Take The Right Financial Road In 2018

I recently read about a 28-year old New Jersey man who typed the wrong address into his rental car’s GPS in Iceland and drove six hours in the wrong direction – SIX! – from the airport to a fishing village in the north of the country….when he was just trying to get to his hotel. Now, his first mistake is quite understandable. I’ve been to Iceland and they are apparently too cheap to buy a vowel because every word is virtually unpronounceable. But, despite the long drive and “poor road conditions” he plowed on because that’s, ahem, what the GPS told him. And he never questioned that Reykjavik’s airport would be 6 hours from, well, Reykjavik. That’s like assuming Lexington’s airport is in Detroit.

This was really quite funny until I realized how many people figuratively make this same mistake in their financial lives. Unfortunately, they assume they’re on the right road until told otherwise. Maybe they assume contributing just enough to their employer’s retirement plan to receive the match will eventually produce enough to support them in retirement. Or maybe they’re contributing as much to debt payments each year as their savings. Or maybe they’re invested completely wrong for their long-term goals.

These people aren’t stupid – they usually just don’t have the time to properly plan for what they will really need in the future. To complete the comparison with our Icelandic mis-adventurer, it is quite common for people to be on the wrong road but not know it until they’ve hit a destination that’s figuratively six hours from their desired destination. Only, the stakes are much higher if you don’t realize your mistake until you hit age 60.

So, here are some suggestions for getting on the right road in 2018:

1. Pay yourself first

Automate your contributions to your employer’s retirement plan and any other investment plans first. Then, develop your budget from what’s left. How many times have you heard that cutting out that daily latte will aid your retirement? No, I like that latte, you say. So, don’t make the choice between your financial freedom and your latte. Pay toward your financial freedom first, then choose between a latte and maybe a beer that evening. That approach is not only better for your long-term financial health but you’ll feel a lot less guilty each day too.

2. Pay down high-interest debt

Not all debt is equal and not all debt is bad. In general, if all of your debt – student loans, mortgage, car loan or lease, credit card debt – is more than 36% of your gross monthly income, that’s too much. Additionally, if a loan has a high interest rate – probably about 6% or higher – that should be taken care of too. (Read more on how to determine if debt is acceptable or a problem here -https://lexingtonfinancialplanner.blog/2017/10/27/should-cal-and-rick-pay-down-debt-or-save-for-retirement/.  If you find yourself in one of those situations, make a plan to retire that debt as soon as you can. Again, automate your payments so you don’t have to choose between making that debt payment and your daily latte.

3. Save for some short-term fun

Around the office I’m kind of known as the saver-police. “No soup for you, save!” (A paraphrased Seinfeld reference, by the way) But that’s not true, Lisa and I are good savers, but we also prioritize our spending for fun too. After we save for our future, we have chosen to use our dollars to travel rather than buy expensive cars or buy a bigger house. We would rather enjoy a nice vacation each year, like two weeks in London last summer, than drive a Mercedes. Now, that’s not a choice for everyone, just us. In any case, choose a short-term saving goal for 2018 and make it part of your monthly budget. Recently, new clients wanted to build saving for regular, nice international trips into their financial plan. We showed them how to do that while still making significant progress toward their financial freedom.

If you would like to talk about your long-term and short-term financial goals, please email me at steve@moneywatchadvisors.com or call me at 859-268-1117.

 

Should Cal and Rick Pay Down Debt or Save for Retirement?

There is a natural, and understandable, instinct in most of us to want to pay off our mortgage as soon as possible. In fact, it’s considered a kind of rite of passage. Yep, the missus and I paid off the house and finally have the kids off the payroll, now we can save for our retirement! But, is paying down your house or other debt early really the right thing to do for your long-term best interest?

Let’s take a closer look at a couple of common situations people face:

1. Cal owns a home for him and his family that is reasonably-priced for his family’s income with a monthly payment that allows them to pay all their expenses with a little left over. What should they do with that “extra” money each month? Pay down their mortgage or save and invest for their future? From a math perspective, Cal’s decision should be based on his after-tax cost of borrowing versus his after-tax return on investing. So, let’s assume Cal has a 30-year mortgage at 4% interest and he and his wife are in the 30% tax bracket. The true cost of that debt is 2.8% because mortgage interest is tax-deductible. So, 4% rate minus 30% equals 2.8%.

Cal’s financial planner tells him that his investments – in his 401(k) and his wife’s 403(b) – should earn a 7% annual average return, if averaged over the long term. Since that rate of return is in tax-deferred accounts, we won’t deduct income taxes from the 7% return.

So, comparing where to put that “extra” money is quite simple, right? 7% is more than 2.8%, so that’s where the dollars should go. Carrying a low-interest mortgage and investing extra dollars into your retirement is a wise decision since your investments will have a better return than what the debt is costing you. In other words, Cal will be better off investing at 7% than avoiding a cost of 2.8%.

2. Rick has a good income because he went to a good university and graduate school but he has student loan debt. Should he put his “extra” money into paying down his student loans or into his retirement accounts? First, we would tell Rick to, at the very least, put enough into his retirement accounts to receive the match from his employer. Don’t give away the free money. After that, the calculation is the same as above. This time let’s assume the student loan interest rate is 6.5%. Let’s also assume that Rick’s financial planner tells him he can expect to earn an average of 7% over the long term from his investments. As a high-earner, Rick is in the 35% tax bracket. As most student loan debt is not tax-deductible, we won’t lower the interest rate for comparison. And, as above, Rick’s investments are in his work 403(b), we won’t lower the return number either.

So, should Rick pay down his loans or sock more into retirement? Although the student loan interest rate is lower than the rate of return from his investments, it is close enough that he should put that “extra” money into paying down his student loan debt. (We would recommend he explore refinancing his student loans to get a lower rate but that’s for another discussion)

Student loan debt is a deterrent to saving enough for retirement for many young people and all options should be explored in order to put your money to work for your future self as soon as possible.

Like many things, debt is okay in moderation and under the right conditions, if it helps us purchase things that will help us. Debt for a home with a competitive interest rate at a payment that allows you to pay your expenses and save for retirement – probably good. Six-month old credit card debt for Chinese food you can’t even remember eating – probably bad. As always, having a plan to retire debt and reach your goal of financial freedom will help get you to both faster.

If you want to examine your own personal situation, use the online calculator here: https://www.calcxml.com/calculators/pay-off-debt-or-invest.