What’s inside? Here are the questions answered in today’s reader mailbag, boiled down to five word summaries. Click on the number to jump straight down to the question.
1. IRA or savings account?
2. Rental properties
3. Why risk money?
4. Aggressive mortgage repayment?
5. The Billion Dollar Bracket
6. Freebies and ethics
7. Emergency fund question
8. Short term investing
9. Beard trimming
10. Questions about electronics
My work computer has two screens. I use one of them for my primary work and the other one displays constant updates of several things that I like to keep my eye on, like Twitter search terms and headlines.
Anyway, the second screen has been on the fritz for the last few weeks. I’m not going to replace that second screen – it’s not vital enough for that – but it’s frustrating enough that I keep tinkering with it.
After several experiments, I determined that it was the cable connecting the monitor to the computer that was at fault, so I replaced it.
It took about two hours, all told, to piece together the problem. The issue was that the “broken” cable works almost all of the time. It just “shorts out” on rare occasion.
Diagnosing the problem with something that doesn’t work and fixing just that problem rather than simply replacing it is usually the best option. Even if you do end up buying a replacement, you’ve usually learned something in the process that you can apply later on.
Q1: IRA or savings account?
I am wondering if I should just start putting all my leftover monthly income into my IRA, because right now excess income goes to my savings. About me: I am 25 and employed with 2 jobs, so I usually have anywhere from $200-300 left over at the end of the month after bills, food, education loan repayment, etc. I also have no old credit card debt, and pay my 1 credit card bill in full each month.
I have had a savings account since I was young, and hit $30k on it recently. This would cover my living expenses for well over a year. At this point, I’m not sure if it makes sense to keep building it since the interest rate is not high (it’s comparable to the national average). Currently, I contribute about $225/month (~$2700/year) to my IRA (and my employer matches 3% of gross income). This totals less than the maximum contribution. Should I max out the IRA contribution instead of contributing so much to my savings account? Do something else with it, like put some into a CD? I do not plan on taking on a mortgage for another 5+ years.
Your emergency fund (the savings account) is very, very healthy. In fact, you probably have more in it than I would have in your situation.
If you want to continue to save, I’d make sure I was getting every dime in matching money from my employer, so I’d max out that IRA.
After that, if you still have more to put away, I would look at other investment options. If I were you, I’d put the rest into an ordinary investment account at Vanguard and then start investing in index funds. I’d start with something like the Vanguard Total Stock Market Index, which is a really good bargain. It’s something I personally invest in.
Rental properties make money without much effort if you live in an area where there’s always a flow of people looking to rent, those people are trustworthy and low maintenance, and you can acquire properties cheap enough so that this endeavor is worth it.
Finding that trifecta actually isn’t that easy. If you also consider that you’re either going to have to hire a management company (which costs you) or do maintenance and repair on a rental home (with renters who, by definition, don’t have financial interest in the maintenance of the property), it can also be labor intensive or not earn a particularly good return.
You’ve also got a lot of people that might potentially be landlords but find their time gulped down by other responsibilities and the pool of people who might rent is pretty small.
I have no interest in being someone’s landlord. I don’t want to enter into the legal entanglements and financial risks involved. Give me an index fund any day of the week.
The difference is that money sitting in a savings account is earning returns below that of inflation, where money in a well-balanced stock investment earns returns above that of inflation (over the long haul).
Think of it like this. Every year, the purchasing power of a dollar drops about 3%. You’ve witnessed it in your own life, I’m sure – everything costs more than it once did. The prices overall change at a rate of about 3% per year.
In a savings account, you’re earning about 1% per year. This means that although your money is growing, it’s still buying less and less and less every time. You might have 1% more dollars, but each one buys 3% less stuff.
In the stock market, you’re earning about 7% per year over the very long term. Your money is growing faster than inflation. Your dollars might buy 3% less stuff, but you have 7% more dollars, so you’re ahead of the game.
It’s not just about earning a few percent more in return. It’s about staying ahead of inflation so that you can actually afford to buy things in retirement.
My question is, how does that idea apply to a mortgage? It just doesn’t seem practical to be as aggressive with mortgages.
Mortgages are typically huge, and run for 25-30 years. I fully realize that because of compound interest, a mortgage can easily cost twice the loan amount in total, so it makes sense to pay off as much as possible, as early as possible. But precisely because it’s not going to be paid back in a year or less, it doesn’t seem realistic to make such a big sacrifice?
For the reference, I’ve got a 25 year mortgage of around 200.000€, at 750€ per month (that’s a third of my pay after taxes), zero other debt, and a healthy emergency account. I have two kids aged 1 and 4, so my wife isn’t working for at least another two years, and then only part time. I work more than full time already, and no real chance that do a side business from home as long as the kids are that young. We just don’t have much left over to add to the mortgage payments.
The point isn’t to pay off your mortgage in a year. Very few people are going to do that. The point is that if you have some extra cash left over, you put it toward the mortgage payment.
Let’s say you have a credit card and a car loan that add up to $500 per month. You pay off the credit card and the car, so then you theoretically have $500 more per month than you did when you had those bills. You should then apply that $500 toward extra mortgage payments.
Doing that won’t change your day-to-day standard of living in any way. All it will do is help you to pay off that mortgage faster.
I’ve received this question several times in the last month and I though it would be pure fun to answer it. I wanted to wait until I was sure that I wasn’t going to win before I answered, so now that we’ve crossed that threshold, here’s what I would do.
First, I’d take the “annuity” rather than the “lump sum.” That would mean I’d get $40 million a year for the next 25 years rather than an up front $500 million sum. Inflation would have to be well over 6% for this to not be the best choice.
After that, I’d do everything I could to “drop off the grid” as much as possible. My main worry, in at least the first few years, would be privacy. I’d honestly ask Buffett’s advice (since I would theoretically be sitting there beside him during the final game) on how to handle personal security and privacy should I win, since he’d know this.
I’d buy a pretty large parcel of land in a secluded area with plenty of woodlands to freely enjoy and spend the rest of my life doing community work. I’d do my best to make sure that my children didn’t grow up with a sense of entitlement of “coming from money.”
Q6: Freebies and ethics
My husband always chooses to go to the store on Saturdays when they have a lot of samples. He usually takes three or four laps around the store, hitting all of the samples each time, and fills up so he doesn’t have to eat lunch. He never buys any of the samples either unless it happens to be something that was on the list. I won’t go with him when he does this because it feels cheap and we usually end up arguing about it. What do you think?
Here’s the thing: stores (sometimes in conjunction with the manufacturers) use samples to convince people to make impulse buys. I’m sure they’ve run the math on them and have decided that samples are profitable for them. If the percentage of people that are converted into sales by samples goes down too much, they’ll stop doing samples.
This is an example of the “tragedy of the commons,” which pops up over and over in life. When there’s a shared resource that everybody benefits from a little bit, that’s great. However, if some people start using more and more of that shared resource, it’s not long before that resource is completely gone and no one has it.
Some people think it’s okay to devour as much of the “commons” as possible so that they get every bit of their share. I don’t particularly like that. If I ran a store, I’d encourage the people giving out samples to deny them to repeat samplers.
Q7: Emergency fund question
I have a question concerning emergency funds. My husband and I have very good jobs and four children ages 6-19. Like everyone, we also have expenses that about equal what we have coming in. Over the years I have saved small amounts and now have about 20,000 in an emergency fund. My concern is now that I have child in college, whenever I fill out the financial aid information I have to list that as an asset to use for his education. While I could certainly use some of that for our son’s education, that would defeat the purpose of it being an emergency fund. How do other people handle having their “safety net” being considered money to be tapped for college expenses? Should I lower this fund and just pay off more of my debt? Is there any way to shelter that money from being counted toward our available assets for schooling?
There are lots of completely legal and ethical strategies available for improving financial aid – here’s a list of some of them.
The best thing a parent can do is to keep as many assets as possible in the parents’ name, not the child’s name. A 529 in which the child is a beneficiary is fine, however.
Why? Only a small percentage (2.6% to 5.6%) of a parent’s assets are considered eligible to be used to pay for schooling, according to this site. In your case, of the $20,000 you have sitting in savings, only about $1,000 would be considered eligible to help with your child’s college savings.
I wouldn’t sweat it too much.
Q8: Short term investing
My wife and I have about $75,000 saved in a mutual fund. We are going to buy a house late this summer. Given that stocks are sputtering where should we put that money until then?
I wouldn’t keep them in stocks. Stock volatility over a four or five month period can be incredible and you really don’t want to potentially lose 20% or so of your money right now.
Honestly, if you have enough for that down payment right now, I’d put it into a savings account. There, it’s FDIC insured, won’t lose any value, and can be withdrawn very easily when needed. It’ll also earn a small amount – probably around $300 or so – during that time.
Remember that when you pull that money out, you’re probably facing a tax bill at the end of the year. Your brokerage can help you assess that bill, but you want to account for it.
You can trim a beard with a comb and a pair of scissors, but it takes a lot of practice to do it well. Back in my beard days, I tried doing it and could never get it to look good – my sideburns were always too long. Still, you can start there and see how that works for you. Just run a comb through your beard at different angles and use that for a trimming guide with the scissors.
As for actual beard trimmers, I’m not sure. I used a Panasonic model back in the day, but it’s been discontinued for years. I asked a few friends what they used and have heard good things about and the only sub-$50 trimmer with strong positive remarks was this Panasonic Milano. If I were to grow a beard again, this is what I would choose.
I highly, highly recommend having someone else help you judge your beard for a while until you get used to trimming it, though. I often thought my beard looked fine and then I’d learn later that others thought it was bushy (again, particularly on the sides).
Q10: Questions about electronics
I have a smartphone (2 years old) and a laptop (3 years old). If they got lost or stolen, I could easily pay cash to replace them with equivalent or slightly better models. Does this mean I don’t need insurance for the items? The premium isn’t a lot but it still feels like a waste if it’s not necessary.
Also, at what point should I think about upgrading these products? Both have been a bit slower than usual lately and I’ve been thinking about trading them in while they’re still in a working condition. Or should I ‘run them into the ground’ and keep using them until they stop working completely?
Insurance is all about risk. Is it worth paying the small amount to avoid having to pay a larger amount if something goes wrong? The companies set insurance rates based on how often they think they’ll have to actually pay out (along with the overhead and some profit for them). Thus, if you’re insuring a $500 device for $50, they think there’s a less than 10% chance you’ll ever turn it in.
Given those odds, if you can easily cover that money out of pocket without skipping a beat, it’s probably better for you not to insure such small items.
I wouldn’t upgrade the items unless they’re either not performing the functions that you need or the upgrade path is free or extremely cheap.
Got any questions? The best way to ask is to email me – trent at thesimpledollar dot com. I’ll attempt to answer them in a future mailbag (which, by way of full disclosure, may also get re-posted on other websites that pick up my blog). However, I do receive many, many questions per week, so I may not necessarily be able to answer yours.