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Hey everyone! Welcome back to another episode of Budget Friday. This is seriously my favorite part about personal finance, the chance to help others get on a budget, get out of debt and reach their financial goals. I love showing the power of a well-thought out budget plan, and the long term results they can have. I know it’s been a while, and I’m glad to be back today with an awesome reader’s budget.
Today’s budget is an anonymous submission. We’ll call her Stella.
Background: Stella is a medical doctor who has been in the workforce for just over 2 years. She has already amassed a sweet savings fund, and is maxing out her 401k match at work. The only problem is that her savings are almost ALL in a money market fund earning like 0.15% interest! I want to help her make the most of her money, and use her high income to build a sweet stash of cash and allow her to hit financial independence ASAP! Let’s check out some numbers:
Assets
- Home – $200,000
- Retirement Fund Savings (401k and Roth IRA) – $7,900
- Money Market Savings – $78,000
Debts (Balances)
- Mortgage – $160,000 at 3.65%
Goals
- “Pay off house. I’m not in a hurry, my interest rate is pretty good, right?”
- “I want to have a significant savings for my son, so he can use it for school, life, etc. I did not start a VestED as my husband strongly believes that we should have control of that money. He does not like the idea of all the restrictions that come with the VestEds (has to be used for school, minimum age my son can withdraw money, etc.)”
- “I want the option to retire early if I want to, perhaps at 57 or 60yo. I took one 4 hour course on finances as part of residency requirement (basically, this is where I first heard for 401(k)s, and mutual funds, stock market, IRAs, etc) and was told that I need $1-2 million to retire.”
Priorities
- Come up with plan for money market funds and monthly savings.
- Want an entertainment and date night budget, as well as a vacation budget (possibly to visit family in Vietnam).
Here is her budget:
| Old | New | Comments | |
| Starting Balance | $ – | $ – | |
| Total Income | $ 8,000.00 | $ 8,000.00 | |
| Total Expenses | $ 3,075.00 | $ 8,000.00 | |
| Projected Ending Balance | $ 4,925.00 | $ – | |
| Income | |||
| Monthly Income | $ 8,000.00 | $ 8,000.00 | Way to go! |
| Total Income | $ 8,000.00 | $ 8,000.00 | |
| Bills | |||
| Mortgage | $ 1,150.00 | $ 1,150.00 | |
| Electric/Gas | $ 160.00 | $ 160.00 | |
| Cell Phone | $ 70.00 | $ 70.00 | |
| Internet | $ 35.00 | $ 35.00 | |
| Car Insurance | $ 50.00 | I didn’t see car insurance in the original. | |
| Water/Sewer | $ 60.00 | $ 60.00 | |
| Garbage | $ 25.00 | I didn’t see garbage in the original. | |
| Extra Mortgage Principal | $ 4,500.00 | You can pay this house off RIDICULOUSLY FAST! You can hang on to the mortgage at that low rate, or kill it and be done FOREVER. Your choice. | |
| Total Bills | $ 1,475.00 | $ 6,050.00 | |
| Necessities | |||
| Food | $ 400.00 | $ 400.00 | |
| Gas | $ 200.00 | $ 200.00 | |
| Date | $ 100.00 | To meet one of your goals, have $100 available each month to date your husband! Requirement in any couples budget I put together! | |
| Spending Cash | $ 200.00 | I split out all discretionary spending. This cash is $100 for each of you to spend however you want without consulting each other. Enjoy it 🙂 | |
| Entertainment | $ 100.00 | Separate from date night, family entertainment (movies, fair, outings, etc.) Start here and see how $100 works. | |
| Restaurants | $ 150.00 | You had this lumped in with Misc. I split it out so you can see what you’re spending on eating out. Adjust as necessary. | |
| Retail Shopping | $ 100.00 | Same as above. | |
| Misc | $ 1,000.00 | $ 100.00 | $100 for other items that don’t fit into the above 5 categories. |
| Total Necessities | $ 1,600.00 | $ 1,350.00 | |
| Savings Buckets | |||
| Gifts | $ 100.00 | Gifts seems to always drain the budget when not planned for. Set aside $100 a month for birthdays, Christmas, or anytime gifts. | |
| Vacation | $ 500.00 | You stated wanting to taken occasional family vacations and possibly visit family in Vietnam occasionally. I’ve built in $6,000 a year for family travel. I suggest taking advantage of travel rewards credit cards to get sign up bonuses and earn miles/points for these vacations. Having flights and hotel paid for allows for much less stress on your family ventures. You can check out how we do this by reading HERE | |
| Total Other | $ – | $ 600.00 | |
| Total Expenses | $ 3,075.00 | $ 8,000.00 |
Ummmm….Amazing. That is all I have to say.
Debt Snowball
Here’s the deal. You have a mortgage with a VERY low rate, and can probably earn more money investing than paying off the mortgage. But here’s the other caveat. If you apply your extra cash to the principal each month, you can pay this mortgage off in 2 YEAR 8 MONTHS! Which is RIDICULOUSLY amazing!!!
So, I’m going to leave it up to a vote in the comments. Should she pay off the mortgage with the quickness, or let it linger around and invest ALL her savings starting now?
Stella, it’s obviously up to you and your comfort level with debt. I won’t tell you my vote until later in the comments, but either choice is still pretty awesome.
Goals
1. Pay off house
As you can see above, you have the ability to pay off your mortgage in less than 3 years. But as you said above, you’re not in a hurry because of an EXTREMELY low interest rate. I leave this up to you.
2. Savings for son/Early Retirement
This is where it gets fun. Your goals of saving for your son and early retirement are going to follow a similar path, as it involves making your money work for you in the stock market. So I am going to join them together, but explain how to hit both goals.
First, you can read the investing book that has shaped my current views on investing: Millionaire Teacher. It’s a very easy and engaging read, and can help show you the benefits of using index funds to help invest for your IRA and other investing accounts.
You have the power to build significant wealth in a relatively short amount of time, but you also don’t want money managers and financial planners sucking your returns dry with all their “fees”. So give that book a read and then reach out to a Vanguard professional to help you get started. (Disclaimer: I am not a investing professional of any sort or kind. I have read a bit about it, and am thoroughly convinced the average investor needs index funds. But consult a professional [preferably at Vanguard, because they’re a non-profit and don’t want to kill you with fees] before executing on any investment decision).
I suggest opening a Roth IRA with Vanguard first, as you are just under the income phase-out limit ($178,000 for married filing joint in 2013), and you want to take advantage of the tax break when possible. You can open one for both you and your husband, and contribute $11,000 per year, as long as your income is below the “phase out” amount. (Hint: Get a cool tax guy to help you figure this out). You have $78,000 in savings, so if you wanted to pay off the house, you could take $11,000 of that savings per year to invest in the Roth while talking the house with your monthly savings.
Next, I would take all but $24,000 (keep this cash in money market as your emergency fund) of your savings and put it into a taxable investment account (again, at a place like Vanguard), and look at investing in a comfortable mix of index funds. Consult with a professional on what mix you’re would be comfortable with, and make sure to state your goals and risk tolerance. I know the stock market can be a scary place, but historically it has done well, and your money will work hard for you when invested.
Once you decide to either pay off the house, or invest the funds, I would first max out your 401k contributions up to $17,500 per year. That give you’re the most pre-tax savings of any retirement account, and will lower your tax bill quite a bit. Once that is funded, take the rest and do the same as above. Get a good mix of funds and let them work!
Since the most you can contribute to retirement funds is $28,500 per year, and you have AT LEAST $4500 per month to invest (over $5,500 when mortgage is gone), you will have PLENTY of savings in your accessible investment accounts for your son’s college, savings, down payment on home, etc. If you invest that $25,000 for the next 16 years at 8%, you’re at over $1 Million dollars. I think he will be well funded 🙂
Now, if you take all the money invested at 8% over the next 15 years, you will have $1.8 Million, not including the tax savings! You stated in our emails that you wanted $1 – $2 million to retire. There it is! RETIRED ONLY 15 YEARS FROM NOW!
Final Thoughts
I know that was a lot of info, so let me do a quick recap:
- New budget. WOOHOO!
- Pay off house (or not).
- Invest in index funds.
- Retire in 15 years, net worth about $2 million.
Your financial outlook is positively AMAZING. And here’s the great part, you can retire if you want to, or keep working if you enjoy what you are doing. You will be financially independent of having to work a job ever again, and you can choose what to do with your time for the rest of your lives.
Now, the key to this is what you seem to have already mastered; Avoid lifestyle inflation. With your low expenses and modest spending, you can build wealth very quickly, allowing you to “retire” MUCH earlier than anticipated. Assuming you are under 40, you will be done before your goal of 57-60 years old. And I’ll let you in on a secret: YOU DON’T MEET $2 MILLION TO RETIRE!
Your current expenses are $3,500 per month, including the mortgage. When you are done here, your expenses may be closer to $3,000, because the mortgage is gone. So you only need $36,000 a year to live your current lifestyle. If you keep expenses that low, you could retire on $1 Million and never touch your assets using the 4% rule. And you could get there in just 10 years investing at an 8% return. But again, it’s all about your comfort level, and if you need more, just work a few more years.
And lastly, if you want to find some fun reading on someone who did something similar to the plan laid out above, read through Mr. Money Mustache’s blog archive, starting at the beginning. He worked with his spouse for 9 years, then retired, enjoying a simple, frugal lifestyle. You are well on your way to a similar financial place. Well done!
UPDATE: New poll added. Vote below!
Comments: So, what do you think? Is there anything you would have changed about my proposed budget? I’d love to get some reader feedback on what you would do. Stella is going to be BALLIN’ on this budget, financial independence her she comes!
Note: All calculations were made using the Dave Ramsey retirement calculators. Mortgage one is here. Investing one is here.
Disclaimer: The link to the book is an affiliate link, and I get a few pennies if you purchase it. Thank you so much for your support, I hope you enjoy the book as much as I did!
Jacob,
Nice job – as usual, but I don’t see any school loans in this budget. Did she get a fullride with a stipend?
She didn’t say, but just said no school loans, no car loans. She’s MILES ahead of her peers, and is going to retire early no matter what. 🙂
Her effective mortgage interest rate is likely even lower because of the deduction. I would absolutely MAX OUT the 401k before putting anything extra into the mortgage. The expected benefit of that strategy, with the extra tax deduction plus the returns, is much bigger than prepaying the mortgage. And I would also prioritize that above saving for her son’s education. There are plenty of ways they can handle that, especially with their cash flow, but they need to kick their own savings in gear first.
Agreed.
Is the mortgage fixed or variable rate? If fixed, over how many years?
Fixed, 30.
With the stability of the interest rate, I think she should be confident of earning a higher interest rate (in the long-term) on alternative investments.
Therefore, I would keep the mortgage and strive for returns higher than 3.65% (especially when considering tax benefits on mortgage payments).
I’m still on the fence. Knowing that the mortgage interest is much higher in the beginning of the loan would make me believe that she should pay it off. But the interest is SUPER LOW, and if they outgrow the place and leave it as a rental, they can keep the mortgage long term and make it worth it to invest instead.
I totally agree with you on the mortgage payoff plan. Having that out of the way means that if you have to move (or WANT to move) in 5 years you aren’t just paying the high-interest payments at the beginning of the mortgage all over again. The effective interest rate goes way up in that scenario!
Great call, and something I want to dive into more later. Amortization on a home mortgage is not straight-line, but front loaded with high interest. Most people don’t look at it that way. The only true way to take advantage of the low interest rate is to keep that mortgage for 30 years.
Oh, if only I could start over with the same smarts as Stella seems to have! I would totally pay off the house, assuming it is the one they want to stay in long term. After a short career of working full time, Stella could kick back and do what she wants, still seeing patients if she chooses, but not having to worry about managed care and the worries that go with that. That is my ultimate goal, but it is going to take a bit longer because we didn’t avoid lifestyle inflation. Run from lifestyle inflation, Stella. Stay away!
Great to hear from you on this one, Kim. I know that you have a similar story, except you jumped into lifestyle inflation, and now are back on track and KILLING IT! Stella, if you read this, heed Kim’s advice! 🙂
I would keep that mortgage FOR.EV.ER. What a great rate! Beef up investments instead – tax-advantaged when possible, in normal accounts when not. Also spend more, sheesh! It doesn’t seem like Stella wants to retire particularly early so she has room to live it up a bit more if she wants to. (Yes, I am advocating for a lifestyle increase if they’ve been feeling pinched – not inflation but deliberate high-value spending.)
We now have 2 votes yes, 2 votes no on the mortgage. And yeah, I gave her some spending cash and entertainment, and a BIG vacation budget, but she definitely has the means to bump all those categories a bit.
Why would you want to stay IN DEBT FOR.EV.ER ? Terrible idea!
Because she can earn greater long-term returns on the debt amount in alternative investments, thereby effectively earning infinite ROI on these other investments!
Say she has $1000 and she has the 3.65% interest to pay, but can earn 8% elsewhere.
If she pays down the loan, she earns $0 on the $1000.
If she keeps the loans, she pays $36.50 a year on this amount, but earns $80.00 on her investment.
So, she can either have a net income of $33.50 on her $1000 each year, or $0…
I think I’m one of the fewest here to say “pay off the house” ASAP. If it takes less than 3 years, I’d do my best to get over with it. Then you can invest as much as you wish. Being debt free is really worth the effort 😉
Actually, now we’re at 3 – 2, pay off mortgage team is winning. 🙂
I think I am with Emily on this one and not rushing to pay off the mortgage. That’s a stinkin’ awesome rate. I get it’s part of the goal, though I’d put more towards investing and absolutely in some solid index funds.
3-3, back at a tie! And yes, that’s an amazing rate!
We’d keep the mortgage, but move that money out of the money market fund (or by all means find one like ally that will at least pay .8%) and get the money working for you! then just invest everything you don’t spend every month. You’ll reach your savings goals before you know it.
4-3, keep mortgage takes the lead. And yes, the money market is not the place for your dollar to work.
Wow, that’s a great income! And no non-mortgage debt? Awesome!
That’s a pretty awesome interest rate, I think I’d keep the mortgage around longer. And increase spending as well. Live a little :).
5-3, keep the mortgage!
To them, the $200 a month IS living it up, which is what is pretty awesome about her. She said all their peers are getting in HUGE debt, buying fancy junk, and they’re content with dinner and movie out and a comfortable home. Contentment is really going to get them far, to the point they don’t have to answer to anyone! 🙂
I’m voting for kill the mortgage. That stock market can wipe you out (more than once) and you’ll never regret having that mortgage paid off.
What’s the score now?
5-4, keep the mortgage! Getting closer. And yes, the mortgage is a guaranteed return, that is true. Though if she invests long term, I do have faith in index funds and the market as well 🙂
I vote trash the mortgage. There’s nothing like the feeling of owning your home free and clear.
5-5, it’s a tie! BOOM!
And yes, owning a home has to be a feeling like no other. Except maybe owning SEVERAL homes! 😉
I really enjoyed this post and I will be coming back to read more of your Budget Friday posts! Personally, I would pay off the mortgage first to be done with debt for good, especially since it would take less than 3 years with a bit of planning.
Glad you enjoyed it, I enjoyed writing it!!
Nice, make sure you vote using the widget. In the comments, that 6-5 in favor of paying off the mortgage. THE TABLES HAVE TURNED!
Paying off the mortgage early is not a good choice. The rate is lower when you consider the tax implications. I think you would want a higher return on your investments.
How is paying off a mortgage early “not a good choice” ? That is the dumbest thing I’ve ever heard! Risk versus Reward. It’s not like it will take her 10 or 15 years to pay off the mortgage. We are talking 2-3 years and she is DEBT FREEEEEEE! How could the financial gains of two years of investing outweigh the risk of having a mortgage?
Do you factor in front-loaded interest and the fact that they might move into that? I think the percentage only works out if you keep the mortgage for 30 years…? What do you think?
Either way, that’s 6-6, back to a tie!
Pay off the mortgage ASAP. Who cares about the interest rate! Why would any financial expert [above] recommend someone STAY IN DEBT? Why take the RISK of staying in debt? I would personally take the elimination of risk over two years of investing returns.
If I could pay off my house in 2 years, I would probably make it happen. I think the arguement is instead of money to mortgage principal, effectively earning 3.65%, you could invest in index funds over that 30 years instead, and earn 10% more.
It’s now 7-6, KILL THE MORTGAGE! (in the comment voting)
I’m always a fan of killing debt. In her case, I would max out a Roth IRA for her and her husband every year and kill the mortgage with the rest. When that’s done, I’d look into investments like target date mutual funds, index funds, or maybe even rental properties.
That’s one thing I didn’t get into here, is rental properties. But is definitely a possibility if they want to diversify 🙂
It’s such a waste to have all that money and not have it work to her advantage. I agree of getting rid of the mortgage as soon as possible. There’s no better feeling than having that done and finally owning the house.
Alright! 8-6 kill the mortgage!
I would vote to keep the mortgage and invest the money.
I don’t understand the fascination with paying off the mortgage. To me, if you have the money in investments that are earning more than the mortgage is costing you, and the investments exceed the value of the mortgage, you’re much better off. Also, the suggestion that she could purchase subsequent property and retain this mortgage at the current low rates is an excellent one. I’ve used HELOC (Home Equity Line of Credit) money to purchase rental property and am earning a steady income from that as well, which exceeds what I borrowed. To me, I would only pay off the mortgage if I was afraid that I might spend the money foolishly if I didn’t pay it off.
It’s a fun battle. Keep vs. Destroy the mortgage. Honestly, the math doesn’t make much sense unless you keep the mortgage for the full term. Problem is, most people ReFi or sell before that happens. Either way, she;s in an awesome position and should be set for life very quickly 🙂