Afford Anything - Ask Paula: Should I Pull Money from My Emergency Fund to Invest or Pay Off Debt?

Episode Date: December 3, 2021

#352: Anna and her husband have volatile income, but Anna thinks that having 18 months of living expenses is unnecessary. She’s torn between paying off her student loans ($30,000) or investing the money. Mentally, she always figured she would pay off her debt first, but wouldn’t investing pay off in the long run? Charlotte and her husband are taking a phased approach to financial independence, where they need to bridge two gaps before they each turn 59 ½. How can they calculate how much they need at each phase? Elle has a retirement plan in place, but her company is adding a Roth 403(b) option soon. Should she stay the course or adjust her strategy in these last five years before retiring? Sara wants to purchase land and build her dream house by refinancing her rental property and turning her current home into a second rental. How can she improve this plan? Joe Saul-Sehy, my friend and former financial planner, joins me to tackle these questions on today’s episode. Do you have a question on business, money, trade-offs, financial independence strategies, travel, or investing? Leave it at here and we’ll answer them in a future episode. Get the show notes delivered to your inbox by visiting https://affordanything.com/shownotes Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every choice that you make is a trade-off against something else, and that doesn't just apply to your money. That applies to your time, your focus, your energy, your attention. Any limited resource that you need to manage, saying yes to something implicitly means. You are saying no to all other opportunities, and that opens up two questions. Number one, what matters most? Number two, how do you align your decision-making around that which matters most?

answering those two questions is a lifetime practice. And that's what this podcast is here to explore and facilitate. My name is Paula Pant. I am the host of the Afford Anything podcast. Every other episode, we answer questions that come from you, the community. And my buddy, former financial planner, Joe Saul Seahy, joins me to answer these questions. What's up, Joe? I'm in big trouble, Paula. Why is that? So Cheryl had knee surgery recently, which you know, my spouse, Cheryl. She asked me to get her lipstick and I accidentally gave her a glue stick. You gave her a glue stick? Yeah.

And she still isn't talking to me. Welcome to the Terrible Jokes podcast. That was so bad. That is retribution for the terrible joke that I told on your podcast. It absolutely is. I'm going to tell it now. I'm going to do it. All right.

Ready? Did you hear about the guy who invented the knock-knock joke? No. He won the Nobel Prize. We're here all week. Do you realize anybody that's listening to this podcast for the first time is like, what the hell? Right. Exactly.

I thought this was an intellectual podcast. All right, let's not waste anybody's time anymore. Let's get on with the show. The show must go on. We are going to answer four questions today. Anna and her husband have volatile income. But Anna thinks that having 18 months of living expenses, which is the size of their current emergency fund, is probably unnecessary. And so she wants to take a portion of.

their emergency fund and use it to either pay off her student loans or invest. Which one should she do? We're going to tackle that question first. And then we're also going to answer a question from Charlotte. Charlotte and her husband are taking a phased approach to financial independence where they need to bridge two gaps before they each turn 59 and a half. They plan on reaching financial independence in the year 2025. So it's going to be coming up. How do they calculate how much they need at each phase? Then we're going to answer a question. from Elle, Elle has a retirement plan in place, but her company is adding a Roth 403B option soon. So, should she stay the course or adjust her strategy in these last five years before retiring?

And finally, Sarah wants to purchase land and build her dream house by refinancing her rental property and turning her current home into a second rental. How can she improve this plan? We're going to tackle all of these right now, starting with Anna. Hi, Paula. My name is Anna. I love the podcast and I hope that you have some insight into my question. My husband and I live in the Seattle area. My husband's a real estate agent and I'm a loan processor for a private mortgage company. I earn about $50,000 to $60,000 a year currently, depending on my bonuses. Over the last few years, my husband's income has averaged at about $120,000 to $150,000 a year gross.

However, he just hired a showing partner, which he will pay $40,000. $1,000 a year to assist him in showing homes, which in turn, we hope, will increase his production. In the last few years, we've worked really hard to pay off debt, so we haven't really invested before, despite wanting to. Currently, the only debt we have is our cars, our house, and my student loans. My student loans are about $30,000 at 6% interest, when interest rates are not suspended, that is. My payments are $350 a month, and I have nine years left, as I deferred them for quite a while. while after I had kids. We currently have $150,000 in savings, which is about 18 months of living expenses, not including the showing partner's salary. And I have a few thousand dollars in a 401k. Obviously, we don't need 18 months or reserves, so we're considering our options. First, I've

considered paying off my student loans in one sweep, as the stress of that debt weighs on me. But with our extremely variable income and the added liability of my husband's showing partner, I'm unsure if the benefit of paying off the loans outweighs the risk of taking $30,000 from our savings. I've also thought about just making regular payments on my student loans and instead investing that $30,000 into an index fund or something like that. But then that would result in $30,000 less in our savings and we would still have a $350 a month student loan payment. At the same time, I wonder if the investment would pay off and be more beneficial in the long run than using the $30,000 to get rid of a $350 a month payment. Our overarching long-term goal here is to fund our retirement. In my mind,

the last step before investing was to always pay off my student loans first, but now I'm wondering if I skip that step and just go for it. But given our unique financial scenario, it makes me nervous. What advice do you have? Thanks for your thoughts. I really appreciate any perspective you may have on this situation. Anna, first of all, congratulations on everything that you're building. Congratulations on saving an 18-month emergency fund. That is significant. And also on maintaining your focus on debt payoff. As you said within your voicemail, you and your husband have been prioritizing debt payoff and you are currently working through paying off your cars, your home, and your student loans. And that leads to your question, which is you have probably far too much cash. You've got

$150,000 in savings, which is 18 months of living expenses. And you reasonably want to take a portion of that and either invest or pay off debt. So which one should you do? I'm going to answer this very simply. Number one, I am concerned about the fact that you haven't invested. Number two, from the way that you spoke within your voicemail, it seems clear to me that you won't have the motivation, the confidence, the enthusiasm to invest until your student loans are paid off. So I would say, take $30,000 from your $150,000 that you've got saved, take $30,000, pay off your student loans in one giant check. And once those student loans are wiped out, I think that, number one, your emergency fund will still be plenty big. You'll have $120,000 in your emergency fund,

which represents more than a year's worth of expenses. Your expenses are $8,300 a month. So you'll have over a year's worth of emergency fund saved and you'll be student debt free. And I think that that is going to free up your mental space to then turn your attention to investing. So, behaviorally, the peace of mind that comes from knowing that that student debt is wiped out seems to be the right choice for you. And I say that based on the wording that I heard you use when you asked the question. You said it's mentally difficult to start investing before paying off your loans. And you used the word nervous.

So for all of those reasons, you know, this is not necessarily the same recommendation that I would give to everyone personal finance is personal, but based on the wording that I heard you use as you framed your question, rule number one of money management is know thyself. And that's why I think you, behaviorally, would be best served by wiping out the student debt and then feeling more confident about any new investments that you go into from that point forward. I'm on board with that strategy. And I think that this is a great model. for all the different decisions are that you have because everything is on a risk or reward scale, right? There's a, and the reason that she didn't invest sooner is because she's worried about the risk of investing.

The problem is, is the longer she doesn't invest, the more risk there's going to be on the back end of her not reaching her goals because without money in either the stock market or real estate, she's going to struggle to reach her goal. She's going to have to basically save dollar for dollar in the types of things that she's using now, a savings account. She's going to have to save dollar for dollar every dollar she needs later. And unless she finds significant amounts of money later, that's going to become increasingly problematic, which is going to only, it's funny because she felt very reticent to do that earlier. But the weird part about this whole thing, Paula, is that that's going to increase her stress later on. that part of this that is always difficult is to look at the continuum and that things don't have to be an all or nothing game. Do I pay down all of my debt before I start doing any savings? You could actually pay down debt a little bit slower and begin saving a little bit so that

you at least make some headway in that area. Things don't have to be one or the other, which I think is great. Generally, the middle ground is a great place to go. And in Anna's case, What's cool is the quicker she gets started investing, you and I know something. We know that everybody makes mistakes and Anna will definitely probably make some mistakes. And that, by the way, increases your fear. But the cool thing is, is that once you make those mistakes, Anna being as smart as she is and she has all of her numbers laid out, she's going to make those mistakes once. She's going to learn from those mistakes. And then she'll be a much better investor because of it.

So what I would do is I would try to start off at least small. So she gets the small mistakes out of the way with small numbers. And then when the numbers start getting bigger and bigger, then she can feel confident in her strategy. And by the way, the thing that most people mess up, Anna, is not picking the right fund. It's not being in the right investment. It's that you decide that your strategy is not working and you second guess it and you make behavioral mistakes. That's where most people make mistakes. is they put money in and then they take it out. They put it in, then they take it out. And I,

I can't guarantee that Anna's going to make that mistake, but most people I know of, including me, have made that mistake where I second guess my strategy and I go, yeah, shouldn't have done that. So I would encourage her at the very least to put some money toward investments. And I also want to say one thing about her husband's business, which, you know, that additional salary, Paula, makes me nervous too, the additional $40,000. But the only way to make more money, once you get past a certain threshold in any business, Anna's husband's business, your business, Paula,

my business is to realize that you only have two hands. And until you bring other hands to the job, you just can't get further. It is so difficult. I mean, think about if her husband doesn't hire somebody else to help out. I mean, that is a $40,000 expense. That's a lot of money. But without going from two hands to four hands, he's always going to be limited in his output by the fact that he only has two hands. Right. So potentially, he could double it by bringing somebody on board. And that's, that's something that's, that's very hard for everyone who is just getting into

entrepreneurship to realize because it's difficult to delegate. It's difficult to take on more expense. And by the way, those are great, those are great fears to have because I think that you should think seriously about your overhead before you take on new overhead. But an analogy that I really like in my own life is I got smart about how I cleaned my house. And what I did when my kids were, I'm going to say, about seven years old, was that before I would start cleaning my house, I would start the dishwasher first, and then I would start the washing machine with clothes second, and then I would put my two kids to work. And at seven years old, they weren't that great. But now I had four different entities working on the house before I put my own two hands to work. And we got the house clean, even with

seven-year-olds, Paula, we got the house clean so much faster. We got so many things done faster when I used machines and I used people before I, and basically used my head first before I used my own hands. Right. I agree that hiring a person is the right move. And at the same time, I understand Anna's fear that from a cash flow management perspective, there may be lag time between when they began incurring this expense, the expense of the additional overhead of that salary, versus when that starts paying dividends and starts paying rewards. And so I think Anna has some nervousness around cash flow management around that lag time. But to that, frankly, I would say, Anna, you've got an 18-month emergency fund. So I think you are more than well prepared for this expense.

And my concern, given that you stated that it's mentally difficult to start investing prior to having your debts paid off, given that you stated that you know, you feel a little nervous. You know, my objective for you is for you to do the things that would reduce your anxiety so that you can then embrace being more aggressive in your investments. Her anxiety, Paula, also shows me not which investments to use because those should always be based on your long-term goal and your time frame. her choice is tax shelter-wise though are limited to either leaving the money in a flexible brokerage account paula where she can take the money whenever she wants and then she has the ability if she needs the cash to just take it and not have to worry about tax rules or if she wants to be slightly more aggressive she could use a backdoor roth IRA where money comes out

fifo meaning first first in first out which means her contributions will come out first And because she's already paid a tax on those contributions, they aren't going to be subject to a tax. So she could still get out any of the money that she put into it without a penalty and only the money that is earned in the account, right? Interest, capital gains, whatever it might be. That money is then subject to all of the regular IRA, Roth IRA rules. That could be compelling. But if I were her, I think I'd forget about the whole raw thing. And I would go with just invest it, believe it in a flexible brokerage account.

Because at some point, I think most of us should have that anyway, right? I mean, how many times on this show have we talked about having a flexible brokerage account? Constantly. And we've talked on several previous episodes about the concept that sometimes flexibility trumps optimization. If there is a tradeoff between the two, then you need a disqualification. which one is the priority, and sometimes flexibility does become the priority ahead of optimization. And in this community of beautiful financial nerds, we tend to worry about optimization, way more than flexibility. So Anna can go the opposite route. Now, Joe, to be clear about the answer that

you gave when you said that you wanted to see her do both, pay off her debt and invest, are you suggesting that she take $30,000 and split it, 1515? No, I just wanted to tell her that that it was less for Anna more for everybody else, that along the way, Anna was waiting to pay off all of her debt, and she could have done a 75-25 strategy. So she had some investments already. So that was actually less for Anna,

but even now, I think what I would do would be to, rather than reinvest the $350 a month that she frees up by paying that off, I think I would actually take that money and put the $350, into her beginner investment, or maybe split that 50-50, 175 back into the reserve to replenish

the reserve of the 30,000 bucks and then 175 into investments. I would just find a way to begin that faucet right now. Yeah, I would think given that her emergency fund is already so stacked, I think it would be totally reasonable for her to pay off the student loan in one fell swoop. and then start funneling that $350 per month that she frees up into index funds in a taxable brokerage account. Absolutely. She keeps it in a place where she can get at it if she needs it.

I think for me, that would calm a lot of my anxiety. Yeah. That would make me feel much better, knowing that the money's invested, but if I need it, whatever's there at that time, I can take that money out and still get it right now. Yeah. Forget about the tax savings. Right. And while she and her husband are in that gap period in which they've just hired a new employee, but that employee is not yet.

Profitable? Earning his lunch. Yeah. Profitable. If what they're concerned about is cash flow management, then certainly putting those investments into a taxable brokerage account could allay some of those fears. And what's cool is if things work out fantastically, you know what she can do with that money later on? Paula, she could take that money later on and make it a Roth IRA contribution. Yeah, exactly.

I mean, she's got, she decides to you. You've got, we've all got up until the tax filing deadline in 2022 to make retroactive contributions for the count for the year 2021. So there's several months still where we can make 2021 contributions, but, you know, before that window closes. So thank you, Anna, for asking that question. congratulations on your upcoming debt payoff and new investments. We'll return to the show in just a moment.

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That's W-A-Y-F-A-R.com. Sale ends December 7th. Our next question comes from L. Hi, Paula. I have about 600,000 in a retirement account 403B that's administered by Vanguard. I make $85,000 per year from my W2 job and clear $11,000 on a rental, while my husband makes $63,000 per year from his W2 and his rental combined. He has about $100,000 in a simple IRA, and together we have about $80,000 in Roth IRAs. He maxes out his contributions now,

I contribute 5% of my salary to gain a company match worth 10% of my salary. I'm 54 and my husband is 55 years old. We're cash flowing our child through college at about 13,000 per year and any extra income goes to pay off our remaining mortgage balance of 110. We have no consumer debt. I'd like to have the mortgage paid by the time I retire, since I still have an additional 30,000 mortgage on a rental property that I'll let ride over the next six years since it has a really low 2% interest rate. We're also building on working a two to three year cash reserve in taxable brokerage accounts so it can float us through any poor return years in retirement, but we'll focus more on this when our child graduates from college.

I'm planning to leave the workforce around 58 or 59 years of age. Let my account grow while my husband continues to work. He won't be contributing the max to his simple IRA at that point, but instead just enough to get his 3% company match. I don't think we'll need to tap into my 403B at 59.5 as I can always work part-time if we need it. When he's 63, we plan to both start collecting our own Social Security and collect no more than 4% per year from our retirement accounts. my company is adding a Roth 403B option in January of 22.

So now my real question is, should I be changing my investment strategy and contribute to the Roth and possibly even increase this contribution? I think we'll certainly need to use our investments during retirement, and most of our estate will include properties to be sold upon death for our children's benefit.

What do you think is my best strategy for building funds during my life? last five years of work. Is there something that I've overlooked? Now, I'm not going to work any longer. I work on government contracts with my institution, and this one expires in five years. I don't want to apply for another one. Thank you for your help. El, this is such a great question, and it is one of my favorite types of questions, because this is completely a financial planning question. Like, How do we lay out all of the pieces and decide the best strategy? I love these questions because of the fact that there are so many moving pieces.

And anybody that just heard this question knows that you've got a lot of moving pieces. But here's the way that I look at this. You have not included the value of the real estate in your calculations toward retirement. you're just looking at the cash flow. I'm assuming that you're going to continue to have those rental properties. And if you're clearing 11,000 now with a mortgage on it, I'm assuming then in six years, that will go up, which is awesome because that comes very close to the time that you are going to be retiring.

So when I look at that, my question then is, how much money then will you net per month off that because for you, even though that's not a pension, it is a stream of income that we don't have to rely on the asset base to accumulate. So let's take a look at the asset base. Right now, you're closing in on $800,000. If you want to leave in five years and we use a simple calculation of the rule of 72, you're going to get about a little more than halfway to another double of your assets, doubling your assets would bring you to 1.6.

So instead of that, we're looking at about 1.2 million in retirement assets plus whatever equity is in the houses. And you already mentioned that you could work part time. But I'm still looking at that number. And I don't know. And this is the big key thing you want to think about. I don't know what your expenses are. And I don't know how much you're going to need to harvest from that. asset base, but the financial planner in me says, that's not enough, that that's close,

but it's not enough. And I think you already know that in your head because you already said, well, you could work part time, right? And that your husband would put money away, but wouldn't be maxing it out anymore. He would reduce that. So I got the feeling from your call. This is maybe putting words in your mouth and I don't want to do that. But I got the feeling that you kind to know that too, that you're going to come in a little hot. So anything that you can do to take advantage of stocking more money away, even though this late in the game, and I'm 53, so I'm right there with you, this late in the game, we're not looking at compound interest to make us a ton of money, although some of this money you're not going to need until you're 70 or 80, right? So you can still

double that money. But the more money you can put in that pile over the next five years, the better off you're going to be. My answer is yes. Yes. Put more money into that Roth 403B option. Also, when you finish cash flowing your child through college, whatever that number is, and I put twins through college, and that's where all my hair went. It graduated as well, apparently, and is gone from me. But the second that Cheryl and I finished that, I immediately applied that cash flow into our own plan, because my expenses were fine. And, you know, I'm living a lifestyle that I already like, so why not just save that money? It'll be the same, hopefully, for you as well.

So my strategy would be figure out first how much money you're going to need per month in retirement. And then second, how much cash flow is that rental house going to bring you after the mortgage is paid. And then third, how can you put more money in the Roth to meet those numbers? And so that's a fuzzy answer. That's not the exact answer, but those are the things, Paula, that are going on in my mind right now. So what jumps out at me is that, again, she's cash flowing the child through college, it's $13,000 per year. So that money's going to get freed up.

That's going to be extra money. She says she wants to pay off the remaining mortgage balance, which is currently $110,000. Yeah. It seems to me, and Joe, I agree with you. I think the Roth 403B is a fantastic option, and she should be socking money. away into this Roth 403B. It seems to me like, similar to Anna, she may have the ability to do both to sock additional money away into this Roth 403B while also paying down that mortgage balance. I mean, 110,000, she said she wants to have the mortgage paid off by the time she retires.

But wait a minute, isn't the mortgage going to be paid off in six years? So she wants to have the rental property paid off in six years. The rental property has a debt of $30,000 on it. and she wants to have that paid off over the span of the next six years. She said she'd let it ride over the next six years. Gotcha. And then her primary residence has a balance of 110,000. And that she wants paid off by the time she retires.

But she's going to retire in five years. So within the next five to six years, she's going to pay off two different houses, the primary residence and the rental property. Like, number one, the rental property is going to bring in a whole bunch of extra cash flow. number two, her expenses are going to plummet once she no longer has to pay out of pocket her mortgage on her primary residence. And so between those two things and number three, her kid, five to six years from now, will presumably no longer be in college, even if that kid

is a freshman today. So between those three things, the rental property getting paid off, the primary residence getting paid off, and the kid no longer being in college, her income is going escalate at exactly the same time that her expenses decline. I don't know, though. I look at the primary residence, and I think about that interest rate versus the money that she has in investments right now. And I think at the very most there's a middle ground. There's a big piece of me that says that she should invest as much of that money as

possible into the financial markets. And maybe what she does, maybe the middle ground is not to put. part toward mortgage payoff and part toward investing. Maybe what she does is when she gets to retirement, she hooks up her money to make that payment every month. So she is freedom from worry of making the payment. And now her pile of money is making the payment. And she doesn't have it coming out of a cash flow.

I'm not convinced. And this is because I don't have enough numbers about, I don't have enough detail on how much money she is going to spend. If I knew how much money she was going to spend per month, that would give me greater confidence. But without that, I certainly feel like that the amount of asset she has is just a little shy of where she wants to be. Yeah. So I guess, so to review, she's got 600,000 in a 403B, and her husband has 100,000 in a simple IRA. And the two of them combined have about 80,000 in Roth IRAs.

So in total, they've got 780,000. So if she gets average return, she's going to come. in at about 1.2 to 1.4 is where she's going to be by the time she wants to retire. Yeah, I don't know. But the cool thing that she has is she does have though, and this is where expenses comes in, Paula. She does have the cash flow from the rental house, which the average person doesn't have. So even though she hasn't counted that asset, that's $11,000 of income a year that she is coming in that other people don't have that are just relying on the property. It's 11,000 right now with debt still on it.

So once it's paid off, which is going to be in six years, then who knows what that number is going to be? Yeah, we don't know that number either. So those are a couple of the numbers that I think about that would it would help me just help her decide if she can be more conservative, which is pay off that primary residence or if she needs to be more aggressive. There is one thing, though, that I missed. What's that? And that is she talked about taking Social Security early. If there's a way to not do that, you know, the way Social Security has been calculated lately, there's a huge payoff, Paula, in taking Social Security later. And once again, this isn't right for everybody.

But you're getting many places show about an 8% return on your money if you don't take Social Security and you let it go to the next year. That's for the average person. But what you have to look at is your own family's life expectancy. because with Social Security, if you don't use it, you lose it, right? So you definitely want to look at your own family's life expectancy. More conservative would be to take it earlier. But if she can avoid doing that and her family has a nice, long life expectancy that she's hoping to achieve, by all means, not taking that Social Security earlier could be a big benefit to her.

Yeah, you know, that's a great point because she mentioned that she plans on drawing down on social security when her husband is 63, and currently he's 55, she's 54. So that means she would be 62 when she starts taking out social security. So if there's any way to avoid that, that would certainly be the ideal option. That could potentially be a lot of money. So I'm with you, Jo, in that given all of the advantages associated with delaying social security, even if they can just delay it by a few additional years, if shoveling extra money into this Roth 403B is the act that would allow them to delay Social Security even by another couple of years, that would be pretty powerful. You know, that thing that I don't know is if they paid off their primary

residence, you know, we know that the remaining mortgage balance is 110,000, but we don't know what that monthly payment is. And so we don't know how much paying. off this mortgage would reduce their expenses, thereby reducing the amount that they need to draw down. If they have a really high fixed monthly payment on this mortgage and paying it off would relieve them from needing to draw down a bigger number, then I can see an argument for prioritizing that primary residence payoff prior to retirement. But on the flip side, a Roth 403B is pretty darn attractive. And they're young enough that they can compound some pretty decent money for the latter half of their retirement years when they're in their 70s, 80s, 90s.

Yeah. So I'd say my answer is if the mortgage on the primary residence constitutes a huge percentage of your monthly expenses, then there's more reason to prioritize paying it down. But if it doesn't, if it's not going to actually reduce your expenses that much, if it's a small, reasonable chunk of your monthly expenses and most of your money goes towards other stuff, then there's a stronger argument for prioritizing the Roth 403B. And that's where the key to this whole thing really is, the question, how much are you going to spend? Yeah. It's amazing to me that the double-edged sword of frugality.

Because frugality on one end reduces your expenses today, but it also reduces your tax burden. right and you think about your tax burden over time that but because taxes are a sliding scale where the more money you earn the more money you spend and take out of your tax-advantaged accounts the more tax you end up paying over time if you can find a way to be pretty frugal and leave your money alone uh the compounding tax advantage on that is huge like as an example your basic expenses may be at 10 or 12% tax rates, but bigger expenses are at a 25% tax rate if you take money out of an IRA to spend that money, right? So the tax implications, especially if you have money that's in a pre-tax 401k in retirement that you're taking money out of, are huge. And that doesn't

mean to live your life on less because I'm not about that. But it does mean the thing that, you say in the title of this show, Paula, you can afford anything, but not everything. Like, choose what you really want to spend money on and spend lavishly on that and cut the hell out of the rest because not only are you paying for crap that you're not going to use, but the tax on that, on that money ends up being way, way, way higher. Think about it this way. The foregone tax deferred growth you're talking about. Yeah, the stuff that you don't care about is the last money out.

Think about this. It's the last money out of your eye. IRA, right? Or your 401k. So if it's a pre-tax money, the last money you're going to spend is that money that was junk. It's the first stuff that you would cut. So the stuff that you really want to do is it may be a 10, 12% tax rate and then or in that bracket, the stuff that you really don't care about that you could have cut. Is it a 25 or 28% bracket possibly or even higher than that? If you cut, if you cut out the unnecessary stuff, you also cut out the surcharge on the unnecessary stuff. Not to get all wacko about taxes.

But it's just amazing what a double-edged sword frugality can be. And by double-edged, I don't mean that it's good and bad. I mean that it can cut twice. You not only are going to save the money by not buying the stuff that you don't need. You can save a hell of a lot of money in tax savings, which also increases your ability to compound the interest. on that money. I don't think the phrase is double-edged sword. There's got to be... It isn't. No, yeah, there's got to be some other phrase. Two birds with one stone? You kill two birds and you get icing on the cake? I don't know. There's got to be a phrase that describes something

that does double duty. Is it just me, but does killing birds has never appealed to me? Yeah. Even as a kid, I was like, why do I want to kill one bird? Exactly. Yeah, right. What the bird do to me? Right? Yeah, I've never liked that phrase. But yes, I think everybody knows where I'm going, though. It's a powerful thing. Let's put it that way. Being frugal has a compounding effect. Ooh, being frugal has a compounding effect. Yes. Should I just drop the mic and leave now? You could, but we've got two more questions to answer. Oh, let's go. Thank you so much, Elle, for asking that question. Whether you pay off the, mortgage or contribute more to the Roth 403B or do a mix of both, regardless of what you choose,

I think you now have a lot more insight into the nuances of these different decisions that can help inform your decision making. So thank you, Elle, for asking that question. We'll come back to this episode after this word from our sponsors. Our next question comes from Charlotte. Hi Paula, hi Joe. This is Charlotte. Thank you for all of the great information and for taking my question. My husband and I are striving to reach financial independence by December 2025. At that point, he will have just turned 50 and will be eligible for a partial pension as he is a public health employee. We live in a state with a very healthy pension system. At that point, we will sell everything and begin our slow travel journey around the the world, all current variables permitting, of course. Because of his age, there will be a 10-year gap between when we hit fire and when he turns 59 and a half and can start using his retirement

savings if we need it. There will be another six years after that until I can start taking withdrawals from mine. Our current fire plan includes his pension, our index funds, rental income from our Airbnb properties, which we now own one and we will be expanding into holding at least three, maybe four total. We'll also have at least a year in cash reserves in case the market takes a bit. With those three things, the Airbnb pension and index funds, we already hit our yearly annual budget needs of 103,000 for fire. It's also my belief that we'll be living a lot cheaper than where we've set that budget because we can utilize geographic arbitrage to our advantage if we need to as we travel. Here's my question. With these two to three phases of our retirement,

so that 10-year gap between fire and, you know, proper retirement, 59 and a half, and so many pieces to our financial puzzle, how do we calculate how much we actually need? Do we do two separate calculations or three, and how do they connect to each other? Bonus points, if somebody can send me a freaking spreadsheet to calculate this. Thank you so much, Paula and Joe. I so appreciate any help you could give, and I hope I've given enough information for you to answer the question. Thank you. Charlotte, first of all, congratulations on being so close to fire. You are on on track to reach financial independence in four years, December 2025. So that's huge, big congratulations. Everything that you've outlined sounds amazing. This slow travel journey around the world sounds incredible.

I'm very, very excited for you. Let's talk about the various phases of your retirement. From what you outlined, I see three phases. So phase number one begins in December 2025 when your husband turns 50 and becomes eligible for that partial pension. And as you stated, the pension, the index funds, and the Airbnb income, those three things will allow you to hit your yearly annual budget needs of 103,000. So phase one of retirement, which begins four years from now, is the phase in which you live on the pension, the index funds, the Airbnb income, right? That phase lasts for nine and a half years, at which point you enter phase two, which is the phase at which you have the option of drawing down from your husband's retirement savings, and then phase three

starts six years after that when you then have the option of drawing down from your own retirement savings. But from what you've outlined, it sounds as though your situation might be a lot simpler than you're giving yourself credit for. So I pat yourself on the back for creating a situation that's quite enviable in that phase two and phase three are both phases in which additional options become available to you.

But it sounds as though you may not need those options. It doesn't sound like you're going to have to draw down from either your or his retirement savings. It seems as though from the numbers that you've outlined, you can live on the pension, the index funds, and the Airbnb income, and those savings, the retirement savings for both you and him in phase two and phase three will exist as additional safety nets, additional options, but nothing that you actually have to plan on or live on.

Now, a couple of hiccups with this. Number one, you mentioned you only currently have one Airbnb property and you want to expand to three or four. So do you have enough allocated in phase one, or actually really phase zero of this plan, for the next four years, between now and December 2025, do you have enough money in the budget to be able to expand to those three or four Airbnb properties by the time you reach fire? Assuming the answer is yes, then it sounds as though you're sitting pretty, particularly given that you're also going to have a year's worth of, cash reserves in case, as you said, in case the market takes a hit? Yeah, I think, Paula, that it is obviously all the tax shelters and ages that are giving Charlotte a lot of consternation.

And would mean, too, because you don't want to run a foul of any of those rules. If you do, there can be some significant penalties. So this is, I think, the case for, you know, she said, if there's a spreadsheet out there, I'd love to have it. There are plenty of calculators out there that are pretty robust. It can actually help her, I think, decide where the income stream should come from at different times. Because I think what she really needs is a calculator that shows all of these timeframes, right, so that she can easily, and I can see it visually like it's a spreadsheet, Charlotte.

So I'm right there with you. Like, what I want to see is here's the money going in the next few years. Here's where the money needs to come out the next years after that. here's where the money comes out the years after that and then here's a more coherent picture after that that by the way can help you make some great investing decisions because as an example if you're taking money from your husband's money first his money's going to be much more conservatively invested than your money will be so instead of having this well-rounded asset allocation where it's all mixed up in one pot i might make his pot more conservative at least the money you're going to need the

first few years. And then the money that you're going to need longer term, aka your money, can be invested longer term. With regard to buying the Airbnb's, I think you nailed it, Paula. I wonder about the return on investment. I'm not thinking about what makes me happier to buy as much as what gives me the most consistent chance of a positive ROI. And I don't know where that Airbnb is going to be. I don't know what her expected return on that Airbnb is going to I do know what financial market expected rate to return over 10 to 15 years historically are, though, right? So once I look at the Airbnb number and I've calculated that versus the money in a diversified collection of index funds, I think I make a much better decision about whether I buy those or not. Can I say one more thing too?

No, absolutely not. Oh, I'm done. Cut off. I was somebody that thought that I was somebody that thought that I wanted to travel the world and Paula as you know better than most people I had the weird opportunity that I didn't expect to do that and in a six month period I realized that that wasn't for me as much as I thought it was for me I love travel I love seeing the world and I will always want to travel but I don't want to do what Charlotte did and I'm not saying that it's not for her but I'm saying that I'm hoping before they get to that point that they have the opportunity to do what I did, which is to spend an extended period of time test driving this a little bit ahead of time. I'm the most shocked that I didn't like it.

Yeah. So for context, Joe, you sold your house. You sold your house. You sold all your belongings. I sold everything. Yeah. You sold everything. And you hit the road.

and within six months, you came back to Texarkana, Texas. You came back to your small town and bought another house, different house. Right down the road from my old house, like a mile from my old house. Yes. Right. And you weren't planning on doing that at all. But you went on the hero's journey. You took the journey just to come back to where you started and to know that that's

where you needed to be the whole time. I realized that for me that there are two families. there's the family that you are born into and there's a family of people that you develop, right? This family and my family's here. I figured that out after living now, not around the world, just living around the United States because this was all during COVID. But I lived in Vermont. I lived in Palm Springs. I lived in some pretty cool places.

And I still love those places. I do not see myself, though, being without a home. And that doesn't mean, and I'm not at all, Charlotte, telling you that's a bad goal. So I hope people hear me correctly. That is a fine goal. And you and I both, Paul, I know people that love it, right? Yeah, I spent 27 months living out of a backpack. Yeah, people that absolutely love that.

I just, I have always preached that you want to test drive stuff, but I never got to do it myself. So imagine my shock when my own advice was very applicable to me that test driving it is super important. Back to Charlotte's monetary question, though. I, frankly, I see this is quite simple. And the answer, in a nutshell, is regard both of your retirement savings as icing on the cake and adhere to the fire plan that you outlined in your voicemail in which you live on the pension, the index funds, and the Airbnb income. And if you can do that, then you're solid. Yeah, no problem.

Yeah, then the retirement savings are just a surplus. Of course, with Airbnb, there's always some risk, right? There's the risk of another pandemic or another national or global event that's outside of our control that has a significant impact on occupancy and revenue. There's the risk that the city council in whatever city the Airbnb is located in will decide that they're not going to be Airbnb friendly anymore. And they're either going to ban short-term rentals or, require a very high friction permitting process or increase the taxes on them or, you know, there's always the risk of something happening with that Airbnb income. But at the same time, Charlotte, you've built this triangle, right? The pension, the index funds, and the Airbnb, it's all a triangle. And so if there is volatility in one of them, and I think the Airbnb corner of that triangle does have some risk attached to it, you've also got the stability of the pension.

and then the index funds playing a slightly more middle of the road role, you know, not as risky as Airbnb, not as stable as a pension. The index funds are somewhere in the middle. So I see a lot of good diversification in the way that you've built that triangle. So I think you're doing great. Yeah, I do too. But if she wants to model that and decide where money comes from first, a great place to evaluate different calculators is our, our friends Chris Mamula and Darrell Kirkpatrick have a site that I've mentioned here before called Can I Retire Yet? And they have a wonderful piece that I'm sure, Paul, you can put in the

show notes, which evaluates lots of different retirement calculators. And she can use those calculators. Some are paid for. Some are free. Generally, I believe you get what you pay for, right? or if she really wants to buy a little insurance, work with a fee-only financial planner for just a quick couple of visits to help her model how the money should come out of her various things. Because I think she is very worried about how am I going to negotiate which faucet to turn on. The Afford Anything community as well, you can go to afford anything.com slash community. And I know some people there have traded some spreadsheets around.

I don't know specifically if it's been retirement spreadsheets or what, but there are definitely a lot of shared resources there among your fellow number crunchers. So I think that could also be a really good resource, particularly as you described so well, Joe, as you're trying to figure out which faucet to turn on when. There are a lot of people there who have spreadsheets that they use and love to share. So that's afford anything.com slash community. Totally free. So thank you so much, Charlotte, for asking that question.

And congratulations on your upcoming fire. Please call back and keep us updated. Let us know if you get those Airbnbs. Let us know when you hit fire and where you end up going to slow travel. That's incredibly exciting. So I'm thrilled for this next phase of your journey. Our final question comes from Sarah. Hi, Paula and Joe. My name is Sarah, and I have a question about potentially purchasing some land to build a dream house on.

Currently, my family and I live in a home. It is worth about $300,000, and we owe $90,000 left. This should be paid off in seven to eight years. We also own a rental house, which is worth on Zillow, $180,000. We owe $40,000 on it, and it also should be paid off in seven to eight years. The property we were looking at is 13 acres and is currently listed for $139. Our plan is to pay $40,000 cash and then refinance the rental paying off the remainder. This would reset the loan to 15 years and require an out-of-pocket expense of $300,000. $50 a month. In seven to eight years, when our current residence is paid off, we would like to build and move into the home on the land that we purchased. We then would rent out the current home and we

would eventually have two rental houses, one of which would be paid off. We plan to pay the new mortgage with a combination of what we currently have allotted for mortgage, plus the rental income that we will be taken in from the house. I would love to hear any thoughts you may have about this plan or any recommendations on how we can improve the plan. I really value your all's opinions and really look forward to hearing back from you. Thanks. Sarah, thank you so much for your question. Let me restate the plan to make sure that I understand this correctly. So you own a rental house, currently, you own a rental house. It's worth $180,000. You owe $40,000 on it. That means that you have about $140,000 worth of equity in your rental house. Your plan is to refinance the rental

house and take out, the bank probably won't let you take out the full $140,000 in equity that you have in it. But they would allow you to take out some percentage of that. 70%, 80%, whatever they allow. So your plan is to refinance the rental house, pull out the equity that you can, and use that money to purchase this 13-acre parcel of land, which is currently listed at $140,000. And you have $40,000 in cash. So if you can pull $100,000 out of the rental property and combine that with the $40,000 cash that you already have, boom, that covers the list price of the $30,000.

So so far all of those numbers seem very, very reasonable. Now, as you said, this would reset the loan on the rental property to another 15 years, and it would require you to pay out-of-pocket 350 per month. And so you would start paying that 350 per month out of pocket, and in about seven to eight years, when your current primary residence is paid off, you would then build on the land and move into the home. And so what that signals to me are two questions. Number one, Are you confident that you can have sufficient cash flow to comfortably pay that $350 a month out-of-pocket expense? Is it going to be a stressful new expense or are you comfortable with it?

If you're comfortable with it, cool. And if you're reasonably certain that you can comfortably pay that $350 a month for the next seven to eight years, even before you are able to make use of this land, you know, you'll be paying $350 a month as essentially your whole. holding cost for being able to lock up that land right now. If you're comfortable with that, if you're confident that you can cash flow that without it being an undue stressor, awesome. But I figured I would throw the question out there just to make sure that that was out there. So that's question number one. But I'm going to assume that your answer to that is yes and that you

can do it and it's not a big deal. Then question number two, and I think this is the bigger question, so in seven to eight years when your current residence is paid off, where will you get the money to build on the land. I thought that's where the that's why she's so what she's doing I think Paula and I don't know because she she wasn't clear about this but my assumption was she's refinancing that home the rental home but she's refinancing it to a bigger degree so she's going to pay off whatever's left on that mortgage but also take out enough to cover the cost of the new house because now she'll have a bigger mortgage on the rental house, she said. But the rental house has a value of 180,000, and she owes 40,000 on it.

So she has 140,000 in equity on that rental. It doesn't seem like enough money. Yeah, if she can borrow, let's assume that she can borrow 80% of the equity that she has, 80% of 140,000 is 112,000. So at most she'll be able to take out $112,000, pull $112,000 out of that rental. We don't know what size, how she wants to build. We don't know. Yeah, there's a lot of variables there.

But my, which brings up my overall question, which is assuming that I'm right that she's pulling out equity and she said she's resetting the mortgage on that rental, why would I do that with the rental property instead of with the primary residence? because if I do it while I'm still in the primary residence, I'm going to get a lower interest rate on that money, right? I'm going to lock in a house that I'm living in now as a primary house. I'm then going to rent it out later, but I would have already locked it alone at a much lower rate that I will on a rental property.

You're not going to get the same interest rate on one that you're not living in right now. So I think she gets a definite break on the interest rate if she flips that, and takes the equity out of the current residence versus the rental property. Right. Well, and in addition to that, she has way more equity in her primary residence. She has $210,000 in equity in the primary residence. Yes. And as you can see, we're not sure neither Paul nor I are sure if this math actually works,

but it definitely makes the math easier at a lower interest rate and gives you access to more funds. So without having the answer to those questions, I think, for my standpoint, I think that was That was my big question when she asked for our opinion on her strategy. It still doesn't seem like enough money to me, though. Like, let's say that she, okay, so she's got $210,000 in equity on the primary residence. Let's assume that she can borrow 80% of that, right? So that's $168,000.

She's got $40,000 in cash right now. So she has just over $200,000, $20,000 that she can play with. 40 in cash and then the remainder that she would pull as equity out of her primary residence. So let's say that she did that. That'll give her enough money to buy these 13 acres. These 13 acres are listed at 140,000. But that's not going to give her enough money to build. So then we get back to my question number two.

Where is the build money going to come from? Where's that cash come from? Yeah. And does she, and maybe what she's thinking then, maybe that's her strategy around. renting out the primary residence as well. But then once again, she said that that was going to give her the money to just buy the property. I don't know. She must have a piece of this question that she isn't shared.

Maybe there's a fund of money someplace. You know, she's not planning on building for another seven to eight years. So it could be that she's planning on saving for the next seven to eight years so that she has some sort of a build fund. And then maybe taking out a new mortgage, like a new construction. mortgage. That's what I was thinking also as you were talking, Paula, was that once that other loan is paid off at the seven to eight year mark, she's using whatever that cash flow is to do a building loan, which will then convert into a mortgage. Right. It still becomes a cash flow issue. Does she have enough cash flow to cover the cost of whatever that building loan is going

to be plus this additional $350 per month that she outlined in her voicemail? And the thing that I worry about is interest rate cycles move fairly slowly, right? And we're looking at very low interest rates now. Seven or eight years from now, where are interest rates going to be? Who knows? I mean, who knows? Yeah, but I would have only one expectation. I do know, I was looking at a chart just a couple weeks ago about how interest rates generally over the past 40 years have gone lower and lower and lower and lower, right? I mean, they've spiked up and then they've come back and spiked up and come back. But generally it's been a downward trend. But I still don't know that I would bet that they're as low as they are now.

I don't know. I mean, the future, it's all speculation. I don't know. But looking at that we're dragging our knuckles across the bottom right now and looking at, you know, the inflation that we're seeing currently, man, I really don't know. So I might do some, I guess my point is I might do some fairly conservative math on what the interest rate on that loan is going to be. If that's a crux in this strategy, I may be fairly conservative, meaning I might jack up that

interest rate just to be safe on what the future loan interest rate may be on a construction loan slash mortgage. I think that's just prudent anyway, no matter what our expectation would be. Yeah, always better to round up. Yes. Plan for the worst, hope for the best. Yeah, exactly. But yeah, the big looming question in my mind is there are those two questions.

Number one, can you handle the cash flow comfortably? Number two, where's the money for the new bill is going to come from? There's a number three on there, too, Paula, which is how big is the guest wing going to be when you and I come visit for all the work we did to help her with this question? Well, I hope we haven't discouraged her because it sounds like a really cool project. It does sound like a cool project, but we definitely want to see the final product. Duh. I'll bring some board games. Oh, yeah, that'll be fun.

Game night? Yeah. Perfect. So she figures this out. We plan the party. Yeah, absolutely. So Sarah, I hope that helped. I'd say certainly if there's any takeaway from our answer, it is refinance your primary

residence because you're going to get a much lower interest rate on that than you would if you refied the rental house. Yeah. Plus, you have more. equity in it anyway. And I'd say if there's a second takeaway, it's, Joe, the fact that you and I talked about so many different possibilities, like we explored so many different routes of how various buckets of money could be applied in different ways. I think that illuminates how many different strategies could serve the same objective. It's pretty exciting. And I feel like too often people get laser focused into a single strategy. And when you back up and widen the lens,

just a little bit. Sometimes things can become exciting that you didn't even think were a possibility. Can I give any example of that? Yeah. There was a client of mine when I was a financial planner that wanted to own a house on Lake Michigan, just beautiful lakeshore in Michigan. For people that haven't been there, it's just, it's gorgeous. But when we were doing the math on what that real estate costs, she didn't have the funds to do that. She couldn't make that happen. And what was neat was she was able to find a piece of property across the road that was up on a hill that was significantly less expensive. It was Lake Michigan views, not on Lake Michigan. And she's somebody that always wanted to continue working.

And she had been in the hospitality business. So what she did was bought this beautiful old house, remodeled it across the street for a lot less money, turned it into a bed and breakfast. Because she loves people. She's an extrovert. She continually had income coming in. And she woke up every morning and had a view of Lake Michigan. So she, by widening her lens and looking at all these things that she actually liked to do, she was able to do something that she thought was impossible initially.

So the moral is widen the lens. widen the lens. Wind the lens. Well, thanks, Joe. And thank you, Sarah, for asking this question. I'm excited for this project. I'm excited for game night. Yes, the dream house and the board games that will all play in it.

Sarah's going to be like, why are you showing up at my door? What? How did this change? Eight years from now. 29. That'd be so great if there's a knock on the door. That is our show for today. Thank you so much for tuning in.

This is the Afford Anything podcast. If you enjoy today's episode, please do three things. Number one, share it with a friend or a family member. Number two, open up whatever app you're using to listen to this show and hit the follow button. And number three, while you're in that app, please leave us a review. Those reviews are super helpful in allowing us to book amazing guests. Joe, speaking of podcasts and speaking of apps, you've got a podcast, don't you? I do.

And you know what's cool? What's that? You can hear us record episodes at the Stacky & Benjamin Show live now. There's a fairly new app called the Fireside app. at 5 p.m. most Mondays, you can hear Paula and I and a range of other crazy characters record stacking Benjamin's lives. So you can hang out with us. And Paula, you know this. If you want to participate in the show, we give people an opportunity to actually come and be a part of the stacking Benjamin show. So that's Mondays on the fireside app. There's a few

different fireside apps. Look at the one with the picture of Mark Cuban in the advertising for it. Because that's the one this is. He's a backer of this particular app. But we have a lot of fun on Monday's recording, and we'd love to have you come join us while we make the show. Cool. So the Stacking Benjamin's podcast, Listen Live. Cool.

Well, thank you, Joe, for joining us once again. Thanks, Paula. That was super fun. Thanks, everybody, for the great questions. Thank you again for tuning in. My name is Paula Pan. This is the Afford Anything podcast, and I will catch you in the next episode. Here is an important disclaimer.

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