brian, Author at Speed To Freedom

Why Does It Takes So Long to Save $1000?

2 minute read Why does it take so long to save $1000? Every guru will tell you to start by saving at least $1000. But why does it take so long?

2 minute read

Start by saving $1000

It’s good advice.

Let’s face it: when you are just starting out, it takes a long time to save money. It can feel like it is taking forever to save your first $1000.

But, that first $1000 forms the basis of your emergency fund. It is the thing that will cover life’s unexpected obstacles and keep you from back-sliding into ruinous debt. If you are just starting out, working diligently until your savings account (not the ~~spending~~ checking account!) has at least $1000 in it.

Blown tire? You’re OK
Dental emergency? You’re OK
Flight home for a funeral (outside of COVID-19)? You’re OK
Family member in need? You can help
Home repair? You’re OK

Enough with the lecture; you know you need to save the money for your emergency fund. Let’s explore why it takes so long as this is where the real opportunity exists.

Saving $1000 is not the only place your money goes

Your emergency fund (or whatever other savings goal you are working towards) has a lot of competition:

Taxes
Retirement savings
Required expenses (housing, food, transportation, child care, etc.)
Desired expenses (entertainment, vacation travel, subscriptions, splurges, etc.)

Or, when considering a purchase, a lot of folks will tell you to take the purchase price and divide by your hourly wage. That will tell you how many hours you must work to afford the purchase.

Let’s say your family has single income earner and they earn the median US American household income of about $63,000/yr. At 2000 hours per year, their hourly rate is $31.50. Conventionally, you need to spend 32 hours (1000/31.5) to fully fund the first $1000 of your emergency fund. That’s less than a week of work! Unfortunately, it’s not that easy. If it were, I would say see you next week when you have saved $1000.

You don’t keep every dollar you earn

Let’s think about it a bit differently to understand why. You don’t keep every dollar you earn; you have to pay taxes, housing, transportation, food, entertainment, and everything else you typically spend.

Lets say you earn $63,000 as before, but your saving rate is in line with the US American savings rate of 6%. (Networthify has this awesome calculator showing the relationship between savings rate and career length). This means that 94% of your earnings already pay for taxes, housing, transportation, food, entertainment, etc. Without making any changes, the money to fund your savings needs to come from your unallocated budget, the 6%.

Trouble is: 6% of $63,000 is $3,780 of savings per year. Your hourly savings rate is $1.89/hr That’s what you pay yourself. At 6% of gross earnings, that’s downright miserly. At this rate, you need to work over 1/4 of the year just to save $1000. If you start on Jan 01 with $0, you will save $1000 by April 6.

Something has to change

Lots of people write about how to mind the gap, increase your income, decrease expenses. We’ll cover our own in time, but for now, it is enough to understand why saving $1000 takes so long.

Retire Earlier by Understanding How Expenses Change With Age

3 minute read If you could afford to retire (or consider yourself Financially Independent) earlier, wouldn’t you want to know? Check out our app and see if you can reduce some of the uncertainty around your future expenses!

3 minute read

TBD min read

If you could afford to retire (or consider yourself Financially Independent) earlier, wouldn’t you want to know?

I’m pretty risk averse. So, I look at the simple rules some people use to evaluate their ability to walk away from work with a bit of skepticism.

The most commonly touted ways to estimate forward looking financial needs are the 4% rule, from the Trinity Study and the 80% of income guideline, from the BLS Consumer Expenditure Survey. Just so you know I’m not making this up, please take a look at Fidelity’s source for their 80% # here.

Example: I’m a 38 yr old software engineer and single. I’ve saved $750,000 through extreme frugality and a high savings rate. Using the 4% rule, I can safely withdraw $30,000/yr, covering my lifestyle. I am FI and planning to walk away from my full time job soon. Should I?

Maybe. First, pat yourself on the back for being FI now. My hesitation stems from the uncertainty around annual expenses of $30,000. What if you:

Find a partner
Have a kid (or more!)
Get really sick (stupid Covid19)
Level up your lifestyle
Simply get old

Any one of these events (and a whole lot more) could result in significant changes to your financial picture. And that’s the point: understanding how your expenses change over our lives can better inform your planning efforts (as a new Dad for the second time, I can say for certain: little girls are expensive).

We set out to build a view of people’s expenses as they move through life. We found the Bureau of Labor Statistics’ Consumer Expenditure Survey and spent some time working to visualize the data to give folks a better idea of the range of expenses that participants in the survey group faced at different times throughout their lives. It is important to note that these are not the same people surveyed at multiple ages; rather, the BLS surveyed lots of people across different ages.

Start by entering an income value and then selecting demographics values. This will filter the dataset to provide the subset of matching folks and automatically update the displays.

Variation matters.

In the output pane, you will first see an income histogram. This shows the shape of the distribution of incomes for the survey participants with the same demographic data. Sometimes people will use an average to represent the center of a distribution. We don’t think this makes sense, especially when we’re trying to understand uncertainty and when the distribution is skewed. We’re displaying where the entered income falls within the distribution of similar folks from the survey. That gives us a percentile, or position in the distribution. (i.e., the 65th percentile is the income where 65% of the other incomes are below it).

Next, we take the distributions of expenses for all the folks with the same demographics and split them up by age group. We visualize all these distributions using boxplots (if we used histograms, it would be tough to see all the data in a small, useful space). So, think of a boxplot as a dense picture of a distribution.

By Jhguch at en.wikipedia, CC BY-SA 2.5, https://commons.wikimedia.org/w/index.php?curid=14524285

In this case, each boxplot represents the expense category for one age group. Notice how the shapes of the boxplots change within an expense category for different age groups. We’ve also overlaid a black line that shows the expense percentile over age group based on the income percentile entered as input. Because, it can be tough to see the actual numbers this way, our tool also provides a table of these values.

Check out our app and see if you can reduce some of the uncertainty around your future expenses!

How to Afford Your Dream House Without Going Broke

3 minute read

We are buying a Big A$$ House and it scares the living daylights out of me. So I’m going to blog about it.

First, let’s define big.

Six bedrooms. Four for immediate family, one for guests, and one to offset the cost (more on this later) of all the rest. Four+ bathrooms. Probably north of 3000 square feet of climate controlled goodness for us humans, one dog, and our Stuff.

Next, let’s talk money. In our neck of the woods, if we buy this kind of turnkey place, it’s probably $800,000. No, that is not a typo… let me write it out to be certain you fully grasp the magnitude: Eight Hundred Thousand Dollars. My heart is racing again just thinking about it.

If we bought a fixer, we might be able to get an old and busted place for $450,000. Then, we need to put in up to $150,000 to fix it for a total of $600,000. These are just estimates of course, but I’m already seeing opportunity!

As I write this in Dec 2019, interest rates are around 4%. Let’s say we’re able to put in $160,000. (We’ve been eating a lot of peanut butter and jelly to save for this). At 4%, our monthly payments are ~$3100 for the put-your-toothbrush-in-the-bathroom-and-it’s-ready purchase and ~$2300 for the fixer, assuming full financing of the renovation. I know there are intangibles: whoever heard of a full gut-job renovation going smoothly? But I do believe the market charges a premium for no-hassle.

Next up: maintenance, taxes, bills. Let’s assume these are equivalent between the two options. A good estimate for maintenance is 1% of the house value every year. That’s $8000 per year.

Taxes in the county we’re considering are $1.014 per $100 of assessed value (1.014%). Again, let’s keep things simple and assume the assessed value is $800,000 for the ready to go. Taxes become $8,112/yr. For the reno option, we’ll assign the assessed value at the purchase price + repair value. I think that will be conservative. Reno taxes are then close to $6100/yr.

Bills (Gas, Electric, water) can be pretty significant when you’re heating/cooling such a big space. An efficient build averages $210/mo for a total of ~$2500/yr. Let’s apply that to both options.

Add that all up and our annual recurring costs for each of the two options look like this:

Turnkey ($800,000 purchase) total: $55,300
- Mortgage Principal & Interest: $36,600
- Maintenance: $8,000
- Taxes: $8,112
- Bills: $2,500
Reno ($450,000 purchase+ $150,000 reno) total: $42,100
- Mortgage Principal & Interest: $27,500
- Maintenance: $8,000
- Taxes: $6,100
- Bills: $2,500

Ouch. we’re basically locked in to this cost of living for the next 30 years.

Now, let’s make this a bit more exciting. We’ve planned to take on a renter in either case. As part of the deal, each property must have a 1 bedroom suite in the basement. The suite must be isolated from the main house (with a locking door), have a kitchenette, separate access, and a full bathroom (at least a shower). Rents for a 1 bedroom/1 bathroom apartment in this area range from $800-$1200 per month in this area. Let’s pick the midpoint of $1000/mo to keep the math easy.

All of a sudden we get an extra $12,000 of rental income to apply to the total recurring costs. And, we can write off a proportion of the recurring costs. For a 3000 sqft house, we would estimate 500 sqft being allocated to the rental. That means we can write off 17% of every expense associated with the property. Here’s the line item reductions:

Turnkey ($800,000 purchase) total offsets: $15,105
- Mortgage Principal & Interest: $12,000
- Maintenance: $1333
- Taxes: $1352
- Bills: $420
Reno($450,000 purchase+ $150,000 reno) total: $14,434
- Mortgage Principal & Interest: $12,000
- Maintenance: $1,000
- Taxes: $1,014
- Bills: $420

Remember these are deductions not credits. To accurately estimate our total expenses, we need to apply our tax bracket first. Let’s say we’re in the 24% tax bracket. Here’s the final costs of these two options once the reductions are included.

Turnkey ($800,000 purchase) total: $40,200/yr
- Mortgage Principal & Interest: $24,700
- Maintenance: $6700
- Taxes: $6760
- Bills: $2,100
Reno($450,000 purchase+ $150,000 reno) total: $27,700
- Mortgage Principal & Interest: $15,500
- Maintenance: $5,000
- Taxes: $5070
- Bills: $2,100

This still is no yurt, but it’s a whole lot better than just paying out of pocket.

If you are in to frugal living, the entire concept of a house like this is probably just silly. But, if you live in a high cost area, are trying to get your kids into good schools, or simply have the ability to hack your residence, it can be a very worthwhile endeavor. Some other house hacks to consider:

Rent part of your house
Buy a small multi-family and rent most of it
Set up a home office
Subdivide your lot
Build a carriage house and rent it out
Buy an RV; live in the RV and rent your entire house

We’re In The House (hacking) Market … And You Should Be Too.

3 minute read We’re in the market for a new house/rental property. We’re considering house-hacking, a mixed use rental property where we live in one part, and rent out another.

3 minute read

4 min read

We’re in the market for a new house. Because ~~I’m cheap~~ we’re on the path to financial independence, I want to incorporate a rental property. Fusing the two is a form of house hacking, a method of turning your single family home into a small multi-family rental property. Today, I’m going to walk through how we are analyzing the cash flow for a house hack where we combine our primary residence with a rental unit.

A friend of ours passed along a community for us to look into. I figured it’s worth showing our evaluation approach (OK, it’s my evaluation approach. My wife is much more interested in the big picture rather than how the math is done).

The community is in Fulton, MD. (Montgomery county for those of you that read my last post on growing counties in MD). Fulton is a planned community under construction. It has a Town Center with a community area complete with exercise facilities, a pool, and common spaces. There’s a mix of neighborhoods, ranging from apartments, condos, and townhouses to single family “estates”. The community is in the southern part of Howard County MD, so it definitely checks our box for good schools.

Let’s talk more about the math of evaluating a mixed use rental property where we live in one part, and rent out another. While we’re not explicitly looking for a duplex, that’s essentially how I’m approaching this topic. Here’s two of my favorite bloggers weighing in on general rental property evaluation: Afford Anything, and Financial Samurai. Finally, here’s an article specifically about duplex investing on Bigger Pockets, one of the biggest real estate blogs out there.

Analyzing Cash Flow When Hacking Your House

Let’s start with cash flow. For a typical owner “un-occupied” (rental) property, cash flow must be positive to even think about moving forward (rents must be higher than expected costs). In your personal residence, total costs should be less than some % of your gross income. We’re looking to blend the two, For better or worse. See how this seems different: we’re looking to buy a place with a portion of the costs offset by a renter. If it was a classic duplex, we’d likely want to “live for free” such that the renter covers not only their portion of the costs but 100% of ours as well. Somewhere between “live for free” and rents subsidizing our lifestyle is the trade space we’re looking into.

With that said, the math still ends up being pretty straightforward. Here’s a link to the spreadsheet I’ll be using to evaluate potential properties that fit into this kinda-sorta-duplex. (Note: I am tweaking a spreadsheet that I use to evaluate potential rental properties, so don’t worry too much about the Cap Rate, Cash on Cash %, or NPV metrics.)

We can estimate what an individual property will cost us to own and operate/maintain as our primary residence. We can estimate market price point for a rental property that looks like ours. E.g., a 1 BR1BA basement apartment. We can subtract the two to find out what our net cost of living will be.

Financials of house hacking where rental income offsets primary residence expenses.

If you add up the monthly costs above, it would cost over $5,000 a month to live this way! But, by taking on a renter, we can drop our estimated net costs to about $3,500 a month (and that is before any tax benefits).

Next, appreciation. Zero (this one is easy). I never assume we’ll benefit from any appreciation on a rental property. There’s some good reasons for this: real estate tends to appreciate only as fast as inflation. This keeps the math simple when evaluating prospective properties, and keeps my analysis conservative.

Finally, taxes. I figure out what the estimated property taxes will be so I can factor them into cash flow. The source for the tax information is either based on the listing (if available) or the historical tax records…You know those are all public records, right? Here’s the MD website. And, here’s a link to an online public records search site so you could look start your search anywhere in the US. After that, any deductions, expenses, etc are all gravy. I would never advocate buying a rental property just because of the tax benefit. The underlying investment needs to be sound first.

So, how does our primary residence/rental unit stand up?

Now the good news. A 1 br/1ba in this neighborhood is also a pricey affair. I saw $1,900/mo as the nominal rent for such an apartment. So long as we don’t mind neighbors downstairs indefinitely, we could end with a net monthly cost of $3,468.19. That’s still a big number, but it helps to illustrate why I’m so keen on having a rental property baked into whatever becomes our next home. Note that I took a wild guess to arrive at ~20k to convert part of the basement into a rental unit. Here’s hoping that’s in the realm of reasonable! Because these numbers are still pretty big for us, I’m leery of making this kind of commitment without doing some serious homework.

What do you think? Would you ever accept a long-term rental situation in order to afford a big honkin’ house? Is there another way to make this kind of move and keep it affordable?

Did I Just Blow 20K?

4 minute read

…Over a decade and a half. I know: bad trick, using the headline that way.

But seriously, almost everyone in the personal finance space now talks about how using low cost investing options is a good idea. Put your money in index funds rather than actively managed mutual funds or with an adviser.

Why?

One word: fees.

Unfortunately, the investing world does not operate on the, “You get what you pay for” principle.

And, over the long haul, those little fees add up to be a drag on your returns. How big of a difference? Let me tell you a story…

My First Foray Into Investing

When I was 18, my Dad gave me a gift that I will never forget. He started me (now us) on the path to financial independence.

When I was 18, I had my first W-2 job working as a sales associate in the electrical section of the regional hardware store. (I worked for years before that, but I was always a small amount and paid in cash, so it was never eligible for taxation let alone retirement savings.) At the then-minimum wage rate of $5.15/hr, I didn’t make much. But, the little I made was reported to the government as earned income. “Fortunately,” my earned income was so small, I was ineligible to pay taxes.

I was using the money I earned to pay for some of my college expenses. So, my Dad said he would match up to my earned income and put the money into something called a Roth IRA. Of course, this became table stakes to hold a discussion on the general topic of saving for retirement. We talked about the differences between a Roth and a traditional IRA. We talked about contribution limits and the difference in withdrawal rules. Once, we made it through the lecture, we got into the fun stuff: what to do with the money. Pretty quickly, we ruled out a down payment on a car or storing it in my sock drawer. Instead, he suggested investing in a mutual fund, The Growth Fund of America (ticker: AGTHX). AGTHX is, you guessed it, an actively managed fund. Its annual expense ratio (one of several potential charges people pay to invest their money) is 0.62%.

Active Fund Fees Are A Real Drag

So, why is that a problem?

If a typical index fund charges ~0.1% in fees, the observation is that actively managed mutual funds at ~.6% or a human adviser at ~1-2% don’t make you enough extra money in the long run to justify their cost.

Compare AGTHX to Vanguard’s S&P500 index fund (Admiral shares because we’re over $10,000). The Admiral shares have an expense ratio of 0.04%. While the Investor shares (minimum of $3000) have an expense ratio of 0.14%. Last, I checked, 0.6% is more.

Comparing the actively managed fund, AGTHX, with passively managed index fund, VFIAX, fees — Source: www.morningstar.com

But, wait! You say, “don’t the hotshot fund managers get a better return for their customers?” How else can they justify charging more?

Maybe…

Let’s look at the numbers.

I used Morningstar’s portfolio analyzer to get a bit more information. Note that it only looks at changes in share prices (no capital gains/dividend reinvestment included). I simulated buying $100,000 of each fund on Jan 5 of 2001. How have the two funds done over the past ~20 years?

Comparing market returns for $100,000 invested in actively managed fund vs. index fund.

Ouch. Let’s make this even more apparent. If you look at a Google Finance image of the two mutual funds’ values over time, it looks kind of like this:

Comparing % market returns over time for actively managed fund vs. index fund.

So, what gives? At almost no point in the past 20 years was AGTHX returning a higher rate than VTSAX. I think this illustrates something called “reversion to the mean”. That’s fancy talk for an idea that most investments eventually deliver average performance. They may out/under perform for years or a decade and a half, but eventually, they produce average results. This is one of the core reasons for selecting low-cost index funds as your primary investment vehicles. Over the long haul, if most funds perform similarly, then the lowest cost fund wins. You can read a lot more about this from John Bogle, inventor of the index fund, founder of Vanguard, and personal hero. While AGTHX may have outperformed VTSAX before the internet was widespread, in more modern history, VTSAX has outperformed. Yet, AGTHX consistently charges fees that are almost 10x higher. What?

By the way, those fees are pretty insidious. If you look at your statements, you will not see actual dollar values coming out of your account. Instead, the fund management team takes them off the top before they show up in any individual statements (I spent a few hours looking through some pretty arcane sections of both American Funds and Vanguards websites before I convinced myself of this).

Deciding To Make A Change To Indexing…Or Maybe Not

So, now the conundrum. I admit, it’s an emotional one. Math says, roll everything from AGTHX into a lower cost fund (e.g., VTSAX). Our goal is not to tap these funds for at least a few decades. So, shedding the fees should be the right decision. But emotion says maybe those über-smart folks at American will outperform the index once again. And, what about diversification? If hackers get into Vanguard, they may not simultaneously get into American. And besides, my Dad is the one who got this ball rolling, even if I’ve done the vast majority of the contributions. I feel some (totally irrational) guilt at moving away from this fund.

So, what to do? I’d love some other perspectives…drop me a line in the comments.

Living Better, Okinawan Style

< 1 minute read The simple, frugal, socially connected lifestyle of Okinawans can teach us a lot about how to achieve financial indpendence.

< 1 minute readIt’s only my third time in Okinawa, but every time I visit, I learn a bit more about Okinawan culture. Each time, I marvel at their resourcefulness and the many ways they live fully and healthily yet frugally.

Okinawans laugh … together. Over a cup of tea and a small snack, there are always funny stories of kids, grandkids, and neighbors. At least that’s what they tell me. Not understanding shimakutuba, I have to trust that’s what is actually being said. It’s a fascinating exercise: observing a conversation when you understand almost none of the spoken words.

Okinawans are social. We’ve been staying with family while we’re here, and at least once a day, a random neighbor, friend, or relative stops by to say hi. Inevitably, they have a small omiyage or gifts to share. Okinawan omiyage are often fresh from their own gardens, (and therefore free!).

Speaking of the garden, so many food items grow well in Okinawa. On a small plot of land, our family has 4 kinds of citrus trees (lemon, shiquasa, tankan, and kabochi), bananas trees, and persimmon trees. There are green onions, cabbage, carrots, and a staple: Okinawan purple sweet potatoes. Finally, a number of chickens inhabit the property providing fresh eggs daily. You can literally have half or more of your basic food provided fresh from the garden! Growing up with little money, our family did exactly that.

There is so much goodness that comes from having skills to survive without just pulling out cash (or a credit card). We can all learn to stand on our own two feet a little more.

I shelled out 548 Yen for an Espresso

2 minute read

As my family and I travel across Japan, I’ve been drinking a lot of tea. When in Japan, it’s the thing to do. And I like tea, especially Japanese tea. But, I love coffee. And, after 11 days in country, my perfectly prepared Espresso really hit the spot. So, at current exchange rates, that Espresso cost almost 5 bucks. Frankly, it’s ludicrous for a cheap-skate like me to spend that much on a single coffee. And, that is against the backdrop of our 3 week trip to Japan, itself no exercise in frugality.

How does spending so much money fit into the context of a Financial Independence website? Simple; this is my dream: to spend time with the people I love most. This is why I save money in almost every other facet of my life. This is why I put in over-time at work to boost my income. This is why I invest in as many assets as possible.

My family and I have saved for almost 2 years for this trip. We’ve decided to spend our holiday vacation and significant financial resources to visit extended family in Japan and tour other parts of the country while we are here. Our almost 3 year old will meet her 98 year-old Okinawan great-grandmother, and the memories and pictures will be priceless.

So, for an (almost) inaugural post on a Financial Independence website, starting with my “why” seems like the right place to begin.

In the coming years, Dan and I intend to share lots more about our personal journeys, including our mistakes and successes. We plan to distill the principles that guide our decisions into a sequence of modular courses designed to inform your own actions. Our goal is to pay it forward and help others navigate their personal financial journeys to achieve freedom as quickly as possible.

To that, I say, “Kanpai!”