Investment portfolios: Build one without a broker?

What’s inside? Here are the questions answered in today’s reader mailbag, boiled down to five word summaries. Click on the number to jump straight down to the question.

1. Why pay down 0% debt?
2. Retirement planning for highly compensated
3. Strategic foreclosure question
4. Fearing change
5. Heating and cooling
6. Building investment portfolios without broker help
7. Small games for camping
8. Preparing for self-employment leap
9. Investing leftover money
10. Childhood toys

Since I live in central Iowa, regularly get involved with campaigns both locally and nationally, and sometimes switch my party affiliation based on which poltiical field I’m most passionate about, it’s not surprising that I’m being flooded with mail and phone calls from candidates who want me to participate in the Republican Straw Poll next weekend.

The Straw Poll, for those who are unaware, is an event hosted by the Iowa Republican Party where presidential candidates come and attempt to whip up support with an informal vote that’s supposed to give some sense as to what the field of candidates looks like. Mostly, it’s an afternoon of entertainment.

I really consider myself an independent, so I often change party affiliation based on which candidates I’m most interested in influencing the standing of. Since the 2012 election doesn’t have much going on with the Democrats… I’m a Republican, for now.

(I don’t know who I will vote for. That’s half the fun of going, though, isn’t it?)

Q1: Why pay down 0% debt?
Why would you ever make an extra payment on a 0% debt? Shouldn’t you always just put it into some sort of investment?
- Randall

The reason for making extra payments on a 0% debt is to free up your cash flow.

Even though the interest rate on a debt is 0%, making the minimum payment on that debt is still a monthly requirement. Month in and month out, you still have to make that payment. Paying it off eliminates that requirement.

Why not just invest it? For one, many people don’t have the self-control unless they have a goal that they’re saving for. If the money’s there without a purpose, why not spend it? For another, there are many situations where it’s better to not have savings, such as if you’re getting ready to apply for financial aid.

Q2: Retirement planning for highly compensated
I am 36, single, no kids, own my home and have two roommates who pay me rent. I earn $110K a year, and I max my 401(k) and Roth IRA. I have no debt except the mortgage (5.5%, 250K on it, last refinanced in 2004). My home is worth about $500K and I’ve owned it since 2001. I plan to stay indefinitely, both in the home and in the area, as my parents are nearby. My 401K has about $230K in it, and my Roth IRA has $29K. My take home pay is around $4300/monthly. I put $500 into my emergency fund monthly, and it has about 6 months of take home pay (around $24K). My job is quite stable. I also have a “new car fund” that I am putting $300 into monthly. My car, a 2007 Honda, is paid off, and I anticipate I will have enough to pay cash for the next car in about 6-8 years. I also tithe 10% to my church and other ministries.

I just received a letter from my employer saying that I am designated as a “highly compensated employee” (HCE) because my income was just over $110K in 2010. Because I am an HCE, I am now only allowed to contribute 10% of my gross income (about $11K), to my 401K, due to IRS regulations. I am livid! I have done some reading and understand these are the rules, but I think they are awful. I believe there are many others at my company who are in the same boat — $100K is probably the average for most at my company. I am a pretty small fish there and there are lots of folks that are above me. The company has about 20K employees.

What do I do? I am worried that I am not saving enough for retirement. I do receive a 10% employer match on my 401K, regardless of how much I put into it, and I know that’s quite good compared to other plans, and I am quite grateful for it. However, I would really like to be able to save the max of $16,500. Is $11K (my contribution) plus $11K (employer contribution) plus $5K (Roth IRA) enough? Am I worrying needlessly? Should I just not worry about it and take the $5K I would have put into my 401K and put it toward principal on the mortgage or home improvements? Or should I put it in a taxable index mutual fund, or something else? I realize I tend toward the hyper-saver mentality, so perhaps I am over thinking this, but I’d like your take. Thanks.
- Joanna

If you’re earning $110K and you’re contributing $11K (10%) yourself, plus your employer is matching $11K (another 10%), and you’re putting $5K into a Roth IRA (5%), that means you’re putting aside roughly 25% of your salary for retirement. That’s a lot, perhaps even bordering on excessive. You will have a bountiful retirement and should be able to walk out the door at the first possible date.

That being said, there is one alarm bell that’s going off here and that’s with your Roth IRA. If you’re earning $110K per year, you’re over the income cap for a Roth IRA. That means you can’t contribute the full amount to the account (you can, but you run into some messy IRS issues).

If you’re single and your income hits six digits, you should start contributing to a Traditional IRA instead. For single folks, you must be earning less than $105,000 to qualify for a full contribution and between $105,000 and $120,000 to be eligible for a partial contribution to your Roth IRA.

Q3: Strategic foreclosure question
I’m trying figure out what to do regarding my townhome (which is rented month-to-month) and my home. I’m frustrated that they are both so far under water and keep hearing about people that do a strategic foreclosure / short sale. I purchased my townhome in 2004 for $143,000, refinanced in 2007 for $184,000, now it is worth $150,000, and to break even on selling would need a purchase price of about $200,000. With the money from the refi and other savings we bought our home in late 2007 for $380,000, refinanced in 2009 to lower the rate only, currently owe about $295,000, now it is worth about $260,000, and would need to sell for $325,000 to break even.

My wife and I gross about $140,000 annually, have about $150,000 in retirement IRAs, and have $40,000 in an emergency fund. We’re in our mid-30’s. We don’t consider our current home our forever home and would gladly move if we could (we rushed into it and don’t like the location now). Also, our townhome rules only allow us to rent it for 3 years and that time is up in April. They could give us an extension or they could force the issue. We’ve been getting more and more frugal over the past 2 years. Currently we save about 20% of our income and the rental loses $500 per month. Other than the two mortgages, we only owe a $5,000 sewage assessment for our home which is at 0%.

How would a strategic foreclosure / short sale affect us? How bad and for how long would our credit be affected (we’re at about 780 – 800 right now)? Could the banks take our savings via a judgement or garner our wages? Are the rules any different for the townhome since money was taken out in a refi (even though it all went towards the next house)? If we cancelled our 20% savings, we could make both payments but that doesn’t seem like a good idea.

The other pertinent information is that we’re trying to have a child so our savings rate would go down in order to pay for those expenses when it happens. I don’t like the idea of a voluntary foreclosure / short sale at all, but I also don’t like being $500 in the hole each month on the rental and having over $100,000 negative equity. Today’s reality is much different than the original plan of renting the townhome for 3 years and then selling for a profit.
- Shane

The bank certainly could get that type of judgment if they decided to take you to court over it. However, that would require that the bank actually bother to take you to court over it and that they find a judge that’s sympathetic to their claims.

In many cases over the past few years, banks haven’t bothered to take the borrower to court because the costs of pursuing that action exceed their expected return on that action. Given that many courts are sympathetic to the mortgage holder, some of these suits end up returning virtually nothing to the banks.

Your biggest risk is probably to your credit, which will be hit hard by this. It appears as default on a very big loan, which does not have a good impact on your credit. However, this does go away over time. You are also running some risk of legal response from the mortgage holder, and there’s also the moral issue of walking away from an agreement both parties made in good faith.

Q4: Fearing change
I like my life. The only thing I don’t like about it is the financial hole I’ve dug for myself. I’m afraid that if I make changes to improve my finances, I won’t like my life any more. So I sit still and my finances get worse. How do I get out of this cycle?
- Amy

Start making changes and figure out how you feel about those changes on the whole. Try different things that are frugal and see if you actually enjoy them. Spend an afternoon or two doing something that reduces your cost of living, like air sealing your home or having a yard sale.

Some of them you’ll like. Some of them you won’t. If you don’t like it, skip it for now. The key is to get to a point where you’re spending less than you earn, and that doesn’t require doing every frugal thing that’s ever been invented.

What you’ll find is that it feels really good when that debt starts moving in the other direction. When that starts to happen, you’ll want to start trying more and more things to make that debt start moving faster and faster. That’s how it worked for me, anyway.

Q5: Heating and cooling
We live in a tri-level house and keep the temperature as low as possible in the winter and as high as possible in the summer. My husband has a home office in the lower level and it is quite a bit colder down there than it is in the middle and especially the upper level. Cost-wise, do you think it would make more sense to turn the heat up for the whole house, or keep the temp. about the same (or even lower) and use a space heater in the lower level, where he works during the day? During the day, we keep the temperature at about 65; at night it goes down to 58. I just don’t know how much more it would cost to run a space heater.
- Nancy

The best approach is always to run your central air conditioning and your furnace as little as possible. If you can take action so that you have to run those units less, you’re going to save money.

The scenario you describe is a cold-weather scenario. Using a space heater is a great technique for keeping a particular room warm while not running the central furnace for your home, which saves money on the whole. It’s a great move.

In the summer, I sometimes find it more cost-efficient to just work at the library or somewhere else on particularly hot days and let the air conditioner not run at all.

Q6: Investing without broker help
My husband is deploying this month and it looks like he will have quite a bit of downtime while overseas. He has set some goals for while he is gone – get in better shape physically, read a few books, and learn how to invest in the stock market. We are in great financial shape – no debt, maxing out retirement, 529 and IRAs set up, etc. He wants to take some money and start doing his own investing without help from a broker. So far he has been reading Stock Investing for Dummies, what other resources can you recommend? Especially blogs or online sources that he could use since he doesn’t want to haul a lot of books with him. Thanks!
- Abigail

There aren’t a lot of robust online sources for the type of information he’s seeking. Most online sources that discuss stock investing either use it as one sliver of a broader topic (like The Simple Dollar) or discuss it from a very deep perspective (like a stock investing blog). Neither one really matches what you’re looking for.

One good online learning resource is Investopedia’s Stock Basics site, which does a great job of laying out the basics of stock investing.

From there, I would honestly move to Wikipedia. Unlike the state it was in in 2003, most of Wikipedia’s articles are well-sourced and very reliable. Start with a particular area that interests you and move from article to article as you learn more about the topics you want to know.

Q7: Small games for camping
Do you take games along with you for camping trips? It seems to me that games with a small footprint would be great for camping. What do you think? Do you have any such games?
- Erik

I often pack small games for camping trips, just in case the weather is bad and we wind up sitting in a tent together.

A deck of ordinary playing cards is a must-have, simply because of the wide variety of games you can play with it. Other games I regularly take along while camping include a pocket chess set, Hive, Icehouse, No Thanks, and The Battle for Hill 218.

These have all been played on the floor of a tent on a rainy day, and a few have been played at a picnic table late in the evening, by lantern light.

Q8: Preparing for self-employment leap
I’m preparing for a significant life transition and am worried about being financial responsible during the process – I have plans to quit my full time job in August of this year and move from NYC to SC. I’ve been dating the same guy for 6 years and he joined the navy, and will be in training in SC for the next 2 years. He’s asked me to go with him. Since it’s been a long term goal of mine to eventually go freelance full time (I’m a writer/editor at a small magazine right now), and since he has volunteered to help cover costs while I get myself on my feet, these seemed like the perfect opportunity to do that.

Most of the advice out there says to have 3-6 months of expenses saved when you go freelance – but my expenses now are significantly more than they will be in SC (for example, my portion of my rent right now is 800 — that’s what it costs to rent an entire house in SC, and Stephen and I will likely be splitting that). The biggest expense I expect to have is my student loans; payment on those is about $500/mo. (that’s after consolidating my federal loans).

At least one writer whose blog I read suggested saving a significant amount and then inputting all freelance earnings into that account, then to “pay” yourself the same amount every month. That way you smooth out the ups and downs of freelancing–some months you make more than your “pay check amount” sometimes you make less, this way the months you make more pay for the months you make less.

I’d like to set up that type of system.

Since you have been in that place, where you’re leaving full time employment to work for yourself I thought I’d ask if you have any advice, financially, to make the transition a smooth one.
- Marcia

I agree wholeheartedly with having a large emergency fund before you make the leap into freelancing. You often have little idea how things will go after your first batch of clients and you may be facing some very lean months.

As for “paying yourself out of an account,” that works well if you’re paying yourself very small paychecks. The tricky part of freelance work is the income taxes, which you’re now completely responsible for. If you don’t have enough left over to pay the IRS, they won’t be happy.

The approach I use is to take every drop of income I have and split it in half. I put half in my personal account and half in a “tax” account. I then pay all of my income tax and other taxes from the “tax” account. When I need to pay a tax bill, the money comes out of my tax account. At the end of the year, after all taxes are paid, I move any and all leftovers from that year back into my main account (a end-of-year bonus, if you will). This helps me make sure I don’t miss a single tax bill.

Q9: Investing leftover money
Twelve years ago, I was working 3 different part-time jobs just to keep my head above water, a roof over our heads and food on the table. Today, I am living proof that you can come back from such a situation and am in a much more stable position, thank the Lord! Having been an avid reader of your blog for a couple of years now and having taken the Financial Peace class you would think that I know the answer to this question already, but I find myself wishing someone would confirm this decision. Here’s my pleasant situation: I have a 4 months emergency fund built up, plus an equal amount saved up for a new vehicle when that time comes (probably another 4 years or so) and I plan to contribute the full amount allowed to a Roth IRA this year again. The question is what is the best investment for any remaining “extra” funds I have this year – investing in mutual funds, cds, etc. or simply paying extra principal on my mortgage? The interest rate on the mortgage is just over 4%, but it doesn’t seem that anything else has even that much value right now
- Pam

I’d dump it into the mortgage, to be honest. I wouldn’t invest it in the stock market unless you have a specific long-term goal that’s more than ten years out – it’s too volatile otherwise. No other investments offer even a remotely reliable average annual return that beats your mortgage right now.

Putting it into your mortgage locks in a return of just over 4% per year for you with a balance that’s paid out when your mortgage is paid off early. That’s one of the better investments available to you, plus when you pay it off, you drastically improve your monthly cash flow.

This is the way I would go.

Q10: Childhood toys
When you moved out from your parents’ home, what did you do with your childhood toys? Did you keep them? Did they ever get thrown out?
- Ed

My parents kept some of my childhood toys and got rid of some of the other ones. Many of my old toys remain in tubs in the upstairs of their home, and now my children play with them when they visit Grandma and Grandpa.

I don’t think there’s any best way to handle this situation. My parents wanted me to deal with the toys at various points, but I usually just suggested that they toss them save a small number for future grandchildren to play with. I’m pretty sure they eliminated some of them over the years.

It worked for us, though some day I will have to deal with them.

Got any questions? Email them to me or leave them in the comments and I’ll attempt to answer them in a future mailbag (which, by way of full disclosure, may also get re-posted on other websites that pick up my blog). However, I do receive hundreds of questions per week, so I may not necessarily be able to answer yours.

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