# Financial Update Dec 2016

Another month, another update. Some random thoughts this month.

The humbling mathematics of retirement savings.

• The mathematics of retirement are daunting. In order to retire, you can only withdraw 3-4% of your investments annually. This is known as the safe withdrawal rate. 3% is a more conservative number. 4% is less so. Good discussions on the topic are found here and here. In other words, \$1 of investments should yield roughly \$0.03-\$0.04 in interest (through dividends and capital gains) indefinitely.
• If it costs you \$X/year to live, you will require \$X/.03 (=33X) or \$X/.04 (=25X) to retire.
• Obviously, you’ll reach retirement much quicker if you can bring \$X as close to zero as you can. It’s by far the most important thing you can focus on for your financial well-being.
• Let’s put some numbers in. \$50k is probably viewed by most as a relatively modest retirement budget. At that rate of spending, the above calculations indicate required investment balances of \$1.66M and \$1.25M, respectively. These are obviously large amounts of money that most people will never accumulate in their lifetimes.
• If instead we can live on \$25k, these required investment balances drop by 50% to \$830k and \$625k, respectively.
• To me, this humbling exercise in arithmetic should be at the forefront of everyone’s minds.
• When I brown bag a lunch instead of going out (which I do daily) and save \$10 in the process, why do I do it? It’s to increase my investment balances by \$10, which will generate \$10*0.03 in interest forever, or 30 cents per year. Every dollar saved will generate 3 pennies in interest in perpetuity.
• The above is why I save. So my savings can make babies – a few pennies at a time.
• Retirement is certainly a daunting prospect when one is honest with himself and performs the above calculations.
• As I’ve already said on the blog, the best thing you can possibly due to increase your net worth is to dramatically lower your recurring expenditures (housing, auto, health, food, entertainment, utilities, etc). This is most important as the gains to savings are amplified with each transaction (monthly food bill, etc).

A few notes on cash flow optimization:

• You should do everything possible to not receive a large tax refund. The ideal refund is near-zero. Tax refund = stuff you’ve overpaid + free money from gov’t (EITC, etc). If you have low income, don’t withhold any federal taxes throughout the year by claiming exempt on your W4. This will help get you cash in Jan 2017 rather than in April 2018, a difference of 16 months. This cash flow management is especially important if you are in debt, where 16 months of high interest debt can be especially costly. Strive to predict within \$100 what your federal tax liability is and change your W-4 withholding today to optimize your cash flow today. The math says having a near \$0 refund is optimal. For tax year 2016 I claimed exempt from federal taxes, yet I’ll get a huge tax refund (thanks to large family and deliberate tax planning such as \$36k of supplemental retirement contributions).
• A nice thing I did this past month (which I’d never done before) was to ask my credit card company to shift the due date of my statement so that the bill is due on the 1st of the month. I’m paid at the end of the month, so it’s nice to immediately pay the credit card bill after receiving my income. After this bill is paid, I keep around \$4k in the bank to pay for my mortgage (on the last day possible, the 15th) + a tiny emergency fund (around \$1k) and immediately put the rest to work by investing it or paying of debt (in my case I only have mortgage debt). Having near zero cash rotting away at low interest is a good policy, particularly if you’re in debt. Historically I’ve banked at Ally which has of the best money market / online savings rates in the country (currently ~1%). I’d recommend Ally to anyone, as I have banked there for 10 years. Currently, however, I use a bank that has partnered with my employer to provide rewards checking yielding 2% for checking. Not a bad rate of return for idle cash in a checking account in today’s interest rate environment.
• I pay utility bills, etc. with credit cards for a few reasons. 1st: free money with cash back rewards. 2nd: if I incur the expense at the beginning of my billing cycle, the credit card company gives me an interest free loan for 45 days or so. It’s a nice cash flow management tool, but only if you’re paying the credit card off in full every month.
• I recently called up my mortgage company and asked for them to stop withholding property taxes (which are non-trivial in size) into escrow. I’d tried to do so before but they said no (not sure why, perhaps I didn’t have enough equity yet). Luckily, they obliged this time. Why did I do this? 2017 property taxes aren’t due for me until March and July of 2018. Similar to the federal tax witholdings logic above, why would I give my bank an interest-free loan for up to 19 months (Jan 2017 to July 2018)? I can put my money to better use today, and have the discipline to save enough myself to pay property taxes when they are due. The only time this strategy breaks down is when one lacks the discipline to save on his own. I do the same for home insurance, which I pay annually out of pocket rather than through escrow.

Investment thoughts:

• I helped a friend this month lower his expense ratio from 0.67% to about 0.06% though the DIY alternative to target retirement funds (especially Fidelity’s which are expensive) that I advocate elsewhere on this blog. Doing so will easily save him a grand a year based on his current investment balances, and hopefully up to ten grand per year once his investments exceed \$1M. Doing so took a couple of mouse clicks and will make him tens of thousands of dollars richer over the course of his life. But when I helped him make those mouse clicks, balloons didn’t fall from the ceiling. Nobody jumped out of a cake. They didn’t carry me out of their house on a throne. It was largely anti-climatic, and the full consequences the decision won’t be fully realized until 30-40 years from now. This is precisely how the actively managed mutual fund industry still exists (as well as AUM financial advisers). Small differences in investment performance are imperceptible over the short term and only visible after 10+ years. However, in 30-40 years, this will prove to be one of the wisest financial decisions this friend has ever made.

• I had a large cash inflow as I cashed out the property tax escrow. This is mostly what accounts for “Other Income” this month. I now show \$0 property taxes paid every month, though my “Property Taxes Payable” account (not shown on balance sheet) is growing at a rate of \$576/month. So I’m understating my monthly expenditures now to optimize cash flow.
• IRA and HSA funding deadlines is April 15, 2017 for 2016 contributions. With the extra cash we have on hand, we’ll be fully funding our 2016 IRAs (5,500X2) and 2016 HSA (\$6,750) over the next several weeks.
• Actively managing our taxable income this year will enable us to maximize the EITC this year and receive a ~\$9k federal tax return. All moderate income households with (~50k-\$75k) per year in income and lots of kids should actively be managing their retirement and HSA contributions to max out the EITC every year. I’ll be filing taxes for free using Turbotax’s Freedom Edition (turbotax.intuit.com/taxfreedom/) which is usually available at the end of January. I’ll have the federal tax return money in hand in mid-February.

Footnotes:

1. Don’t lend money to friends/family.
2. I lazily approximate home value using Yodlee’s embedded SmartZip estimator.
3. I have a 15Y mortgage; which results in a faster rate of repayment. The true cost of the mortgage should exclude repayment of principal, which I show above.
4. \$15 internet and \$0 cell phones as described here.
5. All expenditures at Costco & Walmart are classified as “Food at home” for simplicity (even if it’s laundry detergent, clothing, etc).
6. I prefer Vanguard funds but my employer offers Fidelity instead. Also, Fidelity mutual funds work better at my Saturna HSA.
7. Nobody knows the perfect asset allocation. Just pick one and run with it. Use a target date retirement fund as a benchmark if you want some guidance (link).
8. My low portfolio expense ratio is the primary reason why I don’t hold target-date funds, which have expense ratios anywhere from 0.16% to 0.75%. I can achieve a much lower expense ratio on my own due to Admiral shares, etc. And it’s not hard. Plus, a DIY portfolio allows one to tax-loss-harvest more easily.
9. The only other administrative cost not captured by my expense ratios is a \$19/year administrative fee for my HSA at Saturna Capital.

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### 2 thoughts on “Financial Update Dec 2016”

1. I love the line “Every dollar saved will generate 3 pennies in interest in perpetuity.” I read the other day that the most important thing to reach your retirement number is what your savings rate. But it makes a ton of sense like you said above. I really enjoyed reading your update. Thanks for sharing!!!