When signing up for a retirement plan at work and faced with a 1% expense ratio (ER) versus a 0.1% ER, many people think who cares? A difference of 0.9%, big deal. For every $1, I only give up 0.9% or 0.9 pennies. No reason to sweat the difference. But if your retirement plan has 1% expense you won’t just lose 1% of the total amount of your portfolio to expenses, you’ll lose 1% per year. That’s the key, your losses COMPOUND, and humans aren’t good at comprehending the effects of compounding.
How close is your current lifestyle to your idealized lifestyle?
Exhibit A: Current
Wake up at 7am to an alarm, shower, eat a quick breakfast and jump in the car. Fight traffic for 45 minutes. Arrive at work, slog it out for 9 hours in the cubicle. Buy a cheeseburger at the cafeteria for lunch. Attend 1 mind-numbing meeting and 1 meeting that skyrockets your blood pressure. Fight traffic 45 minutes and get home at 6pm. Cook dinner and clean the kitchen. Melt into the couch, watch some TV. Surf the internet. Get on the playstation till midnight. Repeat. Continue reading “Lifestyle design on the path to FI”
In the Get FI article I outline the reasons to get FI, and 5 major steps to get there. Here are some steps to get you started.
Evaluate recurring expenses and cut them mercilessly
Do you know all your recurring monthly expenses? Are they all necessary? If not, do they provide enough value to justify their cost? By thinking carefully about just 4 items; cable TV, cell phone, books and coffee I showed how to reduce expenses by $222 per month. What expenses can you reduce or eliminate? Do you need to buy the latest video games or can you play older titles that cost 1/3 as much? Are you using your gym membership? Everyone is different here. If you have a golf membership and use it twice a week that may provide good value, but if you have a gym membership and use it twice a month…. Be ruthless and think outside the box. If your hair style is a number 3 buzz cut, can your spouse cut your hair? How much would that save per month, year, and ten years? Keep going until you have gotten to a balance where you feel confident each monthly expense provides enough value compared to the freedom it would give you once you are FI if you cut it.
In the Get FI article I list minimizing taxes as a means to speed up the time to financial independence. One mechanism to minimize taxes is to harvest free long term capital gains. In 2016 if you were in the 15% tax bracket you could harvest long term capital gains and pay zero in taxes. How cool is that? For a married couple filing jointly in 2016 the 15% bracket was $75,300. Note that if you are reducing your income by contributing to a 403b, a 457, an HSA and traditional IRAs, a married couple may be able to get to the 15% tax bracket even with a six figure income.
How does harvesting gains work?
Let’s say you had bought Vanguard Total Stock Market (VTSAX) for $20,000 in 2014. In 2016 if it was hypothetically worth $30,000 you would have a basis of $20,000 and $10,000 in unrealized long term (> 1 year) capital gains. If you don’t ‘harvest’ then at some point you may have to pay taxes on your gains. By harvesting the gains you can reset your basis higher, thus potentially lowering future taxes. If after selling the fund and harvesting the $10,000 (which counts towards your income) you are still in the 15% tax bracket, you get a ‘step up in basis’ for free.
The Bogleheads are a group whose name honors Jack Bogle. Mr. Bogle has been a champion of the individual investor and a pioneer of index mutual funds. The Bogleheads maintain an investing wiki and a forum for investing advice and discussion.
The Bogleheads wiki
The wiki is a great place to educate yourself if you want to get FI. Where to start? The getting started page. As you start to learn the basics you will eventually come across the “Three Fund Portfolio”:
Investing with the Three Fund Portfolio
You pick three index funds; a total US stock market index fund, a total US bond index fund and a total international stock market index fund. If you are using Vanguard funds the three funds are:
Vanguard Total Stock Market Index Fund (VTSMX)
Vanguard Total International Stock Index Fund (VGTSX)
Vanguard Total Bond Market Fund (VBMFX)
You then pick an asset allocation which is individualized. For example you could decide you want to have your age in the bond fund VBMFX. Then 100 – (your age) will be in the stock funds VTSMX and VGTSX. Next you decide what percentage will be US (VTSMX) and what percentage will be international (VGTSX). There is some disagreement among experts here. My approach is to have 20% in international. So what would this look like for a 30 year old?Continue reading “Bogleheads and the Three Fund Portfolio”