The charitable hack that saved me thousands in taxes and increased my mindfulness

For much of my adult life, every December 31st I’d fall into the same trap. Around Thanksgiving, I’d remember that I was supposed to do my charitable giving for the year. I’d think about how meaningful it would be, how much of a difference it would make, how carefully I’d choose the organizations, how my ritual would work and then, well, I would get distracted and do something else instead. Then, I’d lose the thread, get busy and finally, on December 31st, staring the deadline in the face I’d spring into frenzied action. I’d simplify the plan, whip out my credit card and get to work. In the frenzy, at least one of my credit cards would usually get shut down for suspected fraud. You’d think they’d be hip to the pattern that I gave a lot of money each 12/31 but the credit card companies didn’t seem to catch on.

Are you sick of the end of year frenzy for your charitable giving plans? Tired of sacrificing family time on December 31st to make charitable contributions at the last minute that feel impulsive and unplanned? We have a solution for you! You should consider creating a Donor Advised Fund (DAF) that will allow you to make charitable giving meaningful, easy and enjoyable. Not only that, it may save you thousands in taxes.

It has transformed my giving from frenzied to mindful and it’s saved us a lot of money on taxes too. This is a powerful tool and I hope it helps you as much as it has helped me.

 

What is a Donor-Advised Fund (DAF)?

DAFs are administered by nonprofits like Community Foundations or Schwab Charitable. They function like your own personal foundation but are much cheaper and easier to operate. To participate in a DAF, you open an account and donate stocks, mutual funds, or cash to the fund. After that, you can recommend grants from the fund to nonprofits of your choice, but you can’t withdraw the funds for your own use. Until all of the funds are used for grants, they can be invested and grow (or shrink) as with other investments. 

You get a tax deduction in the year you donate to the DAF, regardless of when the grants to nonprofits are actually made. This allows you to make donations in the years that are best for you for tax purposes while allowing the charities to still receive consistent gifts every year (or whenever you like). DAFs can also make tax time a lot simpler because you can just report occasional big donations to the DAF and don’t have to track every single individual grant from the DAF to charities. No more digging through statements to find your charitable deductions or having stressful marathon giving sessions on 12/31!

 

Who should consider a DAF?

If you give (or plan to give) significant support to nonprofit charities, you are a strong candidate for a DAF. DAFs are particularly beneficial for donors who sometimes itemize their charitable contributions and for those who have appreciated stocks in their investment accounts. The more charitable you are, the more a DAF is likely to help. 

Even if you plan to give smaller amounts after the initial contribution, using a DAF may still be a good idea because it helps make charitable giving meaningful, easy, and enjoyable. Aside from the tax benefits discussed below, DAFs can cut down on junk mail, help nonprofits avoid paying credit card fees, and help systemize your charitable giving.

 

How can DAFs save money on taxes?

Let’s say you buy ten shares of stock for $1500 and, over a few years, they grow in value to $3,000. If you sell them, you’ll have to pay long-term capital gains (LTCG) tax on the $1,500 it increased. If your long term capital gains tax rate is 15%, then you’d owe $225 (15% of $1,500) in federal capital gains taxes.

If you donated the $3,000 worth of stock to a DAF or another charity, you can get the same $3,000 tax deduction as if you had donated cash and you’d avoid paying that $225 in capital gains taxes (and likely state taxes as well). That’s why we often recommend setting aside the stocks with the largest capital gains to contribute to a DAF. We’ve helped clients who donate a lot to charity reduce their taxes by thousands of dollars this way. 

 

For whom is this strategy a bad fit?

When donating stock to a DAF, the tax deduction is taken upon the transfer of stocks to the fund, not when the money is distributed. This deduction is limited to 30% of your Adjusted Gross Income (AGI) so everyone, including people using DAFs, should be careful when planning to make donations that would exceed this limit. Though the excess can carry over to the next year, people who otherwise would take the standard deduction that year may lose out on the benefit. 

If you always take the standard deduction, a DAF can be useful for record-keeping and administration, but it probably won’t reduce your taxes. 

Many people prefer to give to political parties, political candidates, 501(c)4 campaigns, or other organizations that can’t receive tax-deductible donations. DAF administrators won’t approve requests for distributions to these types of organizations, so donors should make these contributions directly instead.

 

What does it mean that I may “advise” on donations?

For compliance and legal reasons, the donor of a donor-advised fund “advises” the DAF on how to distribute the money. Technically, the donor is just an advisor and can’t force the DAF to make a particular grant. But, in practice, it is extremely rare for a DAF administrator to deny a request to distribute money to a properly registered nonprofit charitable organization. It sometimes takes a few days for the DAF administrator to confirm the IRS status of the organization, but we’ve never seen a denial of a grant to a 501(c)3 charity. 

 

What are some common issues with implementation?

DAFs often require initial contributions of $5,000 or more. Several major DAFs like Schwab Charitable or Fidelity Charitable currently charge annual administrative fees of $100 or 0.6% of assets and offer low-cost index fund options for investments. It’s important to check both the administrative fees and investment fees the DAF charges to be sure they’re reasonable. Because the administrative fees include the DAF sending charities checks, using a DAF with reasonable fees can allow you to have an even bigger impact than donating by credit card since it can save charities the 2%-4% they would otherwise pay for processing credit card donations.

 

What should I do if I have questions on this subject or I am not sure about how to use it well?

This strategy is best evaluated in the context of other investment and tax management strategies. Of course, as with all material on this site, this article is for informational purposes and isn’t advice. Given the complexity of the tax system and investing, it’s typically wise to consult a fiduciary financial advisor with the relevant expertise in taxation, investment, estate planning, college funding, student loan management, and other related areas. We think about these issues all the time and would be happy to connect with you about your questions–just reach out!

Zach was featured in the Brown Alumni Magazine

The May/June edition of the Brown Alumni Magazine features Zach and Values Added (link)!

“Brown’s alumni ranks are full of people who aim to do well and also do good. Zach Teutsch ’05 has made it his mission to help others do the same.”

What would you do if you missed two paychecks?

What would you do if you missed two paychecks?

I wrote an article for Vox on:

  1. why emergency funds are important,
  2. how big they should be,
  3. how to get started even (especially) if it seems daunting,
  4. why this a weirdly American problem, and
  5. some hacks to keep you on track.

I hope this helps you or people you know. I also hope we see that the need for large emergency funds indicates a policy failure and that we fix it soon!

 

We’re hiring! Join us and help progressives build thoughtful, prosperous financial lives!

picture of trees, skyline with title of we're hiring

Values Added Financial (VAF) is growing and we’d love to add a third team member in DC.
It’s a great opportunity to learn financial planning in a mission-driven context with people who care deeply about clients. In the job description, you can learn a lot more about the role, what skills might help someone succeed in it, and also who might enjoy working at VAF.

It is essential for anyone joining the team to be able to participate in several meetings per week in-person at our office in Petworth (DC). Team members could work remotely several days per week.

As a small firm, we know that the time to build a diverse staff is now. Given that, we strongly encourage women, people of color, and all members of other historically disadvantaged groups to apply. Having a diverse team is important to us and to the firm’s success.

If you have any questions, email .

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Welcoming Ari Weisbard to the team

I am delighted to announce that Ari Weisbard has joined Values Added as a financial advisor. I’ve known him for decades and have often turned to him for advice myself. Like mine, his first career was in public service (DC Council, DC Employment Justice Center, and SEIU). Ari will be using his expertise in estate planning, tax planning, employment matters, investing, buying a home, and many other topics to help clients make wise financial decisions and live more fulfilling lives.

Ari lives with his family in Petworth, just a few doors down from our house. When he’s not providing financial advice, he’s usually playing with his son, baking, sharing communal dinners, volunteering with Jews United for Justice, or advising on employment and estate issues at the Law Office of Ari Weisbard.

Ari graduated from Harvard College in 2003 and Yale Law School in 2008. He clerked on the Ninth Circuit Court of Appeals for the Hon. Michael Daly Hawkins. He is a member of the District of Columbia and New York Bars.

I love working with Ari (he’s my financial advisor!) and I bet you will too.

Ari is a talented and wise advisor

You might be able to save tens of thousands of dollars on a mortgage–shop around

If you are going to get a mortgage, shop around first! Those simple words might be worth tens of thousands of dollars to you.

Whenever I advise clients who are planning to buy a home, I always encourage them to shop for a mortgage. Most people initially say things like “I have a great rate already!” Sometimes that is so but often the rates have fallen and they’d never know. Sometimes they didn’t have a great rate to begin with.

Among the last few people I’ve worked with on this, the advice to shop around and helping them do so has made a huge difference. In a pair of recent cases the rate they paid was so much lower that over the course of a mortgage, they will save *$90k* and *$100k* respectively.

Anyone getting a mortgage should shop around! This often saves more than all the comparison shopping at the supermarket anyone will ever do in their lifetime and takes just an hour or two. You can read more in the CFPB’s guide to buying a house. They have a great mortgage rate checking tool.

Easy Steps to Take in Response to the Equifax Breach

A major credit reporting company, Equifax, had a large-scale breach. It has effected lots of us. Even those whose data wasn’t compromised should still use this as an opportunity to think about data security and whether everything in our credit reports is correct.

Check out this great resource on what to do in response to the breach. It is from my former colleague Rohit Chopra  who is now doing terrific work at the Consumer Federation.

This piece will answer a lot of your questions. If you have more questions, be in touch!

Featured in Architectural Digest’s 5 Dead Easy Ways to Start Saving for a House We promise, you’ll still have a life

Lot’s of people want to buy a first house and are trying to figure out ways to save up for down payments. I recently contributed to a piece by Meghan Nesmith, an exceptionally fun, approachable writer. She did a terrific job with it, as always!  I suggest heading over to Architectural Digest to read it (it’s below for posterity).

Certain pillars of adulthood feel more achievable than others: finally learning how to hang a gallery wall, say, or flossing. Homeownership, on the other hand, remains a pipe dream so bewildering that the mere idea is as unrealistic as joining the ranks of people who know where to find the “portico.” (In the bathroom, right? It sounds like a bathroom word.) But that first home might not be as far off as you think. While general wisdom has shifted slightly in the wake of the mortgage crisis, moving away from a lifestyle in which you play victim to the whims of landlords and the shrinking rental market can still make good financial sense. And getting started is easier than it appears. We all know an 18-year-old jerk who’s all, I saved my lemonade stand money and oops, guess I bought a detached 3-bedroom with pre-war details! You, too, could be one of those jerks.

1. Think (really, really) small

While the sheer size of down payments can seem terrifying, your first home is still a purchase like any other: with time and a strong savings strategy, it can be realized. “Consider setting up an automatic savings plan where some money goes directly from your paycheck to a down payment savings plan,” says Zach Teutsch, founder of Values Added Financial. “Alternatively,” says Teutsch, “you can set up a recurring transaction to transfer money from your checking account to a special savings account for this purpose.” Apps like Acorns or Digit make this simple, automatically deducting small amounts of money from your bank account to either save or invest. Proactive yet lazy: the perfect combination.

2. Think (really, really) big

Mysterious dead uncles, that scratch ticket a former tenant left under a floorboard, a hoard of pirate gold, your tax return. We tend to view these windfalls as magical money birds, and therefore not subject to the same rules as the rest of our finances. But rather than going wild, put unexpected jackpots in your savings account. Similarly, a raise doesn’t need to lead to lifestyle upgrade if you already have what is necessary to cover basic needs. Set up automatic transfers to move the additional income into that savings account, and let it work for you.

3. Here comes the. . . down payment

Getting married? Teutsch suggests including the option to help with a down payment on your registry. “In some cultures, giving money as a gift is encouraged,” he says, “but for many Americans, it feels awkward.” Using a registry website like Honeyfund, which offers specific options for down payments, makes it more likely that your guests will give freely. After all, Teutsch notes, “How many vases do you really need?”

4. Get real about debt

Feeling snowed under by student or credit card debt creates a psychic block that makes it near impossible to plan for the future. So before you start thinking about mortgages, put your energy towards clearing out your debt. Programs like Mint and LearnVest can consolidate loans, help you create a realistic payment plan, and create a clear roadmap towards that first converted loft with the obligatory exposed brick accent wall.

5. Educate yourself

So much of what makes a first home seem unattainable is that much of the conversation takes place in a foreign language. What exactly is a mortgage, anyway? Does anyone really know? Even if you don’t believe you’re ready to join the ranks of homeowners yet, taking the time now to understand what it takes to buy a home will allow you to consider the possibility more realistically. If you’re feeling especially productive, go one step further and investigate the First Time Homebuyers loans for which you might be eligible, such as a Federal Housing Administration loan or the Good Neighbor Next Door program. “Some of these will have higher monthly costs as a result of insurance, but less of a down payment,” Teutsch says. “There are also programs such as the FHA’s Section 203(k) loan that may be of special interest to architects, contractors, and others who may want fixer uppers.” A little research can go a long way towards building the self-esteem necessary to bring your dreams down to earth.

The Atlantic is asking “Are Index Funds Evil?”

The Atlantic recently published a piece asking a very interesting question: do index funds have the (accidental) impact of limiting competition and driving up prices? Really smart people are taking both sides of the debate. That’s a good sign that it’s worth thinking about.

In April 2014, Azar, Schmalz, and Tecu posted an early draft of a paper titled “Anti-competitive Effects of Common Ownership.” The paper made several astonishing claims. Overall, it said, the high concentration of share ownership had caused serious harm to consumers in the airline industry: Ticket prices were as much as 12 percent higher than they otherwise would have been, because of common ownership of shares. The authors measured how competitive individual routes were, based not only on how often each airline flew a given route—which regulators already examine—but also on the degree to which each airline’s shares were held by common investors. They found that adding common ownership increased the level of concentration on the average route to more than 10 times higher than the levels that regulators presume to be a problem. The paper noted that three mutual-fund families—BlackRock, State Street, and Vanguard—collectively control about 15 percent of the shares of major U.S. airlines, although these funds are by no means the only common owners. At the end of 2016, for instance, Berkshire Hathaway, Warren Buffett’s company, owned 7.8 percent of American Airlines, 8.3 percent of Delta, 7 percent of Southwest, and 9.2 percent of United Continental.

A few initial thoughts with the caveat that I haven’t read the underlying papers yet:

1) The idea that firms will become non-competitive based on investor pressure is plausible but that pressure would push against the intensity and culture of most firms and industries. Further, financial incentives are only one area of influence on firm leaders (who are often competitive alpha types).
2) The air travel industry is sufficiently atypical that in almost all cases one shouldn’t extrapolate findings in that industry to the market as a whole.
3) There is still a lot of non-index money invested (most of the money!) and there are still activist investors so even if this was a potential problem, presumably it is muted in impact some by all the other investors.
4) The government ought to insure competition and it should examine this issue and consider whether it might be able to engage in a way that helped.
5) The rise of Vanguard and other indexers and their substantial and growing market power means they need to be much more careful about corporate governance and shareholder proxy issues.
6) Low-fee index funds have created a huge amount of value for middle-class investors (as well as wealthy investors).
7) If the problem hurts all consumers but benefits some investors, that would create additional inequality and would be very concerning. The bigger the impact, the more it should concern us.
8) Bonus thought on index funds: they tend to increase tax efficiency of investing which also contributes to income inequality.

 

Money in One’s 20s and 30s

There are lots of issues common to folks in their post-college, pre-middle aged years. Here are answers to many questions people in that age range often ask me. I am, of course, happy to provide more specific answers and update the post to reflect concerns left out–just make comments, I’ll be reading them actively.

1) Why Is Advice Different For People In Their 20s and 30s? I am primarily referring to those who are working and not anticipating retiring in the next 30-40 years–that obviously doesn’t apply to everyone in this age range but it is a common occurrence. The length of time that money will be invested impacts substantially how it should be invested. Someone who was 45 and anticipate working until age 72, would probably find this information useful, perhaps even if they planned to retire at age 62.

2) What If I Have Lots of Debt? If you have credit card debt, it multiplies at an astonishing rate. Do whatever you can to eliminate it as soon as possible! If you need to, move in with your parents and get it axed. Don’t eat out again until it’s gone. Do whatever you can to eliminate it immediately. Come up with a strategy to avoid carrying a credit card balance. Many credit cards companies are excellent at tricking you into making “minimum payments”. These payments allow your debt to grow and compound (sometimes at a rate of 30% or more). The bank is getting more than a 30% return and you are paying them for it. From the investors standpoint it’s a “maximum payment” as in maximized their profit. Square things with them immediately. If you have student loans, however, since they tend to charge less interest you don’t have to take as aggressive approaches as with credit card debt. You might be able to invest less as you pay them off but the money you invest will outperform the rate you have to pay for student loans. For many, income-based repayment approaches make the most sense, especially when combined with public student loan forgiveness eligibility or loan forgiveness from their university (especially common for fancy professional grad schools like law school). Student loans are complex and the best approach varies tremendously with characteristics of the loan and the borrower.

3) Do You Have Some Secrets Which Will Enable Me To Amass great Riches? Unfortunately, I don’t. If you eventually want to stop working (retire) then sometime before that point you must start spending less money than you earn (saving). Not saving likely leads to no comfortable retirement. When asked about the most important invention of the 19th century, Einstein is often said to have given it significant thought and then replied with “compound interest.” Insofar as there is a secret to retirement savings it is the power of compounding interest–or in the case of investment, compound return. Let’s say you invested $1 today and received a 10% per year return. That return is somewhat less than the 11.31% average annual return of the US stock market since 1928 (when good data began to become available). After one year that $1 will be worth $1.10. The next year you would have $1.21 (because you received interest on last years interest). After five years the dollar would have turned into $1.61, @10 years–$2.59, @20–$6.73, @30–$17.45, and after 40 years, that original dollar would be worth $45.26. From year 39 to 40 the $1 initial investment yielded $4.12 in annual interest. Now imagine that instead of investing $1 initially, you invested $1,000 and were 25. At age 65 that money would be worth $45,260. Combine that with social security and you can see how retirement could be pretty sweet.

4) But I’ll Be Making More Money When I’m 45. Shouldn’t I Just Put Money Away Then? In our example above you invested $1 at age 25 and ended up with about $45 at age 65. Now, assume you didn’t start investing until age 45. You would have needed to invest $6.43 to have the same $45 at the end. Do you really think you will be making 6.43 times as much money in twenty years? At that point you may have several children, mortgage payments, and many other things about which to worry about and you’ll probably not be making much more than double or triple what you are making now. If you invest 10% of your income every year for retirement starting at age 20 it will be worth a huge amount more than if you invest 30% starting at age 45. Over the course of your life, 10% will be doable. 20% would have you living a rich life in your later years.

5) Where Should I Invest This Money Between Now and When I Retire? Let me take a second and say something very important. Where exactly you invest isn’t nearly important as that you invest. You will make a solid decision of where to put your money and, if you are smart, you will pretty much leave it alone. Dr. Ilia Dichev, of the UMich B-School studied investors and found that the returns of most investors was less than the markets they invested in. The Wilson Quarterly has a great (brief) writeup of that study:

“Buy and hold” is the mantra of many investment gurus. Rather than try to time the market or pick win­ners and losers, they say, indi­vidual investors should put their money into a representative basket of stocks and forget about it. Good advice, says Ilia D. Dichev, an economist at the Uni­versity of Michi­gan’s Stephen M. Ross School of ­Business. What a pity it’s too simple for most people to follow. The NASDAQ market, the main crash site of the Internet boom of the 1990s, would have produced handsome returns (9.6 percent annually) for a person who invested in 1973 and did nothing until 2002. But even committed “passive” investors have a hard time sitting tight. People tend to put more money into stocks when the market soars and pull it out when it turns south. Most wind up buying high and selling low. In order to find out how investors actually fared, Dichev adjusted historical market returns to reflect the flows of money in and out of the market. That juicy 9.6 percent return on the NASDAQ? In fact, inves­tors reaped only 4.3 percent on average. Results were better in other markets. A capitalization-­weighted basket of stocks on the New York and American stock exchanges held from 1926 to 2002 returned an average of 9.9 percent annually. Investors who tried to outsmart the market saw an 8.6 percent annual ­increase.

6) So, Nu? Where should I Invest My Money? A lot of folks like to pay other people a lot of money to financial firms (often via mutual funds fees) to manage their money. This is usually a bad idea. Most financial “experts” aren’t better than the market and the mutual funds they work for often charge you a lot of money for their advice. The Motley Fool has an excellent piece on why Index Funds are better than anything else. Here are two excerpts:

There’s a reason that all these magazines don’t tell you how simple mutual fund investing really is. Scientific marketing surveys and focus group testing have determined that magazines with covers that read “Index Funds: Still The Best Choice!!!” every single month really wouldn’t sell as well as magazines that promise “Our BRAND NEW 10 Best Mutual Funds To Buy RIGHT NOW!” Sad, but true.

Basically, it will cost you anywhere from 1-2% to have an actively managed mutual fund. Sometimes even more when sneaky fees are introduced. Vanguard’s total US market index fund [Vanguard: VTSAX, ETF: VTI] is an example of a diverse, low-cost option. It has typically outperformed 90%+ of other investments over time and costs only 0.04%. If you want to live a very simple investment life, have a long time horizon, and don’t worry too much about short-term fluctuations, many passive investing enthusiasts suggest this as a good choice for your one mutual fund.

7) The Simple One Index Fund Approach Looks Good but What is the Next Step? Dave Swenson, the guy who used to manage money for Yale, is generally regarded as a financial super-genius. Here is a post on a great financial blog discussing his recommendation. It is very close to what a smart 20/30-something investor might do. A younger investor who is okay with more volatility might tweak it to this (certainly most people would be best off with something else, this is just an example!, anyone seeking support with asset allocation should contact a fee-only, fiduciary, perhaps a registered investment advisor):

  • Domestic Equity (42.5 percent): Refers to stocks in U.S.-based companies listed on U.S. exchanges. [Vanguard: VTSMX, ETF: VTI]
  • Emerging Market Equity (12.5 percent): Refers to stocks from emerging markets around the world, such as Brazil, Russia, India and China. [Vanguard: VEIEX, ETF: VWO]
  • Foreign Developed Equity (20 percent): Refers to stocks listed on major foreign markets in developed countries, such as the United Kingdom, Germany, France and Japan. [Vanguard: VGTSX, ETF: VEU]
  • Real Estate Investment Trusts (25 percent): Refers to stocks of companies that invest directly in real estate through ownership of property. [Vanguard: VGSIX, ETF: VNQ]

The above version removes Bonds and TIPS and concentrated on equities. Over several decades stocks have always outperformed bonds. If you are nearing retirement or about to buy a house then most want more stability and are willing to sacrifice some upside in order to achieve it. If you want to maximize money in the future then you need to accept more volatility. Retirement investments for young folks should be somewhat volatile in the short run to make them richer in the long run. The reason that the adapted Swenson approach has a few more funds than the one fund solution is to diversify more broadly to make it less volatile. This will cover you much better if foreign companies come to reign supreme in the next few decades. Also, this version of the portfolio uses Vanguard funds as an example. Many other firms have a wide range of low fee index funds. For instance, one could also construct a nearly identical portfolio using Fidelity funds. Or iShares. Or Schwab. Or many, many others. My point wasn’t to suggest a financial firm so much as give a sample portfolio to consider. I would never write a blog post suggesting how an individual person should invest–providing responsible investment advice requires knowing that person’s situation in depth.

8 ) But I want to buy a house? Generally speaking, real estate doesn’t do as well as the market. Here is an excerpt from a Forbes piece on the subject:

Where’s a better place to put your money: the stock market or real estate? These days the accepted wisdom (at least at cocktail parties) says to pick real estate. But is the accepted wisdom right? It is–in the short term. U.S. real estate sale prices increased more than 56% from the beginning of 1999 to the end of 2004, as tracked by the Office of Federal Housing Enterprise Oversight, part of the U.S. Department of Housing and Urban Development. The S&P 500 index dipped nearly 6% during that same period. But if you take a longer view–say 25 years–you’ll find that the S&P 500 has actually stomped the real estate market, from Boston to Detroit to Dallas. From the start of 1980 to the end of 2004, home sale prices increased 247%. A pretty sweet deal, it would seem. Over the same period, however, the S&P 500 shot up more than 1,000%.

The other big problem with real estate is that it causes a large portion of your assets to be tied up in a single entity. It is very hard to diversify if 90% of your net worth is in a single property as is often the case with young investors. That said, if you are a brilliant real estate investor you may be able to realize short terms gains enough that your share of a nice home is less than renting used was costing you. In general though, if rent prices are attractive, the financial incentive to buy is not very substantial. However, and it’s a big however, there are many non-financial incentives to buy that are worth considering. Perhaps it will help you to feel invested in your community. You might live in a nicer place, you may like the idea of a 3-dimensional investment, you might have help from family members, or you might want to spend money to make your home more attractive and recoil at the idea of paying for your landlord’s investment to improve. Back to the financial side, one compelling feature related to buying real estate is that if you borrow money to do it (a mortgage) the interest payments on that borrowed money are tax deductible. Meaning that you don’t pay taxes on the portion of your income you use to payoff the interest on your loan. In the early years of a 30-year fixed rather mortgage, for instance, the vast majority of your payment is interest. If you are in a high tax bracket this break is very advantageous. Most young people, however, are not in a high tax bracket and those that are may want to see a tax planner or financial planner to get more personally tailored advice. Also, it’s important to realize that if you currently use the standard deduction, then you only save the difference between the new itemized deduction approach and the standard deduction. For instance, if you filed your taxes alone last year and had $3,000 in deductions, you’d have used the standard deduction which was worth $6,300 off of your taxes. If this year, you started paying a mortgage and had $8,000 in interest payments, your taxes wouldn’t be $8,000 less than last year.  The income on which you were taxes would actually be just $4,700 less than last year since you’d have $11,000 in deductions (the $3k in non-mortgage expenses plus the $8k in mortgage interest) but you’d no longer claim the $6,300 from the standard deduction. Though you’d pay a less taxes, it’s important to factor in losing the standard deduction so you don’t overestimate. As always, consult a professional or do careful research about your own tax situation!

9) Okay, back to investing…Should I use a 401k? 403B? IRA? Roth IRA? What are they? 401Ks, Roth IRAs, Traditional IRAs, and 403Bs are four different kinds of tax-advantaged retirement accounts. They have several features in common:

  • All were setup by the IRS to help us save for retirement.
  • All will lead to us paying less taxes, either now or later.

There are also some major differences.

401K and 403B plans are created by employers for the benefit of employees. 401Ks are generally in private (for-profit) companies and 403Bs are for public and non-profit firms though the lines can be fuzzy at time. These two plans work similarly. You tell your employer to deduct some of your salary and put it in the retirement account. You’ll also tell them how you want it invested. Often your boss will match your contributions up to a certain limit. For most people, most of the time, it’s wise to contribute up to that limit. Basically, you are getting an immediate 100% return on your investment. If your $1 is matched then 40 years later instead of being worth $45, your $1 invested will be worth $90. You don’t want to miss out on that. Both 401Ks and 403Bs must be funded through payroll deductions. You can’t move money from your checking account to that sort of retirement account. Money invested with a 401k/403b is tax deductible now (but not later). If you make $40,000 and you put $5,000 into your 403B you are taxes as though you only made$35,000. The 403B (or 401K) contribution is tax exempt. IRA’s are also tax except but aren’t managed by your employer. By contrast, Roth IRAs are not tax deductible now. In exchange for paying taxes now, you don’t need to pay taxes when your withdraw the money later. If you are in a low tax bracket now and expect to be in a high tax bracket upon retiring, this is often the better choice to prioritize. Of course, you can also do both! Basically, if your boss will match a contribution to a company plan, that is free money, consider taking it. If not you may be better off with an IRA, Roth IRA or both.

10) Okay, So I Want a Roth or Traditional IRA and Like Your Index Fund Idea, How Do I Do It? How Do The Mechanics Work? Just about any firm that manages money for individuals will manage your retirement accounts. You probably want a firm that has lots of good, cheap, index funds (and/or ETFs) and won’t charge you to buy or sell their own firms funds. Vanguard was the original firm to develop low-cost passive investment so many people gravitate towards them. They invented index funds and have a very good selection including the funds I used as an example earlier.* Conclusion:

  • There are no tricks or secrets.
  • Consider starting to save now and save more than you think.
  • Consider investing in index funds.
  • Money multiplies at an amazing rate the longer you put it away for. Consider starting right now! Then the money will be invested and reinvested as long as possible.
  • If you push hard to invest enough now, you will have a much easier time later in life. It may well be worth the small sacrifice now.
  • Would you rather put away $1,000 now out of your income or need to set aside $45,000 out of your income in 40 years?

*These funds are neither guaranteed to do as well as they have historically nor are they guaranteed to outperform most funds, as they have historically. I believe in this approach and use it myself and am reasonably confident in its simplicity but you should make sure you understand enough to think clearly about the question of which sorts of funds are best for you and why.