The non-financial freedom. Should you care about opinions of others?

M. asks:
How do you define moderate selective frugality? And what separates selective frugality versus being cheap?
I recently had an experience where I questioned this. I went to Target with a discounted gift card. They couldn't scan it and asked me to download their store app. I automatically asked if they had a free Wi-Fi so I don't have to use my data.  I realized, after getting weird looks, that I was carrying my Louis Vuitton bag. I was a little embarrassed.



I never heard of moderate selective frugality. I thought it is either frugality or it is not. 


It seems that M. is embarrassed to appear frugal to others.  Probably because for some people frugal equals cheap. And cheap sounds negative. So there is a certain fear of negative judgment from others. 

How to stop caring about opinions or judgment from others?
I am not sure if my advise will help, I am not a psychologist, but I will try.

What separates frugality from being cheap?

It is the emotional valuation of "good" versus "bad". 
Many people use the word cheap in a negative sense. Frugal sounds a little better. It is similar to cheap but is considered to be a good and responsible solution.

As I already mentioned in one of the previous posts, I replace "good" and "bad" with "useful" and "useless". The emotional valuation of cheap being "bad" and frugal being "good", is useless to me.

I would have asked for free Wi-Fi, if the savings were significant. One time I downloaded an app in the store using data because the discount was $20. That was useful. If the savings are only $1, I would use free Wi-Fi and use of the data would not be as useful. 

If the cashier gives me a weird look, this look is useless to me, because this person has zero influence on my life.

This emotionless evaluation as "useful" versus "useless"  may be difficult to practice for some people. Let's try to look at the situation from a different angle.


On the surface it looks like there is a mismatch between M.'s appearance decorated with a Louis Vuitton bag and her asking for free Wi-Fi. 
Her appearance signals that she is well off. 
Her question about free Wi-Fi signals that she is trying to save money.
This mismatch was noticed by a random cashier. 
Why should this cashiers reaction bother M.? 

M. has fear of being judged by others. Can this fear do any good? 

I think, at least, the fear of judgment should to be adequate.

In few areas opinions of others can matter. For example, at work you have to fit in with your behavior and dress code because of certain standards.  If people give me weird looks because of my appearance or behaviour at work, it is necessary to catch those looks and act on them, because that can have consequences.

If the the weird look is coming from a person who is unrelated to my financial well being, like a cashier at Target, I usually completely ignore it.

The fear of judgment from a random cashier is inadequate.


Supposedly the cashier is judging M. for having an expensive bag but trying to save money.

The cashier may think:

1. Is it a real Louis Vuitton bag if you are so frugal? Are you pretending about how rich you are?

2. Oh you poor girl with an expensive bag, you are so cheap that you can't spend a dollar on your data?

4. I hate you and your expensive bag. You should not care about spending money on data.

What may be coming over from the cashier is jealousy or contempt. 

What is the worst that can happen after M. got that weird look?
The cashier only spent 1-2 seconds on that look. He probably immediately forgot about that. In the worst case he went home and told about that to his friends or family: "There was a weird woman at the store today, she was carrying an expensive bag but asked for free Wi-Fi. How cheap of her."

Let's make it worse. If that person is a real freak, he may tweet about it or post something on Facebook.
But in reality he may never think about it again.


What actually happened in a neutral view of things:
A random non-related to M. person expressed jealousy or contempt toward her. 
M. cares about opinions of others and she is hurt by the opinion of the cashier because he doesn't like something about her. 



Of course if M. is afraid of judgment, she can just try to avoid all situations which may produce weird looks. She can either stop carrying expensive bags or she can stop trying to save money, because others will be unhappy with her. 
And even if she manages to please most, there will still be somebody who will be unhappy with her for some reason. Will she ever be able to please everyone? 

Those efforts to please others and to avoid negative reactions from others - what are they worth to M.? Are they worth $1 she may have saved in this case? 

I will take $1 over an irrelevant opinion. I have enough of my own opinions.  

What if she is going to buy a car and the salesman gives her a weird look because of her bag? Will she stop negotiating for a better price and agree with a higher price just to make the salesman happy who she will never see again? That will be worth more than $1. But is the situation really different? 


It is very helpful to realize that:

1. Other people don't really care as much about you (and  me) as you think.

2. You may spend more time thinking about what others think about you then they really do. 

3. You are very generous to random people to give them control over your emotions.


No one really spends a lot of time thinking about others. Others are mostly busy with thinking about themselves. 

Realizing that no one really cares about you (and me) should give you FREEDOM! 
With this freedom you can do whatever you want. 

And if others notice you doing whatever you want, they will very judmentally say: "She does whatever she wants". And you will just smile and not bother spending your time or your thoughts on an irrelevant opinion.   


When you care about opinion of others you give others power to influence your life. They take the wheel of your car and you let them drive the direction they want. Just because they want to take your wheel, should you really give it to them?







   

Challenge "Cash flow" update September 2018

Today I hit $100,000 in cash flow from the investments for this year so far.
And with that I reached Level 2 of my "Cash flow challenge" - "Sailing".

With $100,000 the yearly expenses are more than covered. Anything above that will be just fun.  

Below is my cash flow per month compared to the S&P 500 performance. 

my cash flow

S&P500 returns in % to date (September non included yet)

Deadlines for tax advantaged accounts 2018

Deadlines for contributions


Age 50
Start catch up contributions for 
401k ($6,000) - total $24,500

IRA, traditional and Roth ($1,000) - total $6,500

Age 55
HSA ($1,000) - total $7,900

Before age 70½
If you are completely retired, you can't contribute to retirement accounts because it requires to have earned income. 
If you have a side job, you still can contribute but the contribution amount can't exceed the earned income amount.

Age  70½
Have to stop contributions to traditional IRA even if you are still working. 
If you still have earned income, you can still contribute to Roth IRA.

If you are still working, you can still make contributions to the work sponsored 401k.



Deadlines for benefits

Age 62
Minimum age you can start receiving social security benefits. If you are still working, your benefits may be reduced. If you have high combined income even if you are not working, your benefits may also be reduced. 

Age 65
Eligible for Medicare.

Age 67
For anyone born after 1960, 67 is full retirement age.

Age 70
If you wait until 70, you will receive the largest possible monthly social security benefit. More time delay will not produce any more increases.

Age 70½
Must begin taking required minimum distributions (RMD) from traditional 401k and traditional IRA. 
However, if you are still working, there is a "still working" exception for delaying taking RMD from the work sponsored 401k plan. 

If you are not working and don't take required minimum distributions, you will have to pay additional tax of 50% on the difference between the amount  taken out and the required amount.

There are no RMDs on Roth 401k and Roth IRA.



Deadlines for penalties

Age 55
If you leave work you can start taking distribution from work related 401k without 10% penalty.

Age 59½
Withdrawals from 401k and IRAs are not subject to 10% penalty.

Will social security still be available in 20 years for high income earners?

M. asks: Will social security still be available in 20 years for high income earners?

I am wondering that myself.
Social Security already exists for about 80 years. It was established to provide supplemental income in retirement. 


The social security expenses are rising mainly because of following reasons:


1. Lengthening of life expectations 
2. Increasing numbers of retired baby boomers
3. Changing of worker to beneficiary ratio with beneficiaries increasing and workers decreasing.



There are three social security sources of revenue:

1. Payroll taxes on earned income (approximately 87%)
2. Interest earned on reserve assets (approximately 10%)
3. Taxation of benefits (approximately 3%) 

The social security already started to the reserves in addition to the incoming funds.
It was estimated that the reserves will disappear by 2034. 


That means that the revenues will have to be increased. What are the ways to increase revenues?

1. Increasing the retirement age
2. Increasing payroll taxes
3. Increasing taxation of benefits
4. Decreasing the benefit amounts

So, most likely the social security will still exist for a long time. But the once the reserves are depleted, the revenue will have to be increased. 

High income earners will very likely be the most affected by this. It will be easy to move or remove the social security tax cap (currently at $127,000). 
High income earners can be hit by introduction of eligibility criteria. It could be based on total amount of all yearly retirement income (including non-earned income like investment related gains or dividends or rental income). 


High income earners are at risk for both, paying in more and getting out less.   


For the high income earners the social security benefits are already taxable and they pay federal income tax rate on up to 85% of the social security benefits.
 
In retirement the federal income rate is based on the combined income (adjusted gross income plus non-taxable interest and plus half of social security benefits).
 
Adjusted gross income is the total gross income minus deductions. Gross income includes wages, dividends, interest, business income, rental income and all other types of income. In retirement most deductions become irrelevant except allowances for personal exemptions.
 
Example:
In retirement your combined yearly income is $200,000 (401k distributions, IRA distributions, rental income, capital gains and dividends from taxable accounts and bank interest).
After adjusting it by taking out variable deductions it may reduce it to $160,000 (approximate number).

The federal tax bracket for $160,000 is currently 22% (2018). But in retirement the non-taxable interest and a half of the social security benefits will also be added to this number.
 
For example, if the yearly social security benefits are $24,000, that will bring you over the limit of $165,000 for the 22%  bracket into the 24% bracket.
 
Following that your social security benefits will be taxed based on your status.

If filing as single and your combined income is over $34,000, you will pay 24% taxes on 85% of the social security income. That means you will pay 24% on $20,400 of the social security, which is $4,896. 

If filing married and joined and your combined income is over $44,000, you too will pay 24% taxes on 85% of the social security income.

If filing as married but separate, there is no threshold and the benefits will be taxed regardless of how much is your combined income.
 
Those are federal taxes. If you leave in the state that taxes social security benefits, add that.

Does 25 times annual spending estimate work?

M. asks: Did you use 25 times your annual spending to estimate your "magic number" for retirement savings?

She is referring to the post about my "magic number" challenge, which is $3,000,000.

When I was estimating my number, I did not use the popular among FIRE community members 25 times annual spending calculation. it seemed to be an underestimation to me. 

I went another way and calculated my annual expenses, added comfort margin and ran it trough inflation calculator.

I also made some optimistic assumptions about the life expectancy (at least 102 years, see why in the Challenge 102 post).
And I made some pessimistic assumptions about the investment growth which included absence of social security income and low returns).

I also didn't assume that I will retire early, and my estimated retirement age was 65.

 
Per official government actuary table I as a female of 44 years of age have life expectancy of 38.65 years more to live and my estimated expiration date provided by the government is in 2056 at age of 82.65.

If I just take 25x my annual expenses, first thing that bothers me is that 25 is less than estimated 38.65 and the second is that the expenses in this calculation don't appear to be adjusted for inflation.

I will make some example calculation with the following data:
Female 44 years old, official life expectancy 38.65 years (age 82,65 years)
Retirement savings: 25 x annual spending = $1,250,000
Retirement date - now at 44 years of age (FIRE)
Yearly returns - 7%
Estimated annual inflation - 3%
Calculations done on www.mycalculators.com, you can use your variables for your own calculation.

You can see that at 7% annual growth rate on the investments the yearly withdrawal is around $62,000 per year. For the first few years that will work.
 
It looks like in this calculation the annual inflation rate is only applied to the growth. The withdrawal amount is the same each year and is not adjusted to inflation (you can see it on the withdrawal schedule which is provided by the www.mycalculators.com.  

But how much are the $62,000 in today's dollars are worth in 38 years?

I calculated it on www.smartasset.com. The $62,000 will be equivalent of approximately $190,637 in 2018 dollars.
It doesn't look like it will be enough.

That supported my suspicions that FIRE is not for me.

Next, I used the Retirement Income Calculator from www.bankrate.com
It gave me the monthly income at age 45 (the same for the next 38 years).

 

 

 



I decided to check the only 3% yearly return which is what you can reach with government bonds. The monthly income decreased appropriately.

 

 

 

 

 

With the inflation, the necessary withdrawal amount will have to increase. The monthly withdrawal amount income should change with estimated inflation of 3% from $4,217 to $12,966 in 2056.

 

 

 

 

 

 

The inflation increases the amounts substantially. That was my main reason not to use the 25x yearly expenses estimate. The number $1,250,000 seems to be too low.

 

My estimates gave me the number of $3,000,000 as a comfortable minimum.  

If I don't retire early and keep working as planned until 65, this number should be reachable for me.

 

If I figure out how to stay alive until 102, this amount should be enough.

 

For calculation, that will be 37 additional years from age of 65 to 102.

According to the inflation calculator the $50,000 of yearly expenses will be approximately $93,000 in 2039 (retirement year).

At that time I will be able to withdraw about $152,000 (according to the calculator below) every rear for 37 years until age of 102 (year 2076).

 

 

 

The inflation calculator from www.smartasset.com doesn't go until year 2076, it only goes until 2068 and the value adjusted for 3% inflation for that year is $219,000. If I use less in the beginning and more later, it seems to be enough.

 

I am finding it very funny to plan until 102 years of age. That is probably a serious overestimate. I am really curious about how it will turn out.  

What to do with your 401k when you change jobs?

My husband is changing jobs and a question came up what to do with his 401k.

Usually this decision must be made within 30-90 days.


After researching this I found that there are four options available:


1. Cash everything out.
That doesn't make much sense. He is still too far away from retirement and there is also no point to pay penalty on early distributions in addition to the taxes. 
If you are younger than 59 1/2, there will be a 10% early-withdrawal penalty on the sum you remove.   

2. Do nothing and leave the 401k with the old job.
You can do it with a minimum balance of $5,000. If it is less, the amount will most likely be paid out to you and you have to make sure to immediately roll it over into a simple IRA or a Roth IRA (dependent on what type of 401k you had. If you had a mix of both, see below).
If your old company will be sold or switches 401k providers, your login information may be changed and you will have to spend time to locate the new information.
Also an additional fee may be charged to non-employees.


3. Roll over to an IRA.
With IRAs there are more investment choices which include stocks and ETFs which are not available in the 401k plan. The fees are lower.
If your 401k is a partial Roth 401k, which are more common in the last years, it will require some more work.
Since 2014 it is possible to roll over the 401ks which have both, pre-tax and post-tax contributions. Those contributions are kept separate and when you log in into your account you can see them listed separately. You can request the pre-tax portion to be rolled over into an IRA and the post-tax portion into a Roth IRA. But the entire amount in your 401k has to be rolled over at the same time. You can not roll them over at different times. 

4.  Roll over into the new employer's plan.
Many new employers accept rollovers. You might check out the investment options and the fees before deciding.

There are two types of rollover: a direct rollover and an indirect rollover.

Direct rollover: The money is transferred from one account to another by the institution without you touching it. You will fill out a form. The company will do the rest.

Indirect rollover: You will receive a check and will have to send it yourself to your new account.
You will need to make sure that you deposit it to the IRA timely. The time limit is 60 days.


If you decide for options 3 or 4, you will have to initiate rollover by calling your 401k administrator to give instructions about the specifics of the rollover. If you rolling over into IRA, you have to have open an IRA account before initiating the rollover.


What will we do with my husband's 401k?
We will wait until we get the information about the new 401k plan and see if the fees and expense-ratios will be comparable with the old plan. They probably will be.

If he decides to roll over into the IRA he will have to do the split because this 401k contains both, pre-tax and post-tax contributions. I am worried about that being done correctly but I probably worry too much. The providers had since 2014 to learn and develop processes how to do it without mistakes/mischaracterizations. They will have to calculate the same pre-tax/post-tax split for rolling over to the new employer's 401k anyway.  

With a rollover into IRA we could save on fees.
The statements of the current 401k shows $75 in fees for the year. He probably will still work for another 21 years until he is 65. If he rolls over into the IRA instead of the new employer's 401k plan, he will save on fees. If the fees are comparable, that will make  about $75x21= $1575.

This is not a very large amount. It probably outweighs the  unnecessary worries about the transfer being messes up.

Having multiple cash flows - is this the ultimate goal?

M. asked me: Should having multiple cash flows be the ultimate goal? Some say that this defines the level of wealth.


Multiple cash flows are nice to have. If they are multiple, at least some of them should be passive or you will work yourself tired.
This goes along with not keeping all eggs in the same basket. But maybe instead of juggling multiple small baskets one can get a single really sturdy basket with a lid and with a low upkeep and have all the eggs in it?

How will that define the level of wealth? It depends on how much return those eggs will bring.

Articles about generating passive income are very popular right now. The suggestions focus mostly on something like creating an online course, writing an e-book or some other side hustle.
If you are a high income earner, you will not bother with anything like that. A super successful online course or an e-book are "zebras".

I prefer 'horses".  "Horses" in this case will be using your saved money to produce additional income. Some people buy timber land and get income from timber, some buy farms and rent them out, some buy rental property. This requires work and dealing with people.

I was looking for something like a business that produces income but has no customers to deal with. And I found it in investing.

I see my investments as a business which I bootstrapped with my savings. The trading fees and expense ratios are business expenses. The realized gains and dividends are income (which is taxed). The stocks and other investment vehicles are your "clients" and you can be very selective with which clients you work. The good thing, those clients never complain.

This business is brutally honest. Any mistake in investing is your own mistake due to lack of knowledge or experience. The more you know the better you get.  

The percentage value of your return is the profit margin. You can get down your business expenses by picking a broker with lower fees. There is not much tweaking on taxes. But you can select your clients and you can fire your clients too. You can follow up with the statistics and see how your business is doing.

You also an choose the degree of involvement into this business. You can put it onto the slow burner and just buy ETFs and dividend paying stocks long term. Or you can choose to be more active.

Like every business it will have seasons. And they are called "bear" and "bull".  They vary in length but those are just seasons, and after a bear there will always be a bull. And after a bull there will always be a bear. I know, the previous sentence sounds like I am unconcerned about the bear markets. I am actually concerned a bit, but I am not close to retirement and if one will happen tomorrow, there is still time to recover. Also the dividend paying stocks give you some protection during the bear markets. I am curious to see how I will deal with the next bear.

I would separate 4 levels of risk in this business:
Risk level 1: Very low risk - CDs, government bonds, money market accounts
Risk level 2: Medium risk - ETFs, dividend paying stocks with good track record
Risk level 3: High risk - Non-dividend paying stocks or stocks of troubled companies, junk bonds
Risk level 4: Very high risk - Penney stocks, options

Many might disagree with this classification and it will be just an opinion against another opinion. Only results will matter and show who is right.

Since I have a very big fear of loss, my risk level is level 2. I might move slower, but at least I will move forward.

A good thing about this type of business - investing doesn't take much time. Any other side hustle feels like a second job with very low pay compared to my main job.

By the way, this blog is not a side hustle. It only qualifies as a hobby. It costs $12 a year to maintain and has brought in $1.5 trough advertisements this year (there were 2 clicks on the ad banner sometime 2 months ago). That is it. 
I am writing just for fun and education. $12 per year is really not a big deal. I am not doing anything to promote it. Mainly because I want to stay anonymous but also because that requires to post comments on popular blogs so people can click on your name and see what blog do you come from, but I am too introvert for that. 

In elementary, middle and high school my school jobs were "class nurse" and "stengaseta" - Russian word for school wall poster/news paper. That is almost the same I do now. Physician and blogger, hahaha. But at home I had a different job. I was "the money keeper". My father was giving me the money from his side hustles to hide from my mother. I kept it well. Mostly I didn't give it back to him, because many times he forgot to ask back for it. I had a good stash. I still do the same thing today. Of course I don't keep my father's money, now I keep my own. I use this Warren Buffet's rule: Never loose your money. So I keep it.

If some strange star constellation will move me to write an e-book, writing it shouldn't feel like a second job. If that will be fun, like this blog, I might. I just don't know what about...  

How to calculate your net worth?

M. asks: When you are talking about net worth do you count everything you can sell and get money for? Paid off cars, jewelry, any collectibles?


According to the most used definition, the net worth is the value of all the non-financial and financial assets owned minus the value of all its outstanding liabilities.

But practically, in case if you get in trouble and you have to sell your assets, you will not just sell everything you own. Some items like collectibles are not easy to sell. And there will still be some items you will have to keep like your car or your house.

For items like car, house, jewelry and other personal items I would only count the net liquidation amount.
That means, that for the house I would take the amount it will sell for in the current market minus realtor fees. 
For the collectibles and jewelry - only that what you can sell it for. Collectibles are sometimes difficult to sell, the jewelry might be worth less then it was bought for.

Knowing and tracking your net worth is useful. It will make you aware of your financial situation and it gives you a reference point for measuring progress.  


How to create your personal net worth statement

List all your assets:
1. Cash in bank accounts
2. Retirement savings (tax-deferred accounts)
3. Investments (taxed accounts)
4. Cash value of insurance policies
5. Personal property (if there is any high value property like art, or jewelry or precious metals bars or coins)
6. Car value
7. Value of your house
For the last three I would use the current sell value.

List all your liabilities:
1. Mortgage
2. Car loan
3. Student loans
4. Other personal loans like credit card balances

Subtract the liabilities from the assets. The number you get is your net worth. You can update it monthly and hopefully enjoy to see how your liabilities are melting and your assets are growing.


After you got that, you might be interested to see how you rank among your fellow Americans.
Here is the link to the Net Worth By Age Calculator for the United States which will show you where you stand compared to your age group.

Here are two more interesting calculators:
Income Percentile by Age Calculator for 2017, United States and Net Worth Percentile Calculator for the United States in 2017.

How to stay within budget? Where is the problem?

Here is another question from M: How to make a budget that flows better? I've been too strict with my monthly budget and it never seems to work out. Some months we are really short and some month we are way over.


When I just started to date my now husband, he asked me if I have a monthly budget. I said: "No. I don't use a budget. I just buy what I want." I could see that he got scared because my answer sounded like I suffer from uncontrollable spending. In reality it was the exact opposite. 

I already went trough my budgeting phase and learned my best way to spend and to save. When I saw that my method is working, I didn't see the need to track my spending anymore. My savings were maximized. Everything was automated and "didn't have a budget" anymore. 

He didn't know all that. I explained it to him and he calmed down. I guess I passed his test to be suitable as a potential future wife who will not spend the family money out the window.

For me, budgeting is not a torture instrument. It is just an emotionless tool. Let me explain. 

Most people use budgeting to restraining themselves from overspending. Some kind of a too to enhance will power.

But that is not what I used it for. I used it as information gathering about my spending, comparing it with my goals and making adjustments. 

To start using a budget, you first need to learn what your expenses are and only then you can start to budget.

You can't start to budget before you have enough information about your spending habits. If you don't know your expenses it is like budgeting rainfall. You predict some level of rainfall and get either disappointed if there was more rain and happy if it was less. This is not budgeting, it is guessing.


Here are steps I used:

Step 1.
Write down all your expenses. Everything: fixed and variable expenses. Include luxury items (like Louis Vuitton bags or expensive travel).

Step 2:
Track your expenses for 4 or 5 month.This is not budgeting yet. It is careful collecting of information about your expenses.

Step 3: (optional)
Divide all your large fixed expenses which are payed yearly like disability insurance, car insurance payments or vacations. Calculate the total estimate for a year and divide it by 12. This will be your monthly amount which you can put into a separate savings account, which can play a role of an escrow account.  When a large expense comes, the money can come from that account and the monthly budget will not show any wild swings.  This is an optional step. I used to do that when the money was less.

Step 4:
Start budgeting. Get your monthly numbers from the data you collected. Ad 10-20% for surprises if you prefer to be in a good mood. Don't add any % for surprises if you like to torture and guilt yourself with no reason.

Watch for 4-5 months and see if you need any adjustments.
If you buy more Louis Vuitton bags and blast your budget, you have to either add it to your expenses or to convince yourself that 6 of those bags are enough. If you just can't stop buying those bags, there might be another solution (see this post about consumerism versus minimalism).  If you are constantly under your budget you can celebrate at the end of each month. If you like celebrating, keep that 10-20% room to stay in a good mood. If you don't like celebrating, adjust your budget numbers and celebrate less.

People in general like to constantly put themselves under some sort of restrictions. Even young children do that. You see it when they start to jump over the cracks in the asphalt or seams between the bathroom tiles, trying not to step on the lines. Putting restrictions on yourself is very natural. But like anything, if it becomes extreme, it becomes pathological.

Budget is simply a realistic projection based on previous statistics which will be evaluated, adjusted and used for more projections and optimization. It will help you to know what to expect and to catch deviations early.

Some people talk about saving 50% of gross income or setting 10% of bonuses for fun things like vacations and hobbies for emotional well being. But the percentages say nothing. If your monthly income is $2,000 you just can't save 50% of your gross income. If your monthly income is $20,000, setting only 50% for savings is not appropriate. And if you have loans, all of that will be modified by that. The same problem is with setting 10% for vacation and hobbies. If the budget is made and used properly, it should not raise questions about arbitrary percentage amounts.