Handling Finances

For the past year, as I graduated, got a job and got married, my finances have been quite chaotic. I paid off my student debts and started saving for long-term goals like retirement. I have started investing with a general goal to have a diversified portfolio, but until now I haven’t had time to sit down and plan it in detail.

First of all, I am diversifying my paying of taxes on my retirement savings. There are a number of tax-advantaged accounts that allow you to reduce the impact of taxes on retirement savings, but they generally fall into one of two catagories. “Traditional” 401(k)s and IRAs allow saving before taxes but charge taxes on any withdrawls. Roth IRAs, and the new Roth 401(k)s allow saving after taxes, but charge no taxes on withdrawl. With the traditional accounts, you pay taxes at retirement, and with the Roth accounts, you pay taxes now. If tax rates were constant, there would be very little advantage to one over the other but it’s pretty safe to assume that tax rates will not be constant!

Given that there will be more people retiring than entering the workforce for the next decade or two, I fully expect taxes to rise out of necessity, but since it will be a full four decades before I retire, I really have no way to predict what taxes will look like in my retirement. Further, it’s important to take tax brackets into consideration as well as tax rates. I only started my job in September, so I only earned a quarter of my yearly salary. Because my income was so low, I will be in a low tax bracket and I made sure to take advantage of this opportunity by investing the maximum in a Roth IRA. As my career progresses, and my income grows, I will be bumped into higher tax brackets making my 401(k) more attractive since it allows me to reduce my taxable income now so I can pay taxes later when I’m retired and my income/tax bracket is lower.

There will be times throughout my career that I find my tax rate is lower so I choose to invest in the Roth IRA and pay taxes now, and there will be times when I find my tax rate is higher so I choose to invest more in the 401(k) and pay taxes later. However, the key, in my opinion, is that investing in both types of accounts gives me a very basic level of tax diversification. When I retire, I will have more control over my tax burden and my retirement savings is subject to less risk due to changing taxes.

Without goals, it’s incredibly difficult to determine where you are and whether or not you’re on track with your finances. I’m not the sort of person who finds it useful to tag and track every penny, but I do review my expenses every week and I keep track of what I spend where to make sure it’s reasonable (in other words, if I forget to bring a lunch to work twice one week I’ll be extra careful to make my peanut butter sandwiches next week). At the same time, it’s very important to set and strive to meet financial goals. The discipline of figuring out what’s reasonable and what steps need to be taken to reach the goal helps to keep you from making purchases you can’t afford or wasting money on things you don’t really want or enjoy.

With that said, here are my financial goals for 2008.

• Save $10,000 (about 12% of my gross income) in retirement accounts.
• Have $24,000 on hand as a down payment on a new house
• Save $3500 for a trip to England (first wedding anniversary)

I think these goals should be quite achievable over the next year. I’m putting about $500 per month into my 401(k) right now which will give me some leeway to decide whether to step up contributions later in the year or to put the other $4000 into my Roth IRA. I will be saving $2000 a month toward my new house which will cover a 10% down payment plus a few thousand to cover extra fees.

If we can keep our monthly expenses (minus rent) under $1200 this goal should be easily within reach as we could live reasonably comfortably on $900 a month or so. There is some wiggle room to allow for working on increasing our emergency fund from it’s current level of $1000, but in general, we’ll be living on bag lunches and free concerts for the year. Once we’ve purchased the house, we’ll have a lot more room to pour money into savings and retirement as well as to work on getting ready for children.

The travel to England and our stay in a hotel for our first wedding anniversary is already paid for, so we haven’t really started mortgage savings yet, but we’re still on target to meet the goals. We won’t be traveling really frugally like my last stay in Europe (wandering around London and Paris hopping from hostel-to-hostel) but $3000-$3500 seems quite reasonable to me and is definitely achievable.

Because of the large commitment to buying a house, I’ll be putting off purchasing a camera (probably around $1500 with accessories) until after we have a new house. I’m sure I want a digital SLR, but I’m not quite as sure how much I’d use it or that it’s worth the expense right now. I’ll have to make an effort to get out and photograph events in film when it gets a bit warmer so I can justify the expense (I love taking pictures, but I haven’t made time recently).

The debate over details is over and we’re getting economic stimulus checks to try to help boost consumer spending and stave off the dreaded recession. Of course, the tax rebates won’t be coming until July because the IRS just isn’t set up to deal with a set of tax rebates and 2007 tax submissions any faster, but it certainly has the potential to at least limit the length and severity of a recession even if the recession is not avoided entirely.

On my way home from work today, I heard a great interview with one of Clinton’s economic advisers, Jason Furman on NPR. It discussed the 2001 tax rebates where 36 billion dollars were sent out to 2/3 of American households and what we might be able to expect from the upcoming tax rebates. Jason said that in 2001, 2/3 of the money was spent, though the top item people bought was clothing — a detail that is a bit discouraging as most of our clothing was made outside of the US so a good chunk of that money didn’t stimulate the US economy. However, the next two highest categories were health-care items like glasses and then food — items that are generally made in America.

In the past few days, I also heard (probably on NPR) that some economists weren’t convinced that people would spend as much of the money this time around. It certainly helps that the package includes 28 billion that will be targeted to the poorest working Americans who wouldn’t have been helped by a tax rebate since they pay little or no taxes. They are by far most likely to spend the money compared to those with higher income who might be more likely to save the money or use it to pay off debt after feeling pressure of falling home values and rising mortgage rates.

What will I do with my check? I will be putting it all toward the down payment on my new house sometime next winter. Note that I’m not putting it toward a house to help the economy — my primary advice to anybody considering spending the money is to save every penny. While it might make a small difference toward holding up our consumer-driven economy, what we need most is an economy where debt no longer rules the average American’s finances and no matter the temporary effects of a recession, saving this stimulus money will put our nation one step closer to fiscal responsibility. In fact, although I (almost guiltily) am going to use this money toward purchasing my first home, that simply means that I will be able to increase my retirement contributions about a month sooner as I’ve been capping my retirement saving at 10-12% of my family’s income until we’ve purchased the house.

It’ll be interesting to see how consumers react to this stimulus package. Those who can look ahead past the looming recession might see that less debt payments and more savings will ultimately result in more passive income from investments. Long-term, that would result in a much greater net increase in consumer spending than the 100 billion we’re getting in July. I’m in favor of the stimulus package — it’ll certainly keep the stock markets from falling as fast and potentially from falling as far in the next year or so. At the same time, I’m also a great believer in the need for a cyclical economy where great booms must be followed by slower growth to weed out inefficiency that tends to build when money is flowing fast and furious. In the end, since this money is coming as a tax rebate from a government that is already deeply in debt, all it means is that I’ll be paying it back in a decade or so when taxes are raised to recoup the losses or as programs like social security are slashed in the face of rising costs and stagnant tax revenue.

Does saving my stimulus check mean I’m unpatriotic? Not one bit. I might not be stimulating the economy now, but in raising two or more children, I’ll be spending like crazy for the next few decades. The better prepared I become now (like with saving my money instead of blowing it on cheap clothes or glasses I don’t need) the more I’ll have to spend later, stimulating the economy like the good patriot I am.