A Big Risk to Early Retirement – Inflation Risk

Lest you read my last post and think that I completely ignore the very real inflation risk in retirement, allow me to walk you through my thought process of how I account for it.

I already mentioned that when I project out our portfolio growth I’m assuming a non-inflation adjusted rate of return of 8%. If inflation were to average 2%, then my real return would actually be just 6%. I could just assume a lower rate of return, but I prefer to make some more granular assumptions about inflation.

It All Starts with Budgeting

Each year, I pull our full years’ expenses by category and make some minor adjustments to come up with a representative retirement budget.

First, I eliminate principal and interest payments on our house. Our mortgage will be paid off well in advance of retirement, so this won’t be needed. Next, I reduce our income taxes to account for lower income in retirement. I also reduce our charitable giving amount to account for us not having an income to tithe from, but not to zero since we will still want to be generous in retirement. Lastly, I eliminate any retirement account contributions since I won’t be eligible to contribute.

Not all of our expenses will be lower in retirement. I adjust our healthcare and travel expenses by assuming they will each be double current levels. Everything else stays the same. After all of these adjustments, I’m left with a budget that is roughly half of our household expenses. That sounds really low, but the majority of our current expenses are paying down the house, income taxes, and charitable giving so it is not unrealistic. In some categories like groceries, it may even be high given that we currently cover food for a family of six and will someday be empty nesters.

Inflation Assumptions

With this representative budget, I then apply inflation assumptions. The key difference here is that I use different inflation assumptions for different categories. Historical inflation has been 3-4% and I assume for most categories an inflation rate of 3%. The average for my lifespan hasn’t exceeded 3%, but it’s a real risk that it could be much higher. For me, medical expenses are the big wildcard. Not only do I assume they will be double my current level of spending, I also assume an inflation rate of 7% on medical expenses. If I were budgeting to be paying for higher education costs in retirement (I’m not), I would use a 7% inflation assumption for those costs as well.

Using this representative budget and specific inflation rates, I then inflate our expenses by the number of years between now and retirement to get an inflation adjusted retirement budget. Each year of retirement, I assume that expenses will continue to increase at the rates outlined above.

Inflation Impact on Retirement Income

One very interesting thing to consider is how inflation can eat away at your portfolio. For simple numbers, let’s assume you retire and have $1M worth of investments to live off of. It’s an oversimplification, but let’s also assume a steady 8% return, 3.5% inflation, and first-year expenses of $60,000. Since $60,000 is 6% of $1,000,000 and you’re earning 8%, then you can live off the earnings forever, right? Wrong.

You see, what happens is that even though you are consistently earning 8%, the growth of your earnings is lower than that because you aren’t reinvesting all of those earnings. Because your expenses are growing at 3.5%, and your income isn’t growing as quickly, your expenses will actually be greater than your income after just 15 years. After that, you begin whittling away your principal until year 33 when you run out of money entirely.

In this way, inflation is one of the biggest risks to early retirement. Everyone is impacted by inflation. The longer your retirement, the more time inflation has to grow and exceed your investment income.

Below I’ve outlined what hypothetical portfolio values would be with the assumptions outlined earlier.

How to protect against inflation?

There are a few things I am doing to protect our retirement dreams from inflation. The first is to have an initial withdrawal rate much lower than 6%. In your working years, you want to have as big a gap as possible between income and expenses. In retirement, you want to have a gap between expected investment income and expenses. Whether you plan to spend most of your money in your lifetime or leave an inheritance, inflation can derail either of those plans.

The primary other strategy is to remain invested in stocks. Over time, stocks are the only asset class that has consistently outperformed inflation. While earnings growth may not exceed inflation, left untouched a diversified stock portfolio would not lose purchasing power over time.

There are many ways to account for inflation in retirement planning, but this simple method works for me for now. It is absolutely something you don’t want to ignore, but I don’t lose sleep over it either. What are your inflation assumptions?

Assumptions for Early Retirement

I recently was talking to a friend who disagreed with my retirement planning assumption that our investments would average an 8% return. I had felt that my assumption was conservative given that I am close to 100% invested in equities. He felt that 4-5% was a better long-term assumption. Dave Ramsey assumes 12%. Who is right?

At the end the day, who really knows? We’re doing our best to save and invest a good chunk of our income and staying invested in the asset class with the best track record and best potential growth. But the conversation did get me thinking so I did some additional research.

Over at Moneychimp.com, there is a great resource that shows annual returns on the S&P 500 going back to 1871. You can look at any date range and see returns adjusted for inflation. This is great data for us because the majority of our portfolio is in index funds that track the S&P500. Their biggest takeaway is that:

“Over the very long run, the stock market has had an inflation-adjusted annualized return rate of between six and seven percent.”

When I assume 8% return, I’m assuming that to be before inflation. Is that what my friend meant? I don’t think so, but I’ll have to follow up. My impression was that he was just particularly pessimistic.

I was curious though, so I did some digging into the data set and found some things worth sharing (all numbers not adjusted for inflation).

S&P 500 Historical Returns

  • The best 1-year return for the S&P 500 was 56.8% (1933)
  • The worst 1-year return was -44.2% (1931)
  • Average annual returns from 1871-2016 were 10.7%

As you would expect, the longer you invest the more likely that you wouldn’t have lost any money.

  • The best 5-year annual return was 29.8% (1924-1928)
  • The worse 5-year annual return was -6.9% (1928-1932)
  • The average 5-year return was 10.7%/yr

It took going out to a 10-year time frame before there were no periods where you would have lost money. Investing in the worst 9-year period of 2000-2008, you would have averaged -1.7% per year.

  • The best 10-year annual return was 21.6% (1949-1958)
  • The worst 10-year annual return was 0.6% (1999-2008)
  • The average 10-year return has been 10.8%/yr

Our Retirement Plan Assumptions

The length of time I’m really interested in is even longer than 10 years. My goal is to have my working years last around 25 years and then to be retired for 40+ years. I’m about 10 years in with another 15 to go.

  • The average 25-year period has been an 11.1% return
  • The best 25-year period was 18.2% (1975-1999)
  • The worst 25-year period was 5.8% (1872-1896) 

We first started saving for retirement in 2006 and average market returns from 2007-2016 have been 8.8%. Our returns have been slightly higher than this, but aren’t as clean to track since we have been continuously investing new money for the past 11 years.

All this to say, we’re assuming 8% returns over the next 15 years and based on what we’ve seen so far and what has happened long before we started investing, we remain comfortable with that assumption.

I should have even more years in retirement than in my career, but my plan assumes a low withdrawal rate, under 4%. In retirement, we won’t be relying on sustained market returns to provide for our lifestyle but will remain invested primarily in equities similar to the strategy outlined in Simple Wealth, Inevitable Wealth.

I’m currently reading Nassim Taleb’s book Antifragile and he makes the very valid point that until the worst of anything happened, it wasn’t actually the worst. Said another way, just because a mountain is the tallest you’ve seen doesn’t mean it’s the tallest in the world. I know that future returns could be worse (or better) than we’ve ever seen before, but planning on an early retirement allows me to have sufficient margin in my plan to compensate for unexpected downturns.

See below for some more info on different investment horizons high, low, and average annual returns for a specific number of years.

What rate of return do you use for your retirement planning assumptions?

April 2017 Net Worth Update

For those who are just joining, each month I publicly update our household net worth. April was a good month for us, but nothing out of the ordinary. With this months’ increase of $6,744 to $657,793, we are still on pace to reach our goal of $700,000 by the end of the year.

NET WORTH DETAILS

CASH

Our cash went up a bit this month and continues to get closer to our goal of ~$40-50k. We had a couple items this month that slowed us down like a week of travel, rental car, etc. This next month we’ll also be fencing in part of the backyard and starting some other backyard projects. Household projects slow down our cash build up, but these allow us to enjoy our yard in a way we never have.

INVESTMENTS

The S&P 500 returned 0.9% this month, and most of our investments track that index. 15% of my income continues to go to my 401k, but we haven’t done anything else special.

We finally received and paid all of the hospital bills for our newborn this month as well. We paid from our HSA which I include in the investments category because I do plan on eventually having it invested and growing. As long as the balance is lower than our deductible though, I’ll keep it in cash.

Our total out of pocket was ~$3,500 for the baby. That was literally the cheapest we could go and still give birth at a hospital. My wife has always preferred natural childbirth, and is super tough. This is our fourth child to be born naturally and she’s never had any anesthesia/epidural. Avoiding pain meds during childbirth significantly reduces the hospital bill. Saving money isn’t the reason she avoids them, but it is a nice side benefit. One money saving tip we do use at the hospital though, it to bring our own Tylenol. Have you seen how much hospitals charge for OTC meds?

This month I had an experience that helped highlight a benefit of regularly tracking my net worth. One of our investments accounts is an old 401k we haven’t added to it in several years. I was feeling that it wasn’t moving much even though it is all invested in equities. Since I track the monthly balances for all our accounts as part of this process, it was nice to be able to quickly go in and show that it actually has gone up quite a bit. It just didn’t feel like it since the balance has been hovering around $15,000 for so long. That account has actually gone from $14k to $19k just in the past year or so.

CARS

Nothing too exciting in the car department. As expected, they continue to depreciate slowly, but really are close to their end of life value so long as they continue to be in good mechanical condition.

Late in the month I was driving back from the airport and noticed what smelled like engine coolant coming from my wife’s Expedition. Shortly before I got home the hood briefly started smoking but thankfully didn’t overheat. Much to my chagrin, I knew I didn’t have time to fix this myself, so had to bite the bullet and let a mechanic do it. Thankfully they were able to get it done all in the same day, and $500 later the leaky hoses and parts have been replaced.

I am certainly an advocate for DIY, but there are some instances where it just makes sense to pay a professional. Reasons to hire a professional either are for time or expertise. If the reason is expertise, I’ve found that I can often learn to do most things myself (thank you YouTube!). If I need something done with a tight deadline, I am not always able to do it myself. This was one of those times. It is worth pointing out that we tend to have at least one $500 repair per year on my wife’s Expedition. Her truck has 140,000 miles on it. Contrast that to my Corolla, which has never been in the shop (beyond routine maintenance) and has over 200,000 miles. If Toyota made a big enough vehicle, we’d probably have two. (No, the Sequoia is not big enough).

HOUSE

We continue to pay extra towards our mortgage, but less than we plan to pay once we reach our cash goal. We really haven’t seen many houses go up for sale in our area, but feel the estimate is conservative. Our next-door neighbor will be selling his house and downsizing as he becomes an empty nester this summer. His house is a bit smaller than ours and I’m not sure about the interior condition, but it will be interesting to see what it sells for and what the new owners do to the place.

All-in all, I’m pleased to report we’re on track to reach out net worth goals.

 

5 Unexpected Benefits Of Living In A Good Neighborhood

Welcome readers from TheSavvyCouple!

If you’ve been reading for a while, you may recall that we have moved around the country a bit and are currently living in our third house. Each time we’ve moved, we’ve learned a little bit more about the home buying process. Some of the latest lessons learned in real estate are not things that I was expecting to learn.

When we bought our last house, we really were focused on the house itself and the cost. We thought the location was ‘good enough’, but we really didn’t know the area. During the time we lived there we had our house broken into, learned that the public schools were unaccredited, and even heard gunshots from a nearby area that we didn’t realize we lived so close to. Location, location, location. Got it.

As we searched for our current house, we focused on having the things our previous neighborhood lacked. We now live in a great neighborhood that was built about 20 years ago. Although the houses are starting to get a little bit older, the architecture is very traditional and the homes and yards are all very well maintained. Curb appeal. Got it.

We were attracted to this neighborhood because of the large lot sizes, the awesome school district, low crime, and overall privacy. Each time we’ve moved, we have learned a little bit more about what is important to us in a house and neighborhood. In our current house I’ve realized that there are actually some really great benefits of living in a nice area that you may not be thinking of.

An Established Neighborhood Is Better Than A New Neighborhood

Our last house we built brand new in a new subdivision. The house we live in now is 20 years old. When all the houses in a neighborhood are new, it’s expected that the everything will look great. But until they are all maybe 5-10 years old, you really don’t know how well people are going to maintain them. This can impact your property value and have an impact on how quickly you can sell when that time comes.

One other interesting observation is that where we live, your typical first-time home buyers are priced out of our area. I have a theory that neighborhoods are better maintained by people who have previously owned homes. First time home buyers might bite off more than they can chew financially, which can limit the ability to perform maintenance. They might also underestimate the time commitment needed and grow complacent with neglecting proper maintenance.

That’s not to say that no one in our neighborhood is living beyond their means, but people are established enough so that they know what is needed to maintain their homes physically and financially. One piece of evidence I can point at to support this theory is that the foreclosure and short sale rates seem to be inversely correlated to home price in our area.

An HOA Can Add Value

Contrary to popular belief, HOAs can actually add value. But that isn’t always the case. Our last neighborhood had an HOA where we paid around $350/year and I really don’t get anything for it. We had an embarassingly large percentage of homeowners who never paid their dues, and the HOA didn’t have the power (or money) to enforce collections. If people didn’t mow their lawn or adhere to other covenants, the HOA really had no enforcing ability. It was useless and a waste of money.

Contrast that with our current neighborhood and it is night and day different. Here we pay $700/yr, but have access to incredible neighborhood amenities (pool, tennis, etc.). Our HOA sponsors tons of social events and has newsletters and communication that really help build a great community. 95% of homeowners pay their dues on time and the HOA finances are managed very well. The HOA has almost $200k in cash reserves for major repairs so the odds of a surprise assessment are virtually zero.

Schools Matter

In The Millionaire Mind, Thomas Stanley surveyed households with net worths exceeding $10M to observe differences and similarities to households with net worth between $1M and $5M. One thing that stood out to me was that people in that demographic tended to buy homes in established areas with great schools so they didn’t have to pay for private schools.

I think I always knew that schools mattered, but now that I have a child in school I have been very impressed with the experience we are having. This is especially true when compared to stories I hear from friends with kids in the neighboring counties schools.

Informal Mentoring

One thing I really didn’t expect when I moved into a nicer area was the career benefits. When I go to the neighborhood pool, church, or the grocery store, I often run into people I recognize from work. I’ve had that happen before, but being in a nice neighborhood surrounded by even nicer neighborhoods, pretty much all the people from work who live near me are higher in the org chart than me (our CFO even used to live not far from us).

Because of my proximity to company leadership, I have had a lot more personal interactions with people who can be intimidating at the workplace because they might have several thousand people under them. I’ve done things like campouts, Sunday dinner, and carpool with people I consider friends, who just happen to be officers of a Fortune 100 company. Even those who don’t work at the same company are often in very senior positions in their companies.

I don’t ever want to abuse my relationships to advance my career but have found these friendships provide a lot of opportunities for me to be mentored, especially on navigating my career.

Free Stuff!

We get offered so much free stuff from our neighbors, we have to say no. We’re talking about really nice stuff too. One friend gave us $1,000 worth of Thomas the Train toys his son had outgrown. He also gave us a 55″ TV that he didn’t want anymore (which ended our 6 year stretch of having no TV). The same friend offered us almost new furniture that wasn’t big enough when they moved to a new (very large) house.

We’ve received clothes, toys, playsets, you name it. Not only do our neighbors tend to buy nice stuff, but they also don’t have very many children. This means that things don’t get too beat up before we have our four kids do their handiwork.

In our area, we have donation centers for Goodwill/Salvation Army, etc, but none of the corresponding Goodwill/Salvation Army stores to actually buy things. I’ve found many people would rather give things to people they know than a faceless organization for a tax writeoff they’ll probably forget to take.

Every time we move, I’m sure I’ll learn more about what is important to me in a house. Recently I’ve learned that living in a nice neighborhood has benefits I hadn’t considered. An established neighborhood has had time to mature and you can know what to expect. HOA’s can add value when done right. Paying extra to live in a good school district may actually save you money over time. People buy and give away a lot of stuff. Being on the receiving end in a nice area you can get a lot of great stuff for free. The most unexpected thing I’ve learned is that living in a nicer area can create opportunities for informal mentoring.

Overreaction leads to Underperformace

Have you ever heard of the Dalbar study? This company does an annual study that looks at the impact of investor behavior on returns. What they’ve found is that over time not only do mutual fund investors underperform the market, but they also underperform the underperforming mutual funds. Wow…that’s a lot of underperforming.

This underperformance is attributed to picking the wrong mutual funds and getting in and out of the market at the wrong times. Since it is impossible to time the market, I would argue that it is always the wrong time to be getting out of the market.

Here’s an example of a chart Vanguard put together using data from the Dalbar study:

source: Vanguard

What do YOU do when the market gets scary?

The answer to this question should be “nothing” or “buy more”. Sadly, research shows that many people do exactly the opposite. Selling everything when things are scary can feel good and provide a sense of safety in the short term. These same people will buy back in ‘when the coast is clear’, which typically means prices are much higher than when they sold in the first place.

For your long-term investment strategy, sitting out of the market is the one big mistake that you can’t afford to make. With craziness looming in North Korea and other parts of the world, it would be easy to self-justify getting out of the market right now. But when do you get back in?

Do you remember how Greece’s economy was going to destroy global markets? How about the fiscal cliff and government shutdown? Oh, and let’s not forget about the debt ceiling or the flash crash. For eight years the market has continued to rise, quickly recovering from any number of fear-inducing events. Over longer periods of time, short-term declines aren’t even noticeable.

It can best be summed up by a chart I have framed on my desk at work from Behavior Gap.

The Value of a Financial Advisor

I am a Do-It-Yourself investor. I think most anyone can successfully manage their investments without a financial advisor. Financial advisors will point to the chart above and argue that you need to have your accounts professionally managed to protect you from yourself. While there may be some truth to that, I think all you need is someone who can talk you off the ledge.

Even though I am a DIY investor, I have a financial advisor. He is someone I used to work with and trust his judgment and integrity. He doesn’t manage my accounts, but I get free dedicated access to him because of the size of my accounts. We talk a few times a year and he helps validate that I’m still on track to reach my goals.

If I ever were considering selling everything, he would (hopefully) be able to talk some sense into me and prevent me from making that huge mistake. The real value of a financial advisor is when they can remind you of your long-term goals in times of short-term uncertainty.

March 2017 Net Worth Update

Wow, is it really April already? Hopefully, you avoided getting pranked too badly on April Fools’ day. Here in the DIY house, we don’t really like playing jokes on each other. We spent the day doing some spring cleaning of the garage and playing with the kids. As we enter a new month, it’s also time for another net worth update. In March, our net worth increased to $651,050. 

NET WORTH DETAILS

CASH

Our cash went down a bit this month, but it’s mainly because we did some large charitable giving. The largest chunk of this was our monthly tithe paid in March for February, which was a big income month. Additionally, we made our annual donation to our alma mater. With all that, I’m actually surprised that it only went down as much as it did.

We are working on growing our cash cushion but do have some decent size house project expenses coming up that will slow that down. These projects include a backyard fence and small kitchen remodel. Whenever we do projects we plan to do them without taking money out of our savings account .

INVESTMENTS

The market was essentially flat for the month of March, so our investments didn’t really change other than monthly contributions.

We still haven’t made the final payment for our hospital visit, which will come from our HSA included in this total. The only reason we haven’t paid it yet is that there has been some confusion on who we owe what since it depends on the timing of when claims are submitted whether we pay 100% as part of our deductible or 20% after our insurance kicks in. I think we’ve figured it out, but we had to get refunds from doctors who we paid in full but then didn’t need to since they took their sweet time submitting the claim and ended up getting paid mostly from our insurance.

What a mess. I really hate dealing with doctors’ offices. Thankfully they are used to this confusion and aren’t in a hurry to get paid by us and they won’t send the repo man looking for our baby if it takes another couple of weeks.

CARS

I crossed over 200,000 miles in my Corolla this month! It was a bit anti-climactic but does feel like a pretty big accomplishment in delayed gratification and proper maintenance. We’ve been prepping/planning for a replacement vehicle for a little while now, and I had been thinking that something like a used Lexus was in my future. When I did a little bit of shopping, though, I found that I can actually get a brand new Corolla for cheaper than a 5-year-old Lexus. We aren’t pulling the trigger anytime soon, but I’m now leaning towards a newer, less luxurious car when that day comes. Either one would be a huge upgrade from my current vehicle.

I walked through this logic the other day while carpooling with a co-worker who suggested I get an even more expensive car brand new (they don’t make ‘em like they used to, right?). Rather than give him a sermon on FIRE (Financial Independence, Retire Early), I just nodded and said: “hmm, something to think about”. I’m not going to change his mind and he’s not going to change mine. We can still be friends, but we are at different stages in life/career and don’t have the same early retirement goals. He earns ~4x as much as me, drives a $100,000 car, and is already at the age that I plan to be when I have the option to retire.

HOUSE

Nothing too exciting here other than continuing to pay a little extra on the house each month. We plan to kick this into overdrive once our cash balance gets a bit higher, but we are only paying $600/mo extra until then. A house down the street is for sale and they are asking $490k, so $450k doesn’t seem unrealistic. In the years since moving here, I’ve learned that many of the same features that attracted us to our neighborhood are qualities that continue to attract buyers (proximity to great schools, large lot size, neighborhood amenities, traditional architecture, etc.), which helps houses to sell quickly.

529s

We first started funding our 529s about a year ago and I haven’t included them in our net worth figures. I still don’t plan to even though it is all technically still ours, but I will track it here. It is worth including to show what we have been saving and how that amount continues to grow.

We add $200/mo and have it allocated 100% towards equities. I know this won’t be enough to fully cover college, but we are torn on how much support to provide. I had limited financial support for the first half of college but was on my own entirely for my MBA. My wife was completely on her own for her entire degree. She finished with no debt and I had some debt for undergrad, but we planned and saved aggressively to finish my MBA with no debt.

I know all about the rising costs of education, so hold the hate mail. I also believe that there will always be a way to get the education you need without debt. We’re savings towards our kids’ college, but don’t want to have it all in a 529 so we preserve flexibility on how much support we provide.

So that’s it. Another good month of building our net worth, and we’re still on track to hit our 2017 goal of $700,000. Given the strong 1Q gains, we should get there if our return for the rest of the year is >3%.

Book Review – Black Edge

I just finished reading Black Edge, by Sheelah Kolhatkar and I give it a 4/5 star rating.

The book focuses on the hedge fund industry and insider trading, specifically at SAC Capital. SAC Capital started in the early 1990s by Steve Cohen and has enjoyed ~30% annual returns for more than a decade. Black Edge outlines some of the methods by which these massive returns were generated.

What exactly is Black Edge?

White Edge refers to information that gives some advantage but is already publicly available. Gray Edge refers to information that is not widely known and could influence a stock price once widely known. Black Edge, however, is information that is clearly illegal to share or to trade while in possession of the information. In this book, traders would try to get Black Edge like detailed quarterly earnings and drug test results.

On Wall Street, traders are always seeking some type of edge. A great example of this can be read in this article from the Wall Street Journal a couple of years ago. Did you know you can subscribe to a service that will fly a helicopter over oil storage facilities to measure inventory levels with advanced cameras? These subscriptions can cost over $300,000 per year, but can be worth millions to traders.

This book also talks about ‘Expert Networks’ used by SAC to get access to company insiders. These networks allow individuals with expertise to tap into a network that will pay them handsomely for consulting. Investment management firms can use these experts to refine their models and assumptions. These conversations are supposed to avoid discussion non-public information. It’s a pretty good arrangement on its face but it opens the door for information to be shared that shouldn’t be. Those who might want to profit from knowing something big before anyone else can use these networks to their advantage.

The Bottom Line

The story is very well researched and written and provides a window into a secretive area of the market. Although I read it for entertainment, I still tried to learn something. My takeaway was yet another reminder that I have no business picking individual stocks and competing with folks like this. I’ll just stick with index funds for the bulk of my investing.

Evaluating Life Insurance Needs

It’s that time of year again, where I get the invoice for my annual life insurance payment and re-evaluate our life insurance needs. This year is a little different than previous years because we also welcomed our fourth child into the family last month.

WHY HAVE LIFE INSURANCE?

To me, the purpose of having life insurance is to provide for my family in the event of my death. It is no coincidence that my policy payment occurs in the same month as my oldest child’s birthday. Prior to having children, the only life insurance I had was whatever was offered free through my employer (4x salary plus $50,000). While that was certainly generous, as a newly married couple it was actually more than we probably needed. My wife had a good job, and either of our incomes was enough to support us both. When we found out we were expecting our firstborn, we knew that we wanted to have more coverage.

During my wife’s pregnancy, we were saving 100% of her income and our plan was for her to be a stay-at-home parent. We wanted to have enough life insurance so that if something were to happen to me, she would be able to continue to stay home with our children at least until they finished high school. If something were to happen to her, the plan was (and is) for me to move closer to family, but still to have some life insurance to help cover childcare costs that we currently aren’t incurring.

At the time, our household expenses were under $50,000/year and we settled on 20-year term life insurance policies of $500,000 for me and $250,000 on her. This, in addition to my employer provided plan felt like plenty of coverage. I have since moved on to a new employer but still have life insurance provided by the company equal to one year of my salary. It’s worth pointing out too that the death benefit of life insurance policies is not taxed, so 100% of the benefit actually would be received as cash.

RE-EVALUATING OUR NEEDS

Each year when we pay our life insurance bills, we ask ourselves if we still feel that we have the right amount of coverage. So far, that answer has always been yes. As our family has grown, we’ve been able to keep our expenses pretty well contained and we’ve continued to save and grow our net worth.

Although much of our net worth is tied up in retirement accounts and home equity, if I were to die Mrs. DIY$ would sell the house and be able to access my retirement accounts without any penalties and would have a net worth over $1M. We are targeting to have more than $1M in net worth before we fully retire, but this would be plenty of cushion to allow her to sustain the household long enough to get all of the kids grown and then some. She hasn’t been in the workplace since becoming a mom but looks forward to being able to re-enter the workforce at some point in life, so this would not be a burden if she weren’t left with enough for an immediate lifetime retirement.

SIMPLE ADVICE FOR CONSIDERING WHOLE LIFE INSURANCE

Life insurance salespeople will sometimes argue that buying term life insurance is throwing money away and that you should consider whole life insurance for the savings and investing benefits. To that my simple rule of thumb is this.

“Don’t invest using and insurance product and don’t expect insurance from an investment product”.

If you can remember that one simple rule, you’ll avoid significantly overpaying for life insurance and also have more realistic expectations from your investment portfolio.

To the life insurance salesperson who says we’re wasting money on term life, I’d add that we have 14 years left in our 20-year policy and my policy costs $365/year. I’ll be thrilled if 20 years passes and I end up having flushed $1 a day down the toilet for that time, but my mind is at ease knowing my family would be taken care of should the awful happen.

February 2017 Net Worth Update

February has been a busy month in the DIY$ household. We welcomed a new baby into the family, had family visit from around the country, and even found time to take a trip to the beach with our newborn (it felt crazy, but turned out great). It was also a great month for us in the net worth department. As I alluded to in last month’s update, we were expecting February to be a great month and it certainly did not disappoint. We ended the month with a net worth of $646,721, an increase of over $35k.

NET WORTH SUMMARY

CASH

Our cash went up substantially, largely due to year-end bonuses that paid in February. We’ve been working on increasing our cash savings, and this helps us get closer to our new goal. We haven’t fully decided how high we want the balance to get, but it’s probably somewhere around $50,000 so long as the potential for a new vehicle purchase remains on the horizon. We also just had a baby and haven’t seen all the bills, but we should be able to cover those expenses using our HSA which is included in the Investments category.

INVESTMENTS

Our investments grew from good stock market performance as well as extra large 401k contributions with the accompanying company match from my year-end bonuses. The S&P 500 notched a 3.72% gain during the month and our largest holding is IVV, which is responsible for over $10k in gains. I added some very small speculative positions in NLY and MORL through my Robinhood account but this won’t move the needle in either direction.

Nearly all of our investments are in no-load mutual funds or ETFs that our brokerage firm allows us to purchase with no trading fee. I do place occasional trades but have opted to use Robinhood for most transactions that otherwise would include a transaction fee. In early February, Schwab announced that they were lowering their trading cost from $8.95 to $6.95. This was definitely a win for consumers but the price seemed selected only to be able to say they were cheaper than Fidelity who has been offering trades for $7.95 for several years.

Over the weekend, I was poking around on the Fidelity website and noticed that they were no longer comparing themselves to Schwab, opting to only compare to companies that charged higher commissions like E*Trade and TD Ameritrade. It seemed a bit shady, so I called them out on Twitter and got the typical canned response.

Yesterday I noticed that Fidelity had lowered their trading cost to just $4.95. Not to be outdone so soon after gaining the lead in the race to the bottom Schwab quickly announced that they would be matching Fidelity at $4.95, temporarily calling a truce in the price war. I don’t see myself trading more often just because trading commissions are lower, but $4.95 certainly feels a lot cheaper than $6.95 or $7.95 and should be a win for investors.

CARS

Sadly, this isn’t going to be where I tell you that I hit 200k miles in my car. That update should be coming soon though since I just hit 199,000! While reading through Twitter it sounds like Corolla’s are pretty popular in the FI community, and hearing other stories of immortal cars gives me confidence that mine will be able to make it to 250,000 miles or more. I did go to a used car lot that specializes in the type of car I’d like to replace my Corolla with, but only because I’m not normally in that area and I successfully avoided giving myself a case of car fever.

HOUSE/MORTGAGE

This month, we finally got our mortgage balance under $200k, woo-hoo! It was always part of the plan to throw a good chunk of my bonus at the mortgage and even though $199k is still a lot of money, it’s a psychological boost to pass that threshold. This month my oldest was asking me if we could buy something like a 4-wheeler and I explained that I would love to have those types of toys, but not until we pay back the money we borrowed to buy our house. To help visualize what this meant, I created this chart that showed how far we’ve come and how far we have to go.

Each red square is $1,000 we have still to pay back. The green squares show how much equity we’ve paid off, including our original down payment. The yellow squares are market appreciation since we purchased.

My projection is that we’ll have the house paid off before the oldest is 12 years old, which would be perfect timing to get a 4-wheeler.

Some thoughts on Bubbles and Student Loans

“The market can stay irrational longer than you can stay solvent” – John Maynard Keynes

These words from the famous economist John Maynard Keynes come to mind whenever I think I see some type of bubble in the stock market or elsewhere. The saying refers to the risk of taking a short position, or betting that a particular investment will go down in value. When you simply purchase an investment, your risk of loss is your purchase price and your potential gain is unlimited. When taking a short position, you profit as the investment loses value and lose as the investment gains in value. In shorting, your gains are limited to the point that the investment goes to $0 but your risk of loss is unlimited.

Michael Lewis’ book turned movie, The Big Short, popularized short selling by showcasing investors who won big betting against the U.S. housing market in 2008. The Greatest Trade Ever showcases other traders who made even larger gains on similar types of trades. One thing that was common between both stories was the serious risk of insolvency many of the investors faced as they continued to pay premiums waiting, and waiting, and waiting, to be proven correct. They knew that the housing market couldn’t continue rising indefinitely, yet it continued to defy their predictions almost to the point that they (and their investors) could no longer handle the continued losses.

FINDING THE NEXT BUBBLE

It seems like every week I come across an article predicting the rise of another bubble. There’s the ‘Auto Loan Bubble’, the ‘Housing Bubble’ (again), and don’t forget the ‘Student Loan Bubble’.

“An investment in knowledge pays the best interest” – Benjamin Franklin

For hundreds of years, this mantra has been repeated in this country and for the most part, I tend to agree. Education can be the key to a better life and can allow for significantly higher lifetime income. What is missed from this simple quote though, was clarified by John Adams who said:

“I must study politics and war that my sons may have liberty to study mathematics and philosophy. My sons ought to study mathematics and philosophy, geography, natural history, naval architecture, navigation, commerce, and agriculture, in order to give their children a right to study painting, poetry, music, architecture, statuary, tapestry, and porcelain.” – John Adams

Interpreted for our day and age, I take this to mean that education is great, but don’t study something that doesn’t have a financial return unless you don’t need a financial return. If you build a legacy sufficient to sustain the next generation, then by all means, allow them to study something they love that may not pay the bills, because you’ve got that covered for them. If you don’t have this luxury and do actually need your education to provide a return, then you need to study something that has value in the marketplace.

TOO MUCH OF A GOOD THING IS BAD

Where we run into problems is the belief that an education is worthwhile at any cost. I recently was reading about the astounding levels of debt the average dentist owes. The author of this article finds the average dentist just starting out has an average of $450,000 in student loans with an income of just $120,000 without even taking into consideration the cost of buying into a practice or other borrowing such as a mortgage. Add it all up and it’s not difficult to find a dentist with over $1,000,000 in total debt. An income of $120,000 sounds great, but it doesn’t go very far with debt levels approaching 4x annual income.

Is this a new thing? One of my favorite fiction authors, Michael Crichton, started his career going through Harvard Medical School (which later helped him as a writer for the hit TV show E.R.). While he was a student there, he wrote Five Patients where he walks through the hospital visits of 5 hospital patients in the 1960s. The book was first published in 1970 and I read it 40 years later in 2010. Even though the book was 40 years old, I was surprised how relevant some of the stories were and was shocked that some of the same problems that existed in the medical field then, persist to this day. I specifically remember that he highlighted that in order to enter the medical profession one had to either come from a well-off family or have a strong tolerance for high levels of debt.

I’ve been saying for years that it doesn’t make sense that students are able to borrow as much as they do and that reform is imminent, yet for years I’ve been proven wrong. Thankfully I haven’t made any investments based on that theory. If people have been saying this as far back as 1970 though, are we truly close to the bubble bursting?