section. I had hoped that the fare for three sections would be around $800 to $900. Two of those a month would keep the wolf from the door, and if I actually manage to keep my expenses around $1,400 to $1,600, during the few months when the college is disbursing two full  paychecks, it would cover almost all my expenses. The Social Security money, then, could go into savings to cover the high-cost summer months and the six-week winter break.

In the fall, one of my classes is an eight-week session. This means that for half the semester, I will be paid for only two sections; in the other half, I’ll be paid for three sections, with one at an accelerated schedule. Net pay over 16 weeks will be the same, but for half the 16 weeks, I’ll be just barely scraping by.

Clearly, the strategy of cobbling together a living from several piddly sources is not something that can be done without a substantial base to use as a cash cushion. If no major expenses happen, at the end of the year I’ll probably come out about even, maybe as much as a thousand dollars ahead. But it’s going to be close. Very close.

And the car, house, and pool had better keep running without a hitch…

Should you pay off your mortgage?

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Preparing to write the next installment in a series on achieving financial freedom, I ran some figures to compare the result of paying down a mortgage with extra monthly payments toward principal with investing the same amount monthly in a mutual fund. What I discovered runs against my theory that you’re well served to pay off a mortgage as fast as you can.

I still think that’s true if you’re getting close to retirement. In retirement, every debt should be wiped off your books, because you will need all your cash flow to live on. However, if you’re younger—say, anywhere between 20 and 45—and your mortgage rate is low compared to returns on equity investments, it would be to your advantage to invest extra dollars in a mutual fund earning around 8 percent. At today’s rates, this strategy allow you to accrue enough to pay off the principal faster than will throwing a monthly amount at the loan principal. Here’s how this shakes down:

M’hijito and I have a 30/15 mortgage at 4.3 percent. This means that for the first 15 years, we make payments at the 30-year amortization rate, but after the 15 years have passed, we either have to pay off the loan or we have to refinance it. The loan’s principal is $211,000.

We chose this mortgage because, at the time we bought the house, we believed the real estate market was nearing the bottom. We believed the house would drop in value another $4,000 or $5,000 and then begin to rise, probably at around 3 percent p/a. We figured that in five to ten years we could sell or rent the house and either break even or make a small profit. As everyone now knows, this was dead wrong: in fact, real estate was in free-fall, and the house is now worth at best $170,000, but more realistically around $150,000. This turns the loan into a real albatross. One strategy we are considering is to try to pay down principal with whatever extra monthly payment we can make (which ain’t much!), so that in 15 years, the amount to refinance might at least be no more than the house is actually worth, possibly allowing us to sell the house at that time.

In 15 years, with no extra payment toward principal, the loan balance will be $138,338. Monthly principal and interest payments are $1044; PITI comes to something over $1200.

Note that the projected loan balance is less than the most pessimistic present-day valuation. If the market finally has bottomed out and housing increases in value at 3% a year (a figure that is now being bandied about), in 15 years the house will be worth $233,695. That is less than we paid for it, but at least if we sold the house at that time we would walk away with a little cash in our pockets.

With me out of work, about the most we can afford to pay extra toward loan principal is about $100 a month.

Using Excel’s full value (=FV…) formula, I calculated the the return on a $100/month investment in a mutual fund earning 8% per annum. (Over at Vanguard, a number of stock funds and even a few bond funds are returning at this rate; one of them is Windsor II, in which I happen to already have a little cash.) I then used Quicken to run an amortization schedule, and compared the amount a $100/month investment would be worth in 15 years with the amount an extra $100/month principal payment would reduce the loan balance.

Assuming that our mutual fund investment averaged an 8 percent return, if we sent Vanguard $100 a month, in 15 years we would accrue $34,604 (full value =(.08/12,15*12,-100). If we paid an extra $100 a month toward the loan principal, in 15 years we would have paid the balance down by an extra $18,000 ($100 x 180 pay periods). According to Quicken, we would still owe $113,116.

With no extra payments, remember, we would still owe $138,338.

$138,338 – 113,116 = $25,220

Compare that with the $34,604 we would have earned in the mutual fund. Clearly, we would be ahead—by over $9,000!—by investing the money in a mutual fund with low overhead, such as Vanguard and Fidelity offer.

Well, now. Suppose you were not out of work, and so had plenty of cash to throw at the principal. Let’s suppose you really have plenty of cash and you decide to pay the equivalent of an entire P&I payment toward principal. Then what?

If you put $1,044 into a mutual fund every month, in 15 years you would have $361,264. If you paid $1044/month toward principal (in addition to your regular payment) on a $211,000 loan, you would pay off the loan in 10 years.

But by putting the cash into a mutual fund returning 8 percent, in 10 years you’d earn $190,995. Since in 10 years, with no extra payments, your loan balance would have dropped to $167,901, you’d still come out ahead:

$190,995 – $167,901 = $23,094

In other words, if you put the amount of an extra loan payment in an 8% investment, in ten years you would have enough to pay off the mortgage and still leave $23,000 in your pocket. If you used the same amount to pay toward the loan once a month, you would pay off the debt but would have no cash left over.

The conclusion is obvious: If your goal is to pay off your mortgage, you’re better off investing a regular payment in a decent mutual fund than paying the same amount toward principal.

This assumes your mortgage interest rate is lower than the rate of return from an equity fund. Note also that my figures do not take into consideration the small tax advantage gained by paying mortgage interest; this factor also would tend to improve the picture if you invested in the market.

Risky? Sure. But we now know that investing in real estate is wildly risky, too: more so, it develops, than the stock  market. My stock investments are rapidly regaining their pre-crash value, but there’s no credible sign of any recovery in the real estate market here. Even if the value of the house starts to increase at 3% p.a. today, in 15 years it won’t be worth anything like what we paid for it. If property values remain flat for any length of time (as it appears they will), we will lose not only our shirt but our pants, socks, and underwear.

I used to think my father was crazy because he refused to buy a  house until after he had saved enough to pay for it in cash. All the time I was growing up, we lived either in company housing or in rentals. His reasoning indeed was crazy—he bought into The Protocols of Zion, an irrational tract that led him to believe all mortgage lenders were part of a hallucinatory international Jewish conspiracy. However, the effect was that when he retired at the age of 53, he had enough cash to buy a house and a car and to support himself and my mother in a middle-class lifestyle without having to work.

Crazy like a fox, that old boy was.

A rabid fox, but still…

Financial Freedom: An Overview

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Having finally arrived at financial freedom, I’d like to write a series for Funny about Money on how to achieve financial freedom before you drop in the traces. We’ve seen that SDXB managed to escape in early middle age and that he’s never had to go back to a day job. So we know that with luck and smart financial management, it can be done.

If and when reasonably priced universal health care coverage becomes available in this country, quite a few Americans will be in a position to get off the treadmill. Too many of us work in miserable day jobs, pushing paper or waiting on other people who are in equally miserable day jobs, for no other reason than that we must have health insurance and there’s no other way to get it. When we’re freed from that trap, the possibility of running our own daily lives becomes a realistic choice…but only if we can achieve financial freedom: freedom from debt and from the pervasive cultural and psychological influences that herd us toward debt.

To engineer financial freedom, several components of personal finance need to be dealt with and brought under control:

• Education
• Work
• Debt
• Housing
• Transportation
• Savings
• The health insurance hurdle
• Strategies to maintain financial freedom

Though none of this is nuclear physics, it’s a process takes several years. Short of inheriting a fortune or winning the lottery, you can’t achieve financial freedom overnight.

To begin with, you need some education or training that will allow you to earn something more than minimum wage. While you don’t need to earn big bucks to find your way to financial freedom, you do need to earn above the bare subsistence level. You need enough income to pay off debt that can’t be avoided (such as student loans and mortgages), to stay out of credit-card debt, and to build savings.

Then you need to find housing that’s affordable, not only in terms of what you earn but within the framework of your goal to escape the rat race. The cost of your roof, whether it’s rent or mortgage payments, has to be low enough to leave something to put into savings.

The same is true of your personal mode of transportation. If you live in one of the few U.S. cities that provides good public transport, you’re in luck. The rest of us have to own a car. We need to find ways to keep the cost of car ownership from consuming funds that could keep us out of debt or be invested in savings.

The foundation of financial freedom is freedom from debt. All debt, including mortgage and car loans. This is tightly linked with another key component of Bumhood, building and investing a fund of cash. Debt and savings have been talked to death on the personal finance blogs, but we’ll review those issues in the coming series.

Finally, there’s the question of how you manage to stay free once you’ve managed to break free. Any number of issues bear on your continued financial freedom, ranging from adult children who need help to the lifestyle you want to (or can) sustain. Since that exploration is about to become the subject of FaM, over the next few months we should make plenty of discoveries along that line.

Financial Freedom

• An Overview
• Education
• Work
• Debt
• The health insurance hurdle
The roof over your head