Ask the grumpies: Next stage financial advice

Good saver asks:

My husband and I have done a recent financial checkup and in the process realized it’s time to do more interesting things with our money than build up savings in a savings account. The question is what.

We are both gainfully employed and spend an obscene amount on childcare for our toddler. We hope there might be a second little one running around wrecking havoc in the next year…. (Well maybe not running yet… but you know…). My husband is in his early 40’s. I’m in my mid 30’s. We both have highly stable jobs.

We own a house in a good neighborhood. The loan was taken out at a good interest rate (4.5%) with a good solid downpayment (25%). It’s a 30 year mortgage and we plan to be here for the next 5-15 years. We have 6 mos emergency fund.  We contribute to our employer’s 403(b) programs and take the match. With this combo we contribute about 15% of our salaries to retirement automatically. We can’t drop below that contribution rate and redistribute the money elsewhere.  This acct currently totals around $160,000. We also have been contributing to my husband’s Roth for the last 4 years at the max allowable contribution.  We’ve been aggressively saving and have had a couple relatives die and now have significant cash sitting around ($120,000).

Now that we’ve met the obvious goals, we’re not sure what to do next — How do we find people to help us think about this in a smart way? Who (broker, financial planner, bank trust dept.?) do we interview? And what are the right questions to be asking at the interviews?Do we pay off the house first and foremost (a friend strongly advocates this)? Others argue that between the mortgage deduction and the low interest rate it’s not the best way to spend our next dollar.  Do we put more into retirement savings specifically for the tax break or do we just invest and not set the money aside so particularly?  Do we try to rebalance the retirement portfolios into different investment devices (and if so, how much into what devices?) Do we seek to do different things with the different pots of money we have? College savings or retirement?

I can’t tell whether or not 160K is enough saved for retirement at your ages.  Play with online retirement calculators to see if you’ve saved “enough” or need to up that savings amount.  15% a year is the recommended amount, but it also assumes that you’ve been saving 15% a year the entire time.  If you did graduate school of any kind, or didn’t max out, or started making much less money than you are now, or had really lousy investment timing, you might be behind.  That would be the first thing to check, because it’s an easy answer.  If you don’t have enough saved for retirement, put more in your tax-advantaged savings vehicles.  You don’t need a financial planner to help you with that, just some internet calculators.  (Though, of course, you shouldn’t just take advice from strangers on the internet– our standard disclaimer applies.)

4.5% isn’t low enough to make it obvious that you shouldn’t pre-pay the mortgage, but it’s not high enough to make it obvious that you should.  So there’s no clear answer there either.  One thing to note is that, unlike most other forms of debt, a dollar spent early in your mortgage is worth more than one later.  You can play around with the GRS mortgage amortization spreadsheet to see how much different principal payments save you– that will put a dollar value on the benefit of mortgage pre-payment.  Remember also that you can unlock some of that prepayment in the case of an emergency by re-amortizing your mortgage and lowering your required monthly payment.  You can do this even in situations in which the stock market has crashed (so selling stocks is a bad idea) or the housing market has crashed (so refinancing or selling the house is out of the question).

We’ve never actually dealt with financial planners.  #2’s significant other recently had a windfall and will be getting a recommendation for a financial planner from a trusted wealthy friend.  Most of us don’t have trusted wealthy friends, however.  I point people to Walter Updgrave’s advice whenever I’m asked this question.   However, I add my own caution.  Many financial planners are terrible people who just want to separate you from your money by recommending high cost mutual funds and other terrible investment vehicles.  DO NOT stop by your local Edward Jones office to get advice.  You really do want a fee-only certified financial planner who does not get any kick-backs from recommending you high-cost funds.  Personally, I’d rather figure things out myself, possibly with the help of the Bogleheads forum (or their book), but I also have a PhD in economics and like dealing with money.

In general, we can’t tell you which saving/investment things to do first or in what order.  That is going to depend a lot on your own goals and your own situation.  How much of your children’s education do you plan on funding?  How much financial aid are you thinking you’re going to get?  How much do you like your jobs?  Do you want to retire earlier or later?  Do you want an upper-middle-class retirement or do you want to live a simpler life?  Will you have a short-term need for funds outside of your emergency fund (ex. IVF, new cars, private school, sabbatical etc.)?  Do you want to leave your own (monetary) legacy?

I can tell you what we’re doing.  We’re prepaying the mortgage, but not just prepaying the mortgage (and we stopped doing this so much when DH was unemployed).  We’re maxing out our tax-advantaged savings (we dropped this down to the required 12% when DH was unemployed), but I’m not sure we’re going to put money in the IRAs this year.  We’re hoping that we’ll be in the income bracket that keeps us paying full-tuition at private colleges or universities for our kids, and we’re planning on covering the entire bill, so we’re putting $500/month away for each kid in their respective 529 plans.  As I’ll talk about next month, we still have trouble figuring out what to do with extra money… it’s a nice problem to have, but not one with an obvious answer.

In terms of where to put your retirement savings– if you have access to Vanguard, then you have one stop shopping with their Target-Date funds.  Pick a date, set, and forget.  If you don’t have access to Vanguard, then the Boglehead forums are a good place to look for asset balance heuristics for your particular situation.  You should be looking for a combination of low fees and the right diversification of risk for your planned retirement date and risk tolerance.

Don’t worry so much about the “best place” for the next dollar.  The best place in hindsight is not going to necessarily be the place you think it is because none of us can predict the future.  The best you can do is to make a lot of good choices.  For us those good choices are never going to be best or worst because we’re doing a number of different things with our money.  That’s the essence of diversification.  We’re not going to win as big on the stock market as we could because we are pre-paying the mortgage.  But we’re also not going to lose as much as we could for precisely the same reason.  Are we getting the percentages “right”?  Well, there’s really no wrong answers.  We have enough places to tap short-term that we’ll be ok in a number of scenarios, but we’re also taking advantage of many of the tax-advantages to saving for retirement.

The bottom line though, is that an extra 120K in cash on top of your 6 month emergency fund is way too much.  Put that somewhere soon!  Each month you delay making a decision, you’re potentially losing more money than you would if you just randomly chose any one of your good suggestions for potential vehicles*.  If it were me, I’d max out the retirement for this year (there’s still time to fund your 2013 Roth!), put some in a 529, maybe put some in taxable (Vanguard Index fund) stocks (because it sounds like you don’t have any, and taxable stocks are a nice secondary emergency fund), then put the remainder into the mortgage. If you don’t need a secondary emergency fund, then skip the taxable stocks in favor of the other options. Remember that the Roth can function as a secondary emergency fund just like taxable stocks can because you can withdraw the principal.  That gives it a slight advantage over just taxable funds.  But anything you choose from that list you gave is going to be better than sitting in savings.

*exception:  120K is probably too much to put into one kid’s 529 plan, depending on where you think they’ll go and if they’ll be eligible for financial aid.

Grumpy Readers, What advice do you have for Good Saver?

30 Responses to “Ask the grumpies: Next stage financial advice”

  1. First Gen American Says:

    Having gone through a stock market dip at your age I’d ask yourself the following questions: if my savings got cut in 1/2 because of a stock market dip akin to 2008/9, would I be kicking myself for not putting the money elsewhere. That would help you gauge your risk tolerance. I did and that led me to more mortgage prepayment because cd rates were so low. I did use a financial planner during this time as it was a very busy time in my life and he underperformed the market and took his commission on top of it all. If you don’t have time to actively manage your portfolio, then you can just put it in an age based fund or some portion in a total stock market fund.

    Then I would ask myself a bunch of worst case scenario questions…what if my spouse died or became disabled. Do I have enough insurance. What if we lost our jobs. What if we had to move? What if my parents need care? What If my children need soemthing special either because they are a prodigy or get a disability. How would those things change your outlook? My coworker and friend is 43 and dying of a really bad cancer right now….what if that happens to me or you? It’s like the old saying, plan for the worst, hope for the best because the last thing you want to do when there is a major sh!tstorm in your life is to be worrying about money.

    • nicoleandmaggie Says:

      That’s all really great advice.

      Personally, I just rode out what I already had in taxable stocks during the big dip and didn’t particularly kick myself. But we also didn’t need to tap that secondary emergency fund. It might have been different if we didn’t both have secure jobs at that time. I did start prepaying the mortgage more during that time period rather than funneling extra money into taxable stocks, but I was also putting more money into tax-deferred stocks too. (And I converted a bunch of traditional IRAs into Roth IRAs and didn’t need to pay taxes on the earnings because earnings were negative! They’ve since recovered.)

  2. Leah Says:

    I’d max out the other Roth for sure, since they’re both employed. You can max out the 2013 Roth and both the 2014 Roths right away.

    I’d also put a big chunk toward the mortgage, but I am both risk and debt averse. I like to have my simple bases covered first.

  3. becca Says:

    Why would 120k be too much for one kid’s 529 plan? Playing around with a college cost calculator, I got a value of 193k (lump sum contribution, 16 years to grow, 5% increase/year college costs, 6% returns, using the cost of Harvard because what parent wants to say no to Harvard? [kidding, somewhat, but I thought it as good an example as any for what parents would not want to exclude based on price])

    • nicoleandmaggie Says:

      Because those are all assumptions (are you just compounding on 1% difference?), and you’re assuming the kid doesn’t qualify for financial aid or merit scholarships (and, of course, the kid doesn’t prefer a cheaper school and gets in to expensive schools). If you saved more than college costs you don’t have to pay a penalty for the 529, but you also lose out on the tax advantage from the gains. Better to put that money into retirement accounts if you haven’t maxed out your tax-deferred options so you can keep the tax advantage. You would then be able to direct less money to retirement once the kid hit college if you wanted to pay directly if you needed to pay more than you had saved.

      Essentially, it’s assuming less risk. If they’d already maxed their tax advantaged retirement accounts and they’d already paid their mortgage, and they had a secondary emergency fund, and they were willing to pay full-freight for an expensive school and they had to pay full-freight for it, sure, the 529 is probably better than just taxable stocks because there’s always that chance. But given their other options, the 529 is not the first place they should put 120K. A portion of 120K, definitely, but not all of it.

      • becca Says:

        Ah! Ok. You’re not saying 120k is too much for a 529 in terms of what they could expect college to cost, but that there are other good ways to save available, and it makes sense to save for less than the full costs given the risk some of it won’t get used (well, used for college in a fashion that keeps the tax advantage relevant, anyway).

      • nicoleandmaggie Says:

        Yeah, given their current options, putting it all in a 529 is not one I would recommend. The other options are better, but among those other options, there’s probably no bad choices. Just pick one or a mix of them.

    • Happy Says:

      We had this same concern but, you can put in in a 529 plan that is not a UTMA but is instead held by you with a child as the beneficiary. You always control the money and can change the beneficiary at any time. So, if you have more than one kid, you can use the money for the second one if the first doesn’t spend it all. You can also hand down the account without penalty to another family member, niece, nephew, you, or even your grandchildren. We’re putting enough away for 3 years of the Harvard scenario figuring that a financial legacy that matches with our values (tied to education) is not a bad outcome in the event our kid goes instate. Just another point of view.

      Oh, and you might want to ask your colleagues for recommendations for a financial planner. We found ours that way -he specializes in 2-career couples and advises on our TIAA-CREF accounts (that he sees no return on personally), life insurance, the 529, as well as investments (he recommended Vanguard timed accounts for our first 100k in savings and some others for the medium term) and insurance, all on a fee basis. It’s much cheaper than I thought it would be and his advice is global rather than just our investments which seems to be exactly what you’re asking about. He’s also given us a lot of options for doing our own research as we needed it as opposed to just saying “trust me”. We’d interviewed several people when we had a windfall to deal with without finding them to be particularly knowledgeable but as soon as I talked with the guy we picked, I knew he was the right choice based on the questions he asked us (many the ones in the post above and then some) about our goals and situation. Good luck!

  4. bogart Says:

    I’m pretty sure I’d max the retirement accounts (unless the 401K options are “bad” ones, i.e. not suitable funds or high-cost funds/accounts). If any of the 401Ks are with former employers, I’d look at rolling into an IRA and then converting to a Roth, while still young enough to benefit from taking the tax hit of the conversion now and enjoying the years of tax-free growth and income, later. But I think that (the rollover) only works for 401Ks with former, not current, employers. Other than that, I’ve got nothing to add besides what’s already been said, though certainly @First Gen American’s advice on checking on insurance and its adequacy is excellent.

  5. Holly@ClubThrifty Says:

    I agree wholeheartedly about staying away from financial planners that are paid based on how much you invest. My husband had a career crisis last year and did a short stint as a financial advisor for a company. They basically train people to sell investments that pay the highest commissions and try to spin things so that it seems like the right thing to do for everyone. My husband is someone who doesn’t easily drink the Kool-Aid so he got out of there quick. Anyway, like the author said, I would stay away from any financial advisor that isn’t paid for their time and not for what you buy.

  6. chacha1 Says:

    My personal choice would be, given the very good financial position the LW is in, to fully fund a Roth, then to open a 529 (are there annual contribution limits? I don’t even know, not having kids), and to put the remainder of that 120K against the house. There is no situation, in my view, in which it is better to pay interest than to earn equity. The mortgage-interest deduction is negligible and I wouldn’t even consider it.

    • First Gen American Says:

      The reader didn’t state the amount of their mortgage debt in dollars. I think my answer might vary on the prepayment depending on on whether they owed $100k or $700k. To me its a no brainier if the $120k gets you close to paying off your mortgage. I think that is less risky to me than plunking $100k down when your cash flow won’t change for years or decades to come. If you can pay the mortgage off in say a year, then I’d work on doing that to free up that extra $1-$2k/month of payments that would otherwise go to debt.

      • nicoleandmaggie Says:

        It’s actually more financially beneficial if the mortgage is 700K than if it’s 100K! Because that takes more time off the debt– those early payments are worth more.

        And, as noted before, you can always re-amortize if times get tough and turn those pre-payments back into cash-flow. Now, if the mortgage is large enough that 120K doesn’t make a big dent, then you won’t be getting much cash-flow back, and it’s still risky, but that’s unlikely to be the case in this situation.

        You can play with re-amortization numbers by using the GRS spreadsheet– remember to include your escrow as a separate fixed cost though (that’s something you’ll have to pay no matter what).

  7. SP Says:

    Some of your links aren’t working correctly.

    I’m personally a fan of prioritizing retirement savings over home prepayment, but as others pointed out, it is really a personal choice. Also, I don’t have a home, so my preference is totally theoretical at this point! :) I think 20% is a better standard in the PF world.

    I’ve been considering a fee-only planner to help me figure out our next steps: optimizing investments, how to think about a home (cost, investment, tax advantages, any advantages of points for tax reasons, any way to get an up-front tax break??), what assumptions are safe to make when estimating retirement needs, etc. I’ve done some DIY learning, but I’d really like to sit down with someone with, for example, your level of knowledge about things and avoid having to dig deeper into Boggleheads or something. I know enough to know if the advice seems reasonable and am easily convinced by math, but I don’t know all the tools, options, etc. Then again, my budget for this kind of service is probably only ~$500, because I’m cheap. :) That is probably no more than 4 hours, probably less. So I guess I’m stuck with smart bloggers and internet forms.

    I can’t quite wrap my head around this statement: “One thing to note is that, unlike most other forms of debt, a dollar spent early in your mortgage is worth more than one later.” Why is that only true for mortgages? I know that my student loans have amortization schedules, and I’d imagine with CC debt you would get more out of paying early as your payments would gradually be applied more towards principle. How are mortgages special? What am i missing here?

    • nicoleandmaggie Says:

      I’m not good at explaining it (without showing out the math which is a PITA on wordpress), but it has to do with the way that your payments are the same every month whether you pay down your mortgage early or not. With credit card debt, that’s not true. I’m not sure about subsidized student loans. (The unsubsidized ones DH had worked like credit cards, at least they did theoretically while they were in deferment and the interest was getting put into the principal, IIRC. I don’t know what would have happened after deferment ended.)

      If you get two calculators out– the GRS amortization spreadsheet and then another credit card debt calculator, you can put in the same amount of money and see how things are different with early prepayments.

      I didn’t get it either the first time someone told me this, but playing with the amortization calculator I was convinced.

      • Liz Says:

        My student loans (down to $18.5K w00t!) allow me to pay extra without affecting the automatic monthly payment. (I save some % APR by letting them take directly from my bank account, but I then send them more money on my own.) I’m guessing this is similar to the mortgage situation?

        I have a mix of subsidized and unsubsidized loans, and this extra-payment applies to both kinds.

      • nicoleandmaggie Says:

        Yeah, that sounds like the mortgage situation.

        I don’t really know much about student loans!

      • Leah Says:

        My husband was able to pay extra on his student loans and apply the extra to principle, thus reducing his interest amount. You have to be really careful to make sure the bank is applying all the extra to principle and not just as “future payments” (which don’t reduce the amount of interest you pay). Sometimes, he was lazy and didn’t call to make sure they applied, but he paid his loans off so fast that I think this cost us a negligible amount.

      • nicoleandmaggie Says:

        Oh, yes, that’s something to be really careful about. They do that with mortgages sometimes too.

      • OMDG Says:

        Out of curiosity, how can you tell if the bank is doing that (applying your pre-payment to “future payments” rather than interest)? We prepay each month, and it tells us on our statement that it went to principle, but is that definitely the case? Just want to make sure we’re not getting screwed.

      • nicoleandmaggie Says:

        Is 100% of the extra payment going to principal, or just a portion? You can also call and ask.

    • nicoleandmaggie Says:

      I fixed the amortization spreadsheet link. That’s the only one I found that wasn’t working though. Was there another?

      • SP Says:

        Hmm, guess not. I thought there were 2 I clicked, but all is good!

        Thanks for explaining – I’ll have to play around with the sheet, because it doesn’t make intuitive sense. As others mentioned, student loans are similar. CC’s re-amortize each month? Couldn’t you just keep paying the same amount anyway? (you don’t have to answer, I’ll see if I can figure it out with the calculators!)

  8. plantingourpennies Says:

    Good problems to have!

    We probably wouldn’t pay off the mortgage, but would it still be possible for you to refinance into a shorter term/lower rate? (Looks like current 15 year rates are around 3.35%.) You don’t mention how much equity you have in the house currently, but since you have cash on hand it might be a good time to look into it in case you need to bring cash to the table in order to refi.

    As others have said, I think it’s hard to go wrong with maxing out retirement accounts – with the exception being if your options within your 403(b) are particularly high cost or unsuitable for you. An easy $22K could go into two Vanguard Roth IRA accounts (one for you, one for your spouse), covering your contributions for 2013 and 2014.

    For the remaining funds, it’s hard to trust advice from the internet when we don’t know you or your complete financial picture, so finding a trusted advisor is probably not a bad idea. Here are a few places that have worked for us in finding one.

    1 – Wealthy Friend in your area. This can also take the form of a supervisor, mentor, or CFO of your company. Depending on the connection, you may end up with “top shelf” advice for a much lower price – this is the case with the partner at a very good accounting firm that has taken us on for much less than his typical rate as a favor to a very wealthy client who we know.

    2 – Your employer. I believe 403(b)s are like 401Ks in that your employer has a fiduciary duty to you, especially if they are requiring you to contribute. How are they fulfilling it? Ask HR! Is there a benefit plan that enables you to speak with a financial advisor? (A caveat wrt to TIAA-CREFF “provided” advisors – my MIL had awful luck with one of these who wanted to put her in a fund with a 5.75% front load fee. Don’t assume they are fee only if your employer refers you to them. The employer should foot the bill on it as well for it to actually count as a benefit.) Some are just over the phone, but my company also hires a fee only planner to come into our offices quarterly for anyone who wants to go over financial planning issues.

    3 – Check the National Association of Personal Financial Planners – . This is supposed to be restricted to fee only planners. Then call around and see who will sit down with you for an informational interview. It sounds like your needs are pretty common now (house, kids, retirement), that you don’t need fancy stuff like estate planning, or trusts. So I’d concentrate mostly on finding one that you feel comfortable with. The planner is not a mind reader, so you’ll have to be comfortable asking every random question and not feeling like you’ll be scolded for doing so.

    Lastly, don’t balk if someone’s hourly rate is $200 and they say it’ll take 5 hours. Yes, it’s $1000. But a good one will probably provide a plan you feel comfortable maintaining on your own for 5-10 years (until the kids get older or you sell the house).

    But if you went with someone who took a 1%-2% fee every year (2% is more common) for your $100K. You’d have paid them at least $5K-$10K over that same time period. At least.

    Good luck!

  9. Daisy @ Prairie Eco Thrifter Says:

    We’re taking an approach that is much like yours. We’re pre-paying our mortgage (at a lower rate than we would like to be, but it will increase in 2015), but also putting money toward our retirement accounts and tax free savings accounts. You don’t want to miss out on the extra time for your money to be growing in retirement accounts, but you also don’t want to be paying the full amount of interest on your mortgage.

  10. Hypatia Cade Says:

    So this has all been very interesting reading! I’m curious about the fees on the vanguard lifetime funds…they seem high to me (.18) given that I’ve got advice that .09 is too high. What’s the logic for fees vs returns?

    • nicoleandmaggie Says:

      .18 is still pretty low, and it should include re-balancing costs and bond funds. Bond funds will be driving that up with costs in the .20s. Vanguard is pretty good at averaging costs of the indexes in their target-date funds and don’t charge that much for the privilege.

      For numbers like .09 you’re talking mainly about very simple large-cap and small-cap indexes that don’t have the range of diversification that a target date fund will. When you’re just starting out and are ok with having 100% of your long-term money in stocks, and you don’t mind rebalancing yourself etc. then it makes sense to do indexes. If you really don’t mind rebalancing yourself, then you can keep mimicking the target-date fund by buying the indexes that make it and rebalancing. But with vanguard it doesn’t cost that much to let them do it for you. In terms of logic, you would just calculate the % difference in the target-date vs. the indexes and multiply that by how much money you’re investing. Then ask yourself if it’s worth that amount to do it yourself or if you’d rather just pay them to keep track.

      In terms of fees vs. returns– you don’t get to choose returns, and the more expensive funds are the ones that either give you less risk (but lower returns), like bonds, or they give you more diversity (like international exposure, emerging markets, etc.). When you’re just starting out you can ignore all that and just buy S&P 500 or Nasdaq or Vanguard’s total market index because you probably don’t really have enough money to need that kind of diversification.

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