Smoking Your Retirement Fund Away

413 days of not smoking! Wooho. Don't worry, I'm not out to sway smokers to stop smoking. Because that's just about the most impossible thing to do; I know it because no one, not even my wife, could stop me. She could only help me stop, but I did the stopping myself. It's mind over matter, baabey!

The MSN Money article 'The high cost of smoking' describes various costs associated with smoking. I didn't find anything new there that I have not read before back while I was smoking. I am sure any smoker has heard them too.

But, a snippet from the article is particularly relevant to my final goal, the end goal of these mini-goals I set out before myself.

Sloan and his colleagues found that the effects of smoking on lifetime Social Security benefits were $1,519 for 24-year-old female smokers and $6,549 for 24-year-old male smokers. This is money paid into Social Security but never collected, because the beneficiary died prematurely of a smoking-related illness.

"You could be paying into Social Security year after year, and if you die at 66 because you're a smoker, it's money down the drain," says Sloan.

What a waste of efforts. After working so hard, enduring various unpleasantness in life, experiencing so many things, one dies without the chance to reap the benefits.

If I am socking away most of my income for retirement, living frugally, not tuning in to the gotta-have-the-latest-iPod insanity, then I better stay around long enough to enjoy it. Deferred enjoyment is possible only if you are still around to do the enjoying.

So, I'm planning to stay around long enough so I don't smoke my retirement fund away.

Invest or Pre-Pay the Mortgage?

Now I come to the point where many others have came upon: to invest or prepay my mortage?

Factoring in interest deduction, my after-tax mortgage interest rate is 3.7%. That's 3.7% guaranteed after-tax investment rate.

I need an investment vehicle that offers a before-interest-tax 5.16% APR to beat that. An equivalent investment vehicle delivering the same kind of rate guarantee is CD. Since CDs are usually advertised in APY with monthly compounding, the equivalent APY is 5.28%. A quick check at bankaholic.com showed only 7 banks offering CDs with higher APY.

The highest is offered by KeyDirect at 5.7% for 120 months (10 years). Unholy cow! But that is the longest CD term I've ever seen and is offered by a bank that I don't want to do business with any longer.

The next one is CountryWide's 5.45% but only for 3 months. Sounds good except that it needs a $10K initial deposit. But building up to $10K takes time and all the while the collected money will be sitting in lower-than-5.16%-APR accounts. The other CD offers do not seem good as well. So, it seems my mortgage gives me the highest guaranteed investment rate for now.






Let's go a riskier route: stock market (includes mutual funds). The tax rate for capital gain is 15%, so, the minimum APR to beat the mortgage's rate is 4.35%. If I invest in various low-expense-ratio index funds or ETFs like VFINX, VTI, SPY, my risk of not making more than 4.35% APR over the next 3-5 years (expecting a baby, see below) is very low. Investing it in stock market gives you the best bang for your time.

Yet, 36% of my income is already in stock market in the forms of 401k and IRA. For me putting extra money in the same basket just increases the risk needlessly. Furthermore, if we own the house, we will be less affected by a recession. That is the virtue of not putting all your eggs in one basket.

Readers who are still with me at this point would probably think, 'this guy is going to prepay'. I would have, but my better half, well, being better, she gives me a better argument.

'We are still young', she argued, 'what is youth without risk?'. We have no children yet. We can basically take as much risk as we want now. We can even be fools and go back to the 30K debt hole we came from without affecting any innocents.

I bought it. For better or worse, I liked the argument. Perhaps I'm just greedy instead of being young. For now, I am reducing the amount of pre-payment from $1500 to $1000/month. Over time, I'll move more and more to the stock market.

When our risk-equation changes, like when we have a baby, I will have to revisit this topic again.

UPDATE 2007-Dec-14: I have a spreadsheet that may help you answering that flummoxing question: should I invest or prepay.

Mortgage After-Tax APR Comparison Goggle spreadsheet.

----
Formulas:
Effective APR = APR * (1-TaxRate)
APR = Effective APR / (1-TaxRate)
APY = (1 + APR/q)^q - 1, where q is number of compounding per year.

Income Distribution

I stumbled upon a gem comment today at getrichslowly.org.

# Baba Ghanoush Says:
June 1st, 2007 at 10:55 am

In our house, the discretionary savings gets allocated in this order:

1) 100% to emergency fund (until at least 3 months expenses)
2) 100% to pay off high-interest debt
3) 401K to point of company match
4) monthly contribution to a “big ticket fund”, which is savings for occasional large expenses, like semi-annual insurance, vacations, etc.
5) Roth IRA to contribution limit
6) 401K to contribution limit
7) remainder: 50% mortgage prepay and 50% taxable index fund

I have #1 and don't have #2. I am already doing #3. The line between #1 and #4 is fuzzy. I guess any liquid asset I have over 3 months expense is automatically part of #4. I'm already doing #5.

I have not been doing #6, instead I have been putting down money for mortgage prepayment. I am still forming a plan of what to do with the leftover after #5. That post at getrichslowly.org has a lot of insightful comments that I have not gone through completely yet.

While my goal is to increase my net worth by $100K in 1.5 years, I have to balance it with long-term interest too.

Poor Elderly Couple

While I was queuing up for casher in grocery store earlier today, I overheard the elderly couple in front of me arguing. They were arguing in Chinese about not being able to pay for the stuffs on their cart. They were talking in normal voice probably because they were confident that no one around could understand them. But, I understood Chinese well enough to snoop on them.

Basically, they were worried that they didn't have enough money to buy the stuffs in the cart. The total for their stuffs came to $23. The man slid his card (I couldn't tell if it was a credit or debit card) and the transaction was declined. He tried again and got declined again. They were forced to let go of some stuffs before the transaction was finally approved.

I didn't know where they got their money from, but seeing that they are from Asia, their children probably support them. It is customary in Asia for children to support their elderly parent.

I am from Asia likewise, and I will support my parents when they are ready to retire. I will do it without any hesitation not because I have to, but because I respect them and thankful for them slaving their prime years towards my well-being.

But, now I think I am the first generation along my family lineage to have the chance to not be a financial burden for my children, and I want to take that chance.