Lazy Man and Money

10 Biggest Money Mistakes Analyzed

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Money MistakesDo you have money mistakes? Of course you do, right? We all have money mistakes. I spend way to much time (and it’s part of how I make a living) limiting mine as much as I can, but I still have money mistakes.

There was a Twitter thread that went viral (for money conversations at least) about money mistakes that caught my attention. It caught my attention because everyone agreed that it was very good. I agree that it was very good too. However, I thought that each mention of a money mistake had a lot more nuance that deserved a deeper look. That’s just the way Twitter is.

I thought it would make for a good blog post to explore some of those nuances. Unfortunately, I’m sure this will come off as if I’m criticizing Nick Maggiulli Of Dollars And Data, but I’m actually a big fan of his work. I’m a subscriber of his newsletter and I recommend that you subscribe as well.

10 Biggest Money Mistakes Analyzed

I’ll be embedding all the Tweets in this post, but you can read the money biggest mistakes here. Some of my responses are a little snarky to make this a little more fun.

“1. Grow Income instead of Cutting Expenses”

The main problem that I have with growing income advice is that it is rarely actionable. If I asked everyone reading this who wants more income, I bet all of you would raise your hands. Making a case for more income in many careers is a long, slow, tedious climb up the corporate ladder.

Alternatively, you can add a side hustle and trade time for money. That can work depending on your life situation. It was easier for me before we had kids. If this works for you, I suggest combining this income with cutting spending to maximize overall savings. Then invest those savings for passive income.

It’s far less complicated to give people advice on how to cut spending. There are a lot of ways to save money. What’s best for you greatly depends on your personal situation. If you are a high income earner with high expenses, growing income more may not be the answer.

“2. Not Thinking Like an Owner”

I agree with this advice, but I think it isn’t the best example.

Brady took stock options (ownership) in Under Armour in 2010 (Source) that were up 800% in August of last year… and Under Armour stock has doubled since then. Tom Brady certainly has a significant ownership stake in his nutrition/sports performance company, TB12 Sports.

Peyton Manning had ownership of 31 Papa John’s franchises (Source.) Manning sold ownership after the CEO got involved in some scandals. I’m sure Manning owns stakes in other businesses, even if it is stock from his many, many endorsements.

Madden may have ownership in some things, but he took $150 Million to license his name in perpetuity to Electronic Arts for the famous Madden Games (source).

“When the company’s stock first went public, he was offered an opportunity to buy it for just $7.50 a share. Thinking EA was just trying to milk money out of him, Madden declined. He later called this decision the ‘dumbest thing [he] ever did in [his] life’ — and for good reason.

EA’s stock was priced at $70 by 1999 and reached an all-time high of close to $150 a share in July 2018 — thanks in large part to the franchise that bears Madden’s name and will for the foreseeable future.

In fairness to John Madden, EA went public in 1989 with a market capitalization of about $84 million. So he was actually getting paid for his name almost twice what the whole company was worth. According to this calculator, an S&P 500 investment would have grown more than 1000%, meaning that John Madden’s name could have reasonably gotten him 1.5 billion.

I don’t know about you, but if the dumbest thing you’ve ever done still nets you 1.5 billion (or half that if he invested more conservatively), it’s still a good day.

But what about Jerry Richardson?

First, it’s hard to connect Richardson’s success with being an NFL player. While he was a player, he only played for 2 years and was far from a star. He used the bonus money from winning a championship game and used that to start the Hardees business. I’m not sure how much the championship bonuses were in 1960, but I bet it wasn’t much. Many other people could have had the same starting money with a little opportunity or inheritance.

In short, it’s more coincidence that he’s a wealthy football player than causation.

As Axios points out, “But the story of how [Richardson] came to sit in [the Carolina Panthers owner’s] box is complex and interesting and improbable and kind of inspiring.”

Richardson started Hardee’s just 6 years after McDonald’s got its start. It proved to be the perfect time for fast food restaurants.

Also from the Axios article, “In 1993, toward the end of his career, Richardson and several investors paid the NFL $206 million to create the Carolina Panthers as an expansion team. That may have proven to be the most shrewd business move he made. The Panthers are now worth north of $1.5 billion, according to Forbes.”

I feel it would be more accurate to say Brady/Manning are more “business owners” than Richardson was a football player. It’s also worth noting that Richardson didn’t start his business ownership until his playing days were over. Brady is obviously still playing. They both have 40 years of earnings and compound interest growth to get where Richardson’s net worth is today. Even with inflation, I wouldn’t bet against them.

The main advice of “think like an owner” is true, but remember that it was improbable that Richardson would be a successful entrepreneur. Don’t go start a burger stand thinking that you’ll make a few billion dollars.

“3. Overemphasis on small wins vs. big wins”

I don’t want to say that you shouldn’t prepare for a salary negotiation. However, I’ve been on both sides of a few salary negotiations, and I can tell you it wasn’t much of a negotiation. The numbers were preordained.

I hope the numbers in your salary negotiation haven’t been preordained. If that’s the case, then it’s certainly worth spending a few hours to prepare to maximize the return there. There’s a chance of a $800/hour return on your time (using the example above). That’s year after year and compounds with future raises. The thing that gives me pause is that the chance isn’t 100% and it may be zero.

Driving across town to save $40 on a television does have a few benefits though. Personally, I like to get out of the house. I like to visit electronics stores. That’s entertainment for me. Also, the chance you are going to save $40 is 100%, which contrasts with the possible 0% chance at $4000. Finally, this kind of frugality can become habit-forming (in a good way!) and lead to savings in other areas. I’ve personally found that I’ve become frugal enough that I don’t have to worry about budgeting.

One last thought: Since I’m being a little snarky with this article anyway, does has anyone actually driven across town to save money on a television set? If I buy locally, I either buy from the one electronic store (an independent one) or Wal-Mart. (We don’t even have a Best Buy.) However, most of the time I would buy a television on a deal that I saw online.

“4. Timing the market”

No one knows what the market is going to do. That is a universal truth.

However, on January 23, 2020, I wrote How I’m Managing Stock Market Risk in 2020, specifically about how the 10 year bull run had made me nervous. I increased my bond holding. That turned out to be very useful when the market crashed in March. The bonds didn’t go down very much and I was able to sell them and buy stock indexes on sale while the market was going down.

With the market back up to new highs, I’m selling some down stocks and buying back the bonds again. I’m still staying fully invested, I’m simply trying to reduce my investment risk in this market environment

There is significant research into using CAPE (Shiller PE) into asset allocation. All of that essentially amounts to “timing the market.” It’s timing the marketing using valuation.

(If you don’t know what I was writing about in last paragraph, just stick to the buy and hold method. It has always done well in the long run… with the exception of Japan’s Lost Decade(s).)

“5. Borrowing too much”

Borrowing too much is a universal mistake. The problem is that “too much” isn’t defined. Eating a strawberry might too much for a single ant, but it’s not enough for me. Borrowing $100,000 is too much for me, but it wouldn’t be for Jeff Bezos. Often, you don’t know where the line of “too much” is until things have gone south and your DeLorean is in the shop.

I think a bigger money mistake is not understanding good debt vs. bad debt.

“6. Paying attention to other peoples’ finances”

Like everything else on this list, this is very sound advice.

I wonder if the average person gets caught up in how much money Tom Brady or Jerry Richardson has. We all know that there are celebrities that are richer than us.

It’s the people in your personal circle that can be more difficult. When I lived in Silicon Valley there were 10 very expensive sports cars on my street. Society and relationships can become strained with big financial differences. I don’t “worry” about them, but it’s hard to imagine that people’s financial well-being doesn’t have an overall effect on those relationships.

“7. Too much lifestyle creep”

Just like the “borrowing too much”, it’s hard to know the correct amount of lifestyle creep. Often you can only tell in hindsight.

Technically spending more than 0% of your raises pushes your financial independence further away. Some people’s goals aren’t financial independence. Everyone has their own comfort level with their savings percentage and this is the same way.

I don’t want to tell you how much lifestyle creep is too much. That’s a personal decision for you to decide. The key thing to understand is that if you save and invest more, you get to financial independence quicker.

“8. Investing in products you don’t understand”

As a parent to a 7 and 8-year-old (who get very good grades in school), I have trouble explaining how stocks work. I think I could do it, but it wouldn’t be a slam dunk. Trying to explain an ETF or index fund would only be more complicated. I’m not sure there are a lot of investments that can be explained very well to a 5-year-old.

The Teen Titans Go explain how rental properties work in an episode down to the details of getting a mortgage from a bank for leverage to build equity. It’s quite good and they explain it quite well. I understand it, but I’m not sure they do.

The advice of investing in simple products is sound. I don’t agree that an average 5-year-old should be able to understand many investing products. Fortunately, if you are reading this blog or the original money mistakes Tweet, you are probably not 5 years old.

“9. Paying too much in fees”

This is a universal mistake. However, I’ve been reading this advice since I started investing in mutual funds back around 1990. Most of the investment options I’ve seen put expense ratios in fairly clear view and show how your money would have grown after expenses.

I hope there aren’t too many still around making this mistake.

“10. Obsessing over not having enough money”

Let’s end on my favorite piece of advice. I’m guilty as charged of this one. We’ve reached to the point where we’ve stopped our retirement contributions. We’re pushing too many chips for age 60 and not enough for now.

I don’t mind leaving hundreds of thousands in inheritance though. I do enjoy the security of not having to worry about money. I don’t want to sound too much like a Scrooge McDuck, but sometimes having money is as comforting as spending it.

So what you think? Have you made these money mistakes? Let me know in the comments.

Pandemic Finances

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The following article is from regular contributor Kosmo. It was submitted earlier last week, before most of the conversation in the United States has rightfully focused on race and police brutality. I’m busy homeschooling a 6 and 7 year old through finals week (who knew there were kindergarten “finals”?). There’s great unrest in the personal finance blogger community as well. Everything around me seems to be an onion of fighting – just layers upon layers of fighting – home with kids, professional, politically, human rights, science (COVID-19) – did I miss anything?

We’re now about 2.5 months into the COVID-19 pandemic.  Some businesses are starting to open, while others will still be closed for a while.

My wife and I have both been working from home since mid-March.  It’s likely that she’ll be returning to the office in the next month.  My employer has announced that we will be working from home at least through Labor Day.  Even then, offices will only be at 25% capacity for a while.

It’s been a roller coaster ride of good and bad financial news:

Bad news: Investments

The pandemic has cost most people money, and we’re no exception.  The biggest hit was investment accounts.  We’re tracking slightly ahead of the Dow, but are still down for the year.  We’re mid-career, and although we haven’t saved quite as much as we’d have like (thanks, kids), we still have more in investment accounts than most people our age.  That means that we’ve taken a decent hit.

Some of our retirement assets are in pensions from my previous and current employer.  The pension from my previous employer is defined benefit, so there has been no impact.  The pension from my current employer is defined contribution, but can’t lose money.  It basically pays a dividend within a fairly tight range, based on bond rates.

Bad news: Compensation

Unfortunately, my bonus for next year will likely take a hit.  Last year, my bonus was around 10%.  The company will likely struggle to meet some of the ROI-related goals for the year, which will impact bonuses.

My wife’s employer is a hospital, and they have seen significantly decreased revenue.  They are looking at more drastic action, which will likely include some sort of temporary pay cut.  We’re just hoping it’s a small cut.

Bad new: home office costs

We didn’t go crazy setting up home offices, but my wife did need a few things.  She’s a CPA, so a second monitor (and the dock to make it possible) was a must, and she quickly got tired of the chair, so an office chair was a must.  Overall, the costs were about $350.

I didn’t have any costs for my own setup.  Currently, most of my job is involving analysis.  If I was doing a lot of heads-down testing, a second monitor might be a necessity.  For now, I’m happy hunkered down in the corner of the dungeon basement.  (It’s actually a finished basement, so it’s not a bad setup at all.)

Not all bad

I don’t want to dwell too much on the negative.  We’re better off than most people.  My wife’s pay cut will only be temporary, and I’m confident that the market will eventually rebound.  We did qualify for most of the stimulus check, which should offset some of negatives.

Good news: no day care

My kids are 12 and 10.  We’ve been paying people to watch them since they were born.  Day care, BASP (B and After School Program), and summer care.  For the last 2.5 months, they’ve been at home.  We’re still paying a holding fee (because if you lose your spot, you’re screwed), but the cost is much lower.

My daughter won’t be going back.  She’ll be in 7th grade next year and will be taking the bus to school.  It would have been nice (and cheaper) to have that as an option in previous years, but we’re 1.9 miles from the elementary school, and kids must be 2.0 miles from the school in order to qualify for a bus.

My son (going into 5th grade) will be going back at some point.  But by the time I go back to work, we will have saved more than $2000.

Note: the IRS is allowing people to change their flex spending for dependent care, but only if their employer allows it.  If you won’t need your entire flex spending amount, check with HR to see if you can decrease your election.

Good news: long hair

I’m the only member of the household who has had a haircut since March.  No, I’m not a jerk who sneaks out to the barbershop in the dead of night.  For the past twenty years, I’ve used a home haircutting kit to cut my own hair.

My son’s hair is getting a bit shaggy, and we’re currently planning a trip to the cuttery next week, with all possible precautions.

Haircuts are expensive.

Good news: lower discretionary spending

We’re spending a lot less money on discretionary things.  We’re not dining out (although we’re doing delivery a couple of times per week), not buying random stuff at the mall, not buying gas, not incurring wear and tear on the cars.  No date nights, no movies, no sports gambling (because there are no sports).

Instead of buying snacks at the vending machine at work, I’ve been getting 2 liter bottles of generic cola (99 cents) and bags of candy bars.  That’s saving a few dollars per day.  I could save even more if I snacked on water and carrots, but who are we kidding?

[Editor’s Note: Our investment in a custom SodaStream kit has kept us with plenty of fizz. Flavorings, such as diet coke, or calorie-free fruit is very cheap.]

We run a lot of household expenses through our Fidelity Visa, since it automatically puts the 2% cashback into 529 accounts for the kids.  The monthly costs has been about half what it is in a normal month.

What are we spending money on?

We’re still spending some money, of course.  The grocery bill has skyrocketed, since those groceries are now providing nearly every meal.  In  a typical week, the kids would eat at school (2 kids X 5 meals per week = 10), and we would eat several meals out.  So the cost of the typical meal is lower, but almost all of that cost is on the grocery bill now.  (Speaking of food, it’s lunch time for me – time to microwave a Banquet Salisbury steak TV dinner.)

[Editor’s Note: I’ve been occasionally splitting Hungry Man dinners for lunch with 7 year old. It’s hard because he doesn’t eat a lot of different foods.]

As mentioned in my last article,  I have begun collecting stamps.  I’ve spend too much and money on stamps in the past month.  It’s a drop in the bucket compare to what we’ve been saving, but it has definitely become a bit of a money pit.  The good news is that I should be done buying supplies for a while.  I have my tongs, magnifying glass, stock pages, and storage boxes.  So I’ll just be buying stamps now.

I also spent a few bucks buying digital codes for the Jurassic Park and Hunger Games movies.  For a total cost of about $30, I was able to get nine movies.  In a normal situation, I don’t have much time to watch movies.  Lately, I’ve had quite a bit of free time.

We also decided to upgrade tech for the kids.  They currently have Fire 6 tablets.  We actually got a great deal  of them at the time.  By taking advantage of a Prime Day deal and signing up for an Amazon credit card, our total cost was $47 – or $23.50 per unit.  The downside is that they kinda suck, and that they’re now five years old.  Battery life has always been an issue, and it’s getting worse.  Surprisingly, the kids haven’t complained yet, because Minecraft still works.

I found a deal on the 8″ Lenovo Tab 3 and bought two of them.  I have a Lenovo Tab 10 for myself, and it has been a very good user experience.  The Tab 3 doesn’t have the same specs, but it should be good for their needs – Minecraft and streaming video.  We ended up paying $59 each.

Non-financial news

We were planning a vacation to Door County, Wisconsin in a few weeks.  Our AirBNB was very nice and was within walking distance from Lake Michigan in 2017.  We planned a return trip last year, but had to cancel due to a family medical situation.  So we made the same plans for this year.  Unfortunately, with all the uncertainly, we decided to push this back to next year.  Finger crossed that everything works out next year.

What about you?

How have your finances changed?

What Makes Up Your Financial Blueprint?

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Happy Independence Day (readers in the United States.) This week you may have already seen a lot of bloggers to write about financial independence. I thought about writing on the topic, but I found myself gravitating to a question of general financial health.

There are a lot of pieces to your overall financial picture. I often look at net worth as it’s a good measure of your overall financial health. However there are a lot of other pieces that factor in. For example, there are credit scores, insurance coverage, retirement funds, retirement planning, and liquidity (such as an emergency fund), and estate planning.

Even after making that list, I’m thinking about other things that I immediately forgot like credit card rewards, identity theft protection, career growth, and real estate.

It feels like all these things are swirling around in a “financial hurricane.”

I can organize a lot of with spreadsheets, but it’s very difficult to get the big picture. When in doubt, I just make what seems to the best decision, which has generally worked out well.

My Financial Blueprint

So today I wanted to stop and think about how all these pieces of the financial fit together. I’m going to need your feedback and thoughts on this because mapping an entire financial picture isn’t easy. Also, I can almost guarantee you’ll have different thoughts and ideas than I do. I’m certainly not married to these number myself:

Net Worth – 20%

This might be low for what I consider the most important financial number. However, since I’ve got a lot of areas to cover, I need to save some room. When I think of net worth, I don’t look at it as a single number. I think about it in terms of age and the cost of living in an area. Having a 250K at age 25 is amazing. It’s much less amazing at age 60. Similarly that 250K means a lot more in Phuket, Thailand than it does in New York City.

In short, context matters.

Retirement Preparedness – 20%

There’s likely some overlap between this number and net worth. For us, our retirement accounts are about 55% of our net worth. So while that net worth percentage above may seem a little low, there’s some of it baked into this category.

I think this category is largely about having a healthy amount whatever retirement accounts are available to you. For most people, that’s their 401k and Roth IRA.

Emergency Fund – 15%

It’s great to be prepared for retirement, but what about now? How prepared are you for a job loss, car repairs, or a big health bill? I could go on, but I think most everyone reading personal finance blogs understands the value of having liquid cash.

Usually an emergency fund is measured in months of expenses rather than straight dollars.

Insurance – 15%

Do you have car, house, life, umbrella, and/or any insurances you may need to protect your income? Protecting your financial behind is important.

Money Ratios – 10%

Which money ratios are important? My friend Jim from Wallet Hacks has a list of seven important money ratios. While some of them overlap the above, not all of them do. There are some about investing, debt, housing, etc. I’ve been meaning to write about some of my favorites for some time. In the meantime, let me know some of your favorites in the comments.

I was on the fence about adding this one. It should be obviously which side I ended up on.

Ultimately, I decided to add this because I think some ratios give you a good view into your current finances. I could have a high net worth, but if I buy a huge mansion, it doesn’t bode well for my future financial health, right?

Credit Score – 10%

Your credit score can be very important… especially if you plan on buying that mansion. Having an excellent credit score qualified us for the very best mortgage and car rates and it’s saved us tens of thousands of real dollars.

Estate Planning- 10%

Do you have a will? Do you have a trust? These things are often difficult to talk about because they involve thinking about death. However, they are important.

For me, one of the big questions I have is, “What becomes of Lazy Man and Money if I die tomorrow?” My wife has no interest in learning how to blog. Maybe in 10-15 years, my kids will be interested in blogging on the site.

Final Thoughts

I don’t know if I could possibly more wishy-washy than I have been, but I do want to emphasize that these are my initial thoughts. I’m sure I didn’t cover everything and the percentages I gave are hardly based on any kind of scientific theory.

What makes up your financial blueprint? Let me know in the comments.

Dobot to Start Charging Fees

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For a couple of years now, I’ve been using some stealth services to squirrel away savings without me noticing. They were free, backed by fairly reputable companies and FDIC insured, so I figured I had little to lose. I started with Digit.co and really liked how after a 3-minute set-up, I had a system set up to save a few thousand dollars a year.

Then Digit started to charge fees for the service and I had to move on.

Before Digit started to charge fees, Dobot contacted me and essentially said, “We’re like Digit, but we’ll help you save towards one or more goals.” I’m really looking to get this 65″ OLED TV from LG (yes, I’m a bit obsessed) so I set that up as one of my goals.

I’m about 50% of the way to my goal of $2500 saved (Amazon doesn’t seem very competitive in this case. That’s a story for another day.) When I moved on from Digit, I created a goal in Dobot with the name “emergency fund” to replicate what I had with Digit.

Unfortunately Dobot is charging fees, so I’m going to have to kick it to the curb too.

Part of their email that I got on July 19th is as follows:

“It is vital that we are able to continue providing the services you’ve come to trust, so today we are sharing important news about our relationship with our Dobot savers and how we make money. Dobot will begin charging a small monthly fee for the services we provide. The fee, $1.99, will begin on July 31st for all accounts created before July 1st. For new users of Dobot, there will be a 30-day trial period.”

They aren’t giving a lot of people time to get out. In looking at the Dobot app, there isn’t an obvious way to close your account either. I did a quick Google search and it seems like contacting them and asking is how they recommend canceling. I hope they have a large staff of people dealing with their email.

It’s not that $2/month is a big deal. It’s less than $25 a year. However, I don’t see the value of that $25. I could set up my bank account to transfer $100 on the 5th, 15th, and 25th of every month to a saving account for free. People have been doing things like this for years and years. It seems to me that banks should offer a Digit/Dobot service for free. Maybe some day they will.

I’m looking into one more of these services that some friends of mine have been talking about. I don’t want to say who it is or give any kind of recommendation until I know how it works and can properly review it.

Taking a Loan From Our Retirement Accounts?

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Happy Patriots’ Day! Yes, it’s mostly a Boston holiday, but everyone in the United States could find a reason to celebrate it. I love 11AM baseball (but not as much as I loved 8AM baseball when I lived on the West Coast).

I was very excited to get this blog post out this morning, but I had a disappointing experience at my son’s school. It turns out that I had unknowingly been breaking a school rule for about 6 months. They explained the rule to me this morning. I explained how we were in compliance with the rule. They then clarified an unwritten, not-communicated point about the rule. That point makes a lot of sense for the whole existence of the rule know that it is clarified. However, I defend my wife and myself taking it literally.

The end result is that we felt terrible that we were taking advantage for 6 months. They probably felt terrible that both me and my 4-year old were confused. Hurt feelings all around. The lesson as always: Communication is important.

You aren’t here for communication lessons, so let’s move from personal to personal finance, shall we?

In the past 10 years I’ve read a lot of personal finance articles. There are almost no absolutes in personal finance. However, this comes close: “Never borrow from your retirement plan.”

Case in point. From Here’s what happens when you take out a loan on your 401(k):

“While 401k borrowers are borrowing from themselves, this isn’t a harmless transfer of money from one pocket to another, experts say. ‘The best spin you could put on it is it’s the lesser of several evils,’ said Greg McBride, chief financial analyst for Bankrate.com.”
…
Borrowing from a 401k plan exacts a big opportunity cost. Borrowers miss out on any compound growth that their investments would otherwise have earned in the market.
…
Unless the money is repaid quickly, the loan represents a permanent setback to retirement planning, McBride said.
…
Those who borrow from their 401ks lose out on tax efficiency, too. Loans are repaid with after-tax dollars. In other words, someone in the 25% tax bracket would need to earn $125 to repay $100 of the loan. Savers’ 401k money is taxed again when withdrawn in retirement, so those who take out a loan are subjecting themselves to double taxation.
…
Employees who leave their jobs, are laid off or fired typically have to repay their loan within 60 days. If they don’t, the loan amount is considered a distribution, subjected to income tax and a 10% penalty if the borrower is under 59 and a half.
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[CFP Andy] Smith’s list of acceptable reasons to take a 401k loan is short: to pay back taxes or other money owed to the IRS, to pay a tax lien, or to try to avoid bankruptcy.
…
But to the extent possible, experts say it’s best to avoid getting into a situation where we need fast cash in the first place. That means setting aside a liquid emergency fund of six months’ expenses.

[I bolded the point about double taxation, because I’ll cover that later.]

Whew! That was a lot of digest. I’m not going to into each point. Instead, I’ll use that as a “flavor” of the issues… and then drill into a few points that I consider significant in our situation.

Today, I want to challenge the thinking about borrowing from a retirement account. Or at least, I want to make a case that like almost everything in personal finance… it is personal.

Regular readers know my wife is an officer with military benefits. As a government employee, her retirement program isn’t a 401k, but a TSP. As best I can tell there aren’t any significant differences between them… other than TSPs tend to have investment choices with extremely low expenses. As best I can tell a TSP loan is almost the same as a 401k loan. TSP loans aren’t written about very often because they aren’t as common.

If you aren’t familiar with TSPs, it might be best that you think “401k” when you read “TSP.” As always, please consult your professional financial and tax advisor about any and all of this stuff.

What are TSP Loan Terms?

Because TSPs are a government plan, taking a loan out is straight-forward. There’s no need to talk to a loan officer and justify your need. The theory seems to be, “It’s your money, you can get it easily… under these conditions.”

There’s one set of conditions for buying a primary residence, but that’s not us. The other set of conditions are the ones we are interested in. I’ll focus on those.

It seems you can currently take a loan of up to $50,000 at 2.375% for up to 5 years. It’s a fixed rate. Procedurally, it is as simple as sending in the application. You pay it back with the interest into your own account. Yes, instead of paying interest to the bank, you are the bank. You are lending it to yourself.

There’s a fee involved… a one-time, $50 processing fee.

You might think there’s some kind of breakage issue involved. There might be with 401Ks, but TSP loans can be set up to come out of your paycheck. You set it up once and forget it.

Defending a TSP Loan

My wife has been maxing out her TSP contributions for around 15 years. That’s roughly $16,000 (some years were less and now it’s more) a year or around $240,000. The stock market has been doing well, so there are investment gains as well. It’s not a small account.

Let’s address a few points:

  • Undermining Our Retirement Plan

    While the TSP account isn’t small it also ISN’T the major focus of our retirement plan. I don’t think taking a TSP loan undermines our retirement planning at all. I understand how it would most people, but we aren’t most people.

  • Opportunity Cost

    This may be considered one-in-the-same as the above point. However, I wanted to make a special point that the stock market has had an extreme run over around 8 years now. In the short term, I think the opportunities aren’t that great. That’s because I know where the stock market will go now (I write half-jokingly.)

    If the stock market stays relatively flat for a few years as I think it might, the loss of opportunity is minimal. I don’t want to discount it completely, but I no longer assume that we’ll get 7% over the next 3-4 years.

    I might falling into the same trap that Punch Debt in the Face did in 2013. I hope not.

  • Loss of Job

    This is the bogeyman that keeps financial planners up at night. It’s a trifecta of financial pain. You need to come up with a pile of cash in a short time. You have no job. You presumably have no emergency fund (or you wouldn’t be borrowing in the first place.) You are going to have pay income tax on the money and a 10% penalty. Penalties and fees always make me feel ouchies (to borrow a phrase from our kids).

    With my wife’s career, the likelihood of job loss is minimal. High ranking officers aren’t typically fired. Also a pharmacist can usually get work relatively quickly (even if it is an hourly wage.) We have some other coverage even in this extreme case… such as these hidden emergency funds.

Why Should We Get a TSP Loan?

Maybe I should have addressed this above. I wanted to dispel the general reasons why experts are against retirement loans before getting into “Our Why.”

Last week, I wrote about our surprise condo assessments. They are around $20,000 for each condo unit… and we have two in the property. The terms of the loan are 5.2% for 11.5 years and then they adjust to some higher rate.

We could try to sell the properties, but that seems to be a terrible idea. When you considering these expenses would be passed onto a prospective buyer they will offer $20K less than the value of the properties a few months ago. After seller fees, it would amount to a fire sale… a big loss to us. However, the rents are good and the financing would lead us to lose an extra $100 or so a month. That’s not a huge amount. We still have a tremendous price-to-rent ratio (it was around 6.5, but now it’s probably closer to 8).

While the one-time $20K seems like a lot (and it is), each of these properties should earn us $10K a year when they are paid off. Perhaps they will earn even more as the property is greatly upgraded.

The terms of the loan that the condo association got really caught my attention. As I was I writing the article, I realized how terrible the terms are for people with great credit like us. It isn’t competitive with current fixed loan rates now and it feels like an exploding loan as it will adjust in some unspecified way in 11.5 years. I defer to Clubber Lang for a prediction on how these loan terms will turn out for most owners:

I’d rather have a loan at a fixed 2.375% rate vs. an exploding 5.2% rate. Wouldn’t you?

There are a couple of other reasons why we might take this loan.

  1. Paying Off Our Solar Panels

    We financed solar panels a couple of years ago with a HELOC. It had a good teaser rate at around 2.5%, but it is 4.5% now. If I had it to do over, I would have locked in a TSP loan at around 1.5% back then and use that. I simply didn’t realize we had access to better rates.

    I don’t miss paying for electricity. And I think I’ll enjoy each and every year of the next 25 years of not paying for it (or paying pennies for it).

  2. A Master’s Degree for My (Pharmacist) Wife

    I never would have thought of looking at a TSP loan unless my wife mentioned that her friend is doing it to finance a master’s degree. It seems that is the next step in the corporate/military ladder. Borrowing for an advanced degree might make sense for most people, but for a doctor (of pharmacy) it seems like a step back to me.

    I shrug my shoulders and justify it as complimentary. It might make her a Captain. It might not. It can only help, right? And if it doesn’t carry weight with the government, it will carry weight in the private sector.

Retirement Loans and Double Taxation

Remember the bolded text above about double taxation? Clearly Marketwatch couldn’t be wrong about double taxation of 401K loans, right?

Well, Vanguard seems to have a different view.

Vanguard makes the great point that “First, it’s easy to see you aren’t ‘taxed twice’ on the principal balance of a ‘k’ loan. If you borrow $10,000 from your retirement plan, you receive $10,000 to use as you want — you don’t have to pay taxes on it.”

This makes sense to me. You weren’t taxed in withdrawing the funds the first time, right? You simply have to put in what you took out.

The analysis on the interest is more complicated. I defer the Vanguard article. Worst case scenario we’d be taxed twice on that interest. However, the amount of interest we’d be charged is fairly minimal. One calculator projected it at around $200. If the government wants to tax me twice on $200 interest, I say Bravo Zulu.

Conclusion

It seems to me that there are legitimate reasons to take a loan from a retirement account… and I don’t think they need to be “last resort” reasons.

There is at least one important question that I didn’t answer above. Why not have an emergency fund to cover this?

We have layers of emergency funds as I hope I explained. The extreme expenses from the condos are somewhat planned for. We could finance them, but I think we’ll decide that we have better options.

The alternative is to not invest a sizable amount of money… and I’m not sure that is a great idea. In all the retirement articles I’ve read, I didn’t find something like “put the money under your mattress.”