Expenses, SWR, and Holy Sh&%#t

[youbet]

Oooh.. an online hug. That felt good, thanks Ladelfina  .

No hug from me.........we've never been properly introduced!

But, no problem with your view on your personal residence as being a reduction in expenses as opposed to an asset.  I do it the same way.

My proposed retirement budget includes the expenses of maintaining my home, RE taxes, utilities, etc., but no rent.  I offset that by not including the equity in my home on the asset side.

Of course, this would never pass gaap muster, but it works for me.  I'm an old guy and get confused by posting the house as an asset and then offsetting it with phantom rent.  Too hypothetical for my shallow mind.

IMO, as long as you don't do it both ways, it'll work out ok.

 

[Rich_by_the_Bay]

(SanFrancisco condo to South Carolina house). And we live once again in a much appreciated asset, and this time wihout a mortgage. But I don't count the value as a FIRE asset. I figure on eventually trading this place for a small condo and/or spiffy fifth wheeler--and much later, assisted living (especially if DH goes to the great beyond first

Those are our priorities to a T.

My paid-up (and admittedly more-than-we-need) house is probably the closest we will come to long-term care insurance. Tap those precious assets only when an alternative living situation is needed by one or both of us. That way, if a move to a nursing home is necessary, the house becomes automatically too big for one, and a whole bunch of change is freed up to help defray the costs either by selling and downsizing, or reverse mortgage.

 

[SteveR]

Way to go Rich!  

At least some of the posters here see your message for what it was meant to convey....not paying any recurring expenese will save some significant $$$ needed to fund an income stream to pay the expense over time.  It may not be 25X annual expense unless it is a very long term mortgage and you need to pay it until it the end of the loan term (30 years).  A 15 year note might only require 12X annual expense for P+I (you still have taxes and insurance).  

I have a couple of mortgages that are being funded out of current wages.  I am doing accelerated payments on one of them to get it paid off in a couple of years to reduce my expenses in retirement.  I plan on carrying the other mortgage for a while since we plan to downsize the house in 8-10 years.  I see no need to pay off the house mortgage since we can easily make the payments out of our planned RE income stream.  After we sell it and move our expenses will go down and that is in my budget plan.  

Planning income streams in RE can be a complex task for some folks.  In our case, we have a number of reductions in expenses over the first 10 years of ER.  Some people might be tempted to keep working to fund these 10 higher income years but we won't.  We will have a higher SWR during those years but the net effect on income in later retirement years is projected to be insignificant even with conservative investments.  

Lowering expenses is a great way to get to ER sooner or to have a larger income while in ER because it reduces the amount of money required to fund the required income stream.  For many of us it comes down to quality of ER life vs quantity of assets to generate the income desired to fund the expected quality of life.  This is a moving scale and being flexible will pay off handsomely by allowing more spending in an "up" market or reeling in our expenses in a "down" market.  Having a  nice buffer between what you really need vs what you want will make for a much more comfortable retirement life.  Our plan has about a 20-30% buffer in expenses; more after the first 10 years (40-50%) all on a 100% SWR not using all our investment assets.  

Oh..we don't use the house or the other home's equity in our asset calculation of SWR.  We do include in our NW but that is just a "feel good" number and not a real one for calculation of our expected SWR since we don't intend on selling either property to pay for groceries.  

 

[cute fuzzy bunny]

I guess the problem everybody (except CFB) is having with this revelation i

CFB didnt say a dang thing about the "revelation". Unless you've developed "Brewers disease", re-read my post for the ACTUAL content please? If you've in fact developed Brewers disease, then continue to rant for 3 more pages about it and then declare that your misreading of the post was just semantics

Back in the land of reality...I quoted a very specific component of Rich's thread regarding expense reduction and commented further on the benefits of said expense reduction.

 

[donheff]

Hey Rich, I am with you. Hug, hug. I just paid off a $270K mortgage. For me it had nothing to do with detailed calculations of net worth, investment value, et al. It had to do with a modicum of piece of mind. I too saw that thirty year payment as an albatross that I would be well rid of.

With the mortgage paid, I now have all of my wife's and my basic expenses covered by a relatively sure thing (Fed pension). Our portfolio is there for travel, etc and we are comfortable leaving it a bit more agressively invested than we might otherwise in hopes of a large transfer of wealth to the kids (who don't have a safety net because of those darn CEOs and short sighted legislators we are ranting about in the PBS Nightline thread)

 

[doushioukanaa]

Bottom line, if you have a great loan rate and if it's further improved by deductability of mortgage interest, it may make sense to keep a home loan. For this case, with a high and growing ARM at 7% and with enough emergency liquidity, Rich in Tampa made the right call in my opinion.

Real estate is so regionally specific and with returns which are somewhat but not fully correlated with stocks and bonds. It doesn't make sense to ignore it in your SWR calculations, but it doesn't make sense to give it the same treatment as a liquid portfolio either.

In formulating an annual budget I count the full value (after cap gains taxes and expenses) of the real estate (primary residence and a vacation home) and just presume a lower withdrawal rate (2%) on that portion to be conservative.

Quicken software has a good retirement simulator where you can model these sorts of events like an asset sale -- kind of figure out when we would need to sell the home or homes in order to not run out of cash under a fixed assumption of returns. Of course, it's not the full monte carlo approach, but it's a decent guestimate.

 

[cute fuzzy bunny]

And make sure you throw in the tidbit that I gleaned from rich's post.

Look at the expense number. You can squeeze some float out of a loan, but consider the safety factor.

Some people buy lots of bonds. Some people buy annuities. Both to provide income and protection from volatility, along with increased diversity. Some people invest in riskier/higher volatility investments to (hopefully) maintain a high rate of return to really squeeze out that float.

If you dont have a lot of big monthly bills to pay, volatility and rates of return become a lot less critical. I dont own many bonds and no annuities. I dont need "ballast" and low volatility. On the other hand, high volatility that brings an associated high return doesnt scare me either.

If my wife lost her 2 day a week job (really unlikely), couldnt find another one (impossibly unlikely), and the equity markets dropped 80%...it wouldnt make any difference at all to me.

Its REALLY a LOT more than just figuring the mortgage payment, the tax deduction and how much you think you can make with that if you invested it...

 

[modlair]

Another comment on . . . to net worth or not to net worth your home equity.

A poster noted he does not include his clothing or art collection in his net worth because he's not going to sell either. Potentially valid point.

But . . . if the art collection is insured and burns in a fire, along with the insured house it's in, then what? Your intent is to some extent irrelevant in the world of net worth. You either are worth it or not.

I hope the concept of paying off the mortgage to lower monthly expenses and celebrate on the lowered required asset base for SWR . . . also includes a careful assessment of annual depreciation in the value of appliances that are ageing and must be replaced, annualized overall repair costs to the house (including the big ticket item roof every 20 yrs or so), property tax and insurance, sewer, trash pickup . . . just every single item that one would not explicitly pay when renting. But that's a significant digression.

If your house is burned tomorrow and your insurance company puts the check in your hand, I'm pretty sure that for that moment at least, your home equity is part of net worth.

 

[youbet]

If your house is burned tomorrow and your insurance company puts the check in your hand, I'm pretty sure that for that moment at least, your home equity is part of net worth.

If you keep the cash and don't rebuild the house, don't forget to put rent expense back into the budget!

 

[tryan]

This is problematic in that the SWR studies do not include real estate, so deriving an SWR number from real estate is not going to be historically accurate.  

This is the heart ache I have with all the retirement calculators.  Hurts because we're ~75% investment property.  Makes the SWR game a little harder.

Hey Dory -

Ever thought of adding real estate as an asset class to FIRE Calc?  Could use some historical appreciation number like 3 or 4%.  Or maybe just tie it to inflation.  

Huh ... I guess it might be the same as assigning the real estate to  the TIPs portion of FIRE Calc ... (never mind).

 

[Rich_by_the_Bay]

If my wife lost her 2 day a week job (really unlikely), couldnt find another one (impossibly unlikely), and the equity markets dropped 80%...it wouldnt make any difference at all to me.

Wow, CFB. Does that mean that you have assets spinning off more than 5 times what you really need to live on at a SWR? Or do you just mean you have a "plan b" - e.g. go back to work, inheritance, etc.

Just curious. In any event, nice work getting to that place.

 

[astromeria]

CFB is better off than me, but even I would be pretty OK in that scenario (DH lost his job, market tanked). I have over 10 years of expenses in fixed income that I could slowly cash out. Presumably my stocks would've recovered in spades by the time I was sweating bullets!

 

[doushioukanaa]

And make sure you throw in the tidbit that I gleaned from rich's post.

Its REALLY a LOT more than just figuring the mortgage payment, the tax deduction and how much you think you can make with that if you invested it...

Absolutely.  The quickie analysis is just a rough cut and shouldn't be a final answer, hence the use of conditional language "may make sense" in the post.  To be more specific, it may make sense to keep the loan if the "spread" between the return you get putting the money to work versus the after tax cost of the loan is high enough to compensate you for the risk of taking on debt, loss of sleep factor, etc.  That's a personal decision and there is not really a cookie cutter answer.

The impact of keeping the loan to fund your investments is not unlike what some hedge funds do.  It leverages a smaller asset base to amplify gains in your liquid portfolio -- the problem is the losses can be amplified as well.  

 

[Martha]

Hey Dory -

Ever thought of adding real estate as an asset class to FIRE Calc?  Could use some historical appreciation number like 3 or 4%.  Or maybe just tie it to inflation.  

Huh ... I guess it might be the same as assigning the real estate to  the TIPs portion of FIRE Calc ... (never mind).

Part of the problem with real estate is that it is local.

We are at maybe 25% real estate right now and on the sell down. I have used FIRECalc using the TIPS portion, but take it with a grain of salt as I don't see real estate outpacing inflation for a while. But because of the sell down process, it is close enough for government work.

 

[cute fuzzy bunny]

Wow, CFB. Does that mean that you have assets spinning off more than 5 times what you really need to live on at a SWR? Or do you just mean you have a "plan b" - e.g. go back to work, inheritance, etc.

Just curious. In any event, nice work getting to that place.

Nope, it just means my interest and dividends cover our fairly small expenses, and those expenses can easily be temporarily reduced without too much hardship. Drop all the satellite premium channels, quit eating lobster and filet mignon 2-3 times a week...you know, real hardships.

Stocks drop 80%...the interest and dividends still get paid, excepting defaults. Keep the shares, cut the expenses, maybe cut a few lawns or do a few hours behind the counter at the quick-e mart. Back to business as usual once things pick up.

Or we just live off the wifes small income until things smooth out. More than half of her income goes to her 403b and our Roth's. We just stop that for a year or two and we've got more than enough cash, even if half of our portfolio defaulted.

Still got the house. We can still live in it. It hasnt "lost" any of that basic benefits.

And we're not trying to figure out how to come up with 12-25k+ a year to pay the mortgage in the 7th year of a full bear slide. It just...doesnt...matter...

Rich - since you're in the medical business you'll appreciate the safety of her job...she's a certified respiratory care specialist/therapist, with neonatal certification. We get postcards in the mail every other day offering to pay her full relocation, a five figure bonus and extra vacation if she'd take a job elsewhere. Theres about 50 hospitals within a 60-90 minute commute from here, and lots of individuals who would pay her for a daily visit to their home to check their equipment and give them treatments.

No matter how bad the economy gets, you pretty much cant stop breathing...

 

[unclemick]

Hmmm - one has to expect a few minor surprises in retirement and adjust accordingly.

Sump pump failed last night after relocating washer/dryer to the basement from upstairs.

Let's see - in the last year: wiped out by Katrina/relocated 1000 North, bought a house/mortgage instead renting(1st preference), bought an SUV with payments, two unexpected deaths(SO and Mom) and remodeling is turning into a self eating watermelon.

Did take a cruise in Feb.

Have yet to gain a mental sense of control over expenses up here - but that will happen.

'Agile, mobile, and hostile' - Bear Bryant.

Holy What! - heh heh heh heh heh - Rock up and party on - have a plan and adjust as reguired. 13 year of ER was different than I originally scoped out - but life happens.

 

[jdw_fire]

This is the heart ache I have with all the retirement calculators.  Hurts because we're ~75% investment property.  Makes the SWR game a little harder.

Just put the real positive cash flow in FIRECalc like you would a pension until you are ready to get out of the real estate business and then add the after tax equity figure to your portfolio (there is also a place to do that in FIRECalc).

 

[jdw_fire]

To be more specific, it may make sense to keep the loan if the "spread" between the return you get putting the money to work versus the after tax cost of the loan is high enough  

"The return you get putting the money to work" also needs to be after tax.

 

[cute fuzzy bunny]

Yep a lot of people miss that too, and its different for an accumulator than for an ER.

To get the tax break, you first have to withdraw the money from your investments, and pay taxes on that.

Nice if you're getting a deduction on your 33% taxed income while paying 15% capital gains.

Kinda worthless if you're taking a withdrawal as ordinary income to pay the mortgage, that puts you in a higher tax bracket, then you get the tax break to bring the scenario to neutral.

If you're still working, accumulating, and paying a third or more of your income in taxes...then you're already creating the money...deploying it to a mortgage and getting the tax break is a good thing. Makes sense.

Lighting something on fire, then putting it out, and then praising your firefighting skills is an interesting activity...

 

[free4now]

For the most part I think having a mortgage (or any leverage) in ER is a bad idea. As CFB says, it's not just a matter of subtracting the interest you can get from the interest you pay. You have to look long and hard at how the leverage can bust you when the going gets tough. That's the real cost, and it is steep.

I have a mortgage in ER because I don't consider myself really in ER There is a relatively high likelihood that I'll go back to work full time or part time in a year or two, and the income can then pay the mortgage. If I'm still ER in 2008 when my ARM adjusts up from the 3.75% I'm now paying, I'll probably pay the loan off.

 

[Rich_by_the_Bay]

For the most part I think having a mortgage (or any leverage) in ER is a bad idea. As CFB says, it's not just a matter of subtracting the interest you can get from the interest you pay. You have to look long and hard at how the leverage can bust you when the going gets tough. That's the real cost, and it is steep.

My DW pointed out something else: we intend to sock away the prior mtg payments into our savings. However, we now have the ability to skip that for a given time if higher priorities or necessities arise. With the mortgage payment, that was not an option -- it was like paying the rent, or get into a HELOC which defeats the whole pupose. Newfound flexibility.

 

[slepyhed]

Fun with a paid-off house plus hindsight:

Let's suppose that I retired in the year 2000, just in time to enjoy a decline in the S&P 500 from about 1400 down to ~900 by 2003. Very scary, but I'm not worried because (hypothetically) I have a paid off house plus the benefit of hindsight!

In the bleakest days of January 2003, I decide that its time to take action. I take out a $100k mortgage on my house, and go get a part-time job paying $7.50 per hour for 17 hours a week. Meanwhile, I invest my $100k into an S&P500 index fund (valued at 900).

Two years later, Jan 2005, I decide I've had enough of my part-time gig. I sell my S&P 500 index fund (now valued at 1200) and pay off the mortgage. After paying long-term capital gains, I get to keep $31k.

...so I got paid about $17 per hour to work at the quik-e-mart!

 

[igsoy]

sorry, slepyhed, I don't see why you would want to add two years at 7-11 to your resume to come out with 31k, when you could sit home and still come out with about 24k.

Only invest 90k of the 100k mortgage in the index fund, and just pay the monthly payments out of the extra 10 grand, plus a little early selling off in the second year.

Get paid $13.57 per hour to not work at the qwik-e-mart!

There's probably some money to be made somewhere selling people on your Hindsight Investing Seminars, as long as you keep that talk about min. wage employment out of it...