DIY oil changes and investing

The Top 5 ways changing your own oil is like doing your own investments

Just the other day, I changed the oil in our 4Runner and our Honda.  It was the first time in my life I ever did that by myself instead of taking it to a dealership or one of those quick lube places.  First, I want to thank my new BFF Jesse Bearcat for helping me.

Second, as I was doing that and since, I have started to think how changing your own oil is a lot like doing your own investing.  In fact, a lot of the benefits of doing an oil change yourself are exactly the same as doing your investing yourself.


Here are my Top 5:


More conscientious:  No one cares more about you and your wellbeing than you.  Twice in my life I have had horror stories of the guy at the shop doing a crappy job and it leading to bad, bad results.  They were sloppy and forgot to connect a hose which led to my car breaking down and needing a tow.  Once I was driving on the road into the LINCOLN FREAKIN’ TUNNEL.

When I do the work on my own car, the car that hauls around my family, you can be sure that I check and double-check every screw and tube and everything.  Investing is the same.  Is someone else going to check the next day to make sure your fund transfer happened or that the change in your 401k allocation took?


Better materials/parts:  I buy name-brand oil and filters.  I don’t know if they are better than the discount stuff those quick-lube places use (normally I am a big fan of generics, but motor oil seems a little different).  It’s an open question.  At a quick lube place I never used synthetic oil because it was an extra $30 or so, and I’m too cheap for that.  When I do it myself, 5-quarts of oil costs about $3 more when you buy synthetic, so that’s a no-brainer.

Similarly with investing, when you do it yourself you can pick the best mutual funds at the lowest price.  I have spent a ton of time on why I think index funds with a low management fee are the best.  When you do it yourself, you can pick anything you want.  When someone else does it for you, your choices tend to be more limited.


Better use of your time:  This is a bit counter-intuitive, but it’s absolutely true.  When you change your own oil or do your own investing, you actually save a lot of time.  To change your own oil, you take 5 minutes to set everything up, 1 minute to unscrew the oil plug, and 1 minute to unscrew the oil filter.  Then you let the car drain for 10 minutes or so while you’re doing something else.  You can come back, screw the new oil filter on (30 seconds), screw the drain plug in (30 seconds), fill the oil and check the levels (5 minutes).

If you go to a place it might take you 10 minutes to drive there, 10 minutes waiting time, 20 minutes for them to do it while you’re stuck in the car.  Doing it yourself saves a lot of time.

Investing is the same way.  If you have your investment advisor do it all, you still need to meet him, drive to his office or schedule a call, etc.  You can do it on your own at night in your pajamas after the kids have gone to bed while the World Series is on in the back ground.  I know which one I would choose.


Look at other things:  As I have started doing my own oil changes, I am becoming more knowledgeable and look at other things about my car as well.  When I went to a place to get my oil changed, they always say I need extra stuff down, and I totally shut them down because I think they’re just trying to fleece me (good analogy to personal finance there).  However, there are other maintenance things you need to do to your car.

Changing the air filter is one of those.  The oil change place says I always need to do it, and I actually do it every once in a while.  Now that I change my own oil, I have the confidence to check that and it’s surprisingly easy.  I can do it in 2 minutes (plus get a good price on the filter from which is maybe 80% less than what they charge me).

Investing is the same.  It’s easy for an “expert” to come at you and tell you all the things you need to do.  It’s natural to resist that a little, knowing a lot of it you don’t need to do, but some of it you probably should do.  As you get more knowledgeable, you’ll know what does make sense (probably an IRA) and what doesn’t (probably an annuity).  That can pay HUGE dividends (figuratively and literally).


Lower cost:  It costs $40-60 to change our oil at one of those quick lube places, plus a lot more if they did my air filter and other stuff.  It’s much higher at a dealership.  My all-in cost for an oil filter and 5-quarts of synthetic oil are probably about $20.

Those are decent numbers for a car, but you know how that translates to your personal finances.  If you do investing yourself, you can save a boatload in costs and fees that would line the pockets of investment advisors, mutual fund companies, and everyone in between.


The tax man cometh

“In this world nothing can be said to be certain, except death and taxes” –Benjamin Franklin


I love this woodcut from the 1600s.  I imagine the artist drew it so the skeleton’s hand is asking for the guy’s life, but it kind of looks like he has his hand out asking for money like he’s collecting taxes.  Either way, if you’re death or the tax man, you probably aren’t too popular.

Obviously taxes are important when you’re thinking about investments and your retirement.  Uncle Sam (for all you foreign readers, what is the name of the personified tax collector in your country?) is definitely going to take his share of your earnings and investments.  Given the progressive nature of most countries’ tax codes, as your nest-egg gets larger and larger, they take a bigger percentage, so that raises the stakes.

The government has built the tax code to offer huge tax breaks to people saving for retirement, particularly allowing people to defer taxes from their earning years to their retirement years. That’s really all that accounts like 401k’s and IRAs are doing, taking money you earn when your income is high and allowing you to pay taxes on it when your income is low.  It may not seem like a big deal at first but suffice it to say, optimally managing your tax situation can be the difference of hundreds of thousands of dollars.  As always, it’s important to remember that I’m not a tax expert; also I’ll be making assumptions on future stock returns which in no way guarantee that is what will actually happen in real life.


Working tax rate versus retirement tax rate

US tax rates go up pretty quickly the more money you make.  So when you’re in your prime earning years, that is when your tax rate is going to be the highest.  Take my old neighbors Mr and Mrs Grizzly as an example.  They both work and have a combined income of $150,000.  Throw in a couple assumptions like they have two cubs, a mortgage, and live in the great state of California, and they are paying a total of about $41,000 in taxes, about 27% (there’s a great website that I used for these estimates).  Look a little deeper and their marginal tax rate is 43%; that means if they earned one more dollar they would pay $0.43 in taxes, and conversely if they lowered their income by one dollar they would save $0.43 in taxes.  Wow!!!  That’s a lot in taxes.

Now let’s fast forward and think of Mr and Mrs Grizzly in retirement.  Their house is paid off and they don’t have to save for their cubs’ educations, so what they need to support their retirement lifestyle is $80,000 (believe me, I will have many future posts dedicated to estimating how much someone needs per year in retirement, but for now let’s just take the $80k on faith).  Each year they tap into their savings and the $80,000 breaks down into three buckets: $20,000 is interest and dividends; $30,000 is long-term capital gains on the profits from their investments over the years; and $30,000 is the basis, the original money they invested which doesn’t get taxed.  Run your tax calculator again and they’re paying a measly $1,200 in taxes!!!  Read that again; it’s not a misprint.  That’s only 2% compared to the 27% they were paying while they were working.  And their marginal tax rate is 4% in retirement instead of 43% while they were working.

That, my friends, is some powerful stuff!!!  Now, how do Mr and Mrs Grizzly translate that into cash money?


The value of deferring taxes

During their working years, Mr and Mrs Grizzly set up their budget to save $1000 per month.  Because they are avid readers of the Stocky Fox, they know they should save that through their 401k’s (in this unfortunate example, let’s assume their cheapskate company doesn’t offer any matching).  In a year they will have saved $12,000 but since 401k’s are tax deferred they don’t pay taxes on that money, saving themselves $5160 in taxes (remember, their marginal tax rate is 43%).  Nearly $5200!!!  That’s some serious honey comb.  They do that each year and after 30 years (let’s assume a 2% dividend and a 5% stock increase), and they have a nice little honey pot of $1.12 million for retirement.  They’ll withdraw their $80,000 per year and pay the lower tax rate on it, and life is good.

The Grizzleys are sitting pretty, but what would happen if didn’t use their 401k to defer taxes and instead invested their money in a normal brokerage account?  Each year, they’d pay the $5200 in taxes but then they would also have to pay taxes on the dividends.  If you assume the same investments as we did above, 2% dividends and 5% stock increase, after 30 years they would have $815k.  That’s nothing to sneeze at, but that’s about $300k less than what they had with their 401k.  Those numbers seem crazy, but that’s the power of tax deferral.

2015-02-16 deferred taxes graphic (qd)

So the lesson is that using tax deferred accounts offers a really powerful way to accelerate the growth of your nest-egg by cutting out the tax man (in a totally legal way, of course).

You missed the boat

We all know that stocks have been on an absolute tear lately (that’s the reason I’m smarter than a Nobel Prize winner).  In fact, if you look at 11 months since Donald Trump was elected, stocks are up about 20%.

On election night the S&P 500 was at 2140 and now it’s at 2550.  It’s blown through major milestones like 2200, 2300, 2400, and a few weeks ago 2500; all in fairly short order.  If you are fully invested you’re loving it and obsessively looking at your spreadsheet to see how your net worth is climbing (okay, maybe that’s just me).

If you aren’t invested, this is a definite missed opportunity.  There are a couple ways you can go with that:

  1. Just don’t invest because you feel you missed the boat already.
  2. Go all in now to not miss any more.
  3. Hold off to wait for the market to fall again, and then invest on the dip.

As you can probably guess, I think #1 is a bad idea and I would recommend #2.  However, what about #3?


Waiting for the downturn

We all know that stocks have been on an unrelenting upward path.  The S&P 500 started at 17 in 1950.  Today it is over 2500.  Of course, it’s never a smooth path.  You’ve had bumper years like this one, really since 2008, all of the 1980s and 1990s, etc.

You’ve also had your downturns.  Some have been long grinds like the 1970s while others have been sharp like the Great Recession.  However, even with those, we’ve definitely done well.  That said, if you missed out on a good run, should you just wait for the next downturn to get back in?

First, I believe that it’s impossible to time that well.  But let’s say your crystal ball is working really well. How often will stocks fall back so you can get back in at the lower levels you missed before?

I looked back at the S&P 500 since it started in 1950, and I looked at all the major milestones for the index.  On January 1, 1950 it started at 16.66, so the first major milestone was 20.  It passed that level in Oct 1950 and it never looked back.  Never again did you as an investor have a chance to get in at 20*.

Same story for milestones 30, 40, and 50.  In the 1950s the stock market did its relentless march, and every time it passed those levels they were never seen again.

It was a different story in the late 1960s and early 1970s.  A MAJOR milestone was hit in June 1968—100 on the S&P 500.  You could imagine this was accompanied by the usual fanfare of surpassing such a level.  The 1970s proved a lousy time for stocks, and the S&P 500 had major moves above and below 100 eleven times.  That’s a lot.  It wasn’t until the Reagan bull market of the 1980s that the stock market broke the trend.

For milestones 150, 200, 400, and 500 there were no pull backs (300 had a pullback thanks to the crazy one-day plunge in 1987).  So again, just like the 1950s, the 1980s and 1990s had a stock market that just blazed through, and if you missed it you missed the boat.  Never again would those levels be seen again.

Milestone First time Revisited
20 Oct-50 0
30 Jul-54 0
40 Jun-55 0
50 Sep-58 0
75 Dec-63 2
100 Jun-68 11
150 Mar-83 0
200 Nov-85 0
300 Mar-87 2
400 Dec-91 0
500 Mar-95 0
750 Nov-96 0
1000 Feb-98 3
1500 Mar-00 6
2000 Aug-14 3
2500 Sep-17 0

Since the 2000s we’ve crossed four major milestones—1000, 1500, 2000, and most recently 2500.  All of those were revisited, mostly due to the Great Recession where the S&P fell from about 1565 all the way down to 670.

Since the Great Recession, the market has been blazing, but it’s been crazy in the process.  The market cleared 2000 in August 2014, but has gone through some brief downturns with fast recoveries like January 2016.  I think more recently we’ve experienced greater volatility in the market, so revisiting might be more common.


Bottom line

That was a gripping history lesson, but what does that mean we should be doing now?  Overall, I think the data shows that stocks always go up.  Sure there will be bumps, but if you invest now, the data shows that, at least based on history, you’ll make money.

On the other hand, despite this crazy good bear market recent years, there have been revisits of these levels.  Are we going to see the S&P 500 at 2000 again?  Maybe.  Based on recent history, I wouldn’t be surprised.  However, I certainly wouldn’t bet on it.  I mean that in the literal sense—I wouldn’t wait to invest my money until I saw a market downturn.  I think it more likely things will keep cranking along and 10 years from now we’ll remember the good ole days when the S&P was at 2500 the same way we think about $0.10 hamburgers from McDonald’s.

You might have missed this boat, but you don’t want to be on the sidelines when the next boat (S&P 500 at 3000) comes around and miss that one too.



* I defined “revisited” is going under the milestone at least 100 days after it passed it.  This is to keep from counting times when it gyrates above and below the milestone over the short term.  For this we wanted to look at times where the market was comfortably above the milestone and then at a later time period fell below it.

Vacation homes—don’t do it

Summer has come and gone, and it’s one more year that I haven’t surfed a 15-foot wave.  I blame the move from LA for a lot of that because I just can’t get out to the ocean as often as I need to (now we’re about 3 hours from the Atlantic).

The obvious solution is for Foxy and I to get a beach house.  This is something we have talked about seriously, off and on, since we moved to North Carolina over two years ago.  The clear benefit is we would have an awesome second home on the Atlantic Ocean: it would be beautiful and peaceful and a blast for the cubs as they grow up, plus the SURFING.

Why wouldn’t we do that?  As with many things the answer is—cut to Stocky rubbing his thumb and middle finger together—money.  It would be a huge expense, but just because something costs a lot doesn’t mean it’s not worth it.  After all, vacations and leisure time are very important.  We’re fortunate that it is a possibility for us.

Ultimately, I think vacation homes tend to be lousy ideas for most people because of two main reasons: 1) They are expensive compared to other options.  2) They really limit what you can do (or want to do) for vacations.


Breaking down the numbers

A vacation house is typically not cheap.  Let’s say a decent beach house right on the water would cost $500,000.  Definitely they can vary widely in price, but we’ll see that the price really doesn’t change our calculations.

Based on some of our recent blogs, we know that you’d typically buy a house with a mortgage, although vacation homes have mortgages less frequently than primary residences.  For simplicity’s sake less assume we bought it outright (again, this won’t really impact our decision).  If we sink $500,000 into a vacation house that means we wouldn’t be able to invest it at a market average of about 7%.  That comes to about $35,000 per year.

Also, owning a vacation home comes with considerable costs.  There’s property taxes—let’s say $4,000 each year.  We’d also have utilities, including luxuries like internet and cable—we’ll put that at $500 per month or $6,000 annually.  Then, because the ocean is such a harsh environment you have a lot of upkeep.  Air conditioners rust, wood needs to be restained, and on and on; I asked a neighbor who used to live on the beach and they said that was probably another $5,000 annually AT LEAST.

The expenses come to $15,000 a year plus the investment potential at $35,000 a year, so now we’re talking $50,000 annually.  My, oh, my.  What we could do with $50,000?  More on this in a second.

Of course, as we talked about a lot in looking at rental properties and your house as an investment, there are some upsides.  Our beach house could appreciate, but national averages put that at about 0.4% annually, so that comes to about $2,000 each year.  Not a big deal.

Plus, I think (I haven’t found a lot of hard data on this) prices for vacation homes are much more volatile than primary residences.

Also, we could rent it out.  That’s what most people do with vacation homes.  There are some major risks with that.  Best case someone else is putting their butt on my toilet seat.  Worst case is someone turns my slice of heaven into a meth lab.


The fun we could have

If we look at all the calculations above, we can simplify it to thinking we have $50,000 annually on vacation.  Think of all the things we could do with $50,000.

If we were super committed to the beach to fulfill my surfing dream, we could rent a place on  After a few minutes of searching I found similarly sized places to the one that cost about $500,000 which are also right on the beach.  We could rent those for $6,000ish for the month of July.  Throw in June and August, and we could rent a beach house for the entire summer for $18,000.  If you annualized that $6,000 per month it comes to $72,000 which is more than the $50,000 we were saying owning a beach house would cost, but there are some problems with that.

Since it’s a beach house aren’t those three summer months really the most important?  Honestly, how often would you be going to the beach in November or March?  Maybe a little bit but probably not that much.

You could imagine a similar scenario with a ski cabin in the mountains.  You’d love it during the winter months when the snow was there, but the other times probably wouldn’t be as awesome.

Oh, and there’s that little thing called . . . the cubs.  We have two little cubs who have school and friends and all that.  So it’s not realistic for us to be away from home during the school year.  Maybe we could pull off a whole summer away at a beach house, but if it was a mountain cabin how often could we spend there?

Add in things like sports, friends’ birthday parties, boy scouts, and on and on.  It just doesn’t seem realistic that we could spend enough time there to justify the $50,000 cost.  That leads to the idea of renting it out when we don’t want to be there, that creates a conundrum too.

We’d want to be at our vacation house during the best times (summer months, holiday weekends) when the rental demand would be the highest.  We could get high rents during those peak times, but then that kind of defeats the purpose of US having the place.  We could rent it out when we didn’t want to go (think March), but that’s when most other people wouldn’t want to go either.  You can see the problem.

There’s a huge connection between the amount of time we’d spend at the beach house and the “goodness” of the decision it would be to buy—the more time we spend the better it would be to purchase.  We just talked about how it’s not really realistic to spend all our time there or even most of our time there.  For a beach house you’d probably max out at all three summer months, and maybe 5 weekends scattered throughout the rest of the year.  That’s the absolute most.

Call that a total of 18 weeks or 4.5 months, and that’s really pushing it.  At $6,000 per month (which is inflated because that is all high season), your rental expenses would come to $27,000 a year.  Doesn’t look good.


Tied to an anchor

In some way, if we bought the beach house it would seem like a sunk cost.  We’d be paying for it whether we spent time there or not.  That would really motivate us to spend every possible moment there, certainly every vacation there.

Yet, that would be a bit of a miss, no?  Beaches are awesome, but what if we wanted to spend a week in the summer visiting Mimi and Grandpa Ocelot in Michigan?  That’s a week we wouldn’t be at the beach house.  Or Disney, or going up to the mountains, or a trip to Washington DC or California.  Just owning that place would put us in a weird spot where we would feel we’d have to go there all the time even if we wanted to go somewhere else.

Now if we rented, we could go to the beach when it suited us but also anywhere else that caught our fancy.  Plus, apparently there is more than one beach in the world.  If we rented we could go to the beach we would have bought at, let’s say Surf City, but also Virginia Beach, Myrtle Beach, Nags Head, Florida, and on and on.  I understand that going to the same place would be nice to get comfortable there, but variety is the spice of life too.


For those main reasons, I think that a vacation home for us doesn’t make sense.  It’s too much, and it ties us to one place.  But I do think there are situations where it does make sense.

If you don’t have little kids, a vacation home makes a lot more sense because you don’t have your calendar dictated by school.  After kids, we could spend the summer months at our beach house but also April and May and then September and October.  Those are beautiful months to stroll on the sand and watch the sun rise over the water.

Plus, as you get older I think you tend to shift from wanting to see a lot of different places to knowing what you like and just wanting that.  My in-laws, Mimi and Grandpa Ocelot are at that stage.  As an example, they have gone to the same timeshare in Florida ever since I’ve known them.  They like the place, like the people, know there won’t be any surprises or anything.

For someone like them you could imagine a vacation home would make sense.  It’s predictable and they could spend enough time there to justify the costs.  Just for Foxy and me, at our age, when we still have an itch to see a lot more of the country and the world, plus with two little cubs, I think you can get a lot more bang for your vacation buck buy NOT buying a vacation home.

Congratulations to Professor Thaler

Today, Richard Thaler won the Nobel Prize in economics.  Professor Thaler was one of my professors at the University of Chicago.

I know I openly questioned the value of a college education, and I still stand behind those posts.  However, as I look back on my own life, the University of Chicago has played such a monumental role.  It springboarded my career, allowing me to make a healthy income that permitted me to retire in my mid-30s.  It had such a rich and vibrant learning environment which really changed the way I looked at, and continue to look at, the world.  Oh, and I also met my wife there.

Don’t quote me on this, but I believe that the University of Chicago is home to more Nobel Prize winners for Economics than any other institution.  When I was there we had two laureates on the faculty—Professors Becker (1992) and Fogel (1993).  Since I graduated, two professors who were on faculty at the time have won: Fama (2013) and today Thaler.

We can’t forget Coase (1991), Scholes (1997)—yes, he’s the guy who developed the Black-Scholes pricing model which is how pretty much all options are priced now, and Miller (1990)—any intro to finance course spends extensive time on his M&M models.  Let that sink in for a minute—a UofC professor won the Nobel Prize in four consecutive years from 1990 to 1993.

Now get ready for the big guns.  Stigler (1982) and the most important economist of the 20th century, Milton Friedman (1976).

That’s a pretty incredible collection of the smartest economists in the world all in one place.  It was very humbling to have learned from such world-changing people.  I am thrilled that Professor Thaler’s amazing contributions have been recognized at the highest level.

You only need three investing ingredients

“Less is more” –Robert Browning


The fine people at McIlhenny make Tabasco sauce, one of the most popular condiments in America.  Can you guess how many ingredients go into their sauce (you might have an idea from the title of this post)?  You guessed it, three: peppers, vinegar, and salt.  That’s it.  Nothing else.  Only those three.  In investing you can take a similar approach.  In a world where there are thousands of stocks to pick from, thousands of bonds, tens of thousands of mutual funds, how do you pick which ones to go with?

Let’s break this down one step at a time.  First we know from Asset Allocation that our portfolio needs some stocks and some bonds.  That’s at least two different investments—one for stocks and one for bonds.

Second, we know from Diversification that we should be . . . well, diversified.  There are a ton of mutual funds out there that can give us plenty of diversification with the stock market.  I personally like either the Total Stock Market Index from Vanguard (VTSMX) or the Spartan Total Market Index from Fidelity (FSTMX).  But wait, those are all (or very nearly all) US stocks.  To be really diversified don’t we need international stocks as well?  The answer is an unequivocal “YES”.  So let’s add a highly diversified international stock mutual fund like Vanguard’s Total International Stock Index (VGTSX) or Fidelity’s Spartan International Index Fund (FSIIX).

With a broad US stock mutual fund and an international mutual fund, you pretty much own a small sliver of every stock in the world.  Add to those two mutual funds a bond mutual fund like VTSMX or FBIDX, and you have your three ingredients, just like Tabasco sauce.

Can it really be that easy?  I say “yes” but let’s look at some of the objections you might have:


What about an international bond fund?

Fair point.  We have an international stock fund to give us diversification for our US stocks.  Shouldn’t we have an international bond fund for a similar purpose?  Maybe.

I don’t because bonds are such a small portion of my portfolio right now (less than 5%), mostly due to the stage of our lives that Foxy Lady and I are at.  So I don’t think it’s really worth the hassle.  When we get older and Asset Allocation dictates that a larger portion of our portfolio should be bonds, then having two bond funds might make a lot of sense from a diversification perspective.


Why not use a total world fund?

Vanguard does have a total world stock index fund (VTWSX) that combines both US and international equities.  You could imagine just having this one mutual fund for stocks instead of two (a US fund and an international fund).  That’s reasonable and knocks your ingredient list down to two.

Yet I choose not to do this because I am cheap.  The total world index fund as a management fee of 0.27%.  That’s low but the management fee is 0.17% for Vanguard’s US fund and 0.22% for their international fund.  Shame on you Vanguard!!!  Why are you charging more when you combine them.  It’s not a ton, but we know that even increasing your returns a small amount like 0.05% can still be thousands of dollars over the years.


Why not use a target date fund?

You could do a total one-stop shop using a target fund like Vanguard Target Retirement 2050 (VFIFX) or whichever year makes sense.  You get your US and international stocks and your US and international bonds all in a single mutual fund.  As I mentioned before, I’m not a huge fan of these because I think figuring out your asset allocation is a little more nuanced than just picking a year, but I’m a little OCD when it comes to this.  That might be the best choice for someone who is willing to trade a small amount of mutual fund performance for a lot of simplicity.


What about all the other investments out there?

Ahhhhh.  That’s the question we’ve been waiting for.  I am a firm advocate of efficient markets so I really don’t think I can successfully pick individual stocks or even stock sectors.  I’d rather just pick a really broad index mutual fund knowing that the winners and losers will balance each other out and over the long run I will do okay.

That said, beyond those basic three ingredients, the Foxes have invested in two other investments.  We have a commodity ETF (DJP) which has turned out to be the worst investment that we’ve ever made (which I chronicled here).  Also, we invested in a REIT index fund (VGSLX) when I thought that real estate would be a good investment.  From 2010 to 2014 this turned out to be the case and we did quite well with this, but since 2017 it has been mediocre to bad.  That just goes to show that trying to beat the market is a futile effort.


Does Stocky Fox eat his own cooking?

For the sake of full disclosure, I’ll tell you where our investments are.

Investment Ticker symbol % of portfolio
US stock fund VTSAX 51%
International stock fund VTIAX 36%
Bond fund VBMFX 1%
REIT fund VGSLX 7%
Commodities DJP 3%
Others 2%


I already mentioned the REIT and commodities investments.  The “Other” is composed mostly of Lady Fox’s 401k accounts, our money in Lending Club (which has been a total disaster which I’ll chronicle in a future post), and a couple other odds and ends.


So there you go.  With all the crazy things going on in the world, and all the things that need your attention, I think which investments to pick is an easy one.  With three fundamental building blocks—a US stock mutual fund, an international stock mutual fund, and a bond mutual fund—you can build a rock solid portfolio.

So which investments do you pick?

Invest in 401k before you payoff student debt

“The longest journey begins with a single step” –Laozi (580 BCE)

Investing is a long-term game.  As that really smart Chinese philosopher said, that long-term game needs to start with your first move.  For most people, investing will start when they get their first “adult” job after college (you already know how I feel about college).

Some people start with a clean financial slate when they leave college, but many have student debt from all the loans they took for that degree.  That sets up an interesting question as they get their first paychecks: what to do with the money?  You can even make the question more precise and ask: should I use my savings to payoff my student loans or start investing?  Let’s dive right in

My niece Starty Fox just graduated with her engineering degree from State U.  She has $20,000 in student loans that has an interest rate of 4.45% (I think that’s the current rate for government backed student loans).  Because she listened to her wise uncle, she got an engineering degree which presents many job opportunities.  She took a good job paying $54,000 per year (luckily her salary is divisible by 12 so this post is a little easier to write).  Plus, they offer a 401k which matches her contributions up to 6% of her salary.

After she accounts for rent (her parents made it clear she could visit, but not live with them), her car payment, food, and other living expenses  she is able to save 10% of her income each month.  She makes $4,500 per month and has $450 left over at the end of each month (let’s ignore taxes for a second, but just a second).

So what should she do, payoff that nagging student debt as fast as she can or start investing in her company’s 401k?


A match lights the world on fire

Let’s say Starty has a neurosis about her debt.  She was raised never to have any debt (although maybe that’s not always the best idea—here and here), so she wants to pay it off as quickly as she can.

If she applied all $450 each month to her student loans, she would pay off that whole $20,000 in a little over 5 years.  There would be a couple things she wouldn’t like.  First, that $450 would be taxed (just like the rest of her income).  Let’s say her marginal tax rate is 20%, so that means the $450 she has set aside is really only $360 after she pays Uncle Sam.  Taxes are unavoidable, so while that’s a bummer for Starty, she accepts it as a fact of life (although maybe she shouldn’t—more on that in a second).

When it is all said and done, she will have paid everything off by the time she turns 27, which isn’t bad.  Through it all she would have paid about $2,300 in interest.  That interest is tax deductible, so it would only feel like about $1,840.  After everything is paid off, she can start investing in her 401k with a clear conscious.

Let’s take the other extreme, and assume that Starty watched Wall Street a lot with her adoring uncle when she was little.  She’s not too concerned about debt, especially when there are other good investment opportunities out there.  She pays her minimum payment on her loan ($150 per month before taxes, $120 after taxes) and then invests the rest in her 401k.

Obviously, the downside of this is it takes her a lot longer to pay off her loan; instead of being done by age 27, she’ll have the debt until she’s 40.  That sucks.  But she more than makes up for that with her 401k.  Every year she contributes $3,600 to her 401k.  When she does this she has three really big spoonfuls of awesomeness working for her:

  1. Tax free—her 401k contributions are pre-tax so just off the top she is saving $30 per month that would go to taxes if she used that money to pay off her loan. That’s enough to buy a new Lululemon outfit and splurge on extra spin classes each year (Foxy Lady just took over my computer for a second).  Sure, eventually she’ll have to pay that in taxes, but there are a lot of things she can do to minimize that when the time comes.
  2. Match—the big one is that Starty gets to take advantage of her company’s match. They match dollar-for-dollar up to 6% of her salary.  Since she’s contributing more than that, she takes complete advantage of the match, and that comes to $270 each month.
  3. Investment returns—obviously this is why we do invest money. On average Starty is going to earn a 6-8% return on her 401k.

If you put that all into the pot and mix it, you’d have a 27-year-old Starty who is debt-free but with nothing in her 401k, or you could have a 27-year-old with $41,000 in her 401k and still with $16,000 in student loans.  Obviously, the 401k option is much better. She has a net worth of $25,000 on her 27th birthday (versus $0 if she paid off her student loans first).


The cause of it all

Those numbers tell a pretty powerful story that from a mathematical point of view, paying off your student loan at the lowest level is best so long as you put that money into your 401k (and not spend it on stupid crap).  However, there are some fairly big assumptions there.

Match—obviously the match is a big part of it all.  Without the match the numbers don’t look nearly as good, but the 401k option still comes out ahead.  On her 27th birthday, she would have a net worth of $5,500, without the match.  Many people may complain that this example isn’t realistic because Starty’s 401k match is so generous, but without the match she still comes out to the good.  And we know a 401k without a match is basically like a traditional IRA which is available to everyone.

Liquidity—when Starty chooses to go all in on her 401k she’s losing a lot of financial flexibility.  At 27 she’ll still have $15,000 of debt that she’ll have to pay off plus she’ll have a lot of her money tied up in her 401k which is very hard to access.  If something happened at ages 22-27 she’d be in pretty much the same boat either way, but after age 27 she’d have a little more flexibility if she had killed the college debt.  This becomes a question very similar to the one we raised with the post on the emergency fund.  Personally, I would be willing to roll the dice for that extra $5-25k over five years, but risk aversion is different for all of us.

That’s all good, but fundamentally this boils down to Starty being able to borrow money at 4.45% (3.6% after taxes) and being able to invest it at a higher rate, 7% for argument’s sake.  Over a 20 year time horizon (about how long it takes her to pay off her student loan), stocks have historically done much better than that 4% hurdle.  For all these reasons, it does make a lot of sense—in Starty’s case thousands of dollars each year—to slowly pay off her college debt and put that money into her 401k.