The 4% rule – How does Real Estate Play In?

The common goal in the FI/RE (Financial Independence, Retire Early) community is to reach a point where your net worth is 25x your annual spending, meaning your expenses are 4% of your net worth. This is an extreme oversimplification of things because of the number of variables associated with where your net worth might be, and how to access it. For example, retirement accounts have requirements to be met before drawing funds; while you may have hit the 4% expense to net worth ratio, it may not mean that you have that money liquid to cover your spending.

When the ODAs started down the path of FI/RE, we did it with a real estate rental portfolio. This path of net worth growth really doesn’t fit the traditional mold. It provides regular cash flow, rather than an account with a balance that’s drawn down. 

As mentioned in previous posts, there are numerous ways to make money in real estate. The path we have taken is probably one of the simplest and most repeatable for anyone. We own a portfolio of single family rental houses, most of which were bought straight from the MLS. These basic properties are in basic neighborhoods with regular tenants. Nothing special. We acquired these properties by focusing on the 1% rule in real estate – try to secure 1% of the property’s purchase price in monthly rent. Another oversimplification of how things really go, but if we were able to find a $100k property that rents for $1,000 a month, we know we’re going to make money long term. 

For these properties, we typically put 20%-25% down and finance the rest through a conventional mortgage. We find a tenant, and then the 4 ways to make money in real estate go to work for us: appreciation, tenant mortgage pay-down, tax advantages, and most importantly for our situation and FI/RE – cash flow. 

I want to talk about how we can reach a FI/RE number through real estate cash flow differently and more quickly than using traditional stock market investing. 

The $100k house had a 20% down payment and mortgage rate at 5% interest, which brings the monthly principal and interest payment to $429. Add another $121 for taxes and insurance (using round numbers here!), $100 for maintenance and capital expenditures savings, and $100 for a property manager; this comes to $750 worth of monthly expenses. At $1,000 per month of income, you have $250 per month of cash flow in your pocket. $250 per month equates to $3,000 per year of cash flow. With the $20,000 down payment and about $5K in closing costs, it means that our $25k investment nets us $3k per year in cash flow. 

Circling back to the 4% rule for stock market investments, $3k in cash flow requires a savings of $75k. But we only had to invest $25k! We’re banking on the monthly cash flow, rather than a “stagnant” savings.

We took that math and ran with it. Our rental portfolio has 12 houses in it. While we’ve shown in prior posts that each house’s numbers aren’t as clean and simple as this example (some better, some worse), if we take that $3k annually and multiply by the 12 properties, we have $36k in annual cashflow for only $300k invested. 

What would you rather need to produce $36k income – $300k or $900k?

Can you scale a rental portfolio to reach enough annual cashflow such that you can live off the cash flow? 

Rental property investing is not completely passive. We have tenants to manage, properties to maintain, property managers to manage, income and expenses to track for taxes, lending efficiencies to explore, and the list goes on. But if you’re willing to put in a little work to reach financial independence (the FI part), you can do it substantially faster by finding strong properties to provide significant cash flow than if you were to take the totally passive route of simple stock market (index fund) investing. 

Note, there’s nothing wrong with that – we have a substantial position in the stock market due to the tax free growth benefits of retirement accounts. The power of real estate investing saw our net worth grow faster than we’d have ever dreamed since we bought our first rental in 2016. The proof is in the pudding and we advocate to anyone to just get started!

Amortization Schedules

An amortization schedule is a document that is a huge spreadsheet of numbers that tells banks and their software how to apply your monthly mortgage payment. It defines the amount of each payment going to principal to pay off the loan balance, and the amount going to interest for the bank allowing you to borrow their money.


Let’s rewind. How does the bank figure out how much your monthly principal and interest payment is going to be? This is a function of several things:

  • Loan amount (purchase price minus down payment)
  • Interest rate
  • Loan term (length)

Want to see a formula for that?

  • loan amount = x
  • interest rate = y
  • loan term (months) = z

Looks like a blast doesn’t it? I saved this formula into my spreadsheet for evaluating properties so that once I fill in the purchase price, expected down payment, loan length, and the predicted rate from my lender, it will auto-populate the monthly mortgage payment amount. I then take that number and can calculate predicted cash flow based on a rent estimate.


Back to the point of the post. Loans with long terms borrow the money for a long time. Loans with high rates borrow the money more expensively. In both cases, the early stages of the amortization schedule give much more money to the bank as your fee for borrowing (interest) than they do to pay down the loan. This is because every dollar of that loan principal is being borrowed and needs paid for.

In the first payment, the entire principal amount borrowed is in that formula above, so it’s expensive to the bank to give you that money. Fast forward 15 years of a 30 year loan and you have far less outstanding principal left, so the interest charge associated with that is less. Since your total monthly mortgage payment (principal and interest, ignoring escrows) total doesn’t change, the interest applied towards a smaller balance leaves more ‘room’ to pay toward more principal. Basically, the bank gets its money out of your monthly payment first, and what is left over can go to principal pay-down.

DAILY INTEREST

To better explain the cost of borrowing each dollar over time, it’s likely easier to break it down into daily interest. An amortization schedule calculates the cost to the borrower for giving you the bank’s money on a per day basis. So while I have access to $X for the whole month, I owe the bank for every day I’m carrying that principal. Multiply by 30 and that’s what the bank charges me for interest for the month. Then, remember that the leftover is what goes to the principal pay-down.

How to calculate. Divide your annual interest rate by 365 to get your daily interest rate. Multiply that rate by the outstanding principal to get your daily interest charge. Multiply that by the days in the month (or most banks use a standard month length = 365/12) and come up with the interest the amortization schedule charges you for that month’s payment.

We mentioned the different types of amortization we’ve seen in the House 1 post. This loan calculated your monthly principal part of the payment by the exact number of days in the month so each month’s proportion of principal to interest varied up and down. This is in contrast to what most banks do that I mention above.

THEORETICAL EXAMPLES

A pretty standard rate in the last decade is 4% on a 30 year fixed mortgage. Lets say the loan amount is $100k. Plugging that into my formula above, we get a monthly payment of $477.42. Above are the first 10 payments on that loan. Only about 30% of your monthly payment is actually paying down principal at the beginning. It takes 153 payments (i.e., months) before the amount of each payment going to principal is actually more than paying interest. Total interest on the full loan in this scenario is $71,869.


Now lets look what happens when we change it to a 15 year loan. The total payment jumps to $739.69 because you are paying the principal down twice as fast. But, the first payment you make is already $406.35 worth of principal pay down. Compare it to the first loan example in the terms of daily interest. The rate is the same. The amount is the same. So the interest due for the month is the same. But because your amortization schedule knows that you’re paying the loan off much earlier and requires a larger total payment, the leftover for principal pay-down is far more substantial.

Next, look how much quicker the interest charge drops after just 10 payments compared to the first example. $320.98 vs $328.95. This is because you are paying principal down more quickly, so the outstanding balance decreases and the daily interest is then lower too. Total interest in this scenario is $33,143.


In this example, we move back to a 30 year loan, still at $100,000, but we bumped the rate to 6%. The total payment rises to nearly $600, and the principal to interest ratio of the beginning payments is quite poor. Only 17% of the payment is going to principal pay down, which means that the daily interest is high, and stays high for many months. It’s not until month 223 (18 years later!) before the amount of principal in each payment is higher than the interest payment. Total interest in this scenario is $115,838.


Side story – Mr. ODA’s parents paid off their 30 year mortgage on their residence in 12 years. As a child, Dad would explain to me their process. They printed out the amortization schedule and put it on the fridge. Each month, based on their regular cash flow of life, they would choose ‘how many months’ they wanted to pay to the loan. So they’d make their regular payment, then they’d pay the principal portion of the next 2-3 months on the amortization schedule also. They’d make some really gnarly extra payments with weird dollars and cents, but it was a calculated decision. Then they’d cross those months off the schedule, knowing that with that extra payment, the interest that was tied to that principal portion on the schedule was simply avoided/canceled, by paying that principal early. This was a powerful tool to help me understand how the loan process worked, and one that help create the foundation for me to look at time value of money, opportunity cost, guaranteed return vs potential invested return, etc. Dad missed a lot of stock market gains by accelerating a 30 year mortgage to 12 years, but very few people ever regret owning the roof over their head free and clear – with a byproduct of NO MORTGAGE PAYMENTS for the 18 years that would’ve been remaining! Now he can make more investments with that leftover cash flow of life.


Amortization schedules are one of the largest “gaps” in understanding for the typical mortgage customer. They typically get told what to pay each month and ascribe to a “set it and forget” mantra that they know in 30 years, their house will be owned free and clear. Anytime before that, why bother understanding the background math?

As you can see in the examples, a shorter loan means faster pay down with less interest overall, and a lower interest rate means a smaller payment. When looking at loan options, understanding how the math operates to get to your options can help you determine what your priorities and goals are, and how to execute them.

In our recent refinancing post we talked about analyzing when was a good time to refinance our existing loans and which ones we’d target first. Simple advice you can find on the internet is that it’s a good idea to refinance if you plan to keep the property for longer than the result of closing costs divided by monthly payment. Most times this was about 2 years for us. You can see above that the 6% example had a $123 larger monthly payment than the 4% example (30 year term). So if closing costs are $2,000, it would only take 16 months (2000/123=16) to “break even” on a refi to go from a 6% loan to a 4% loan. No brainer!

There’s another hidden benefit there too, that gets missed to make it even shorter than 16 months. Look at the principal portion of the monthly payment. On the 6% example, it’s only $99 on payment 1, but on the 4% example it’s $144. That’s another $45 benefit! You’re paying down the principal at a faster rate. Add that extra principal portion embedded within the monthly payment to the $123 lower payment savings ($123+45=$168) and you get a “break even” point of only 12 months ($2000 closing costs/$168=11.9)!

Understand how your mortgage math works so that you can speak intelligently to a lender, ask good questions, and set yourself up with the best scenario for your finances and your future.

Contrarian View on an Emergency Fund

There are many teachings out there that talk about a safe, sustainable, and efficient way to wealth being many streams of income. This diversifies and provides multiple avenues for growth, but also mitigates risk and protects your larger portfolio against any one stream failing.

Our financial portfolio meets those goals. Instead of having an emergency fund sitting in a savings account earning 0.03% interest (that’s literally our savings account interest rate, and that’s the ‘special’ relationship rate), our money is put to “work,” earning more money for us.

INDEX FUNDS

Probably the simplest and most common example of multiple streams is index fund investing. A quick read of JL Collins’ “The Simple Path To Wealth” will teach you that through index fund investing, you have an ownership share of every company the index fund covers. Some are matched to S&P 500 companies, some to International, some to the DJIA, and most to the “Total Market.” Mr. and Mrs. ODA invest in the “Total Market Index Fund,” through Fidelity, in our IRAs and taxable investment portfolio. By owning a small part of every publicly traded company, we own that many streams of income. Any one company going belly up will only be a blip on the radar of that index fund, and, over enough time, it will go up, and up a lot. This is as risk free of a true investment as you can get. 

Being Federal Employees (Mrs. ODA no more, though), we both have access to the Thrift Savings Plan (TSP) for our 401k’s. The TSP provides a group of 5 index funds to choose from: Government Securities, Fixed Income Index, Common Stock Index, Small Cap Stock Index, and International Stock Index. 

In times of market upheaval, we can ‘escape’ to the Government Securities fund, and pending a nuclear winter or alien attack, is guaranteed to be paid (TSP.gov). However, with this little risk also comes little reward, so it won’t grow fast. With index funds and a safety spot, our TSPs are about as low risk a retirement investment as you can have. Note that Index Funds through Fidelity or Vanguard (for example) and the TSP have the industry’s lowest fees on their funds, so we won’t lose our nest egg to management costs either. 

REAL ESTATE

Outside of anything related to the stock market, we have 12 single family rental properties. Each of these houses operate as their own small business, with long term tenants in most of them (that have thankfully all been able to maintain rent payments through the pandemic). If one or two houses did lose their tenant, or have an AC break, or a roof needing replaced all at the same time, the other houses (businesses) can pick up the financial slack. A few of the properties are owned outright, so the lack of a mortgage certainly helps the whole portfolio’s cash flow. And actually, we did have to replace/repair multiple roofs and HVAC units at the same time in the summer of 2020! On top of the individual homeowners insurance we have on each house, we have a Commercial Liability Umbrella Policy covering anything above and beyond the individual policies.

DIVERSITY

We also have some money tied up in more actively managed mutual funds – investments we owned before we discovered index fund investing – and individual stocks. However, I can’t bare the capital gains taxes required if I were to sell them and shift that money over to an index fund. But – they’re there in case of an emergency.

That Federal job I mentioned – I’m lucky to have about as much job security as any W2 employee can have in this great nation. Through the shutdown a couple years ago, I had 2 paychecks delayed, but my rental properties made it so that I didn’t have to worry about our finances. Otherwise, a safe, consistent paycheck is something I can count on – with health insurance for our whole family that comes with an annual out of pocket maximum of only $10,000.

So we have a W2 income, 12 rental property small businesses providing monthly cash flow, and a slew of stock investments diversified across all markets. We have diversity that mitigates risk and shields us from small “emergencies” manifesting themselves as such.

We view “medium” emergencies as something that can be solved with a new credit card deferring needing to truly “pay” for our expenses until life gets back to normal. You’ve seen a past post discussing our perspective on strategic credit card usage (and the Chase cards specifically). Twelve to fifteen months of no interest on a credit card can get anyone out of a financial bind when emergencies hit. We haven’t found a reason to NEED this option, but know that it’s always out there if the perfect storm of bad luck were to ever hit.

For these “small” and “medium” emergencies, stocks could be sold before we would need to be faced with something like not being able to pay utilities, buy food, or get foreclosed on. We simply don’t view a “large” EMERGENCY cropping up with any higher than a near non-zero probability given the shielding and structure we have built out of our total financial portfolio.

I can’t fathom what that perfect storm would look like. Six months of expenses can easily be found in selling our stocks if all of our tenants suddenly stopped paying rent, for example. But if a pandemic isn’t going to make that happen, what would?

All this to say – Mrs. ODA and I keep very little cash liquid to cover our “emergency” fund. Outside of a couple thousand in our checking account to cover regular monthly/cyclical financial obligation fluctuations, we don’t have any dollars NOT “working for us.” Whether it be investing in index funds, contributing to IRA/401k, or paying down mortgages to eventually achieve more cash flow, we put all our money to work. We see the rewards of this strategy far outweighing the risk of encountering a debilitating financial emergency, and therefore don’t follow the traditional personal finance advice of keeping X months’ living expenses in cash handy at a moment’s notice.

New Year

In honor of my last post being two years ago, we’re starting this back up! Here’s a summary of what’s been happening, and I’ll delve deeper into specific topics with future posts.

In January 2019, Mrs. ODS was back at work part time after having our first child, burning through sick leave, getting ready to quit her job. In February 2019, the Federal government was shut down for several weeks, and I found other tasks to occupy my time, including being the full-time caregiver to our son. I took a temporary assignment over the summer of 2019, moving my family to Lexington, KY for 3 months. My wife was pregnant with baby #2, which wasn’t easy. On January 2, 2020, she was admitted to the hospital for pre-term labor at 26 weeks. Luckily, they were able to stop contractions and send her home for bedrest for the next 10 weeks. A week after the country shut down, baby girl was born full term and healthy. Living through a pandemic and limiting our social circle while at home with a newborn and toddler (19 months apart) made us realize how we wanted to be closer to family. On a whim, we agreed to move to KY. Everything played out a lot faster than we expected, and we sold our VA house in September 2020, moved into our new home in KY in November 2020, unpacked, celebrated the holidays, and here we are. We both feel better suited to continue to build these efforts started so long ago.

Here are the goals: teaching posts, story (background) posts, and monthly financial updates. Each post will be categorized into one of these for ease of future searches. We’ve made a lot of financial decisions over the past two years and have a lot to share!

TAXES! Part 2 – Is Your Bonus at Work “Really” taxed more?

Hopefully you read my previous post trying to dispel some incorrect understandings of how marginal tax brackets work. This will build off of that, including showing how the marginal tax brackets for annual income affect the “per paycheck” payroll withholdings your employer processes before paying you.

Let’s take another common misconception, the payroll tax withholding.

When you start a new job, your employer likely hands you a W-4 to fill out. This tells them how you want your federal taxes to be withheld from your paycheck. This depends on your filing status, the number of dependents you have, the way some of your personal activities throughout the year may affect any tax credits or deductions you’ll claim, etc. The W-4 is used to approximate your federal tax liability for the year, divided by the number of paychecks you’ll get in the year.

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I’m going to look in my crystal ball and know that my federal tax liability for 2019 will be $13,000. I want to fill out my W-4 so that my employer knows to take out $500 of my paycheck every two weeks to pay the tax man on my behalf.

This is easier said than done, and most employers will allow an employee to adjust their withholdings throughout the year (I can do it for every paycheck if I needed or wanted to).

When you file your taxes in the winter/spring of the following year, this process analyzes your tax liability (what you owe based on deductions, credits, income, etc) and compares it to how much your employer paid on your behalf throughout the year. If your employer withheld too much, you get a refund. If your employer didn’t withhold enough, you have to pay. There are differing opinions on how to strategize this situation, but a general rule of thumb should be to match as well as possible your withholdings to your projected liability.

  • If you get a refund, you’ve given Uncle Sam an interest free loan on your money for several months or the whole year. However, this can be a forced saving tool that people use who are scared they’d spend that money if they received it in their paycheck. Others see this as a cash windfall they receive in the spring and use it to splurge on a big purchase.
  • If you owe money, sometimes there are fines for owing too much, and it can hurt to have to shell out a big sum of money at the beginning of every year, if you weren’t saving for it and didn’t expect it.

Where things get tricky, and people start to misunderstand, is if people get a bonus at work, or work some overtime, and get a higher paycheck than normal.

Payroll processors use a chart similar to the tax brackets, where they know your filing status and the number of exemptions you requested on your W-4, and use your income for that pay period to determine how much federal tax to withhold.

If every paycheck you get in the year is for working the same amount with the same salary, your withholding amount will not change and your taxes will be easy to follow and understand.

When it changes, payroll processors do not look at your yearly salary or previous pay periods. They only look at the dollar amount that you earned for that paycheck.

Let’s say you earn $2,000 per bi-weekly pay period in 2019. You file single with 1 exemption. Each exemption (withholding allowance) is worth a deduction of $161.50, so you can deduct $161.50 from your taxable wages for every paycheck for the purposes of reading the payroll withholding charts. (This dollar amount comes from the IRS, as part of their math for how withholdings are estimated to determine tax liability.) Now, you can say you “earned” $1,838.50.

More information on this can be found here, on pages 22 and 44 specifically.

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From the chart, you owe (will have withheld) $174.70 plus 22% of the amount over $1,664, which is a balance of $174.50. Times this amount by 22% = $38 (rounded). This totals $213 deducted from your paycheck.

Let’s say that happens 24 out of the 26 paycheck you get this year, but in one, you get a $2,000 bonus, and in another you work $500 worth of overtime extra.

For the check with a bonus, your payroll processor knows you earned $4,000 that pay period, independent of what has happened the rest of the year. Using the same table, your tax withholding will be $553.32 plus 24% of what you earned above $3,385 (don’t forget to subtract your exemptions). That’s $109 more dollars. So you’ll have $662 deducted. That’s a big difference from your $178! Makes the bonus come with a tad bit of bad news, right?

The overtime paycheck works similarly, but because it’s only a little bit more money that paycheck relative to the norm, your tax withholding that check is $323.

Let’s add up your whole year.

24 paychecks of $2,000 income = $48,000 with ($213 times 24) $5,112 taxes withheld

One paycheck of $4,000 with $662 withheld.

One paycheck of $2,500 with $323 withheld.

$54,500 in earnings and $6,097 withheld.

Federal Income tax liability is 10% of $9,700, then 12% from $9,701 to $39,475, then 22% for the rest; this comes to $7,848. However, our system includes a standard deduction of $12,000. This means that you can take $12,000 off the top of your earnings and it won’t be taxed. We’re going to calculate as if you earned $42,500 for the year.

Your tax liability for the year is $5,208. With $6,097 withheld by your employer, this means you should expect an $889 refund!

A couple things were in play here. You claimed one exemption. You could’ve easily claimed a second exemption for some or all of the year to have less deducted from each paycheck to more closely match your eventual full year liability.

Secondly, those two paychecks where the payroll processor charged you extra tax, your paycheck was proportionally smaller, which means your refund at the end of the year was higher. You weren’t ACTUALLY taxed more for that bonus check, you simply had more withheld, a majority of which you’ll get back when you file in the winter/spring of the following year. The bonus check had an even more profound difference because the marginal bracket it fell into that period was the 24% bracket!

If your employer allows as many withholding/exemptions adjustments as you want, you can track your tax withholdings and projected liability changes throughout the year to strategize and minimize your potential difference between the two numbers.

In summary, your total annual income is the only thing that affects the tax liability when you file income taxes at the beginning of the following year. It does not matter if your paychecks were consistent, all over the place, front loaded, back loaded, or any other weird scenario that might happen with bonuses, overtime, raises, job changes, etc. Those variables do affect a single particular paycheck and how much cash you bring home in net that week, but the effects of that can be mitigated by shifting withholding amounts with your payroll processor and planning ahead by tracking your numbers.

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Reminder, do not confuse payroll tax withholdings from your tax liability. Withholdings are an estimate, meant to match your projected liability. Filing your income tax at the end of the year simply remediates the difference between the two total amounts. If you had too much withheld, you get a refund. If you didn’t have enough withheld, you’ll owe the tax man.

HAPPY TAX SEASON!

TAXES! Part 1 – What are Marginal Tax Brackets?

Recent national media, Facebook, and personal interactions served as the catalyst for these posts on taxes. There is a lot of misinformation and misunderstanding of the way things work, which create opinions and divisiveness not necessarily based on fact.

First, let’s talk about tax brackets and the key word for the American tax system: marginal tax brackets.

In 2019 there are 7 tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Each of these brackets has varying dollar thresholds for the 4 filing statuses: single, married filing separately, married filing jointly, and head of household. Once you establish under what status you are filing, you know where each dollar you earn will fall in the brackets on the chart.

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What I’ve heard many times before, and still see implications of misunderstanding in the media, are folks that think that the last, or highest, dollar you earn is what dictates what tax bracket you fall in. This is incorrect.

In 2019, single filers get taxed on 10% of their income up to $9,700. That means that the first dollars they earn are taxed at 10%, but the $9,701st dollar they earn is taxed in the next bracket, or 12%. The 12% bracket goes to $39,475. Similarly, the $39,476th dollar they earn will be taxed at 22%, and so on.

Individuals that say they do not want that raise, or to make more money, because it would put them in a higher tax bracket are sorely mistaken. Yes, the higher dollars they earn would be taxed more, but those dollars do not suddenly make all the lower amount of dollars be taxed at the high rate too. Those lower amounts stay in the marginal brackets they already were being placed in, based on the way the charts work.

Another single filer example (simplified for easier illustration). You make $80,000, which is the 22% bracket. Taxes for the year are figured as follows.

10% for $9,700 = $970

12% for $9,701 to $39,475 = $3,573

22% for $39,476 to $80,000 = $8,915

For a total tax liability of $970 + $3,573 + $8,915 = $13,458

If you make $80,000 and have to pay $13,458 in taxes, that is 16.8% of your income, not the 22% that the “tax bracket you fall in” might create the perception of.

Say you get a $10,000 raise to $90,000.

We know an $80,000 salary pays $13,458. Let’s add the taxes for the final $10,000.

$4,200 of that is still in the 22% tax brackets, so we can multiply = $924

$90,000 minus $84,200 = $5,800 in the 24% bracket = $1,392

So total taxes are $13,458 + $924 + $1,392 = $15,774.

That represents 17.5% of your income of $90,000 being paid to taxes, not the whole 24% bracket.

If we did not have marginal tax brackets and that raise really did bump all of your dollars up, or if it was calculated in a manner that many Americans think it is, then $90,000 times 24% = $21,600. It would look like your $10,000 raise caused you to pay $8,142 more taxes.

Good thing it doesn’t work that way!

Tax Loss Harvesting

We’re in a market downturn. These are expected, happen fairly frequently, and contain strategies to efficiently optimize the times they happen. One of those strategies is tax loss harvesting.

This year, we “benefit” even more from this strategy because the downturn is happening at the end of the year, at a time when savvy personal finance folks are thinking about all the varying ways they can reduce their tax liability for the closing year.

For the last decade, we’ve been in an uncommonly long and strong bull market, so many young people have no experience adapting to a struggling market and understanding ways to harness the red numbers.

Tax loss harvesting involves selling shares of a “losing” stock, fund, bond, etc and immediately purchasing a similar asset that’s “on sale” to maintain exposure to the market, hopefully buy at the low point, and prepare yourself for the eventual market upturn.

You cannot sell and buy the same stock or fund in this process because that would invoke the “wash sale” rule that disallows claiming capital losses. If you re-buy after thirty days, it’s no longer considered a wash sale.

The reason for utilizing this strategy is to be able to write off capital losses on taxes come April. This could offset earned income, other capital gains, dividends, passive income streams, etc. Paying fewer taxes is the goal, always, right?!

It could even have the double benefit of allowing you to get rid of a stock that doesn’t have a bright future in exchange for one that you think might be better.

Minor issue

One caveat to this strategy: you’ve now placed yourself in a lower dollar value cost basis in the new security you’ve purchased. When you choose to sell that, you’ll be subject to higher capital gains amounts. There are strategies to minimize that too. Tax gains harvesting is something people frequently employ. You do this in a year where your taxable income is lower (preferably below the $77,400 married filing jointly threshold for 2018) so that you can pay less or zero in capital gains taxes.

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My circumstances

Personally, with Mrs. One Dollar Allowance quitting her job in 2019 to focus on child rearing and managing our rental properties, this year should be the highest tax liability we have in quite some time. Harvesting our losses this week will have a more substantial effect than it would in future down years, and will make the availability for tax gain harvesting in future up years more “profitable.”

Good luck to everyone in this tumultuous holiday week. Shutdowns and market losses don’t lend to great things on the news, but at least this strategy can add a silver lining to your end of the year tax decisions.

October Financial Update

Tracking your net worth allows for a full picture of your finances. It gives a complete understanding of assets across all classes, as well as liabilities or expenses that you are indebted to. Without knowing what this picture looks like, it wouldn’t be possible to accurately strategize financial moves or create short and long term goals.

This post will describe my family’s assets and liabilities, the changes that have occurred in the last month, and why.

Assets

Cash Accounts

End of September: $9,489
End of October: $5,401

Changes: Paychecks; rental income; paying mortgages, credit cards, utilities; accelerating debt payoff; investing

401k (Index funds)

End of September: $493,441
End of October: $473,748

Changes: employer contribution, paycheck contribution, and personal loan payback totaling $13,880; market fluctuation

IRAs (Index funds and Mutual funds)

End of September: $159,622
End of October: $151,148

Changes: $965 contribution; market fluctuation

Taxable investments (Mutual funds and individual stocks)

End of September: $102,435
End of October: $98,800

Changes: $96 dividends; market fluctuation

Personal Residence

End of September: $389,089
End of October: $389,804

Real Estate Investment Properties

End of September: $1,068,957
End of October: $1,074,345

Changes: 10 investment properties’ market value fluctuations

Note: 2 vehicles owned outright

Liabilities

Real Estate Investment Mortgages

End of September: $628,379
End of October: $626,739

Changes: mortgage paydown

Personal Residence Mortgage

End of September: $269,495
End of October: $268,844

Credit Cards

End of September: $9,706
End of October: $9,236

Changes: $1,100 payment on 0% card balance; $861 payments on all other credit card statements.

Spending:

  • Grocery – $342
  • Restaurants -$174
  • Online Purchases – $75
  • Clothing – $76
  • Gas – $99
  • Travel – $234
  • Business expenses – $375
  • Cable/Internet – $55
  • Miscellaneous – $122

Summary

The stock market was not kind to us this month, but that just means we bought more shares on sale when we made our contributions! Our goal over the next few months is to pay off the rest of our 0% credit card and the remaining obligation of Mrs. ODA’s 401k loan.

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The Son’s Perspective on a Few Parenting Strategies to Ensure Financial Success Later in Life

Student Loans

One of the things I have not had to be saddled with in my young adult life is student loan repayments for my wife or me. We both went to state schools, not the fancy private schools that really don’t typically provide much better (statistically) of an education anyway. My wife’s parents paid her tuition all 4 years, and her housing the first 2 years. She got a job to pay her housing otherwise.

Student_Loans

I’ve had a lust for learning for as long as I can remember. I taught myself geometry at home while I was learning algebra at school so that I could compete better on the math team in middle school. I began taking accelerated classes in 3rd grade, went to the “gifted” middle school program, was one of 30 kids in my county of 3000 freshmen to be accepted into the math and science program in high school, and went on to get a full academic scholarship to college. It covered tuition, housing, food, books, and a small stipend. I also applied for a couple small ad hoc scholarships that gave me some extra spending money those 4 years.

Side note – I finished 16th in my class and opted to go to a state school with financial aid rather than a private or more prestigious school that I would have to pay for. My parents said 2 things early on: If you get a scholarship to college they’d buy me a car (hey, cheaper for them) and if I didn’t get a scholarship, I’d be going to the local state school. Massive student loans and private/out of state tuition weren’t an option. I am so indebted to my parents for many of the hard lines they drew, knowing what was best for their children despite us not being able to see it at the time.

Anyway, each step of my academic career prepared me for the next. I worked hard in elementary school to test into the middle school program. I really developed my passion for math in middle school and used it to get into the high school program. My success and test scores in high school propelled me to a college scholarship. My work ethic in college, despite the many factors that some adolescents fall victim to, had me graduate with honors and find an engineering job with the federal government – in the midst of the recession when the vast majority of all my graduating classmates couldn’t find work.

I was lucky to be born with a propensity to learn quickly and retain information that allowed me to succeed in school. However, I did not squander that gift and worked hard to use it efficiently and make smart decisions with my future in mind.

scholarship

My parents instilled values in me that complemented my internal motivation to succeed. They created expectations that told me that anything less than success wouldn’t be tolerated. They even “dangled the carrot” of the new car that really catalyzed my drive (pun intended) to get that scholarship. These actions, both direct and indirect, in our household throughout childhood built the foundation for a solid academic career that got my finances and my net worth started in the positive direction once I became an adult.

Personal Finances

One of my earlier posts  focused on the ways my parents set my values for frugality, strategic decision making and spending, and saving. When I got money as a kid, I first saved it, then chose to carefully spend it when something was worth buying. When I got money from grandma for birthdays and Christmas, I put that money away for a rainy day rather than going and spending it all the next day. My wife and I still operate that way. Rather than looking at this “extra income” as a source of money to go buy something we don’t need, we simply add that money to our regular financial accounts to fund our next goal or debt payoff.

My parents led by example. When we traveled, we stayed at lower cost hotel chains, or with family and friends. We drove all of our vacations because flying was expensive. We brought our food and ate meals outside of restaurants where possible. Our day to day didn’t involve many restaurants. Feeding a family of 5 adds up quickly when you eat out. We didn’t have video games, a big screen TV, or the highest cable package, as socializing and playing outside is far more important to adolescent development than sitting behind a screen like many kids of the current generation.

frugal

As soon as I was old enough to understand, my dad began teaching me about investing. While in high school he helped me buy my first mutual fund (one that I still have, but I’m trying to find the right time to sell now that I realize the horror of high expense ratio funds!). When I went to college, I learned that he had been investing on behalf of my siblings and me for many years, and then gave us the money he’d invested as a gift to get us started in the real world.

Everything I saw, and continue to see, my parents do with any relation to finances or income and expenses is deliberate, and with the future in mind. This has translated to my own daily thinking. It became a habit, became natural. Since these thoughts and weighing of fiscal pros and cons have been part of me for as long as I can remember, it’s easy for me to analyze options on the fly and choose the best decision for my family in the moment. I don’t even have to try.

The one place that I would say I have deviated from my parents is my willingness to turn off the conservative thought process and attack my financial future with more risk and aggressiveness. However, growing up in a household of conservative money management gives me the past experience to draw from that keeps me grounded as I leverage more debt and make choices to expand my net worth as quickly as possible.

Stay tuned for more on the net worth conversation…

Why You Should Start Saving for Retirement at Age 10

Compound Interest is the 8th wonder of the world

-Einstein

When I was a kid, I would walk into the bank to deposit something like $50 of soda selling money, and I would be so excited to see how my money had grown since the last time I had an account update.

There was no online banking. I had a bank-provided ledger book that the teller updated in ink pen for me every time I deposited money in my savings account. I wasn’t entirely sure how it worked in those early adolescent years, I just knew my money was supposed to grow by giving it to the bank.

I learned the details of the time value of money and compounding interest in middle school.

FV = PV x (1 + r)n where:

FV: Future Value

PV: Present Value

r: rate of return

n: number of periods

This is simply telling you what your money today will be worth in the future given the set of assumptions shown. For example, if I hadn’t saved a dollar since I started tracking my net worth in December 2010 and just wanted to know what that $30,000 is worth now (let’s say December 2018 for simplicity) at varying market conditions (let’s assume the market has averaged 8% gains in that time) then I would have:

FV = 30,000 x (1 + 0.08)8 = 55,528

A simple rule is that it takes about 10 years for your principal to double at 7% interest.

As many financial advisors will tell you, the power of compounding interest starts slow, but increases at exceedingly rapid levels the longer you extend the math.

After 20 years that $30,000 should be worth $139,828

After 30 years: $301,879

After 40 years: $651,735

Not bad that $30,000 of adolescent savings would be worth over $600,000 when I’m 63 years old.

Parents, teach your kids to save. Save early, save often. Many articles start hypothetical scenarios for saving for retirement at age 20. Why can’t you start at age 10 and add another decade of compounded interest to the math for retirement years?

The learning will compound as you teach your teenager positive financial habits, saving, frugality, and the power of math for watching your money grow.

Now lets say that I contribute $100 per month, or $1200 per year, to my retirement fund, starting back at the end of 2010.

The formula for that is:

FV = A [(〖(1 + r)〗^n -1)/r ] where A is the annual contribution.

FV = 1,200 [(〖(1 + 0.08)〗^8 -1)/0.08 ]= $12,763

If I had started doing that in December of 2010, I could add that money to the new worth of my original savings of $55k, totaling approximately $68,000.

Again, the value is from the many years of allowing this savings to compound.

After 20 years of $1,200 annual contributions I would have saved $54,914

After 30 years: $135,939

After 40 years: $310,867

If you add that money to the future value of my original savings, I’ve got just shy of a million dollars of net worth. We can all find $100 a month in our budget to put toward retirement, can’t we?

Further, if you can avoid/minimize lifestyle inflation as you get older and your earnings increase, you can save more than $100 a month in your 30s, 40s, and 50s to grow these example dollar amounts much larger.

How do you avoid lifestyle inflation?

  • Every time you get a raise – be it cost of living for inflation or merit based – you should set aside some (or all!) of that extra money in your paycheck to pay yourself first in your retirement savings.

Mrs. OneDollarAllowance here – This is how I handled my early retirement savings. I thought the concept of putting money towards something so far away, while I was barely getting by with living expenses in college, was ridiculous. My parents said, “at least put in what gets matched.” So I did. Six months into my part-time job, I graduated college and was hired full time, with about a $10,000 raise. With all of that extra money and no extra expenses, I should have maxed out my retirement, but I was a dumb kid. I increased my retirement savings, but didn’t max it. It wasn’t until I met Mr. OneDollarAllowance that I was pushed to contribute to all retirement accounts fully.

  • Don’t rush to go buy the next big gas guzzling SUV. Drive your cars longer and buy vehicles that are more fuel efficient and reliable at higher mileage levels.
  • Don’t go buy that big dream house in your 20s. You don’t need to keep up with the Joneses. Remember that people don’t post the negative side of their lives on social media. If you compare your life and your belongings to the people you see online, you’ll do yourself and your finances a disservice.
  • Curb your craft beer and your fancy restaurant tastes. These are good to treat yourself to every now and then to maintain your sanity, but eating out is the biggest thing I see my generation spend their money on, watching their paychecks disappear every two weeks.

There are countless examples of ways you can flex your frugality muscles, but I’ll leave those for a future post.

Let’s go back to the numbers for increasing retirement savings and see what happens. We’re going to save $100 a month for the first decade, $200 a month for the second decade, $300, then $400 for the last decade.

Principal End 10 yrs End 20 yrs End 30 yrs End 40 yrs
Starting $  $    30,000  $        64,767  $      139,828  $      301,879  $      651,735
First Decade  $    12,000  $        17,384  $        37,530  $        81,024  $      174,923
Second Decade  $    24,000  $                 –  $        34,768  $        75,061  $      162,048
Third Decade  $    36,000  $                 –  $                –  $        52,152  $      112,591
Fourth Decade  $    48,000  $                 –  $                 –  $                 –  $        69,536
Total  $  150,000  $        82,151  $      212,126  $      510,116  $   1,170,834

There are several takeaways from this chart.

  • It’s surprisingly simple to amass wealth purely from discipline and deliberate, consistent saving.
  • In 40 years, your money multiplies quickly compared to the principal you invested.
  • The amount of time you invest is far more important than the amount of money you invest. Note that the money that had 40 years to grow nearly had triple the effect of the last decade, which was 4 times as much money, but only had 10 years to grow.
  • The starting principal made up 20% of total money invested, but its value after 40 years is 55% of the total.

In summary, it’s never too late to start saving, and the worst thing you can do is continue putting it off until tomorrow. The earlier you put money away and let it grow, the more it is worth when it’s time to tap into those funds.

I remember having about $450 to my name at about age 10. That money is worth approximately $2,200 now, and should be worth about $22,000 when I’m in my 60s. Not bad for selling sodas out of a wagon for a couple summers and then just not spending that money.