How to finally get to those money to-dos that are important but not urgent

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There’s a great quote from former President Eisenhower that underpins one of the main issues I’ve always had with managing my finances:

"I have two kinds of problems, the urgent and the important. The urgent are not important, and the important are never urgent."  - Dwight D. Eisenhower

I've always found it challenging to make the time to answer financial questions that I know are very important, but rarely seem urgent. Maybe these kinds of questions haunt you too? It’s stuff like “Am I on track for retirement?” This is a pivotal question for a lot of people, but it’s also related to something that probably seems like it’s a million years off.

So what’s the solution to bridging the ‘important-urgent’ gap?

According to the ‘Eisenhower Matrix,’ a tool I’ve seen applied in corporate settings to improve employee productivity, you should be planning ahead and setting aside time to answer these kinds of questions.  Here’s the complete matrix, including what you're supposed to do to address each type of task: 

The Eisenhower Matrix for Time Management:

 

Not Urgent

Urgent


Do it right away

Important

Decide when you'll do it


Delegate it

Not Important

Don't do it


Sounds great in theory, right?

In practice, even when I do have some free time, I have found myself scanning through all those newsletters piled up in my inbox (definitely not important and not urgent) to avoid getting on the phone to start rolling over my old 401(k). And I’m sure I’m not alone in my tendency to procrastinate when it comes to financial planning. I'm not saying that it's not a good idea to set aside time to work on important tasks. Of course it's a good idea. It's just that I sometimes find myself straying from the task at hand.

So I’d like to propose another possible solution to this problem: do one small thing, today, to get started. This will shift you from the “I need get around to working on this” camp to the “I’m working on this” camp. It’s a subtle shift, but for me, it’s one that creates the momentum I need to start making real progress.

Want one small thing you can do right now to get more on top of your finances? Try figuring out what needs to be true for you to accomplish a financial goal you have in mind. What do you need to save every month to have enough to be able to afford X within a certain time horizon?

For example…

  • What do you need to save every month to afford college for your toddler?
  • What do you need to save to retire at age 67 when you’ll get 100% of your social security benefits (at least if the whole system isn’t insolvent by then!)
  • What should you set aside to afford a dream trip?

Figure that out and you’re one step closer to actually making it happen.

Here are some super simple web calculators to get you started:

And here’s a generic one I built that you can download and use to run simple numbers. (Note that you might be asked to sign-in to Google before you'll be able to download a copy.)

I would love to hear how others get moving and make progress on un-sexy financial planning topics. Or if you have found useful calculators, please share them in the comments, as I’m always looking for good examples of this sort of thing.

Would you rather?

Imagine I handed you $1,000 to spend on your child’s education and gave you two choices of how to use the money. You could either spend it on an amazing summer camp that would help your child develop skills today. Or you could invest it in a college savings account and have it help pay for college in the future. What would you do?

OK, I’m sure many of you out there are poking holes in my little thought experiment. Maybe you’re saying “I don’t have kids,” or “I’d rather spend it on something else” or “It depends on a whole bunch of other stuff.” Yes, all good points. But the details don’t actually matter that much for what I'm getting at. It’s the broader concept that I think is so interesting:

How should you evaluate the trade-off between spending TODAY on things that are important to you and saving for things that may be important in the FUTURE?

I’d love to hear what you think in the comments. What was a short term/long term trade-off you made recently and what factored into that decision? Here’s how I’ve come to think about it:

[financial purpose: the reason you have the money in the first place]

[financial purpose: the reason you have the money in the first place]

Use purpose as a lens for decision making

I think the decision of whether to spend now versus later can be quite hard without some sort of broader context to fit the trade-off into. I found it helpful to zoom out and think about why I had the money in the first place. What was the PURPOSE my money?

Money matters to me for two main reasons. First, it provides financial security, ensuring that I’ll have a roof over my head and food on the table for the foreseeable future. Second, it helps me accomplish things that support my values, like giving my kids access to a good education. So those are the two lenses that I now use to prioritize where my money goes.

Create a secure financial foundation

When I started prioritizing, the first thing I wanted to do was to make sure I had financial security nailed. I think it's a little like Maslow’s hierarchy of needs. You need to meet some basic physiological and safety needs before you can get to self actualization. For me, creating basic financial security meant:

Putting a few safety nets in place:

  • A emergency fund to make sure my family could cope if we experienced a big financial shock

  • Insurance to protect against loss of income and other important assets

  • A will and some other elements of basic estate planning to make sure our kids would be taken care of

Proactively setting my family up for future financial success:

  • Figuring out when to pay down debt and when to invest

  • Figuring out roughly how much we’d need to fund a comfortable lifestyle in retirement and making sure we were saving/investing to meet that target

Build up around values

Once I had built some basic financial security into the picture, I started to think about how my other values fit in. My kid’s education is high on that list. But there are a ton of ways that money could potentially support that value--hence the ‘summer school’ versus ‘college tuition’ thought experiment I started with. And then there’s the uncertainty that comes with planning for potential future outcomes. Will my kids even want to go to college? (Oh, I do hope so!) Will online platforms completely disrupt education and make everything free? (Probably not, but who knows?)

The point is that there are a lot of variables and a whole lot of unknowns. So to me, it made the most sense to gather data where I could and put a stake in the ground in a couple of key areas. For instance, it was helpful to actually talk with my spouse about the things we value and that we’d like our money to support. It was also helpful to do some basic math to figure out what it would take to pay for related long term goals, like college tuition. Then we could decide how much we’d like to allocate to things that are further out, just to know we were covered at some level. Now, with a few stakes in the ground centered around our values, when the short term stuff comes up, like the myriad of amazing summer camps that seem to exist out there, I feel less pressure to make this weighty trade-off decision. We’ve already thought about the big stuff, so if something is going to add a lot of value to our lives for the money, and we have the cash flow to cover it, we feel OK about doing it. 

Winning at Taxes

Back when I was in business school, I remember the term ‘fomo’ coming up a lot. It stands for ‘fear of missing out’ and it definitely describes how I felt from time to time. Taking two years out of your career and writing obscenely large tuition checks creates pressure to wring every last drop of value out of the b-school experience. Plus you don’t want to be the one who missed out on that cool activity, party, class, club, whatever, that everyone else is talking about.

I’ve started to think recently that I may have tax fomo as well. No matter what my tax bill, it always feels like it’s just so much money...so I therefore assume I must be overpaying. Then I’ll hear about these billionaires who are supposedly beating the system and it will bother me that they must know something I don’t. So I’ll start to feel like I’m missing out.

I do appreciate the importance of taxes, and I’m not interested in tax strategies that might fall in an ethical grey area, but I also don’t want to overpay just because I wasn’t in on the big secret like everyone else. I want to feel like I’m winning the game too.

The following is a summary of insights and opinions from my search to figure out if I was indeed missing out. (read: you should not consider this tax advice...if you need advice for your personal situation, talk to a pro...this stuff gets complicated quickly!)

From tactical to strategic

I’ve come to think about tax savings as a spectrum of opportunities that range from tactics to strategies. The tactics are things like deductions and credits that I assume most popular tax software would be able to bring to my attention if relevant. The strategies are the things that I’d have to more proactively pursue and would merit guidance from a professional tax advisor. The following is how that spectrum breaks out from my perspective. Since this is a very broad and nuanced topic, I’m sure there are many more examples that I haven’t included. If you have thoughts or other good examples to share, I would love to hear about them in the comments.


Claim Tax Deductions

Deductions reduce the income you’ll be taxed on, assuming of course that you’re itemizing, because you’re over the standard deduction. Below are a few categories that I thought were interesting. You can check out the IRS’s website if you want to see all the possible deductions out there, or if you want to dig into the details on any of these. Some are only going to apply if you’ve successfully created the right conditions to make yourself eligible. That means adopting an approach to managing your taxes that’s a bit more strategic. 

Federal tax deductions for state taxes you’ve paid: State income, real estate, property and sales taxes can all be deductible, though you cannot deduct both general sales taxes and income taxes. You have to choose one or the other.

Deductions for charitable contributions: You can use contributions to eligible charitable organizations to lower your taxable income. From what I’ve read, as other tax loopholes close, charitable contributions become more popular among the ultra-wealthy as a means of minimizing taxes.

Deducting interest: If you own a home, you may be able to deduct the interest you pay on your mortgage. This might be particularly interesting to you if you live in a place like California where housing prices are out of control and mortgage interest can end up being a considerable amount of money. Student loan interest is another item you may be able to take as a deduction. Depending on your income level, you can deduct up to $2,500 in interest you've paid on a student loan.

Work-related deductions: There’s a range of possibility in this category from business expenses, to a home office, to depreciation and amortization. The catch is that you’re not going to be able to take these deductions unless you’ve created the conditions to make yourself eligible. Skip ahead to the section called ‘Create a Source of Future Deductions’ for more on that.

Investment-related deductions: This category includes things like contributing to an IRA and deducting capital losses. It’s another area where you need to think ahead a bit to actually be able eligible. I've mentioned a related topic, tax loss harvesting, in other posts on this blog. 


Claim Tax Credits

Tax credits reduce the actual amount of tax you pay, so they can have a bigger impact on your tax bill than deductions. In one article I read, a CFP summarized this well by saying: "in the 25% tax bracket, each dollar of a deduction is worth a quarter, but each dollar of a credit is worth a dollar." Here are a few credits that piqued my interest. You can check out the IRS’s website for more details. If you have higher income levels, be prepared for a letdown as many will not apply.

Family oriented credits: The Child Care Credit, which is one of the few credits without income limits, offsets some of the cost of childcare while you work. The Child Tax Credit, which does have income limits, amounts to up to $1K for a qualifying child.

Credits for being energy efficient: The Residential Energy Efficient Property Credit provides up to 30% of the cost of certain alternative energy equipment, while the Plug-In Electric Drive Vehicle Credit allows up to $7,500 for purchase of a vehicle that runs on a rechargable battery. Neither has an income limit. 

Education oriented credits: The Lifetime Learner Credit allows up to $2K/year for post-high school courses that lead to job skills. The American Opportunity Credit allows a maximum annual credit of $2,500 per student for college. Both have income limits. 

Saving/working oriented credits: For low and moderate income households, there's the Savers Credit which allows up to $2K for contributing to a retirement plan and the Earned Income Credit which is a benefit for working.  


Use Pre-Tax Money

Sometimes you can set aside pre-tax money to pay for certain items and as a result avoid paying taxes entirely on the money used for those purchases.

Health Savings Account: An HSA is a tax-favored savings account created for the purpose of paying for current and future medical expenses. With it, you can deposit pre-tax dollars through your employer (or deduct your contributions) and use those funds to pay for qualified medical expenses. It’s not a use-it-or-lose-it account, so what you don’t use in a given year can continue to grow and won’t be taxed as long as you use it at some point for qualified medical expenses. If you take a withdrawal for non-medical costs, it will be taxed as income (plus a 20% penalty if you’re not yet 65). As long as your health plan meets the deductible requirement and permits you to open an HSA, you can open one anywhere. That means you can shop around for better investment options and lower management fees. 2016 contributions are capped at $3,350 for individuals or $6,750 for families.

Flexible Spending Account: An FSA is also a tax-advantaged savings account. It allows you to set aside pre-tax dollars through your employer for eligible expenses. These accounts are use-it-or-lose-it, so you have to carefully consider what you set aside each year because you’ll generally forfeit any unused balance. There are a few different types of FSAs. Two common ones are:

  • Medical Expense Account. Like an HSA, you can use this account to pay for qualified medical expenses on a pre-tax basis. Unlike an HSA, however, there are no eligibility requirements tied to the amount of your insurance plan’s deductible. Another key difference is that an HSA will allow you to invest anything you don’t use, whereas you’ll lose the funds you have set aside in your Medical Expense FSA. 2016 contributions are capped at $2,550.
  • Dependent Care Account: With this FSA, you set aside pre-tax money to pay for dependent care expenses, like daycare. Your expense must be for the purpose of allowing you and, if married, your spouse to work. Generally, you (and your spouse if filing jointly) must have earned income during the year.  2016 contributions are capped at $5,000.

Defer Taxes

Earnings in some types of investment accounts come with tax advantages. Here’s a quick summary of several of those opportunities, though many have restrictions attached, so it bears digging in to learn a bit more if you’re interested. I did a more thorough rundown in a couple of prior posts: Retirement Planning 201 and 529 What?! Here are some highlights:

  • Traditional 401(k): you contribute to a 401(k) account through your employer before taxes are taken out. You don’t pay taxes on your contributions or earnings until you withdraw. So if you're in a lower tax bracket then, you may come out ahead.
  • Roth 401(k): You contribute to a Roth 401(k) with money you've already paid taxes on, but when you withdraw that money, you don’t pay taxes on what your investments have earned as long as you meet a few requirements.
  • Traditional IRA: Depending on your income and whether you have access to a 401(k), you can deduct contributions you make to your IRA. Your earnings are tax deferred, so you’ll pay taxes when you withdraw. 
  • Roth IRA: You contribute to a Roth IRA with money you've already paid taxes on, but when you withdraw that money, you don’t pay taxes on what your investments have earned as long as you meet a few requirements.
  • 529 account: When you invest (after tax) dollars through a 529 college savings account, you won't pay taxes on what you earn if you use those earnings for qualified educational expenses.

Create a Source of Future Deductions

Many of the deductions highlighted earlier don't apply if you haven't planned ahead to make yourself eligible in the first place. Here are a couple of examples of how you could create the conditions that would give you access to potentially more impactful deduction opportunities. 

Starting your own company: There are many deductions you can take if you are running a business, though apparently you can expect additional IRS scrutiny if you haven't turned a profit in the last 3 out of 5 years. One creative example of how to benefit from having your own business that I read about here is to hire your kids. Some of the income they'll earn will be tax-free and if you pay them a reasonable wage and have them use those wages to pay for college, you will have essentially made college tuition deductible. That’s because you can deduct their wages as a business expense. Kids can also earn some income tax-free, so you can minimize taxes there as well.

Investing in real estate: There’s a nice high level overview of the tax benefits of investing in real estate in this article. Some of the highlights are that you can recover the cost of income-producing property through depreciation, use 1031 exchanges to defer profits from real estate investments, and shield profits on the sale of a personal residence from capital gains taxes.


Change the Circumstances that Define your Taxes

There are bigger life changes that you could also make to potentially save on taxes. I’ve listed a few of the possible changes that stood out to me below. Among them are some more extreme choices and all merit the input of a professional.  

Change how you earn: Earnings from investments held over a year are generally taxed at capital gains rates. Capital gains rates (for now) are 0%, 15% or 20% depending on your overall income level — lower than corresponding ordinary income tax rates. For those who recall the controversy around Mitt Romney’s infamous 13% effective tax rate, investment earnings taxed at capital gains rates were one of the driving forces in bringing down his overall average tax rate. So if you were to, say, become a big hedge fund manager or real estate tycoon, you too might end up in this bucket.

Change your filing status: Your filing status, specifically whether you are single or married, impacts your taxes. As this great interactive article from the NYTimes explains, “The marriage penalty is the additional taxes that couples pay when filing jointly, compared to what they would pay if each person were allowed to file individually. The penalty stems mostly from the fact that tax rates rise as income rises — and the brackets for married people and single people are different.” The penalty (or bonus for some) depends on how much a couple makes in total and how evenly their income is divided. If you’re likely to be in the penalty category, you could theoretically avoid getting married and save on taxes. Or you could consider getting married in January versus December, since the IRS considers you married for the entire year no matter when the wedding happened. Obviously this is a very personal life decision that should probably be predicated on a lot more than taxes.

Change the game: There are other, more extreme, strategies that I’d lump in this category as well, like creating a shell company to offshore money. I’ve included a few links in the resources section to some articles I found in this vein. It’s interesting reading but much of it seems ethically dubious to me and it’s unclear where tax minimization ends and tax evasion begins. Personally I do not see this path in my future.

Looking forwards, not backwards

At the end of the day, you have to pay taxes and it’s probably always going to seem like you’re handing over a ton of money. That’s kind of the deal we have with the Federal government to live in the US. Personally, this research has shown me that I have probably been missing out on some opportunities, but that I haven’t missed anything that was going to be life changing. The conclusion I’ve come to is that it’s time to start looking ahead instead of just looking backwards when it comes to taxes. It’s time to build a relationship with a CPA who can help me think more strategically about how to manage taxes over a longer time horizon, instead of just relying on tax prep software to identify the tactical tax breaks that already apply.

The Robo Advisor Rundown (Project: Account consolidation Part II - Where to invest)

In my last post, I talked about a project I’m working on to consolidate my financial accounts. My goal is to spend less time tracking what is where and more time thinking strategically about my entire portfolio. A critical step in that process is deciding where to consolidate those accounts, so here I’ll summarize the research I’ve done to make that decision.

I mentioned my preference for a passive investment strategy in a past post on putting idle cash to work. I also shared how I liked Vanguard funds as well as a new-ish category of algorithm-driven investment advisors called “robo advisors” as a means of executing on that passive strategy. The reason I like robo advisors is that they will figure out your asset allocation for you and will then handle portfolio rebalancing and tax optimization. It allows me to be pretty hands off, without having to work with a traditional financial advisor who would charge a lot more. Up to this point, I've been investing with a couple of different robo advisors to feel them out a bit. Now that I've decided to consolidate and might increase the money I let them manage, I decided to do a bit more scrutiny.

One thing to note is that I didn’t look every robo advisor out there. I concentrated on Betterment and Wealthfront as two of the larger start-ups in the category, Personal Capital which has interesting tools and a human advisor component, and the robo offerings that Schwab and Vanguard recently launched.

Here’s an overview of the robo advisor landscape from my perspective:

Wealthfront: a low friction, low cost way to get in the game

Wealthfront’s offer is pretty straightforward which makes it easy to start investing instead of sitting on the sidelines. They’ll use a model to generate a recommended asset allocation for you, build that portfolio out by buying into 7-8 ETFs (stocks, bonds, alternatives) on your behalf, rebalance the portfolio when necessary and take advantage of tax loss harvesting opportunities for you. They'll manage your first $10K for free (though you still pay the normal ETF fees) and the basic tax loss harvesting service is available for all accounts. I really like how it’s easy to see your account balance as compared to the deposits you have made, so you know if your balance is going up because of market performance or because of the money you’ve put in lately. I've found that this particular view of my investments to be surprisingly hard to come by with other services I've used in the past. 

Betterment: a goal-based lens on investing that’s helpful but limited

Betterment offers a lot of the same funds as Wealthfront, though they intentionally avoid alternatives (real estate funds and commodities) because they do not believe they’re a good bet for diversification or hedging against inflation. They also offer Large/Mid/Small Cap value equity funds, which Wealthfront does not. They approach building your portfolio through the lens of your financial goals. So if you tell them you want to have $150K in 15 years for college, they’ll calculate how much you need to save each month and how you should invest those funds to get there. Then they’ll automate the transfer of funds from your bank account to your Betterment account where it will get invested. It’s a very cool calculator, especially the RetireGuide portion, but the experience around external accounts was pretty disconnected which made their system seem a lot less useful to me. I was able to use external account information to calculate my retirement savings needs, but all of the tracking after that focused only on Betterment accounts. This incomplete picture made it hard to see how I was really doing in tracking towards my goals. Otherwise the service seems pretty solid. 

Personal Capital: awesome free tools, expensive advisory service

There are three components that drive Personal Capital’s recommendations: data they gather about you from their tools, their investment model, and input from a human advisor. They try to differentiate themselves from the pack through that human advisor who can offer guidance on a variety of financial planning topics. However, I have found that service to more of a helpful reference point than a true substitute for a financial planner. Personal Capital also differs in the assets they use to construct their portfolios. With the US stock component, instead of buying ETFs, they create their own index from >72 individual stocks to support their philosophy of equal sector and style weighting. This supposedly gives you better value for less risk. While you’re paying a premium over other robos for their investment services, they do have some great free digital tools. I really like how you can pull in all of your accounts and then view that data in different ways. You can see your overall portfolio asset allocation, calculate whether you’re on track to save for retirement, assess fees that you’re paying, etc. At minimum it's worth checking out their free tools.

Vanguard Personal Advisor: hand holding to implement Vanguard’s philosophy

Vanguard’s service gives you access to an advisor who will help you implement Vanguard’s philosophy. In a nutshell, that philosophy is to: set goals, diversify your investments very broadly, keep it inexpensive and stick with it for the long haul. The majority of your portfolio is going to be invested in very broad based index funds (domestic/international total stock and total bond funds) so you have to be bought into the idea that owning the entire market for the long term is the way to go. The advisor you work with will help you determine your initial asset allocation based on your goals and will check in with you periodically. The more money you hold with them, the more personalized attention you’ll get. They only offer advice on topics related to your investments. So they could help you understand the differences between, say, a Roth 401(k) versus a Traditional IRA, but they wouldn’t give you perspective on stuff like insurance or estate planning.

Schwab Intelligent Portfolios: Is free too good to be true? Yeah, maybe.

Schwab’s big standout feature is that they do not charge fees for the account services that you’d pay for with other robo advisors, like asset allocation, portfolio rebalancing and tax loss harvesting. The underlying funds that you will be invested in still come with fees, but that’s going to be true of any robo advisor you choose. The big caveat with Schwab...and for me this was a deal breaker...is that they make money from the underlying assets in your portfolio, both the ETFs and the cash. Actually it’s really just the cash part that bothers me, because the fees on the ETFs seem in line with what you’d pay elsewhere. No matter how I answered their portfolio allocation questionnaire, I couldn’t get the cash allocation to ever dip below 6%, even when the tool was recommending the other 94% be invested in stocks. This made me really skeptical about whether Schwab’s incentives were really aligned with mine.

My search didn't turn up the one perfect solution, but I do think there's a lot to be said for just getting started somewhere. If you have thoughts to share, please leave them in the comments as I'd be interested in hearing other people's perspectives, especially if you've tried these companies out. OK, now down into the weeds for those of you out there who like to geek out on the details... 

Here’s the criteria I used to compare these players:

Criteria Rationale
Assets Under Management (AUM) + Year established While size isn’t a predictor of the quality or future viability of the company, I felt more comfortable with players in the category who had a bit more of a track record.
Fees + Account minimums The account minimum is simply the ticket to entry. The fees that the provider charges add up quickly and translate to less money compounding in my account. Note that the funds you'll ultimately be investing in will also have related expenses that are not included in the robo advisor fees.
Investment options provided This is really the bread and butter of what the provider is doing for you - investing your money in different financial instruments. I wanted to understand what components each provider was working with to customize a portfolio for me.
Tax benefits offered Most offer some help with how to minimize the tax bill associated with the investments you hold with them. This matters less if you only plan to hold accounts where taxes on your earnings are deferred (401(k), IRA, 529, etc)
Asset allocation recommendation Each provider has to get to an initial recommendation of how to invest your portfolio among different types of assets (stocks, bonds, alternatives, etc.) I wanted to know how they got to that recommendation.
Portfolio rebalancing I wanted to understand what these players do when your portfolio inevitably drifts from that initial allocation because of fluctuations in the market.

Here’s how they each stack up against my criteria:

(All info as of Feb 2016) Betterment Wealthfront Personal Capital Vanguard Personal Advisor Schwab Intelligent Portfolios
AUM $3.2B ~$2.6B $1.5B $31B $4.1B
Year
established
August 2008 December 2012 July 2009 May 2015 May 2015
Account minimum $0 $500 $25,000 ($100K for more robust advisory service) $50,000 $5,000
Fees
(this doesn't include the expenses for the funds held in your portfolio)
0.35%
($0-$10K w/auto deposit)

0.25%
($10K - $100K)

0.15%
($100K+)
Free
($0-$10K)

0.25%
($10K+)
Free
(Analytics tools)

0.89%
($0-1M)

If you have >$1M invested, fees go down on a staggered schedule to as low as 0.49%
0.30%

Vanguard uses its own funds in your portfolio so they do stand to also make money on those funds. Since they're only using a few very broad based index funds, personally I didn't feel that the recommendation they made would be skewed to help them maximize their revenue.
No fees

Schwab makes money from both the funds and cash in your portfolio. Their funds generally seem pretty low cost, but as a novice investor, I couldn't really tell if the portfolio composition they recommended was more heavily weighted towards funds they'd make a larger profit on. I also questioned the cash recommendation I got. It seems to me you really are paying for their service but it's just harder to see.
Investment options Portfolios are invested in a mix of 12 ETFs. Details about their selection criteria are here. They notably make a point of avoiding alternatives (commodities and real estate) because they do not believe they’re a good bet for diversification or hedging against inflation. Their options are otherwise pretty similar to Wealthfront's, though they also offer Large/Mid/Small Cap value equity funds which Wealthfront does not. Portfolios are invested in a mix of 7-8 ETFs. Details about their selection criteria are here. They offer many of the same funds as Betterment (mostly Vanguard and iShares), but they differ in that they do inlcude natural resources and real estate funds. Portfolios are built from 5 asset categories: US stocks, international stocks, US bonds, international bonds, cash. Most categories are funds, but the US stock component is an index that PC builds from >72 individual stocks to support their philosophy of equal sector and style weighting.You can read more about it here, but basically they believe the more traditional approach of a capitalization-weighted index means you end up overexposed to large cap companies which could mean you’re overpaying and taking on more risk. Portfolios are built primarily with 4 very broad based Vanguard funds: total stock (domestic + international) and total bond (domestic and international). Portfolios might incorporate a couple of other index funds depending on the investor. 54 available exchange-traded funds – from Schwab and 10 other fund families representing 20 different asset classes, including stocks, bonds, emerging markets, real estate investment trusts (REITs) and commodities.
Tax benefits Tax Loss Harvesting for all accounts. They claim to have a better model for tax loss harvesting.You can read about it in detail here. Tax Loss Harvesting available for all accounts. “Tax-Optimized Direct Indexing” is available for accounts >$100,000 which they claim is even better. Advisers can help you think about how to strategically use taxable and tax-deferred accounts to minimize taxes. They seem to think the value of tax loss harvesting is over-hyped. Advisers can help you think about how to strategically use taxable and tax-deferred accounts to minimize taxes. They say tax loss harvesting isn’t a big focus because you’re buying and holding very broad based funds. Tax loss harvesting available for accounts with >$50K in assets.
Asset allocation recommendation Your recommendation is based on your age and the time horizon for a specific goal. They differentiate it from just being a Target Date Fund b/c you can customize your asset allocation and you can get advice on how changing parameters will help you meet your goal (e.g., retire later or save more per month) Your recommendation is based on a risk tolerance questionnaire and some investor profile information. They differentiate from being a Target Date Fund primarily because of the ability to customize risk tolerance, tax loss harvesting and the more diversified portfolio they offer. Your recommendation is based on risk tolerance assessment, investor profile data and info from a retirement planning tool on their site that helps identify goals and target savings required to hit those goals. It seems your data is fed into their model and then reviewed/adjusted by your advisor. Your recommendation is based on a conversation with an advisor about your goals, time horizon and risk tolerance. Unclear the role that technology is playing, but presumably your data is fed into a model and reviewed by an advisor. Your recommendation is developed through a 10-step questionnaire to determine your goals, time horizon, and risk profile.
Portfolio rebalancing Threshold of acceptable drift from target allocation is very transparent. They emphasize that they help you rebalance in a tax-efficient way. They monitor drift and rebalance in a tax-efficient manner on your behalf. Rebalancing thresholds aren’t stated as far as I could see. As a general rule, high-level asset classes are rebalanced if they deviate more than a few percentage points from target, while specific securities are reviewed if they move more than 0.5% from target. Taxes are strongly considered in the decision with a goal of keeping turnover under 15%. They rebalance for you when your portfolio has deviated more than 5% from your original allocation target. They automatically rebalances accounts that maintain a $5,000 balance.

For those of you who are curious, here's a bit about my research process on this topic. As a recovering management consultant, I treated this part of the project like the competitive assessments I used to do for clients. First I identified the players I wanted to compare and the criteria I wanted to use to assess them. Then I methodically filled in the blanks by reading a ton of articles, signing up for accounts and sometimes reaching out to the companies directly with questions. Lastly I did a brief executive summary for each player to call out the highlights of what I'd found.

Also please keep in mind that I'm sharing my opinions and that the data I have summarized could become outdated since the robo-advising market is evolving rapidly. I'm not an advisor and am not liable for information you might decide to use, but I do hope you will find this useful context. 

PROJECT: Account consolidation (part 1 - the road to sanity)

One of the most useful things I’ve done in my effort to get my finances more organized is to break down what started as a big project into several smaller projects. So instead of a massive, unwieldy to-do list that covers everything I want to work on, I track the projects I want to do and then map out the milestones and tasks for each project as I work on it. Thinking about the smaller projects individually feels much more manageable and once I complete a project, I call it a win and it motivates me to go tackle something else.

Recently I started tracking project milestones on a giant calendar I posted in my kitchen. Back when I led consulting projects at IDEO, we did this all the time and it was so helpful to see important meetings and deadlines at a glance. This paper calendar is intended as a complement to the digital stuff I maintain, a Google calendar and an Asana task list. It gives me a high level view of the progress I’m making and helps me integrate these projects with other things I have going on in other parts of my life. I was reminded of this great way to plan by a post about creative calendaring I read recently.

The project I’m working on right now is consolidating my accounts so I can be more intentional about how I manage across my assets and liabilities - checking accounts, investment accounts, loans, etc. Looking back, it seems totally reasonable that I ended up with account proliferation. I’ve worked for a few different employers and they’ve all used different companies to manage their retirement plans. There was never a good time to figure out what to do with my old 401(k)s. When I was trying to ramp up on the new job I was far too busy to think about it, and by the time I had my head above water, it was easier to just live with the status quo and do nothing. And retirement accounts are just the beginning. I have a few different student loans at different rates with different providers, a 529 account I just started for my kids...the list goes on.

I think it creates mental fatigue if you have a lot of accounts to track. I do like sites like Personal Capital that allow you to aggregate accounts into one view. It’s a good start, but I’d still prefer to have fewer accounts to aggregate into that view. It will mean less time spent keeping track of things like login IDs, passwords, account statements, and tax documents, and more time spent being strategic about how those accounts fit into my larger financial picture. I’d much rather spend time making sure I have the right types of accounts and scrutinizing the fees and interest rates I’m paying to hold those accounts. To put a finer point on this, I have had a Fidelity account with $0.33 for almost 10 years, leftover from some stock I sold when I worked for Yahoo! Any emails or statements I get from them are just noise -- a total waste of time and resources. I don't want that account as a line item on anything I have to look at, taking up space and distracting me from thinking about more important things. 

So here’s the outcome I’m hoping for with this current project...

Fewer accounts    >>    Less mental energy expended keeping track of what is where    >>    More energy spent being strategic about how those accounts fit into my larger financial bigger picture

...and here’s my checklist for get it done:

1/ Make a reference list of all accounts with their associated login IDs and passwords.

For me this step has so far included sitting on hold with customer service a few times to unlock accounts because I’d tried guessing at old passwords too many times. I have to say that dealing with customer service in the middle of a busy day is enough of a barrier that it’s probably part of the reason I haven’t done this sooner.

2/ Write down the plan of action for each account (hold it, roll it over, etc.)

I also included the account type (e.g., Traditional IRA, taxable investment account) and account balance on this list so I could look at the list with my husband and have a conversation about what the plan for each should be.

3/ Figure out where to consolidate accounts.

In my next post, I’ll do an in-depth assessment of different places that I’m considering consolidating investments. For now, I’m not going to get into consolidating debt.

4/ Systematically work through the list until consolidation is complete.

This project has already taken me a couple of weeks because it has to fit in with all of the other things I have going on. I’m finding that being really systematic about it, just focusing on getting to the next step and hitting the next milestone, has been a helpful way to continue making progress.

5/ High fives all around...

...or not. I think that’s actually part of the problem with personal finance projects like this. There’s not a super sexy outcome that you can tell your family and friends about. And the potential rewards are pretty long term so the benefit doesn’t feel all that tangible. I cannot picture myself saying ‘Woo hoo everybody, I just consolidated a bunch of investment accounts into fewer investment accounts so I can have better visibility into my finances and make better financial decisions in the future!’ I can just hear the crickets I'd get with a choice line like that already. So anyways, I’m open to any and all suggestions for a suitable way celebrate getting this done.

Check back soon (or subscribe) to see the in-depth research I'm doing on the best places to consolidate my investments.

Mindset makes all the difference

One of my big priorities in 2015 was to finally get my financial house in order. I was always so busy with my day job that I never had time to figure out what financial moves I should be making. When I mentioned this to others, I learned there were many in the same boat so I decided to share my experience and research on this blog. The support I’ve received since then has motivated me to make a lot of progress and it's empowering to now feel more connected to my finances.

Reflecting on all of this, I think the big thing that changed for me was that I started thinking about my finances as a designer. I spent many years as a Business Designer at IDEO and it was actually that experience more so than my business school education that has informed and inspired this project. Designers approach problems with curiosity and optimism. They see complexity as an opportunity to create something better and they are generative in coming up with solutions. The meatier the challenge, the more exciting it is to a designer. That was the attitude I needed finally tackle financial planning.

Before I mentally made this shift, I always had a slightly negative mindset when it came to my finances. That’s probably part of the reason why I avoided doing anything for so long. I’d think stuff like:

It’s too much work to figure out what I need to know to make a good decision...
I’ll never pay off these student loans and I’ll never get ahead living in the Bay Area...
Insurance and estate planning are so morbid that I’d rather just not think about it...
There’s so much to figure out and I don’t even know where to get started...

From conversations I’ve had with others, I know I’m not alone. Personal finance is a topic that is sometimes overwhelming, often boring and is generally not something people want to spend their time thinking about. Yet it’s so important to do. This is a huge disconnect and I think there’s a big opportunity to reframe. Personally, here’s the reframing I have done:


FROM feeling guilty about what I haven't done or have done wrong

TO feeling optimistic about the chance to do things right thing in the future


TO breaking the problem down and addressing it bit by bit in the small pockets of time I do have

FROM totally ignoring the problem because I don’t have the time to think about such big topics


TO approaching topics with curiosity and an interest in learning something new

FROM feeling overwhelmed by all of the details and nuances


TO finding a good solution and implementing it now

FROM waiting to find the perfect solution


In 2016 I intend to continue on with the blog. I have a few more personal finance topics I’d like to research, summarize, and share. I’d also like to start writing more about the intersection of personal finance and design. I think everyone should feel in control of their finances and I believe that design is a powerful tool to help make that happen.  

I've really appreciated the feedback and comments I've received so far. I hope this blog is something that others continue to find useful. If there are any areas or topics that you'd like to see in 2016, please let me know. 

 

 

What Happens When the Fed Raises Rates, In One Rube Goldberg Machine

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I thought retirement planning would be the last topic I wrote about for the year, but this is too good not to share. The Fed raised interest rates today for the first time in almost a decade. But what will that actually do to the economy? The NYT did an awesome explanation via a Rube Goldberg machine to show the chain reaction that the Fed's announcement today should set off.

I summarized the highlights below, but it's totally worth taking 2 minutes to check out the video and breakdown here.

  • The "Fed raised rates" meaning it raised its target for the federal funds rate, the rate at which banks lend to each other.
  • The cost of borrowing rises across the banking system and when banks and other financial institutions face higher costs, they pass those costs on to their customers in the form of higher short-term and long-term interest rates
  • Domestic assets like Treasuries and corporate bonds become more attractive to foreign investors because it’s more desirable to hold dollars if you’re receiving higher interest rates. But in order to buy these assets, those investors trade their currencies for dollars, driving up the dollar which is in greater demand.
  • As bonds become a more attractive investment, money flows into the bond market and away from the stock market
  • When banks raise rates, it affects different consumers differently. Taking out an auto loan, carrying a balance on a credit card, or buying a house with a mortgage becomes more expensive. Those with large savings at the bank will get larger interest payments. 
  • People may buy less, if they need to borrow to buy stuff, now that the cost of borrowing is higher
  • If people buy less stuff, the companies making that stuff may see slower sales and may not need to employ so many workers to make that stuff
  • With less demand for their products, businesses will feel less comfortable raising prices, and workers will be in a worse position to demand pay raises. Together, that means prices will rise even more slowly than they otherwise would across the economy. In other words, higher interest rates, after all that, have translated into less inflation.

Retirement Planning 201

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Before I started this project, my understanding of retirement planning was pretty basic. The general concepts made sense but I never had time to dive into the details. I appreciated that there were big tax advantages associated with different types of retirement accounts and that funding a 401(k), at least up to the point that your employer matches, was generally considered a good idea. I also realized that it’s hugely beneficial to invest  - and to start early - because of how your earnings compound over time. But that was about it.

Lately I’ve been going a bit deeper to figure out if I’m making all the right moves to position my family well for the future. The two big retirement questions that have been on my mind recently are…

  1. Are we saving enough to ensure that we can (at least) continue to fund our current lifestyle for as long as it needs funding?
  2. What financial vehicles should we be using to save for retirement?

On the first question, I have used several of the retirement calculators out there and ultimately built my own Excel model to figure out what we’ll need to sustain our current lifestyle. I highly recommend taking the time to answer this question for yourself. It has been a nagging concern of mine for some time and even just having an informed perspective on this has provided great peace of mind. After all, even if you’re tracking to totally run out of money, isn’t it better to know that now than to find out when you get there?

The rest of this post is dedicated to my second question: what financial vehicles should we be using to save for retirement? Below are the highlights of the research I did to figure out the answer for my family’s situation. As always, if you want to go deeper, I’ve listed the sources I used on the ‘Resources’ page of this blog. [Side note - since the audience on this blog has grown a bit recently, here’s the part where I remind everyone that I’m not a CFP or a CPA, but rather a zealous student of all things finance, an Excel geek, and a designer who believes that navigating your finances should just be easier.]

Q: What are the differences between some of the major types of retirement accounts out there?

Some of the most notable differences are in how you contribute, how the money you contribute gets invested and in what happens when you withdraw that money. So that’s how I broke things down in the table below. The management consultant in me always appreciates weighing the benefits and challenges inherent in any decision, so I’ve included my view of those as well. Note that there are other types of retirement accounts out there that I haven't included, like 403(b) plans offered by public schools or SEP plans targeted at those who are self employed. You can check out the IRS guide to retirement plans if you want to see a more comprehensive list. 

Vehicle CONTRIBUTE INVEST WITHDRAW Benefits Challenges
Traditional
401(k)


($18,000 annual contribution limit*)
- You elect to fund this account through your employer before your payroll taxes are taken out. - You can invest in a limited set of funds specified by your employer’s plan.

- Your earnings are tax deferred, meaning you’ll pay taxes on them when you withdraw.
- You pay taxes at the ordinary income tax rate when you withdraw.

- An additional 10% penalty is imposed on withdrawals before age 59.5.
- Money you would have otherwise given to the government in the form of taxes gets automatically invested, its' value compounds over time and then it’s taxed in retirement when you will quite possibly be in a lower tax bracket. - Your investment options are limited and can carry high fees, some of which can be pretty hidden.

- You have to take a required minimum distribution, starting at age 70 ½ or when you retire. If you don’t, you face a 50% excise tax.
Traditional IRA

($5,500 annual contribution limit*)
- You contribute pre-tax money by taking a deduction on your taxes. Your ability to actually claim the deduction though depends on your income, your tax-filing status and whether you can also contribute to a 401(k). - You can invest in a wide variety of investment vehicles. Things like insurance, antiques and a few other options are prohibited, but you have much more flexibility than with a 401(k).

- Your earnings are tax deferred.
- You pay taxes, generally at the ordinary income rate, when you withdraw your money.

- There’s an additional 10% penalty imposed on withdrawal before age 59.5.
- The tax deduction (if you qualify) lowers your tax burden the year you contribute.

- Your investments are sheltered from taxes as they grow and when the government gets its cut at retirement, you might be in a lower tax bracket, depending on your other income.

- You can hold a wide variety of investments.
- Your deduction may be limited if you (or your spouse, if you are married) are covered by a retirement plan at work and your income exceeds certain levels.

- You have to take a required minimum distribution, starting at age 70 ½ or face a 50% excise tax.
Roth IRA

($5,500 contribution limit*)
- You use money you’ve already paid taxes on to fund this account type and the contributions aren’t tax deductible. - You have a broad spectrum of investment options to shelter from taxes as they gain value over time.

- Taxes on anything you earn are deferred and won't be taxed at all, if you meet a few eligibility requirements.
- When you withdraw your money, you don’t pay taxes on your earnings as long as you’ve held the account for >5 years and you’re at least 59 ½ years old.

- You could face a 10% penalty if you withdraw your earnings early.
- The IRS takes its cut up front, so if you earn insane returns on your investments, you should get to keep it all, as long as you make qualified withdrawals.

- You can hold a broad set of investment vehicles.

- There are no minimum distributions required (while you’re alive).
- There are contribution limits depending on your income. (Apparently there’s also a “backdoor” into a Roth IRA if you exceed these limits; however, it may throw up some red flags on your taxes. I included some links to more info in the Resources section).
Roth 401(k)

($18,000 annual contribution limit*)
- You use money you’ve already paid taxes on to fund the account and the contributions aren’t tax deductible.

- Employer matching contributions go to the traditional 401(k), not the Roth 401(k).
- As with the regular 401(k), you are limited to the investment options you have through your employer.

- Similar to a Roth IRA, your investment returns are tax deferred and eligible withdrawals are tax-free.
- Qualified distributions aren't included in your income. Typically you have to be at least 59 ½ years old and have held the account for >5 years for distributions to be considered qualified. - Unlike a Roth IRA, there are no income caps that might limit your ability contribute.

- When you retire and start taking distributions, they won't get counted towards your income which may help you stay out of the higher tax brackets.
- You are required to start taking distributions when you retire or when you turn 70 ½, though it seems that you can rollover to a Roth IRA and avoid this. I haven't thoroughly researched this though.

- Only available for employees of companies that offer them.

*These contribution limits are per category, not per account type ($18,000 total across a Traditional and Roth 401(k) and $5,500 total across Traditional and Roth IRAs for 2015. There are also catch-up contributions that I haven’t listed for people >50 years old.

Q: Ok great, so which type of retirement account is better to invest in?

The more I dug into this, the tougher this question was to answer. Does the pre-tax advantage you get on the front end with a Traditional 401(k)/IRA outweigh the tax advantage you get on the back end with a Roth 401(k)/IRA?

Assessing tax implications is difficult because you have to make so many assumptions. What will your tax status be when you take distributions in the future? Will income tax rates increase over time? In general, you want to pay the IRS its share whenever your tax rate is the lowest, but it’s hard to figure out when that will be.

The general rule of thumb is to contribute to a Roth IRA/401(k) if your taxes are lower now and to contribute to a Traditional IRA/401(k) if your taxes will be lower in retirement. As a thought experiment, I ran some numbers to see how this actually played out. What I found was that the answer is a lot more nuanced. 

For one thing, you have to consider the tiered tax system in the US. Different levels of income are taxed at different rates. So if you’re in the “25% federal tax bracket,” your marginal tax rate, the rate at which your last dollar was taxed, is 25%. But your entire income was not taxed at that rate. Various taxes and credits also phase in and out at certain thresholds. So the combined effects of these two aspects of our tax system mean that identifying the best course of action is not very straightforward. You really need to run the numbers for your specific situation to get a solid answer. 

Another thing to keep in mind is the option value that some of these accounts provide. For instance, even if you ran the numbers and a Traditional IRA edged out a Roth, consider that the Traditional locks you into taking required minimum distributions which could then push you into higher tax brackets in retirement. A Roth is also nice if, at some point, you have an opportunity to invest in something with the potential for outsized returns because you wouldn't ever have to pay taxes on those earnings. 

The ultimate opinion I formed is that, if you can, it’s probably a good bet to diversify among different types of accounts. Shoot for some Traditional, some Roth and some regular taxable investment accounts. They each offer unique characteristics that make them worthwhile to have in your toolkit as the future unfolds. The most important thing to do, however, is to actually set up and fund these accounts. I often find myself worrying so much about making the perfect decision that I actually fail to make any decision at all. And that is definitely not a good strategy!

 

Should I afford it?

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Since I started this project, I’ve had a lot of really interesting conversations with others about how they approach their finances. Many of these conversations have been with accomplished professionals who aren’t in survival mode, living paycheck to paycheck, but who still need to worry somewhat about how they spend their money. 

Among this group, I’ve started to see a common theme. Many have a “buffer mindset” when it comes to their finances. They know they’re doing OK so they stop paying close attention. They aren’t going to struggle to pay the bills next month and if they want, they can occasionally splurge. But they would have trouble putting a finer point on how they’re doing financially than that. The padding they have in their paycheck and savings causes them to disconnect from their finances.

Making larger purchasing decisions with a buffer mindset can be tricky. It’s not a question of “can I afford it?” because if they wanted to, these people could probably write the check or line up the financing. It’s a question of “should I afford it?” What will taking that big vacation, upgrading to a nicer car or remodeling a bathroom do to the bigger financial picture?

For those who have faced this dilemma, I put together the infographic below as a provocation. This is a prototype that I'm interested in evolving over time, so if you have thoughts you're willing to share on how you approach the decision of "should I afford it?," please leave a comment or drop me a note.

THANKS ZANIFESTO FOR THE COOL INFOGRAPHIC DESIGN TOOL AND FONTS.

If you are interested in checking out some of the research I have done as I work to get more on top of my own finances, I've listed a few of my favorite topics below. Or you can subscribe for future updates. 

 

 

 

 

 

Putting idle cash to work

I wrote in an earlier post on Financial Baggage about my commitment to make more active choices with my finances--to intentionally design my financial future rather than letting it happen by default. One of the main areas where I’ve just been ignoring the issue is with investing. For many years I squirreled away any excess cash I earned in a checking account rather than investing it because I was afraid of making the wrong choice about where to put it. While managing to save anything in the Bay Area where the cost of living is ridiculous should feel like an accomplishment, I knew I was missing out on earning higher returns,  I was forgoing tax advantages, and I was probably getting killed by inflation. But still, I never felt like I had the time to do the research I wanted to make an informed choice. Instead I would put off thinking about it until “later.”

Well, “later” is today. Below are the questions I asked myself and highlights from the research I did to figure out how to be smarter with my savings. As always, if you want to go deeper, I’ve listed all the tools and articles I used on the Resources page of this blog.

To skip to the punchline of where I landed on this topic, I prioritized funding an emergency account, accelerating repayment on expensive student loans and setting aside some money for a few upcoming expenses. Then I focused on investing. I’m using a combination of robo-advisors and Vanguard funds to invest right now, but the jury is still out for me on the value of the robo-advisor.

Q: How should I prioritize where my available cash gets allocated?

A:  Here's my list...(1) Emergency fund (2) Expensive loans (3) Upcoming expenses (4) Investing to fund expenses with a longer time horizon

I have read a ton of articles, blogs and books about financial planning and investing since starting this project. While there’s seemingly overwhelming agreement out there on the importance of having an emergency fund and paying off credit cards, after that things get a little fuzzier. Many years of strategy consulting have predisposed me to using frameworks as a way to make sense of complex topics. So below is my attempt to create a simple framework to help prioritize financial objectives. Obviously I’m omitting a lot of nuance in favor of simplicity and clarity, but for me it’s always helpful to start simple and then add on layers of detail.

Priority Rationale
Start an emergency fund If life throws you a curveball, like a job loss or a major expense, your financial situation won’t force you into making hasty decisions.

I’ve frequently seen 6 mos of living expenses as the recommended amount to set aside in a pretty liquid account. You could always build up to that as you fund some of these other high priority areas in parallel.
Take advantage of 401(k) matching It’s basically a guaranteed way to double your money.
Pay down credit cards Credit card loans are crazy expensive.
Pay down mid-rate loans (~5-8%) It’s hard to come out ahead if you’re using cash to invest instead of paying down these loans because it’s unlikely that your after-tax investment return will be much higher than what you’re paying to borrow.
Set aside money for big, near term expenses It’s risky to put money in the market if you’ll need it in the next 5 or so years.

Note that there’s always a tradeoff between spending in the near term and saving for retirement. The earlier you start saving for retirement, the more opportunity you’ll have for returns to compound. However, it’s also important to enjoy life in the present which can mean spending in the short term. I built a spreadsheet to model out the long-term impact of short term spending which has made me feel much more confident about making larger purchasing decisions. Ping me if you’d like it.
Fund retirement accounts (401K, Roth IRA, IRA) Retirement accounts have tax benefits which is why I have them positioned ahead of taxable accounts. However, it’s important to weigh the tax advantages you’ll get against the investment options you’ll have access to and the fees you’ll pay. This can vary greatly.
Fund college savings accounts and other taxable investments I lumped these two together because personally I’m planning to fund some of my kid’s college education from a 529 college savings plan and some from taxable accounts. There are some tax advantages associated with vehicles like 529 plans, but you’ll also pay a 10% penalty if you decide to use the money for something other than education down the road. You also want to make sure you have your retirement needs covered because you can get financial aid for college but not for the old folks home.

Q: How should I be investing?

A: I'm focused on building a well diversified portfolio with low fees (a.k.a., low cost index funds)

To handle the last two categories on the table above, I needed a point of view on how to invest. Gulp! I think it was an undergrad financial accounting class I took that scared me off of investing for years. Our final project was to pick a company, analyze its financials and make a recommendation on whether or not to buy the stock. We picked Pyramid Brewing Company and I still remember that our final recommendation was to “buy the beer, not the stock.” My team put so much effort into making that recommendation that what I took away was just how much research is required to make a good decision. That experience, coupled with having a front row seat to the dotcom boom and bust, where start-up valuations were completely disconnected from a company’s fundamental value, has always made me leery about investing. You could do a lot of research and still get burned in an irrational market.

So while I may be taking a more active role in designing my financial life, from an investing standpoint I’m taking a passive approach. Instead of actively picking stocks or trying to get access to a really talented money manager to invest with, I’ve bought into a diversified portfolio that I plan to hold over the long term. The underlying philosophy of passive investing is that you can’t beat the market by identifying mispriced securities or trying to time the market...at least not in a way that will generate returns that exceed the costs involved to get those returns.

There’s a lot of widely accepted evidence out there indicating that this is a really solid strategy. A good read on this topic is “The Four Pillars of Investing” by William Bernstein where he shares a lot research on why this is a sound approach. There’s also a really good recent article by Stanford GSB professor Charles Lee called “How to Stay Rational When the Markets Go Crazy” that highlights some similar ideas about the value of investing in a diversified portfolio for the long term.

From some work I’ve done to model out how much I will need to fund a comfortable retirement, I have been astounded at how sensitive the model is to inflation and investment returns. [Translation for the non-excel geeks out there: Holy cow! The impact of fees and inflation, compounded over time, is really significant, even though a percentage point seems like something you should be able to just shrug off.]

With all this in mind, I’ve been focusing on investing in low cost index funds. Check the Resources tab for more info on what index funds are.

Q: How should I execute this investment approach?

A: I'm using Vanguard funds and robo-advisors

An investment philosophy is only useful if you actually put it to work. I’d imagine taking the next step and moving money around is where a lot of people get hung up. That was certainly true for me. First, there’s the decision of what company you’re going to entrust with the privilege of managing your hard earned cash. Then there’s the emotional moment where you actually transfer your cash, thereby putting it at risk by investing it. Sure, it may be a smart risk you’re taking that history has shown works out over the long term. But the disclaimer you often see plastered all over anything related to investment advice, “past performance is not indicative of future results,” is true. Nobody knows what the future holds, so there’s always a risk. At some point your portfolio will likely be down...possibly way down.

To address the point about picking the right company, I considered two options to build a diversified portfolio while keeping fees low: (1) buying into index funds myself and (2) using “robo advisors” to invest for me. Vanguard funds are particularly popular index funds because they are so low cost. The history of Vanguard is actually pretty interesting. It’s a mutual fund company created in the 1970’s that wasn't designed to earn profits for a management firm. Instead, it redirects net profits to fund shareholders in the form of lower costs.

On the other hand, robo advisors are a recent innovation in the investing space. They provide automated, algorithm-based portfolio management advice and many use ETFs as a primary investment vehicle. The main benefit is that they help you figure out how to allocate your portfolio for much less than you’d pay a fund manager who would typically take 1%+ to invest on your behalf. Many, though not all, have much lower investment minimums than traditional players. Tax loss harvesting to lower your tax bill is also a benefit they frequently offer. The basic idea behind tax loss harvesting is that by selling a security that has experienced a loss and then buying a similar asset to replace it, you can realize, or “harvest”, a loss on the asset while keeping your portfolio balanced at your desired allocation.

Several companies have emerged since the category was created in 2010, many with help from the huge amount of venture money that is flowing into the sector. Some of the largest players include Betterment, Wealthfront, Personal Capital, FutureAdvisor, SigFig, Vanguard Personal Advisor Services and Schwab Intelligent Portfolios. Established players like Vanguard and Schwab are getting into the space with their own competitive offer as this category is heating up.

In the Resources section of this site, I link to a number of articles that highlight the relative merits of robo advisors and can guide you through picking one if this style of managing your money interests you. I have accounts set up with several of these players as a way to actively follow this rapidly evolving space in addition to meeting my investment objectives. With some, I have an investment account, with others I just have a free account so I can asses their offer.  On the Tools page, I have listed what has stood out for me so far. The bottom line is that a lot of the offers are pretty similar. One big difference is that some charge a bit more but also give you a person to talk to. In the spirit of taking action, I picked a couple of different players to invest with and just got going.

Lastly, I want to comment on the slight sinking feeling I had when I actually transferred money from my bank account to set up investment accounts. In my opinion, it’s best to avoid this feeling altogether by investing a little bit at a time. I wish I would have been more proactive about setting up small, automated transfers from my paycheck to an investment account a long time ago. That approach has the two benefits. First, you’re not timing the market because you’re investing a little bit over a long time horizon. Second, you stop thinking about the fact that you’re investing if you’re automating things. If you’re in it for the long haul, it’s probably better to ignore short term market fluctuations anyway because they’ll just make you second guess yourself. 

529, What?!

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Opening up a college savings account has been on my list of things to do…for years. About 5 years to be exact, the age of my oldest daughter. The problem is that raising small children and researching college savings plans are not very compatible activities. Every time I’d start to do a little homework to figure out what a 529 was, I wouldn’t get deep enough before I’d get interrupted by a toddler waking up or by an emergency after-hours work email.

At last I’ve finally had the time to dig in and do enough research to feel confident in how to proceed. When it comes to doing research, I love getting into the details but I have limited this post to just the highlights of what I learned. This is a fairly meaty topic and everyone’s situation is going to be slightly different, so if you want to go deeper I’ve listed my sources on the ‘Resources’ page of this blog.

My ultimate decision was to set up an automatic monthly withdrawal to target funding 50% of a public school education through the Nevada 529 Plan for each of my children. I’m planning to revisit that decision periodically since my financial circumstances and the regulatory environment can always change. My thinking is that I’ll fund the rest of the kids’ tuition through my regular investment accounts.

For what it’s worth, I also considered contributing to a Private College Prepaid 529 which can be transferred to a regular 529 if my kids don’t attend one of the participating colleges and a Coverdell Education Savings account which can be used to invest like a self-directed IRA. In the interest of not hitting analysis paralysis, for now I’m keeping it simple with just the 529 Plan.

Below are highlights of what I learned to arrive at that decision, based on the questions that were top of mind for me.

Q: What are the ways I can save for college?

There are many possible ways to pay for a college education. Here’s a list I compiled of some of the more popular savings vehicles, along with the pros and cons of each. The option that was by far the most frequently mentioned was a 529 plan, so I shared a little more detail on that one below this chart. If you want to do a detailed comparison, savingforcollege.com offers a great tool to see a comparison of college savings options.

Plan Description Pros Cons
529 Plan Tax-advantaged savings account authorized by Section 529 of the Internal Revenue Code, specifically for qualified post-secondary education costs
  • Earnings grow tax-deferred and distributions are tax-free when used for qualified post-secondary education costs
  • Can deduct contributions from income taxes in some states (sadly not California)
  • With few exceptions, the named beneficiary has no legal rights to the funds
  • Can change account beneficiaries, so if you don’t use the money for one child, you can use it for another member of the beneficiary’s family
  • 10% penalty when distributions aren’t used for qualified expenses
  • Considered a parental asset on the FAFSA which will reduce a student's aid package by a maximum of 5.64% of the asset's value
  • Limited investment options, some plans carry high fees which can significantly cut into your earnings
Prepaid 529 Plan A plan that lets you pre-pay all or part of the costs of an in-state public college education. They may also be converted for use at private and out-of-state colleges. The Private College 529 Plan is a separate prepaid plan for private colleges.
  • College costs have been skyrocketing recently so this program allows you to lock-in today’s rates, making the rate of return on the investment equals the rate of tuition increase
  • Participation is often restricted and a limited number of states offer them
  • Geared toward in-state public institutionsYour principal plus earnings may not cover tuition and fees if the student decides to attend a private or out-of-state college or university
  • Pulling out of a prepaid tuition plan can result in stiff penalties
  • Narrow definition of college expenses
Coverdell Education Savings account A tax deferred account dedicated to saving for education expenses (both college and K-12 expenses)
  • Earnings grow tax-deferred and distributions are tax-free when used for qualified education expenses
  • Investment options aren’t as limited as 529 plans - you can self-direct investments, much like a self-directed IRA
  • $2000 annual contribution limit. If total contributions exceed $2,000 in a year, a penalty will be owed10% penalty when distributions aren’t used for qualified expenses
  • Considered a parental asset on the FAFSA which will reduce a student's aid package by a maximum of 5.64% of the asset's value
  • Contributors have income limits, but children (whose income would be below those thresholds can be contributors)
  • Distributions from an ESA are always paid to the beneficiary and cannot come back to parent
UTMA/UGMA Accounts (Uniform Transfer to Minors / Uniform Gifts to Minors) Custodial accounts that allow you to save on behalf of a child for education (or any other purpose that benefits the child) until they reach the age of majority in their state
  • Because the assets are considered the property of the minor, these accounts are often used to take advantage of the “kiddie tax.” The kiddie tax allows a certain amount of a minor’s income to go untaxed, and an equal amount to be taxed at the child’s tax rate (as opposed to mom and dad’s rate)
  • There is no penalty if account assets aren't used for college
  • Contributions are irrevocable and you can’t change beneficiaries
  • Upon reaching the age of majority, the beneficiary can use the assets for any purpose—educational or otherwise
  • There is a significant impact on federal financial aid. The account is treated as the child's asset and weighed more heavily in financial aid calculations
  • Contributions aren't tax-deductible and earnings are subject to federal income or capital gains tax
US Savings Bonds EE and I bonds purchased after 1989 by someone at least 24 years old may be redeemed tax-free when the bond owners, their spouses, or dependents pay for college tuition and fees
  • Interest earned may be exempt from federal income tax if bond proceeds are used to pay the beneficiary's qualified education expenses, provided certain other conditions are met
  • Bonds are backed by the federal government, hopefully the rate you'll earn is guaranteed
  • You retain control of the bonds as long as they are owned in your name
  • Bond proceeds not used for the beneficiary's qualified higher education expenses will be taxed
  • Income must be below a certain level at the time you redeem the bonds for you to be eligible to exclude the interest earned from federal income tax (yet you must add bond proceeds into your total income for the year when determining whether you meet this income threshold). In 2014, the tax exclusion is phased out for incomes between $76,000 and $91,000 (between $113,950 and $143,950 for married taxpayers filing jointly)

Note, there are other ways you could conceivably fund your child’s college education. Some people do it through their IRA or insurance policies. I didn’t see any huge benefit to doing this and these options seemed pretty complicated and possibly risky.

More detail about 529 Plans…

Because 529s are so popular and because that’s the option I decided to pursue, here are some more detailed notes about their advantages and disadvantages:

529 Details: Advantages

There are significant tax benefits. The biggest benefit is that earnings are tax-deferred. You invest in a 529 plan with after-tax money but you don’t pay capital gains on the appreciation of your 529 account when the money is withdrawn. All money inside the account grows tax free and distributions made to pay for education expenses are not taxed. So it works like a Roth IRA. Also, some states allow you to deduct contributions from your taxes, though sadly my home state is not one of them.

It’s basically a pool of money, controlled by the account holder, that you can target to any family member for education expenses. You need to set up the account for a specific beneficiary, but if that person doesn’t use all of the funds, you can change the beneficiary to another family member, like a sibling or a parent. Also the account holder maintains control of the funds, not the beneficiary. There’s a $14,000 annual contribution limit – the federal gift tax limit – though there seem to be a few exceptions to that if you’re trying to catch-up on contributions.

It’s an easy way to make sure you’re saving for college. Once you set up the automatic withdrawals, you can passively monitor the account.

529 Details: Disadvantages

Investing in a 529 limits how you can allocate those funds in the future. When a withdrawal is taken but is not used for “qualified higher education expenses,” the earnings may be subject to income tax plus a 10% penalty tax. A few people have also pointed out that students can get a loan to pay for school but parents can’t get a loan to pay for retirement. For this reason, I decided to target paying for a portion of my children’s projected education expenses and plan to pay for the rest from other savings.

There’s a possible reduction in the beneficiary’s ability to receive financial aid.However, I’ve read that when it comes to financial aid, these plans are treated very favorably. They are owned by a parent, so they are assessed at just the 5.64% parental asset rate for the expected family contribution (EFC), and the distributions are not counted as base year income on the FAFSA.

Investment options are limited and you need to watch the fees. Apparently fees have been coming down recently and it’s easy to compare fees on sites like savingforcollege.com to find a low cost plan.

Q: How should I think about the tradeoff between saving for retirement and saving for college? How much should I plan to set aside for college?

The best advice I’ve seen on how to make this decision is to err towards funding your retirement because you can apply for financial aid to pay for college but there are no financial aid packages for retirement. You don’t want to support your kid’s college education, but burden them later with elder care costs.

Many experts advise taking full advantage of retirement accounts like 401(k)s and IRAs before you start funding college savings, especially if you have employer matching.  Assets in retirement accounts will not affect your child’s prospects for federal financial aid (unless you actually take distributions from them during the college years).

To figure out specifically how much to set aside, I used a combination of of online calculators, like the one on savingforcollege.com, and the ‘Options Viewer’ tool I built to explore future wealth scenarios and land on a number.

Q: There are so many 529 options, which one do I pick?

I looked for a plan with low fees and an adequate number of investment fund choices. Ultimately I narrowed down the search to states that had Vanguard funds and then compared the details of those plans on savingforcollege.com. I looked in particular at Nevada, Utah and New York. New York’s plan description made it seem challenging to transfer assets into another state’s 529 plan if that ever became necessary so I steered away for that reason. Ultimately I liked that Nevada was fully supported by Vanguard customer service whereas Utah was not.

The Un-Budget

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I hate budgeting. It’s so tedious and boring that I find it hard to stick with. As a naturally thrifty person, I’ve typically relied on the “gut check” method of budgeting instead. By that I mean I’ve had an intuitive sense for how much my earning compared to my spending. I was confident each month I wasn’t going into the red and when I felt like I’d built up a bit of a cushion, I’d start thinking about making a larger purchase or planning a trip. Other than that I didn’t pay too much attention.

I’ve tried several budgeting apps and tools that supposedly make budgeting easier. At best the spending category breakdowns that most seem to center around were only marginally insightful. At worst they felt paternalistic, like they were scolding me for being $3 over my coffee budget for the month. Maybe an extra latte made the difference in that big presentation, Mint, did you ever think about that?!

The problem with the “gut check” method is that I was in the dark about what my financial truths were. What did my spending patterns look like? What was normal for me? What trends were emerging over time? Was I OK with all of this?

Having this baseline understanding also turned out to be crucial for planning ahead. Knowing how much to have on hand in case of emergencies and how much I’d need to plan for in retirement all started with a monthly financial snapshot. Connecting today’s spending with tomorrow’s saving was also a missing piece for me.

With all that in mind, I created an ‘Un-Budget.’ It quickly allows me to see spending patterns so I can make decisions more confidently. It’s now much easier for me to answer a question that has often loomed large with bigger purchases: “Should I afford it?” Even if I knew I could afford something – I could cover the purchase without jeopardizing monthly rent or being forced to eat Top Ramen – I didn’t have a sense for the longer term impact a large purchase today might have. My Un-Budget pulls from Yodlee, so it still has all the automated goodness of those other budgeting apps that are probably still wagging a finger at me from my inbox.

If you’d like to try out my Un-Budget, send me a note and I’ll pass it along.

Financial Baggage - Part 2

Past financial mistakes and missed opportunities aren’t the only kind of financial baggage I’ve sorted through. I include debt as a form of financial baggage because it’s something that you’ll have hanging over your head until you pay it off. But it’s more concrete since there are numbers (and bill collectors!) attached. The good news is that this actually makes debt a much more straightforward form of baggage to deal with. In my case, a little research helped me quickly decide which loans to target for rapid repayment and which to keep in favor of directing free cash flow elsewhere.

In that research, I found a couple of good resources that I’ve shared on the Resources page. I’ve always known better than to carry a balance on my credit cards because of their ridiculously high APRs and I’ve appreciated the value of a mortgage’s tax and investment benefits. But I wanted a little guidance on where to draw the line on other forms of debt like student loans.

The rule of thumb I used to make the call was to compare my after-tax cost of borrowing to my after-tax return on investing. It’s important to consider the after-tax cost of borrowing because that lowers the true cost of debt for things like mortgages since you can deduct them from your federal taxes. It also means that you should consider the tax advantages of investing in a 401K plan, especially if there’s an employer match. Other things to consider are liquidity and risk tolerance. Most financial planning sites I’ve seen point out the importance of setting aside 3-6 months of liquid assets for emergencies before you do anything else.

Here’s a quick order of priority list from Bogleheads. Obviously this will depend on your personal situation and rates at any given time. For someone like me, though, who often falls into the trap of not making a decision because I’m too caught up in all the details, a rough guide like this was helpful (and sufficient!)

  • Invest in 401(k) to get maximum employer match
  • Pay down credit cards (rate 10-30+%)
  • Pay down non-deductible auto/student loans/other medium-rate loans (rate 5-8%)
  • Invest in Roth IRA, deductible IRA or decent 401(k) (rate 5% on Treasury bonds)
  • Pay down deductible mortgage or student loans (rate 4% after tax)
  • Invest in taxable account (rate 4% on municipal bonds)
  • Do not pay down subsidized loans as long as subsidy lasts (rate 0-3%)

All the sources I used to research this topic are on the 'Resources' tab.

From Meaning to Money

I have looked at many, many examples of financial plans in search of a tool that could help me create a useful wealth plan. Most plans I have come across start with goal setting and end with a model of how to fund those goals. I can appreciate how that’s a reasonable, sound approach. It just wasn’t for me. Don’t get me wrong, I’m very Type A and love working towards goals. When it comes to planning out my financial future, however, I just didn’t think that was the right place to start. For one thing, I actually found it kind of depressing. I remember looking through a seemingly promising retirement planning tool with several sample goals. One of those goals was ‘new sedan every 5 years.’ I pictured myself at 63 looking forward to a new beige sedan, still 2 years away, and it just made me sad.

Instead I chose to start with what was meaningful in my life and worked backwards to the money part. What made more sense to me was to think about personal milestones and to take stock of my values first. Then I thought about how my finances could play a supporting role.

Inspired by tools I had created at IDEO to uncover insights about people’s relationships with their finances, I designed a worksheet that I could use on myself (and my spouse) to serve as a foundation for our family wealth plan. This tool helped us map out what mattered most and showed how that connected to our finances.

The exercise revealed that, for us, it’s not about how much stuff we will acquire throughout our lives or when we’ll acquire it. And it’s certainly not about buying a new beige sedan every 5 years. We do, however, value feeling financially secure. We wanted to know that we’d have enough to continue our lifestyle in perpetuity. We wanted to feel prepared for the unexpected should something financially significant and out of our control happen–like a medical emergency or a major car repair.

We also highly valued things like time with family and friends and learning–both through formal education and through experiences. After knowing that the essentials were taken care of, we wanted to understand what options were available to us to spend money on things we valued. What could we fund? Should we be coordinating low cost things like hikes and potlucks to spend time with family and friends? Or could we be shopping for a vacation home where many future memories would be made?

Starting with the heart – personal milestones and values – helped lay the foundation for a wealth plan that was much more relevant and meaningful. From there, I could see how to build something that was just as thorough as other planning tools out there, yet was a much more valuable resource that I could use to guide important future decisions.

If you’re interested in trying out the tools I created, please drop me a note and I’ll send them your way. (kate at wealthredesigned.com)

Wealth, Redesigned.

It’s time for me to come clean. I have undergraduate degree in business and an MBA, both from top-tier schools and yet I basically ignored my personal finances for over a decade. As a “business person” I always felt like I should be more on top of my finances and it embarrassed me that I wasn’t. At work, I’d build detailed financial models to support decisions where tens of millions of dollars were at stake. At home, I had accounts scattered everywhere and had lost the password to most of them.

Of course I knew better. I should have been prudently setting up retirement accounts and investing wisely. But any cash I earned above what I spent went into a checking account and just sat there earning no interest. I wasn’t doing everything wrong but I felt guilty not having more of a plan. I was just too busy to do anything about it. My career was taking almost everything I had. I devoted any extra time I had to building relationships and living out my 20’s to the fullest.

When I turned to financial planners for assistance, I was sorely disappointed. First, there were those whose credentials I didn’t respect. I trusted my financial instincts far more than theirs and yet I was supposed to put them in charge of planning out my financial future? Then there were those who tried to sell me insurance because that’s how they made their money. Clearly I didn’t trust them either. The high fliers at the prestigious firms weren’t an option because my accounts weren’t substantial enough. The person who I wanted working on my behalf was was as well-educated and as dedicated to their job as I was to mine. I never found that person so, suppressing occasional anxiety about not having a plan, I set up automatic paycheck deposits and hoped for the best.

In my 30’s, I made the tough decision to leave a dream job to stay home with my two young children. As a Business Designer at IDEO, a product design and innovation firm, I had spent many years advising financial services companies on how to create better products and services for their customers. As a stay-at-home mom, one of my top priorities was to turn my attention on my own finances to design a wealth plan for my family.

Throughout this journey, two things surprised me:

First, I realized that there are many out there like me. I’ve met a lot of smart, accomplished people who don’t want to completely outsource their financial future. They want to rely on their own judgement, yet they’re so busy trying to crush it in their professional lives that they simply don’t have the time for personal finance.

Second, I was shocked by how terrible the experience of creating a financial plan is. Talk about a space ripe for better user experience design! There are some bright spots of innovation out there – notably in the budgeting and investing spaces – but nothing that would help me put together a holistic financial plan with the transparency and insight I was looking for.

I’ve created this blog to share my journey, with the hope that what I’ve learned will help others in the same boat. I’m not a CFP or a CPA, but I am a zealous student of all things finance, an Excel geek, and a designer with a passion for designing better user experiences.