Wednesday, January 27, 2016

The Joys(?) of Homeownership – Part 1

J Money over at recently blogged about selling his home that he considers the biggest financial mistake he's ever made. I've been thinking about this lately and it's caused me to think back on our real estate purchases and share some things I've learned that will hopefully help others.

In roughly ten years since graduating college and getting married, we've lived in three different houses in three states. Each time we've moved, we've avoided making the same mistakes we made with previous moves but still haven't made the perfect purchase and continue to learn ways to do it better. Given that we are big into DIY projects, we've also had our share of experience learning from home improvement projects. We actually enjoy doing projects around the house, though, so living in a rental where we'd have to ask permission to do little things like paint walls, re-do trim, or tear down walls would be stifling, don't you agree? Ok, maybe we're in the minority on this one.

Over the next couple of posts, I'll detail things we've learned from buying and selling our houses.

Buying Our First Home

Back in 2006, shortly after graduating college and starting our first 'real' jobs, and when housing prices seemed to be going nowhere but up-up-up, we were renting a small one bedroom apartment. The apartment was certainly adequate and we were saving more than we ever had been able to while we were in school, but weren't really focused on any specific financial goals or targets. I knew that I wanted to go back to school for an MBA in the next 3-5 years, likely in another part of the country, but at the same time we had caught a case of 'house-fever'. On evenings and weekends we would spend time driving around neighborhoods looking for things we liked, things we didn't like, and basically narrowing down the areas where we felt we wanted to live. Looking back, I even remember telling myself something to the effect of "we really should buy something while we can still afford to." Another way we rationalized buying a house is that we felt we'd be in the house long enough that appreciation would cover all of our selling costs down the road.

In January 2007, we closed on our first home, a cute but older 3br/2ba house on a cul-de-sac. We paid $225,000 and had to borrow $224,000 for it. We thought we were being SOOOO smart. Based on our income, we were 'pre-approved' for a $450,000 mortgage and we were spending only half of that! However, there were several things that should have tipped us off that we were making a bad move. For example:

  • We offered the full asking price for a house that was listed 'for sale by owner' and had already been on the market for a few weeks. Who does that? 2006 me with a raging case of house fever. That's who.

  • We didn't use a real-estate agent. As a buyer, there really is no reason to not have an experienced agent on your side. The reason we didn't use one was because the seller of this particular home was selling by owner and would have increased the price by 3% to cover our agents' commission.

  • During the due diligence period, the bank appraisal came in $5k lower than our offer and rather than try to re-negotiate the purchase price, we just came up with another $5k for the down-payment. Doh. Having an agent probably would have saved us this $5k.

  • Although it wasn't called this at the time, we definitely got a subprime mortgage. It was a 5/1 ARM at 6.75% interest. We figured we'd sell the house in less than 5 years so the fact that the rate could adjust after 5 years seemed irrelevant. Even though we could afford the payments (they were only about 30% of our take home pay), never once in the process were we asked to show any proof of our incomes. Because it was so easy to get this type of mortgage, we would not have even tried to get a non-subprime loan since the paperwork and documentation would have been more difficult, but at the same cost.

  • Our mortgage provider didn't require that we include taxes and insurance in our normal payment, so we were surprised with a tax bill shortly after moving in. Thankfully, it was less than a single mortgage payment and we could easily pay it. Clearly our budget wasn't as comprehensive as it is now.

  • After moving in, we also realized that there was a lot more stuff we had to buy that you don't need as a renter. These were things like a lawnmower, yard tools, hoses, appliances, etc. I knew that there were going to be things we needed, but something always seemed to pop up that we hadn't thought of.

  • When getting ready for closing, we learned about this thing called 'odd-days interest', which at the time only meant that we opted to have a closing date closer to the end of the month to reduce how much cash we had to bring to closing (if we were worried about paying less than one month's worth of interest just once…what were we thinking signing up to pay even more interest EVERY SINGLE MONTH?)

Once we moved in, the house fever transitioned to home renovation fever. Pretty much every weekend and spare moment we had was spent working on some type of upgrade to the house. Here's an example of some of the projects we did:

  • Painted most rooms.

  • Replaced wood veneer doors with white six-panel doors.

  • Replaced baseboards throughout house.

  • Installed built-in bookshelves in guest bedroom.

  • Installed crown molding in one bedroom.

  • Replaced old railroad ties with concrete blocks in a backyard retaining wall.

  • Planted several trees.

The list exhausts me just looking at it. The craziest part is that these projects all happened in less than 6 months. The list would be longer, but that same summer we came to the decision that rather than wait three more years to go to back to school, we wanted to start in one year. The only problem was, the school I had my heart set on was across the country. I had never visited the campus or even the state the school was in, I only knew that it was very highly rated, a mentor of mine had gone there, and there was the possibility that I could get a job with my same employer in the city the school was located and go through a part-time MBA program in the evenings.

In around October 2007, I reached out to the manager in the city where I was looking to go to school and let him know I was looking to transfer if a position ever became available so I could also pursue an MBA at the local University. I figured that this would be the first step in developing a relationship and dialogue that could allow me to transfer in a year or two, so imagine my surprise when, in our FIRST conversation, he told me he actually had a position opening up in the next few weeks that would be ideal for me. Before I knew it, I had received and accepted an offer to transfer across the country and start a new job.

So, less than 1 year after buying our first house, we needed to sell it. November 2007, we put the house up for sale, optimistically (and naïvely) asking $250,000. The only smart thing we had done financially to this point was that we had paid down the mortgage balance by $12k in that first year. I moved and started my new job in January and my wife joined in February. We ended up not selling the house until April 2008, and sold it for $225,000, exactly what we had paid the previous year. Realtor fees and closing costs consumed any equity that we had, but thankfully we were not underwater.

Some mistakes we made during the selling process:

  • We originally tried to sell the house ourselves, without the help of a real estate agent. We ended up listing with a real estate agent when we moved out of state, and should have listed with a professional much earlier. Had we done so, we probably would have had a more realistic asking price and would have sold much sooner.

  • When we were doing our house projects, some of the colors we chose for bedrooms were bolder than your average homeowner would want. Even though paint is the easiest thing to change in a house, I now know that buyers have a hard time seeing a space differently than it is presented. Not to say that it wasn't well done (definitely not cringe worthy like some of the neon pink/glow can be seen down the hall stories that you hear of), but deep blue or red can be polarizing.

  • We expected all of the price negotiations to have happened before going under contract, but our buyer was a more savvy buyer than we had been and some additional price reduction happened after a home inspection was conducted.

What were we thinking with that wall color…?

A few things we did right:

  • My wife worked in an industry where some of the company owners had frequent dealings with real estate agents, and when we did list with an agent we solicited their advice and got a good one. There are many agents out there, and, similar to the financial advisor industry, a great many of them are not fantastic at their jobs, and those new to the process generally don't know how to tell the difference.

  • Even though we packed up and shipped most of our household to our new state, we didn't leave the house bare. We left window treatments, art, etc., and that made a huge difference in how it looked to potential buyers.

  • We didn't attempt to be long-distance landlords. Even though we had ties to the area and still visit frequently, the thought never really crossed our minds to attempt to rent out the house.

Some things we lucked out on (through no skill or good decisions on our part):

  • We sold right before the housing market really tanked in that area. I still tremble to think of how much worse this story could have been.

  • The buyers came to the table with a large down payment so we didn't have any bank appraisal issues.

In the end, our first home was a huge learning experience. Even though we bought and sold the house for the same amount, we actually lost around $20,000 when considering realtor fees, closing costs, and cost of home projects. We were fortunate enough to be able to absorb the losses, but avoiding those losses would have made the next few months transitioning to a new state a lot easier. Having paid some tuition in the school of hard knocks, we approached our next home purchase with more experience and better expectations.

Tuesday, January 26, 2016

Why a Roth IRA is so great

Towards the end of last year, I converted a portion of my Rollover IRA to Roth. Because money in my Rollover IRA is still pre-tax, in order to move it to Roth, I had to pay taxes on the amount I moved over (about $5K) as if it were income earned in 2015. Why in the world would I willingly pay extra taxes, you ask? Let me explain.
First, roughly 25-30% of our retirement investments are currently in 'Roth' or after-tax accounts. The rest is in traditional, or pre-tax retirement savings accounts. So even though it may look like we have a lot saved for retirement, a large chunk of the accounts are what I refer to as phantom money. Sure, the money is in my name and I can invest it however I please, but even if I were over age 59 ½ and were to go and withdraw it, I'm going to have to give a good sized chunk of it to the IRS for taxes. Our Roth IRA's, on the other hand, are 100% OURS.
At this point you may be thinking "Ok, I get it, putting money in Roth means that it's all yours, but that still doesn't make sense why you would willingly pay a bunch of taxes just to satisfy your inner three-year-old saying 'mine!' It's not like the IRS is asking for the taxes, they're cool with you deferring them."
Actually, it's a lot more than just that. You see, by paying some taxes NOW, I actually end up paying A LOT less taxes down the road. How's that?
You see, $5,000 invested at 10% for 25 years will grow to almost $55,000! This is true whether it is invested in a pre-tax or after-tax account, the only difference between the accounts is how much and when you'll pay the taxes. I don't know about you, but I'd much rather find a way to pay $1,250 in taxes today to avoid paying $13,543 in taxes down the road.
It used to be that only those who earned under $100,000 per year were eligible to convert to Roth. For the past several years, though, that limit has been waived, allowing anyone with pre-tax accounts to be able to convert to Roth, regardless of income level. I haven't been able to find any hard stats on this, but from my experience, removing this limitation created a bit of a windfall for the IRS as many investors began converting large amounts of pre-tax investments to Roth IRA's, opting to pay taxes now and continue investing tax free. When I was a financial advisor, I helped several clients convert balances over $1,000,000 to Roth IRA's.
Even though this decision reduced the amount of refund we'll be receiving from the IRS this year, I didn't convert so much that we won't be receiving a refund. By having the taxes for the Roth conversion paid from our tax refund amount, we're able to pay these taxes without disrupting any other part of our normal monthly budget. We try to minimize the amount of refund we receive each year, but it has been challenging as every year is a bit different (ratio between salary and bonus pay, number of children, etc.). Our plans for now are to convert some of our pre-tax accounts to Roth each year, paying the taxes out of pocket and not touching the retirement accounts themselves to cover the taxes.
I only have two regrets related to this Roth conversion. First, I regret not having converted anything in previous years. I really only skipped 2013 and 2014 since prior to that we didn't have any pre-tax money outside of 401k's. If we had converted in 2013 and 2014, we would have converted before the market went up and would have been able to convert more of the account for the same tax bill. The second regret is that I waited until December to do the conversion. In this case, it didn't really matter when I did the conversion since the market ended the year roughly the same as where it started, but if it had gone up a lot in 2015, the decision to wait could have cost me. That being said, now that the market has come down a bit this past month, I plan to do my annual conversion soon rather than wait until the end of the year. When you convert to Roth, the amount you're taxed on is the value of whatever you convert when you do the conversion. So, if I convert $5,000 now, I'll pay taxes on $5,000 of income no matter what the investment is worth at the end of the year.
The difference in taxes shown above is showing the advantage of a $5,000 Roth conversion, and it clearly makes sense. The extra $5,000 in income didn't push us into a higher tax bracket and we had the money to pay the taxes out of pocket. Since we don't have the cash to pay taxes on an extra ~$200,000 in income, we'll be converting the rest of the accounts a little at a time, hopefully saving ourselves a lot more than just the $12k shown above. The decision on whether to convert to Roth really is just a question of when do you want to pay taxes. My choice is to get them out of the way and invest as much as I can in tax free Roth's.

Wednesday, January 20, 2016

Are Women Better Investors?

There have been several articles and studies in recent years that have come out saying that, on average, women earn higher returns than men when investing (see here, here, and here). The articles cite research that finds that women tend to focus more on the long-term and make less emotionally driven investment decisions, which in turn leads to higher long term investment returns. I've read enough of these types of articles that it almost feels like conventional wisdom, but I recently had an experience that helped me see this in action.

As you probably know, the markets have had a rough start to the year, with the S&P 500 down nearly 10% since the start of the year. If you haven't already had conversations about the stock market with people who don't generally talk about the market, I'm sure you'll have the chance after January brokerage statements are mailed out and people see how much their accounts have gone down in value. My wife found herself in one of these conversations recently where a man was commenting about how much money he had lost in the market so far this year. He monitors his accounts regularly and knew fairly precisely how much his accounts had gone down this month. Her response was basically, "huh, I guess we've lost money too. Not sure how much, but it's invested for the long term so it doesn't really matter, we'll just keep doing what we've been doing."

To some, this response may sound ignorance, but in reality, my wife had the perfect reaction! Investors who fret about short-term market gyrations are more likely to sell AFTER the market has already done down and then wait too long to buy back in. If you are truly invested for the long-term, short-term fluctuations are just noise and should be ignored. If anything, the most recent market decline represents a fantastic buying opportunity for anyone with more than a 5-10 year time frame.
Although I am a man, in our household, financial decisions are made jointly. I have proven to not react poorly to market gyrations and have never made THE BIG MISTAKE of selling out. However, if it is true that I am somehow wired differently and more apt react poorly, I'd like to think that the way we jointly manage our investments will allow us to let cooler heads prevail and benefit from some 'female outperformance'. I won't make a blanket statement and say that women are better investors, but I will say that in my experience the most successful investors are those who can stick to a well-developed plan through market cycles, regardless of their gender.

Monday, January 18, 2016

Saving for College

While walking along the shores of a beautiful island in the Mediterranean with my wife recently, we spent our time talking about what all people talk about in similar situations. Budgeting! Ok, so maybe we're a bit nerdier that most other couples, but our specific conversation focused around how to budget additional income I would shortly be receiving. I got a raise at work that comes out to almost $1,000 a month extra take home pay, and we wanted to make sure we put it to good use and didn't get caught up in lifestyle inflation.

One of the things we decided to do with the extra income is to begin saving for our kids college. Our children are all young and none have started school yet, so now is the best time to start saving in order to have compound interest work in our favor.

We've gone back and forth on whether to set up a college savings account at all, which is probably why it's taken so long to open an account. My wife worked hard, saved, and was able to graduate with her Bachelor's degree with no debt and no assistance from her parents. I received limited assistance from my parents for my first year or so of college and then paid the rest of my way through undergrad, racking up some student loans that we quickly paid off (once we got serious about debt elimination). I also made it through a much more expensive graduate degree with no student loans, no scholarships, and no assistance from my family (just tremendous support from my wife). I've always felt that my kids should pay their way when in college, but I also don't want money (or the lack thereof) to be a limiting factor in deciding whether or where to go to college.

When saving for college, there are few different ways to do so. Below I'll outline the different options we considered and then let you know what we ultimately decided to do.

Option 1: Education IRA (AKA Coverdell, ESA)

  • An education IRA can be funded with up to $2,000 of after-tax contributions per year and growth is tax free so long as withdrawals are used to pay for education expenses.

  • One unique advantage of an Education IRA is that they can be used for private school tuition, prior to college. We aren't planning to enroll our children in private school, so this advantage didn't matter to us.

  • One disadvantage for us was that none of the financial institutions we already use offer the Education IRA as a type of account. In order to open one, we'd have to establish a new relationship with another financial institution.

    • When I worked as a financial advisor, my company didn't offer Education IRA's for two reasons. First, we offered 529 accounts, which provide a very similar benefit. Secondly, Education IRA's aren't big money makers for the financial institutions or brokers that offer them. Since only $2,000 per year can be deposited, even if you maxed out an account every year from the day your child is born and it earns 10% per year, the balance won't ever exceed $100,000 before it begins being drawn down.

    • In my experience, financial institutions that do offer Education IRA's are likely to charge much higher fees and commissions and/or have limited investment options. I recently talked to a co-worker who maxed out Education IRA's for his son for 10 years at his local bank. His only investment options were to have the money sit in a money market account or to invest in CD's. As a result, the account has hardly grown at all from the $20,000+ that he initially deposited and he has missed out on years of compounding at earnings rates much higher than the 1-3% he's been earning.

Option 2: 529 account

  • 529 accounts are also accounts where investments can grow tax free, so long as withdrawals are used to fund higher education expenses. This distinction from Education IRA's simply means that 529's can only be used for college, not for private K-12 education.

  • One thing that make 529s unique is that the beneficiary can be changed. This means that if you designate one of your children as the beneficiary, and for whatever reason that child doesn't use the money, you can change the beneficiary to another child. This comes in handy for families with multiple children like us, and the law also allows for changing the beneficiary to other close relatives.

  • If you're considering investing in a 529 account, I suggest you check out When you do, you'll learn that 529 plans are set up by each state, with each states 401k offering various different investment options within the account. This is similar to 401k's at work, but different in that you don't necessarily have to use the 529 for the state in which you live. Since funds in a 529 account can be used for any college in any state, the only reason you would want to use the 529 for your specific state is if your state offers some tax incentives to do so.

    • In our case, I learned from that our state offers a small state income tax deduction for contributions to the state sponsored 529. In order to get it, we'd have to make contributions through TIAA-CREF, the plan provider our state has selected.

Option 3: General Investment Account

  • One option we strongly considered was to simply set up an account that we would earmark for college related expenses, but that wouldn't be a tax advantaged account. We liked the idea of not being penalized for using money for things besides college, and that our investment options wouldn't be limited.

  • When going this route, we would have to decide whether we would keep the money in our own names or in the names of the kids. The upside to putting money in the kids names is that they would get some level of tax free earnings, but the downside is that once money is in the account it is considered an irrevocable gift and once they are adults we would be legally obligated to hand it over to them, regardless of their maturity level or plans for higher education.

One final option that we did not consider was pre-paid tuition. I'll admit I'm not an expert in the types of pre-paid tuition programs that exist, but I feel I know enough about them that I knew they weren't what we were after.

What We Actually Did:

After evaluating our options, what we ultimately decided to do was to open a 529 account. However, rather than open an account with TIAA-CREF (an institution we don't already have accounts with), we opened a 529 for another state that our main financial institution sponsors. We won't be getting the state income tax deduction but would rather have the account with an institution we already have a relationship with, especially since we don't know how long we'll be living here.

Although we have three children, we only opened one account. Our plan is to fund the account with enough to cover the entire amount we're willing to contribute to all of their educations in one account and to change the beneficiary as needed. Down the road, if we need to create separate accounts, we can do so, but for now this is sufficient and clean. This also makes sense because we would invest the funds the same way regardless of the child. Since I don't subscribe to investing in an 'age-based' approach that gradually gets more conservative over time, I invested the funds 100% in stocks. We've had a rocky start to the year, but this small account is benefiting from regular monthly contributions buying in a lower levels than where it started.

Monday, January 4, 2016

2016 Net Worth Goal

It's hard to believe that in 2015, our net worth increased by over $64k. Reaching $500,000 in net worth was a bit anti-climactic, since it doesn't really change the way we live. In that regard, I don't expect 2016 to be any different. In fact, I don't expect our lifestyle to really change until we have a net worth over $1.5M, at which point I may begin to consider partial retirement.

All that aside, for 2016 our goal is to reach a net worth of $600,000. This represents an increase of $90,000. In one year. Wow. A year ago, I wouldn't have believed we had reached a point yet where this pace of wealth accumulation were possible, but seeing what we accomplished in 2015 even with several large and unexpected expenses, $90,000 in a year seems possible.

Here is an estimate of how I think this will be broken out.

  • 401k contributions (including employer match): $21,500

  • Mortgage reduction (regular and extra payments): $11,300

  • Beefing up our Emergency Fund: $6,000

  • IRA and non-retirement investment contributions: $25,000

You will notice that these contributions don't fully add up to $90k on their own. I will need to rely on stock market returns to get me the rest of the way to $600,000. If our investments earn 8% this year, I'll hit the goal. Lower stock market returns would be needed if my home appreciates in value, but for now we'll assume the value of the home is constant.

Some risks to this goal in 2016 include:

  • Going over budget on some home renovations and upgrades we are considering

  • Potentially needing to replace a car or some expensive car repairs (I just hit 180,000 miles on my car. No signs of dying yet, but the potential is there)

  • Possibility of a work relocation and risk of maintaining two households until our home sells (including the possibility of not being able to sell in a timely manner or for the desired amount)

  • In 2012 we earmarked some money for charitable donations to our alma mater that would cover donations through 2015. In order to maintain our annual giving, we'll have some expenses in 2016 that we didn't have in 2015.

Some advantages we anticipate in 2016 vs 2015:

  • We don't have another European trip planned, which was a large expense in 2015

  • My 2016 income and bonus is expected to be about $25,000 more (gross) than last year, most of of which will be saved (included in above estimates)

  • Our portfolio is more heavily weighted to stocks than it was last year as we have sold off most of our bond holdings

I can't control what the market does, but I can control how I react to the market. If I reach all of the contributions outlined above that I do have control over, and the market doesn't cooperate, I'll still consider that a win so long as I stay invested and continue investing for the long-term.


Friday, January 1, 2016

2015 Net Worth Update – passed $500k

Happy New Year! Another year has passed and it is time to update my net worth.
Since the last update, a lot has happened, some of which helped our net worth grow more than others, can you guess which is which?
  • Our household net worth surpassed $500,000, ending the year at $509,553
  • I got a healthy raise at work (>10%!)
  • We set up a college savings account for our kids (not included in our net worth)
  • I converted some of my Rollover IRA to Roth
  • The stock market closed 2015 with the worst performance since 2008 (1.19% return when including dividends)
  • We travelled through Europe for 10 days without jeopardizing other financial goals
Here are some details on how our net worth is currently made up.
First, you'll notice our cash is basically unchanged over the past 3 months. This is largely on purpose, as we'd rather invest excess cash or use it to pay extra on our mortgage. Over the next few months, I expect our cash to increase a bit as we've decided we'd like a slightly larger emergency fund. We should be able to do this without slowing down other goals because of a raise I recently received at work. We're making a conscious effort to make sure our lifestyle doesn't inflate with our higher income, and have allocated the majority of the additional income to go towards investments, mortgage reduction, and college savings for the kids.
October was a good month for our investments, growing by over $15,000, coming off the August and September declines. Like most index investors, our portfolio has been relatively stagnant throughout 2015, but we've continued to buy in with monthly 401k contributions and periodic IRA contributions.
There isn't a whole lot to tell about our other assets – our cars continue to be reliable and are old enough that they aren't really depreciating like newer vehicles. Our house value also seems about right. There are some similar homes in the neighborhood going for well over $450k, so this estimate should be in the ball park. We've made extra principal payments on our mortgage every month since we bought our home, and have increased the amount of our extra payments slightly using a portion of my increased income.
Overall, it's been a great year. I'm excited for what 2016 will bring and am in the process of finalizing my 2016 goals. For the year, our net worth increased by nearly $22,000. Where it will go in 2016 is unknown, but what I can tell you for sure is that we'll continue to save, invest, and ride the market through the ups and downs. That is, after all, the main thing we have control over.