Some Advice on Fixing Mistakes

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Topic Author
ascarrul
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Joined: Tue Jun 17, 2014 9:31 am

Some Advice on Fixing Mistakes

Post by ascarrul »

Hi, I need a little advice. I am 34 and just now learning how to financially responsible. Unfotunately when i was younger i made a lot of bad choices during my college years and now have 64k in student loans. Here is a brief summary of my financial picture:

Debts:
Mortgage @ 4.5% 216k
Car loan @ 3% 2800
Unsubsidized Federal Loan @5.5% 43k
Subsidized Federal Loan @ 5.5% 21k

Assets:
House value: 240k
IRA's:8000
SIMPLE IRA:3000
E-FUND:4000

My income is 55k/yr and my GF helps out with the mortgage so i am able to save. The house was just bought last year so there is not much equity in it. I am currently contributing 3% to my SIMPLE plan and putting away 458 in my ROTH. In addition i can save approximately 700 every month. I also have a small music studio worth about 10k that i dont use very much anymore(but am very emotionally attached to) that i am thinking about selling.

So i have a few questions.
1. Where should all my extra cash go to? Should i tackle my student loans or max out my SIMPLE IRA.
2. Should i liquidate my music studio and pay off a chunk of my loans?
3. Which loans should i tackle first? (I get income tax deductions on mortgage and student loans so the math is fuzzy)
4. Should i simply prioritize investing over everything else?

I have made a spreadsheet and it seems the math says to max out retirement accounts, then tackle student loans but am not sure if that's the best route for the real world.

Thanks in advance.
wilked
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Re: Some Advice on Fixing Mistakes

Post by wilked »

Welcome!

Some general notes:

-Don't worry about mistakes, worry about what is in your control. You are asking excellent questions!
-Your emergency fund feels very low. It looks like it would cover maybe 2 months of expenses for you. What if you need a new hot water heater, refrigerator, etc for the house? I would suggest building it to ~6 months expenses.

Now, specific questions:

1. Where should all my extra cash go to? Should i tackle my student loans or max out my SIMPLE IRA.
A: I suggest aggressively paying down the student loans. A guaranteed 5.5% is really nice. You can deduct up to $2500 in interest from this on your taxes. I calculate you pay $3500 in taxes or so, so I would at least pay down enough to where you maximize your interest deduction. I calculate this to be ~$20,000.

2. Should i liquidate my music studio and pay off a chunk of my loans?
A: Personal decision, that is up to you. It is not enough to make me advise strongly one way or another.

3. Which loans should i tackle first? (I get income tax deductions on mortgage and student loans so the math is fuzzy)
A: Tackle the student loans first, until balance is reduced to about $40,000

4. Should i simply prioritize investing over everything else?
A: No. You should prioritize a healthy emergency fund first, then student loan reduction to the point where you can maximize student loan interest deduction, then report back
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Taylor Larimore
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Re: Some Advice on Fixing Mistakes

Post by Taylor Larimore »

wilked wrote:Welcome!

Some general notes:

-Don't worry about mistakes, worry about what is in your control. You are asking excellent questions!
-Your emergency fund feels very low. It looks like it would cover maybe 2 months of expenses for you. What if you need a new hot water heater, refrigerator, etc for the house? I would suggest building it to ~6 months expenses.

Now, specific questions:

1. Where should all my extra cash go to? Should i tackle my student loans or max out my SIMPLE IRA.
A: I suggest aggressively paying down the student loans. A guaranteed 5.5% is really nice. You can deduct up to $2500 in interest from this on your taxes. I calculate you pay $3500 in taxes or so, so I would at least pay down enough to where you maximize your interest deduction. I calculate this to be ~$20,000.

2. Should i liquidate my music studio and pay off a chunk of my loans?
A: Personal decision, that is up to you. It is not enough to make me advise strongly one way or another.

3. Which loans should i tackle first? (I get income tax deductions on mortgage and student loans so the math is fuzzy)
A: Tackle the student loans first, until balance is reduced to about $40,000

4. Should i simply prioritize investing over everything else?
A: No. You should prioritize a healthy emergency fund first, then student loan reduction to the point where you can maximize student loan interest deduction, then report back
Wilked:

A very specific and helpful reply!

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
bcjb
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Re: Some Advice on Fixing Mistakes

Post by bcjb »

I just wrote the reply below, but I think I could have written +1 for the post by wilked. :-)

Welcome to the forum!

I don't think you've made any real mistakes; it's fairly common to get into debt as a student and to spend your 20s saving aimlessly rather than investing. (We also only started investing -properly- at age 34.) You're still young and you now make a decent salary, so I think you're in OK shape.

1. Whether you prefer to max your SIMPLE IRA or pay down your student loans depends on how much you expect to get in the market. I'd say, pay down your student loans, since that's a guaranteed 5.5% return, and prospective estimated returns are fairly low. (Google e.g. Rick Ferri on expected 30-year returns by asset class.) On the other hand, if you don't use tax-advantaged space, you lose it. So I suggest focusing primarily on the student loans, but slowly increasing the percentage you contribute to your SIMPLE plan. E.g., 4% in 2015, 5% in 2016, etc., until you max it every year. If you do this slowly, you won't miss the money. If you get a raise, don't spend it, and just put it towards either the loans or the retirement plan.

2. The music studio is worth $10,000, so that's not a whole lot, and you say you're very emotionally attached to it. Most people would recommend that you sell, but maybe you could motivate yourself to save the studio by e.g. budgeting more carefully over the next two years, and saving an extra $10,000 that way.

3. The car loan is not very large, but it's consumer debt that you should ideally not have taken on. Some people would suggest that you start with this, since you can pay it back quickly and that might give you a psychological boost. I think you should tackle the student loans first, since it's a substantial amount of money, the interest is higher, and the loans won't be discharged in bankruptcy.

4. I think the emergency fund is your first priority. $4000 might be enough for you - it depends on your monthly expenses - but it looks a bit low. You own a home, and you might at some point face unexpected, expensive repairs that can't be put off. After that, as I said, I think you should continue to contribute to your retirement accounts while also paying down the student loans.
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sdsailing
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Re: Some Advice on Fixing Mistakes

Post by sdsailing »

Can you rent out the studio?
Topic Author
ascarrul
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Re: Some Advice on Fixing Mistakes

Post by ascarrul »

sdsailing wrote:Can you rent out the studio?
I very much doubt i could rent it. Its mostly a collection of vintage instruments. I used to use them a lot but lately my interest in music has declined but am not sure if i am done with it yet.
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Zabar
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Re: Some Advice on Fixing Mistakes

Post by Zabar »

ascarrul wrote:1. Where should all my extra cash go to? Should i tackle my student loans or max out my SIMPLE IRA.
2. Should i liquidate my music studio and pay off a chunk of my loans?
3. Which loans should i tackle first? (I get income tax deductions on mortgage and student loans so the math is fuzzy)
4. Should i simply prioritize investing over everything else?
Welcome to the forum, ascarrul. As was said earlier, don't worry about any mistakes you made in the past. You're young, employed, and not in a crisis.

1. I'd increase your emergency fund first.
2. Enjoy the music studio rather than liquidate it. Think of it as a source of no-cost/low-cost entertainment. Besides, the value of recording hardware and software plummets during its first year or two. (Unless you have a matched pair of Neuman U87s, in which case we should talk! :D ) I can buy a tremendous amount of used gear for $10,000; you may not get much for what's currently giving you pleasure.
3. Don't let the tax tail wag the loan payoff dog. (Sorry for the terrible metaphor.) Personally, I'd attack the student loans first because they can't be discharged in bankruptcy and the rates are relatively high--although not nearly as bad as some private loans.
4. Absolutely not! Remember that money is fungible. Paying off a 5.5% loan is (very close to) functionally the same as earning 5.5% on an investment. Build your emergency fund. Invest in retirement up to your employer's match, since that's free money. Then reassess what makes sense as the next step.

Good luck!
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celia
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Re: Some Advice on Fixing Mistakes

Post by celia »

How about setting yourself a deadline, say the end of the year, for you to max out the use of your studio? Play your greatest music, record your last song, or whatever you used to like to do. Get this past love out of your system (sorry if that comes across wrong). If you don't get around to it, that shows it is "history" and you're no longer interested and it's time to move on.

Selling the studio will give you an instant emergency fund. Owning a house or having dependents or having a job means you need to have an emergency fund of at least 6 months of living expenses. You know that "emergencies" will happen, but "when" or "what" is the unknown. So be prepared instead of worrying about it when it happens.

I will add that you have done better than you realize. You have some assets, but by prepaying some of the loans, that will probably give you some peace of mind.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
Topic Author
ascarrul
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Re: Some Advice on Fixing Mistakes

Post by ascarrul »

So it seems everyone is suggesting i build up my Emergency Fund first. But seems to me having 6 months of expenses(15,000) sitting in a 0% savings account is a waste. Am i wrong? Would it be better to have say 5k in savings to cover immediate needs and the rest in some sort of low risk investment account that yields better than 0%?
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celia
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Re: Some Advice on Fixing Mistakes

Post by celia »

That's fine.

The point is to have a ready source of money in an emergency, without having to sell a house, car, or investments that have lost money. If you had to put the bill on a credit card, you want to know that it could easily be paid off in the current billing cycle. Carrying a balance on a credit card from month to month is the absolute WORST way to pay for something, because of the high interest rates on credit cards!
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Taylor Larimore
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Emergency funds ?

Post by Taylor Larimore »

ascarrul wrote:So it seems everyone is suggesting i build up my Emergency Fund first. But seems to me having 6 months of expenses(15,000) sitting in a 0% savings account is a waste. Am i wrong? Would it be better to have say 5k in savings to cover immediate needs and the rest in some sort of low risk investment account that yields better than 0%?
ascarrul:

This is an earlier post of mine:
In my opinion, most investors do not need a separate "Emergency Fund" as described above. What we need is a "source" of ready cash--not necessarily another separate, low-yielding account (other than a checking account).

Pat and I have not had a separate "Emergency Fund" for many years. Like most Bogleheads, we know that if it becomes necessary, we can get money from our checking account, portfolio, credit card, bank, home equity loan, life insurance, family, etc.

For young working investors, a Roth IRA can be an excellent emergency fund. Of course, no one likes to take emergency funds from contributions in a retirement account, but if it is necessary (and may never be), its better than delaying the start of a tax-free Roth.

In my opinion, the idea that everyone must have a separate "emergency fund" is an investing myth.
Bottom line: Some investors need a separate fund for emergencies--some don't.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
tomd37
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Re: Some Advice on Fixing Mistakes

Post by tomd37 »

Just to clarify about the student loan interest. You can reduce your taxable income by up to $2,500 (using line 33 on Form 1040) and that will reduce your AGI and ultimately reduce your tax liability. Maybe just a play on words but just want ensure you realize the $2,500 is not a tax credit. :dollar
Tom D.
Topic Author
ascarrul
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Re: Some Advice on Fixing Mistakes

Post by ascarrul »

tomd37 wrote:Just to clarify about the student loan interest. You can reduce your taxable income by up to $2,500 (using line 33 on Form 1040) and that will reduce your AGI and ultimately reduce your tax liability. Maybe just a play on words but just want ensure you realize the $2,500 is not a tax credit. :dollar
I understand. I do all my taxes myself. That is why someone suggested paying off 20k in student loans so that the 2500 tax deduction would be maximized. (i would pay approximately 2500 in interest per year with a 40k loan effectively reducing my interest rate to around 4.5%)
wilked
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Re: Some Advice on Fixing Mistakes

Post by wilked »

tomd37 wrote:Just to clarify about the student loan interest. You can reduce your taxable income by up to $2,500 (using line 33 on Form 1040) and that will reduce your AGI and ultimately reduce your tax liability. Maybe just a play on words but just want ensure you realize the $2,500 is not a tax credit. :dollar
Good point, I think I mis-represented it
epictetus
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Re: Some Advice on Fixing Mistakes

Post by epictetus »

re: your savings account/emergency fund-
however large it is you could look into an online savings account. Would be able to obtain around .9% interest from several options. not the greatest but a lot better than 0%.

just a thought
Focus on what you can control
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