A big change in FIRE plan

In one of our first posts, The Who and the What, we had alluded to our plan (hope?) of being FIRE by 2023. The time has now come to throw some light on activities behind the scenes that will radically change the 2023 timeline.

First, why 2023? With the accelerated pay-down of our mortgage, we would outright own our home in 4 more years. Assets would have grown as well and it would be the perfect time to bow out of full-time jobs.

What’s changing? Well, we are going to super charge one of our RE (not quite the FI) date and slow burn the other’s FIRE date.

M is going to stop working full-time by beginning of 2020. (possibly earlier)

W is going to work full-time, foresee-ably, till 2030.

Why is the timeline changing so drastically and differently for both of us?

Long-ish story …

M started a job last year that increased the paycheck by about 50%. But with that added money comes the multiplied baggage of corporate America – longer hours, more responsibility, travel. Ah, travel. M has been traveling every week since the beginning of the year! People within this industry are are expected to, and do, travel a lot. Before taking the job we were aware about the travel aspect but did not quite understand the rigors it would put on the entire family. The burden it puts on one parent to take care of everything in the home.

Especially, not being home for our child, D. One thing that became painfully apparent was how much M was missing D, and vice-versa. So Travel, bye Felicia!

Another factor is the culture of the industry M works in. People are very, VERY driven. Most will not think twice before putting in an 80-hour work week. The unwritten “expectation” is 60 hours, which M was aware of and have no problem in following. The more M interacted with senior leadership the more M questioned whether M want to be like them in 5 years or so. So completely invested – heart and soul – into the company and what it stood for and the work. It is not in M’s nature to be that invested in work.

Maybe switching to a job that did not involve travel, or moving to a different industry, could be the cure?

This led to a greater introspection of what M wants from a job or life in general.

What M realized is that spending time with family is the #1 thing right now. Especially since D is growing up so fast that missing days away from family is akin to missing a new facet of personality developing. Even a job that doesn’t require travel would require going in to work from 9 to 5. During the summer. On a gorgeous day.

Go out and play. Hit a ball. Catch a fish. Kick a ball. Ride a bike. Throw a ball. Build a castle in the sand. Ride kayak. Get a couple of bruises to reminisce about.

When being at daycare is grandly trumped by the above actions!

FIRE, technically, should give us the time to spend together as family. There is a meme doing the rounds of social media. It says,

We get 18 delicious summers with our children. This is one of your 18. If that’s not perspective, I don’t know what it is.

As parents we get 18 years to really interact with our progeny to mold them into functioning human beings. I would argue that it is actually less than 18 years when you subtract the 0-4 years in front, and possibly the 4 years of high school. 10 full years. If we can’t give our kids the highest priority for these formative years, which is on average one-eighth of our life span, what does that tell about us?

Another thing that came out of the conversations was how W did not see the RE aspect of FIRE the same way M does. W really likes the work, the workplace, the people interaction. Even if we stayed on our current plan, and were to be on the verge of FIRE in 2023, W is not sure if quitting the full-time job would be the calling. W’s health insurance continuing through work is another added bonus, which in turn keeps our out of pocket costs down.

This double realization – where M does not want to continue full-time work and W does want to continue full-time work – made us stop and rethink our FIRE path forward. Could we be at a point where if we did not put in a single dollar towards investments, we still could end up being FIRE in 11 years?

And running the numbers, the answer is a resounding yes!

From our end of June post, we have $604k in retirement accounts. If we stopped funding all of our retirement accounts right now, at the end of 11 years, that sum would have grown to $1.16M, at 6% compound interest. Which is quite a conservative estimate.

It is a very realistic scenario that we might be truly FIRE by year 9 or 10.

Adam, over at Brewing FIRE, had this very lucid and dear to heart post about “Coast FIRE”. He explains the “stopping point” where “we will stop pedaling and let our momentum carry us to financial independence“. Encourage everyone to go over there and read his piece in entirety. He ran some good numbers as well.

We think we are at this coast point now. We can cut back on work, we can remain thrifty (maybe a bit more so), and can start to appreciate the mundane aspects of life.

Wait, what will M actually do after leaving full-time job? Being more involved in taking care of the family is where most of the freed up time will now be spent. Things like cooking dinner most days of the week. Mowing the yard and cleaning the house, and not outsourcing those chores. Less or no before and after school care for D. Even self-care activities as going to the gym regularly, playing on recreational adult sport teams.

M is certain to do some sort of part-time work as well in RE. M really wants to pursue some hands-on endeavor where the fruits of labor are tangible. Coaching athletics/sports, substitute teaching, tutoring school aged kids. Getting a commercial driving license and doing some seasonal work. Maybe get a CFP certification and become a financial planner to help families who aren’t as savvy. Maybe getting involved in local and grass-root activism. There are plenty of options around.

Netting around $1K a month shouldn’t be a huge deal with a few days worth of few-hours-a-day work.

M has worked all 15-years of professional life sitting in front of a computer. That is about to change and the excitement is palpable 🙂

Mortgage – To get the longest term or not

The basic premise of this post is this:

You should get the longest term mortgage that you can get. Say, 30 years.

You should try to pay it off much faster. Say, 10 to 12 years.

Note: If on the 30-year mortgage you were to pay every month as if you were paying a 15-year mortgage, you WILL NOT be able to pay off your 30-year mortgage in 15-years.

It will take you a few more payments, depending on the rates of each mortgage. That is the premium you would be paying for having a greater rate of interest, but lower monthly payments.

But, let’s suppose, you were to pay your 30-year mortgage as if it were a 10-year mortgage, you WILL pay it faster than if you took out a 15-year mortgage and paid the standard calculated mortgage payment every month.

As an example, let’s work with the following numbers. Here is the link to the Google sheet that lays out the numbers …in all their gory details 😀

(Rates are from about 5 months ago)

Principal mortgage amount: $300,000

Rate on a 30-year mortgage: 4.5%

Rate on a 15-year mortgage: 3.875%

If you were to take out the 30-year mortgage, and if you were to make the full 360 payments, you will end up paying $247,220 in interest on your $300k loan.

But we don’t want to do that. This is the control option. We want to know what the interest number is but we will not be following this option.

If you were to take out the 15-year mortgage, and if you were to make the full 180 payments, you will end up paying $96,057 in interest on your $300k loan.

Now …the scenario we want to focus on.

In this scenario, you are paying your 30-year mortgage as if you were paying down your 15-year mortgage – i.e. you are rounding off your monthly payment to what would amount to if you were paying a 15-year mortgage, an extra $680.26 that goes directly in reducing your outstanding principal every month. In this case, you end up paying $120,893 in interest, and you pay this over 192 payment.

More than a 50% decrease from $247K to $120K. Voila! But still more than what you would pay for a 15-year ….

Why 192 payments? Because it won’t be 180 payments as less is going towards paying down the principal than if you actually had a 15-year mortgage. This amounts to paying around $96 more in per month for what I call the “premium for safety” that you pay for not taking out a 15-year mortgage.

Whew. Still with me? We have one more scenario to cover.

Now …we come to the scenario that I really want to focus on.

Look into the second sheet/tab in the worksheet.

What if you were to pay down your 30-year mortgage as if you’re paying a 10-year loan (with the rates from the 15-year loan).

You would end up paying only $76,035 in interest and pay off your mortgage in 125 months (still more than 120 payments if you actually took out a 10-year mortgage, but close enough).

I’ll repeat the theme of this post here again: Get a 30-year mortgage. Then pay it down as if you were paying a 10- or 12-year mortgage.

You will pay far less in interest, $20K in our example. But you also have the option with a lower monthly payment if you cannot accelerate fast enough.

There you go. Download the worksheet and play around with your own numbers.

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There is one more scenario which in the third sheet, that tells you what is the optimal number of payments you should aim for if you want to come closest to paying the total interest if you had a 15-year mortgage. In this case it comes out to 148 payments.

The reasons Americans don’t save

Read this piece by JD Roth of GRS. Thought I would explore the topic in more detail here, rather than just leave a comment on his blog.

JD, and few of commentators on his post, talked a lot about the tactical barriers to saving. JD lays out the numbers that exemplify the sorry state of affairs and the potential solutions. Instead, in quite a role reversal, I have tried took at the malaise from a social and cultural viewpoint; the prevailing conditions that has molded us to become a nation of non-savers. I have made an attempt to answer the philosophical question on why we, Americans, don’t save more. The inherent barriers which we must understand; those that prevents us to save up.

Here are my, almost certainly controversial, reasoning.

Devoid of context, any person should be able to save as much as they want. But they don’t. Everyone knows that saving more is good but invariably they won’t. Saving is hard, or that is what we are told. Saving means sacrifice. Saving is delayed gratification.

More than anything else, saving is a mind game, where the players have made their decisions based on the following:

a) What they have seen their parents do. Knowledge transferred from a previous generation.

b) What they see their peers do. People whom we interact on a daily basis. Our immediate circle of family, friends, co-workers, neighbors.

c) What the general society considers the norm. The current culture as epitomized by television, music, sports, politics.

d) A need for them to break away from the previous 3 points. If everything in my universe tend to point that saving is not a high priority, there is no reason to prioritize it. 

Safety nets

I put the blame squarely on the various safety nets provided in American – or broadly, in first world – society. 

Insurance

Health insurance, life insurance, personal property and vehicular insurance. Insurance on phones, pet insurance, deposit insurance , even insurance on insurance! And anything else you can think so. Even declaring bankruptcy is a form of insurance – the last stand before I get wiped out clean. For generations Americans have been trained to think that insurance will bail them out of serious trouble if they were unfortunate enough to encounter some terrible event. 

Don’t get me wrong here. Obviously, health insurance, even if it is not universal, is a great thing! The point I’m trying to make here is, there are safety nets to hold you if things go south. Now compare it with a scenario in most developing countries. Insurance is a very flighty concept. It is every man, or family, for himself. There is nothing to protect the house you built if an earthquake occurs. If a family member falls ill, you go to the general hospital and get the treatment that’s available, paying all out of pocket. Your bank fails, you lose all your savings. Insurance provides us a sense of security, even entitlement. You can afford to not save, just pay the monthly premium.

Governmental safety nets

Another form of insurance, if you may. Social Security, Medicare, Medicaid. All subsidized form of guaranteed payments when you’re old or sick. 

Another reason not to worry about money for old age or while sick.

Pensions

Till about the 1980s most American workers were guaranteed a pension when they retired from active work – another form of safety net.  

Safety nets – The primary reason for Americans not to save for an unexpected rainy day.

Here’s the next big prevailing factor that intrinsically inhibit Americans to save …

Getting paid more frequently than once a month

I’m thankful that my first paychecks were monthly. I know, the horror! Monthly paychecks are standard in Europe and Asia. It’s the US where employees are paid on a more frequent basis.

Getting paid monthly instills a sense of budgeting that semi-monthly or fortnightly (it is NOT biweekly – biweekly means it’s twice in a week) or weekly paychecks fails to do. Getting paid on a more frequent basis not only fails to prepare employees to budget it actually propagates the mentality of living paycheck to paycheck.

After safety nets of insurance, getting paid more frequently than once a month is one of the primary reasons most Americans do not get to budget properly, and consequently save.

There are other, less pressing, reasons that shape the American mentality that saving is not a priority …

Relative geographic isolation and abundant natural resources of the US

This is a country that shares its borders with just two countries, one of which is another developed nation. From oil to natural gases; from fertile farmlands to verdant valleys; from cattle ranches to lobster farms. America is so fantastically blessed to have such abundant natural resources that “scarcity” is a foreign concept. Deep down no one fears that the gas at the pump is going to be so exorbitantly prohibitive that they actually have to save money to buy gas.

No war fought on home soil in over a century

Extending the previous concept about the geographic isolation of the US, we have been incredibly lucky that no war has been fought on American soil, except for Pearl Harbor. Even then, Hawaii at that point was a US Territory, and separated from the landmass of the 48 contiguous states. The international, political, and military ramifications was undoubtedly huge, but most Americans have not had to really live through a war in their backyard. Notwithstanding the physical trauma of wars, the mental scars of scarcity, fearing for one’s life, and general “staying alive” hasn’t been on the forefront of most Americans.

Contrast this with most developing nations where some kind of war has been waged in the past 50 years or so. Even the prosperous Western European nations such as Britain, France, and Germany had their beaches and cities turned into blood soaked demolition derbies.

Unprecedented economic prosperity

This runs off the previous two points. Since the Great Depression there has been no cataclysmic economic upheaval in the US. Three generations – Baby Boomers, Gen X-ers, Millennials – of adults haven’t had a need to save and scrimp. Sure there have been recessions, great ones too, but nothing to derail the economic juggernaut that is running for 80-90 years now. With this great run has come the access to easy credit, thereby loosening our resolve to save even more. ———————————————————————————————-

There you go. The safety nets provided by government, societal, and private insurance; semi-monthly or weekly paychecks; the isolation and resources of the country; with no wars on home soil; and a great economy where credit is dirt cheap, has lulled most of us into a sense of security without having to work hard for it. Saving has mostly been an afterthought.

Our parents, and possibly grandparents, never really had to save. Our friends and neighbors don’t save. Flashy, shiny, new toys are readily bought on credit, without a second thought on how to actually pay for them. Ours brains are wired to not save. There’s no justifiable reason to. Not saving has worked earlier, it is working now, and there is no reason to believe why it shouldn’t work in the future.

When presented with an alternate version of reality – FIRE  – most people are living, they tend to recoil from this supposed blasphemy. Given some time, exposure to the concept, and logical thinking, a few come around to embrace it. It’s just not human nature. Oh, make that, just not American nature.

What do you think? Any other intrinsic factors I’ve missed out?

Vanguard funds – Admiral shares, Investor shares, ETFs (and Institutional shares)

When we started to get serious about going down the path of FIRE about 6 years ago we realized pretty quickly that investing in Vanguard index funds was the way to go.

But invest in WHAT exactly?

Terms such as VTSAX, VBTLX, admiral shares, investor shares were thrown around and, to the uninitiated, this might be information overload when all we are looking for is a simple guideline on what is what.

This won’t be a crash course in what is a Mutual Fund or ETF (exchange traded funds). Neither this is going to be a debate over index funds v/s ETFs. Vanguard provides a detailed analysis in the differences and similarities between ETFs and mutual funds. 

To put it very simply, to the average personal (individual) investors – meaning regular Joe and Jill such as you and me – Vanguard offers 2 share classes (or variants) of passive, index funds and often times an ETF for the same underlying benchmark or sector that fund is tracking.

We’ll look at the different options to invest in the S&P 500 through Vanguard.

The lowest cost option is the Admiral shares. But their minimum investment is typically $10,000.
Vanguard 500 Index Fund Admiral Shares is the name of the fund. VFIAX is the ticker.
Fun fact: All mutual funds tickers end in an “X”.

Investor shares have a higher ER, at least twice of the Admiral shares, and their minimum investment is typically $3,000.
Vanguard 500 Index Fund Investor Shares is the Investor share fund for tracking the same S&P500 (you can reach it by clicking on the Investor share hyperlink given on the Admiral shares’ page on the Vanguard site highlighted in green in the above screenshot); VFINX is the ticker.

If you don’t have $3,000 lying around, Vanguard has an option for you.
The Vanguard S&P 500 ETF; ticker VOO.
The ER for this is 0.04%, same as the Admiral fund.
Notice that the ticker doesn’t end in an “X” as ETFs are akin to stocks.

Since the ETFs are essentially treated as stocks, there is a bid/ask spread and premium/discount.

Also, Investor shares can be easily converted to Admiral shares once you meet the minimum threshold. Vanguard takes care of that. As far as I know, to move ETFs over Admiral shares you’ll have to sell your ETF and buy Admiral shares. If you have a taxable account you will have tax implications when you sell your ETFs.

NOTE: I’m not a tax expert and you should consult a tax professional if you have questions. Materials presented here are for informational purpose only.

Vanguard also has funds to track the same underlying S&P 500 for its institutional investors.
ER are lower than Admiral shares and look at the minimum – $100M!! These are, as the name suggests, for institutional (pensions; insurance companies, hedge funds and such) investors.
Vanguard Institutional Index Fund Institutional Plus Shares; VIIIX

Now there you have it: Go forth and invest!

Fees and commissions matter (even that run into the 3rd decimal place)

The other day I met an affable Financial Planner who’s looking to go to the same grad school as I had been to. We were talking and at some point the topic of fees arose in our discussion. This FP wasn’t pushy or trying to oversell the value of planning for the future but was still a bit coy about really admitting how fees add up. And rightly so, because her livelihood depends on the fees! This is the operating model of any FP, they make money off the fees they charge to maintain your money. I have nothing against her but this got me thinking how fees add up, even little marginal ones such as 0.061%.

Let me illustrate this point by taking a look at my 401(k) investments and then compare it with the what-if scenario of putting the exact same amount in Vanguard index funds. I have to start off by acknowledging that I’m lucky to have a 401(k) plan that has low fees. Lower than a lot of other places. This article says that the average expense ratios for equity mutual funds in 401(k) plans is 0.48%.

 

Before I started to look around I didn’t really think the average would be so low. Nonetheless we’ll run with this. In the table below you’ll see the actual breakdown of my investments in my company’s 401(k) plan.

 

I have money in a bond fund, a targeted date fund, a large cap fund, a mid/small cap fund, an international fund, and in my company’s stock. All funds are Vanguard institutional funds and the operating expense ratios of all the funds are very low. Kudos to my employer!

Side note: We can debate the efficacy of using 5 different funds to hold the money, but let’s keep that for another day!

What skews the perfectly low ERs are the Administrative Expense of 0.08% that our 401(k) administrator, in this case Aon Hewitt, systematically charges across the board.

My weighted average ER comes out to 0.111%. Not bad at all for being 4 times lower than the average! But still higher if not for the dang administrative expenses.

Now let’s assume that I take this money out today and roll-over into an IRA, and invest in similar Vanguard funds.

I have made a couple of adjustments, while keeping the weights of the bond, large cap, and international funds the same.

  • Kept the same weight for the mid/small cap from the 401(k) and rolled into the VIMAX Midcap fund in the IRA.
  • Rolled the ESOP and target date fund from the 401(k) into VSMAX Small cap fund in the IRA

With these changes, my new weighted average ER comes down to 0.05%. Compared to the 401(k), that’s a difference of 0.061%.

Again: We can debate the detriments of not just using VBTLX and VTSAX, another day ….

This change would result in almost $7k in extra money over a period of 20 years, at 6% annualized return. Plug in your numbers here. I’ve deliberately left the future contribution cell blank to have apples to apples comparison.

Dear readers, would love to know how your 401(k) plan expenses compare.

The CFI …falacy?

Mr. Cubert at Abandoned Cubicle, who is a very talented, determined, and resourceful fellow (and a fellow Midwesterner!), has this strange article out there, extolling the virtues of Cash Flow Indexing. In a nutshell, CFI determines which loans to pay off first, freeing up, well, you guessed it: Cash Flows. It does not take into account the interest rates or the term of the loan. Mr. Cubert does a great job explaining why this works for him. I’d suggest you read his article first. This post, if not a refutation, is certainly an addendum to his!

One thing that is ignored in the CFI method is how not paying down your highest rate loans first, makes you pay MORE INTERST, in the long run and the short run. There’s no going around this fact. You are freeing up CFs at the expense of paying more in interest.

Here is a Google doc (which you can download and play around) I created, a pretty simple one at that, which shows the affect of paying more – extra towards the principal – on 2 hypothetical loans: a 15-year $150k mortgage at 4%, and a 5-year $20k car loan at 0.9%. To make for an easier comparison, we’ll assume both of these loans are taken out at the same

The CFI of the mortgage is 135, while the car loan is 59. According to CFI principle, the car loan is an “inefficient” loan and should be paid off early.

An extra payment of $1,333.79 every month will wipe off the car loan in one year, saving interest payments to the tune of $66.19. Whereas the same extra payment when applied to the mortgage would save interest payment of $296.72 over one year. The CFI method would certainly free up the monthly payments that was going towards the car in year. That is indisputable. What is also indisputable is that you are paying more by following CFI.

One thing that I still agree with Mr. Cubert is here: technically smarter move would be to put any extra income towards higher yielding investments, as opposed to paying off the mortgage. But this is a long-term cash flow play for us. At early retirement, we plan to avoid as many recurring monthly payments as possible. Which is cash flow smart.” We hope (and planning) to be mortgage free in the next 4 years.

I should stress another point here. I will take a 0% loan any day, even if I had the money to pay it in full and not take out the loan. Heck, we have checking accounts paying 1.55% now! With inflation, which is around the 2.5% mark now, any loan below that mark is essentially lending you money and paying you interest on that loan!!

In the first worksheet I’ve provided the year 1 numbers. The second worksheet has the whole life amortization schedule for the mortgage. You can plug in your own monthly extra payments to see how soon you can pay off your loan and how much interest you save.