Wednesday, June 24, 2020

Roth > Traditional

One of the goals I have before I retire is to convert the majority of our retirement accounts over to Roth balances. You don't have to search too hard to find folks who can show you how mathematically the Traditional IRA is superior because of tax deferral, or how lower tax rates now reward those who deferred taxes in prior years. 

But personal finance is personal. You can't always just rely on math and always choose the most optimal solution. Just like I could show you how mathematically we're foolish for having paid off our house early, there are real but intangible benefits to the peace of mind I gained from doing so. 

Having more of our retirement assets in Roth accounts is one of those things. Here's a few stories of things I've seen that have shaped my feelings on this topic. 

Phantom Money:

Years ago, I met with a couple in their late 60's who lived in a part of the country hit very hard by the housing crash. Due to a series of sub-optimal decisions and unfortunate timing, they found themselves trying to sell a house that was worth about $100k less than what they owed on it. 

The wife in this couple had mostly been a homemaker but had held a part-time job for several years that allowed her to contribute to a 401(k). After many years of growth, this account was worth around $100k at the time we met. Seeing a potential solution to their being underwater on their mortgage, she asked me 'Well, can't I just use that $100k to pay down the mortgage and be done with the house'?

I'll never forget the look in her eyes when I had to explain that taxes would be due on the amount withdrawn from her 401(k) and that the $100k balance she had become used to seeing on her statements, would really only be ~$70k, still leaving them $30k in the hole. Up to that point, she had always thought she had $100k, when in reality she never actually had the amount on her statement available to her. 

There are ways to take money out over time to minimize the tax consequences, but that wasn't an option when they needed a large amount of money in a short period of time. It's hard not to see your balance and think about what you could get for it, but whenever you see a pre-tax 401(k) balance you should always see that number and deduct ~25%. Our Roth accounts on the other hand, are all ours.

Too Much Tax Deferral:

Is there such a thing as too much of a good thing? Most certainly yes, even in deferring taxes. I've met with several retirees whose primary strategy in their working years was to save as much as possible into tax deferred accounts, with little to no thought put into a withdrawal strategy. 

One particular scenario that stuck in my mind was a client who had saved about $5M for retirement and going into retirement had based their expectations upon a certain level of fixed income to come from those assets. Throughout their careers they were usually in the highest tax bracket, and had put as much as they could into every tax sheltered vehicle possible, including deferred compensation accounts. This was done partially with the belief that in retirement, their tax rates would be lower.

At the point we met, they were within a few months of retiring and finally starting to look at a withdrawal strategy. What became clear fairly quickly was that because of the requirements on deferred compensation payouts and timing of Minimum Required Distributions (MRDs) from retirement accounts, it was going to be virtually guaranteed that they would still be in the same, highest tax bracket for at least the first 15 years of their retirement. 

Yes, this is a great problem to have. But it just goes to show that withdrawal strategies need to be considered early on. With the benefit of hindsight that client wishes they had done some Roth conversions earlier in their careers even though the tax bill at the time seemed unpalatable. They also maybe wouldn't have deferred as much income and would have just done non-retirement investing (the deferred comp account only earned CD-like returns), or possibly even retired sooner.

Lessons Learned and Our Strategy:

I have two main takeaways from these examples. First, never look at a pre-tax investment account balance and think that whole amount is actually yours. I would much rather have a $100k Roth IRA than a $100k Traditional IRA. Second, planning withdrawal strategies needs to be on your mind throughout your accumulation years. Asset location (the type of account) is as important as asset allocation (the type of investment).

As mentioned before, our strategy is that we want as much in Roth accounts as we can afford to by the time we retire. This means that all 401(k) contributions we make go in as after-tax contributions. This reduces my take home pay by more than if we did pre-tax contributions, but also means we're putting more away into retirement accounts than if we did the same percentage of income but pre-tax. 

Each year, we also pay the taxes on a portion of our pre-tax accounts and convert that balance to Roth. We have a lot to still convert with only about 1/3 of our total retirement accounts in Roth, but we are still 10+ years from retirement so should be able to make very good progress between now and then. Also now that we are no longer paying a mortgage, we can afford to convert a bit more than we were doing in previous years. 

Lastly - we plan to be retired younger than age 59 1/2, which means that we can't solely rely on our retirement accounts to live on for the time before we hit that age. With the house paid off, we are now contributing monthly to our non-retirement investment accounts an amount similar to what our minimum mortgage payment was. This amount, while taxable, is what will get us to age 59 1/2 if I retire in my early 50s. 

Thursday, June 11, 2020

May 2020 Net Worth Update - New All-time High

Coming off the heels of a strong month in April, we reached another new all-time high net worth in May, up almost $37k to $1.05M.


We finally got the cash refunded from our cruise that was cancelled back in March. This was the primary reason our cash balance went up by almost $6k. Our bathroom remodel expenses were much lower in May than in April, but we still spent $1,700 on some new tools and hiring out some of the trickiest plumbing parts. 

We typically hate hiring work out when doing home improvement projects but there are times when we know our limits and ran into one of those situations with the plumbing. We've now reached the point where tile is going down so soon it will start to look like a bathroom again. 

Our cash cushion is feeling much more comfortable now. It should be more than 6 months of expenses, but we haven't had a month since paying off the mortgage where we haven't had large 'one-time' expenses so it still feels possibly a bit lighter than we'd like.


The S&P returned 4.5% in May, and our investments performed similarly since we are primarily invested in US Stock Index funds.

We continue to add a bit each month to non-retirement investment accounts, but mentally those accounts still feel as 'untouchable' as our retirement accounts even though I know we could technically get at the money penalty free at any time. We are now up to over $6k in those accounts and since we have no immediate spending goal for that money, it is invested in index funds. 

With the house paid off and already having crossed $1M in net worth, the next medium-term goal is to get our 'liquid net worth' above $1M. The timing of this obviously depends on a lot of variables like the market and my income/bonus, but I suspect we'll get there around 2026.


Our 'Other Assets' remain unchanged other than that we are adding to our kids college savings accounts each month. There are a few large purchases of what I'll call 'toys' that we have been waiting on until the house was paid off that when we finally bite the bullet and buy them, I don't plan to include in our net worth. 

We do include our primary vehicles in our net worth, if we were to buy something like a boat, RV, or ATV I would just show a big drop in cash with no corresponding asset. Nothing like this is imminent, but I wouldn't be surprised if we did buy something 'fun' in the next year or two. 

Sunday, June 7, 2020

May 2020 Reading Review

Last month, I finished 6 books, bringing my year-to-date reading up to 39 books. If you're looking for a good read, check out some of the summaries and links below in the order of my preference among these titles.
    A lot of non-fiction books I find to be too long, but this one was just right. It got to the point and didn't add too much fluff, and gave a few things to think about. I am not an entrepreneur, but do see the appeal and this definitely gives some things to think about. His main thing is to discourage young graduates from joining consulting firms or 'big law' in favor of startups where they'll have much more latitude to implement things they've learned and make decisions that actually drive the success of the enterprise. 
    I'm personally not a big fan of the 'chew them up and spit them out' culture of the major consulting firms and am dubious about the training they provide, so it's definitely something to consider. Say what your want about Andrew Yang's politics and his failed attempt to run for president, this was a good read if you are one who dispenses career advice to high school and/or college students.
    If you've ever been to the Biltmore or seen the mansions in Newport Rhode Island you may have wondered what type of vast wealth was required to build those massive homes. This is a great read to see how that wealth was both accumulated, and subsequently squandered. I didn't know, but within 5 years of the Biltmore opening it's doors, the owner was essentially broke. 
    Also interesting, the land around the countries largest privately owned house (over 175,000 square feet!) is now just a small fraction of the acreage originally purchased to be part of the estate. I have not illusions that my wealth will ever reach 'Vanderbilt' proportions, there are still takeaways for the importance of instilling work ethic and drive in the next generation. 
    Another surprising takeaway was that compared to some of the wealth that exists today the numbers didn't seem that big when compared to some of the wealthiest Americans today. In fact, Warren Buffett, Bill Gates and Jeff Bezos each have more than 10 times the net worth of the peak Vanderbilt family wealth adjusted for inflation.

    This one was good, but not as good as Dare to Lead. The concepts have some similarities and are worth thinking through, but Dare to Lead definitely seemed much more relevant to my life at the time that I read it than this one did at this time. I'll keep reading Brene Brown and listening to her podcast, but if I'm going to recommend a book of hers it would be Dare to Lead over this one. Your results may vary, so definitely give it a read if the subtitle seems relevant.
    I never would have guessed that Airlines would have been in such dire straits financially when I got around to reading this book that was recommended to me a few years ago. It was only a coincidence that I started to read this while Airlines were seeking government loans and seeing passenger volumes down by more than 90% as a result of COVID-19 restrictions.  
    While I typically enjoy a good corporate biography, this one read more like a history of airline mergers and acquisitions, and inside baseball about new route strategies. It was interesting, but I would have liked it more if it had focused more on things that happened inside the company at levels much lower than the C-Suite.   
    Similar to the previous book, this one had a lot of play-by-play of private equity deals over the years, but didn't have as much of a specific 'crisis' like 9/11 and airlines that they had to overcome. Blackstone now has over $500 billion in assets under management which in an of itself is a lesson in the power of compound interest, and the power of strong past performance being a good indicator for future inflows of cash and ability to raise capital for the next fund. 

6. I am Charlotte Simmons - Tom Wolfe

    Years ago, I read The Bonfire of the Vanities and loved it. The story integrated Wall Street Culture, wealth inequality, and racial tensions in a way that had me hooked to the end. I mentioned this to someone a while ago and was persuaded to read more from Tom Wolfe so picked this one up from the library. 
    This book focuses on the college experience of Charlotte Simmons, a brilliant girl accepted into an elite university from a small town in Appalachia. The story also dives into problems with student athletes, NCAA corruption, fraternity culture, and wealth inequality all from the lens of characters embodying extremes. There were a lot of parts that I could have done without, but the story really made me think about a lot of things and reiterate that I really have a lot to teach my kids before they go to college. Thankfully I have plenty of time for that, and am not opposed to them living at home and commuting to a nearby college/university for their first year or two.

As always, please let me know of any recommendation you may have for future reading.