Housing ratios are financial metrics used to assess the affordability of housing costs in relation to your income. Two common ratios are:
Housing Ratio 1 (Basic): This ratio is the percentage of your gross monthly income that goes toward housing expenses: payment on principal, interest, taxes, and insurance (PITI). Generally, a HR1 of 28% or less qualifies for a conforming (best) rate mortgage.
Housing Ratio 2 (Broad): This ratio considers the percentage of your gross monthly income that goes toward all debt obligations. The HR2 benchmark generally used by lenders is ≤36% of gross pay.
One can use these ratios to avoid being “house-rich, cash-poor”.
A 529 plan is a tax-advantaged savings account designed to help you save for education expenses. These plans are typically sponsored by states and some states offer tax deductions/credits for contributing to their 529 plan. Earnings in a 529 plan grow tax-free, and withdrawals for qualified education expenses are also tax-free. It’s a useful tool to utilize in educational funding strategies.
Term vs Whole Life Insurance
Life insurance can seem complicated, but it doesn’t have to be. There are two main types of life insurance:
Term Life: Term is the life insurance most naturally think of. It pays a death benefit in the event of an untimely death. Term life insurance is valid for a term – potentially 1 year, 10 years, 30 years. It’s generally an inexpensive way to protect one’s family when additional money is needed to provide for future plans (pay mortgage, college tuition, child expenses, support a stay-at-home spouse, etc.). Term life insurance is typically not needed in retirement.
Whole Life: Whole life insurance is permanent life insurance combined with investments. These products are generally expensive, high commission products with surrender fees for early cancelation. Whole life insurance is generally not appropriate for a typical family. Whole life policies can make sense for businesses and estate planning for the wealthy.
Higher Taxes from Pre-Tax 401(k) or Post-Tax Roth IRA
Will I pay higher taxes investing pre-tax in a 401(k) or post-tax in a Roth IRA? Assuming tax rates are the same, you’ll receive the same amount of money in either case. If you invest pre-tax, you’ll invest a larger amount. It’ll grow larger over time and incur a larger tax bill. However, the take home amount will be the same as paying income tax upfront, starting with a smaller investment, and avoiding future taxes. If you start with 25% less seeds, you get 25% less apples.
The decision to invest pre-tax vs post-tax has more to do with providing tax-efficient future cash flow options and future tax rate changes (federal changes and your bracket changes).
Dividends are payments made by a corporation to its shareholders as a distribution of profits. They are typically paid in cash. Companies that generate profits may choose to distribute a portion of those earnings to their shareholders as dividends. Dividends can provide investors with a regular income stream. A company’s dividend history can indicate financial stability and a commitment to returning value to shareholders.
It’s important to consider dividends when looking at historical stock prices. Established companies may have large dividends (Dow’s dividend yield is 5.57% as of 9/22/23). Rapidly growing companies may have no dividends. Tesla, Amazon, and Alphabet/Google have no dividends in 2023. They prefer to reinvest those dollars internally rather than distributing cash to shareholders. Due to dividends a more established company may provide a higher investor return despite significantly less stock appreciation.
How Financial Advisors Charge
Financial advisors typically charge fees in a few common ways. One approach is an assets-under-management (AUM) fee, where a percentage of the total value of your investments managed by the advisor is charged. Another method is a flat fee, where you pay a fixed amount for specific financial services. Some advisors charge hourly fees based on the time they spend working with you. Additionally, there are commission-based fees where some advisors earn a percentage from the financial products they recommend.
Terms like fee-only and fee-based can help guide consumers but aren’t well understood. Some advisors transparently display fees on their websites (unfortunately most don’t). Many don’t appreciate the fees they pay under AUM and commission-based models since the fees are “hidden”.
Be empowered and know your fees. No advisor should ever be offended by explaining how they’re paid. If you don’t get a crystal-clear answer, that’s a bad sign. Be empowered. You’re in charge!
Estate Planning Documents
Estate planning documents allow you to manage your assets and wishes effectively. Key documents include:
- Will – Specifies asset distribution and appoints guardians for minor children.
- Durable Power of Attorney: Authorizes someone to make financial decisions if you’re incapacitated.
- Healthcare Power of Attorney: Allows a chosen individual to make medical decisions on your behalf.
- Living Will (Advance Healthcare Directive): States your medical treatment preferences in critical situations.
- HIPAA Authorization: Permits access to your medical information for designated individuals.
- Letter of Instruction: Provides guidance on funeral arrangements and your wishes to help guide those making decisions after your death. This is an informal document and not legally binding.
Items 1-5 are often included in a documents package provided by an estate lawyer. Dow’s benefit plan can pay 100% of these legal fees.
The behavior gap refers to the gap between an individual’s investment returns and the actual market returns. It often stems from emotional decision-making, like buying or selling investments based on fear or greed rather than a well-thought-out strategy.
Dow’s 401(k) Options
Dow’s 401(k) offers many attractive investment options. Fees are generally very low. Investment options are grouped into 3 tiers: Target Date Funds, Core Funds, and Additional Funds (as of 2023).
Target Date Funds are available in 5-year increments. BTC LifePath® 2045 is designed for someone retiring around 2045. These funds invest aggressively when the target date is far away and shift more conservatively over time.
Core Funds include broad-based index funds. Options include an S&P 500 index, a completion index (total US index excluding the S&P 500), an international index, and a bond index fund.
Additional Funds include specialized indexes and active mutual funds.
A wash sale occurs when an investor sells a security at a loss and then repurchases the same or a substantially identical security within a short period, typically within 30 days. The IRS disallows the immediate recognition of the loss for tax purposes in wash sales. Instead, the disallowed loss is added to the basis of the repurchased security. Understanding wash sale rules is essential for optimizing tax strategies when managing investment positions. Seeking professional advice can ensure compliance and informed decision-making.
Retirement Accounts Before 59.5
Generally, you can’t access retirement accounts before age 59 ½ without incurring a 10% penalty. However, there are several ways to avoid the 10% penalty for those planning to retire before 59 ½.
- Rule of 55
- Roth Conversion Ladders
- Substantially Equal Periodic Payments (SEPP)
With proper planning, retirement accounts can be accessed whenever you need them, regardless of age.
What to Invest In? (Accounts)
The US tax code provides us with several tax advantaged ways to invest money. Proper use of tax-advantaged accounts can make a huge difference to your wealth. Below is one general priority guide to place your money. Your personal situation may shift the order. There’s also value in balancing accounts with different tax treatments. Consult a financial planner for personalized advice.
1. 401(k) – Up to the employer match
2. Pay off high interest credit cards (not an account but typically higher priority than investing)
3. Health Savings Account (HSA) – can be an extremely powerful retirement account
4. 401(k) Pretax beyond employer match
5. Roth IRA
6. 401(k) Post Tax Contributions (if available; mega-backdoor)
7. Taxable Accounts
I Bond Off Ramp
I Bonds were all the rage in 2021 and 2022, but you may want to consider selling them soon. The current rate is 3.38%, lower than the 4.15% in my American Express Savings Account.
I Bonds must be held for 12 full months and then there is a 3-month interest penalty on I Bonds held for less than 5 years. Get this wrong and you could lose 3 months of 6.48% interest, rather than the current 3.38%. A good strategy is to wait 3 months after the 6.48% rate has been completed, then redeem early in the next month. That way all the penalty will apply to the 3.38% rate. However, when your 6.48% rate ends/ended depends on the month you bought them. Some can sell now, but others may need to wait several months to ensure they only forfeit the 3.38% rate. Several online articles can be found to explain the nuance.
Marginal Tax Rates
Marginal tax rates apply to the last dollar of your income within a specific tax bracket. As your income increases, you might move into higher tax brackets, leading to a higher marginal tax rate for those additional earnings. It’s important to note that the marginal tax rate isn’t applied to your entire income, only the portion within that bracket. An understanding of marginal tax rates will help you reduce lifetime taxes and understand when pre-tax and post-tax investments are more efficient.
Target Date Funds
Target date funds are investment funds designed to simplify retirement planning. They automatically adjust the asset allocation mix (stocks, bonds, etc.) based on your target retirement year. When retirement is further away, the fund may have a higher stock allocation for potential growth. As you near retirement, the allocation shifts towards more conservative assets to preserve capital. Target date funds offer convenience, are generally well diversified, and often available with reasonable expense ratios. Asset location and tax efficiency should be considered when considering target date funds.
Mutual funds and ETFs have an expense ratio which is a management fee for the fund. You may not see the bill, but you’re paying it, and it may be significant. Below are examples of two popular Fidelity funds.