I got a huge raise out of nowhere this week. I was just given the news about two hours ago and I’m still stunned. Starting salaries took a big leap up again this year, and anyone with under five years of service with the company is eligible to be considered for a possible potential pay adjustment to keep them in line with the salary trends. For the third year in a row, I was included, and this year was a doozy; a $7,500 doozy. Taking this raise into account, over my three years with this company, my pay has gone up by an average of about 11% every year. That’s just bizarre. I guess I should be glad I got in while the market was utter shit.

This places me in the position of having to decide just what the hell to do with the extra $95-ish I’ll be getting in my direct deposit account every week. WHAT A BURDEN. It’s been a while since I blogged about money, so I figure I’ll take this opportunity. Where is this money needed?

My biggest financial obligation right now is my home, which, on its own, eats up $1686.12 every month, mostly through mortgage interest. That can be reduced a bit if I can pay off my “second” mortgage (read: not a home equity loan, but an actual, literal second mortgage). Most of this raise should go toward the mortgage.

I need a new car. My infuriating ‘99 Jetta makes even my short 4.4 mile commute to work unbearable. I genuinely hate getting into it. Busted air conditioning will do that. Right now, I’m setting aside $75 every week towards my next car. I wouldn’t mind bumping that up.

My girlfriend and I are saving up for a wedding (even though we aren’t engaged yet). I’m already on pace to be done saving up for it within the next six months, though. I can probably leave this where it is.

I also think I deserve to be able to spend a little bit more. This was an 11% raise, so I should bump up the tiny allowance that I give myself by at least 11%. It’s only $50 right now; let’s make that $60. Even just that is a 20% jump, but you have to let yourself enjoy your money, or you’ll just grow to resent your budget and never stick to it.

Here we go: $60/week towards the mortgage, $25/week more towards my next car, and $10/week more to spend. I’ll take that. A year ago, I would’ve just spent all of it.

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Steph had one more big question for me.

Background information: My sister and her husband, Tim, are avid homebrewers, as I’ve mentioned in the past. They plan to open a brewery restaurant sometime in the late ’10s or early ’20s. This complicates their financial picture a great deal, because they now have to consider the possibility (and, we sincerely hope, probability) that they’ll be self-employed in the next ten to fifteen years.

So here’s Steph’s question:

Thought of one more, but this is really specific to my situation.

On one hand, it makes sense to go with the Roth 401k, because Tim and I will definitely be in a higher tax bracket by the time we’re 59 ½. So we can pay our cheap little taxes on it now, and then cash in tax-free at 59 ½.

On the other hand, if Tim and I are successful in our brewery, which should hopefully get started by age 40 at the latest, we’re going to be wealthy, and probably won’t give two poops about our 401k. We probably won’t even actually “retire.” I can’t see myself selling a successful brewery if I have children who want to take it over when we die. Why retire from something that is our life’s passion? So if we are successful with the brewery, it might make more sense to go with the traditional 401k. This way we get more income now, which we need to save up for things while we’re young (house, brewing school, culinary school, brewery, travel before we’re tied down with kid(s), beer, homebrew recipe development, etc), and then pay taxes on the 401k later when we don’t care about losing money to taxes as much.

Of course, if the brewery is unsuccessful, we’ll need that cushion of a 401k for retirement. So nixing it all-together obviously would not be wise. Besides, 50% matching by Lockheed up to 8% is basically a 4% raise.

Anyway, I wanted to hear your thoughts on this. Tim and I were talking about it earlier, and we’re both now thinking traditional might be better for our situation. But I’m very curious what you think!

Y’ever see those cartoons where some rich guy is lighting cigars with hundred dollar bills? Even when I was a little kid, I knew it was retarded to think that just because you have a few million dollars, a hundred dollars somehow isn’t worth as much. If I had so much money that I didn’t have to work, would I turn down a fiver if someone handed it to me? Certainly not.

That tendency for humans to perceive money relatively shows through in this question. It boils down to this: If I’m not rich someday, I’m going to want that extra money. If I am rich, though, it’s okay for me to not get as much money. So I should choose to get less money, right?

There is some sound reasoning to Steph and Tim’s suggestion, though. Going Traditional with their retirement plans would free up a good $20-30 every week, and that money could be put towards saving up for their future.

Here is what I would do.

Traditional 401(k)s are still one of the best deals in investing, and whether they have an advantage over Roth 401(k)s or the other way around will be debated until the end of humanity. As long as Steph and Tim keep contributing to one or the other, though, they’re going to come out ahead.

So, I tend to agree with their assessment: I would stick with Traditional, contributing just enough to get the full company match (8% in Steph’s case — not sure what it is for Tim).

I would then squeeze my budget as tightly as I possibly can so that I can invest as much money as possible in the stock market. Steph and Tim have a good ten years before they will need this money, which makes them perfect candidates for stocks. Since I know these two and their incomes personally, I can safely say that, in addition to their 401(k)s, they can quite conceivably afford to set aside another 12-20% of their before tax income for this investment (and I hope they will do that rather than rush into buying a home). With a bit of discipline and a few raises, they should have no trouble affording the loans and education necessary to make this brewery happen.

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My sister, Steph, has been bombarding me with 401(k) questions today (which I find surprising, because I’m pretty sure she shouldn’t be eligible for it yet — we work for the same company, and I wasn’t eligible until the six month mark). Steph could be the poster child for the investing novices of the world. She is literally starting from a cold stop, bringing nothing to the table but an able mind ready to learn. Poor kid.

After the seventh or eight email, it became clear to me that a lot of people could benefit from the answers to her questions, so I had her compile everything she wanted to know into one email so I could blogacize it. Too many people sign up for their 401(k), do nothing else, and wind up with all of their money in a low-yield bond fund until retirement comes and they discover they’ve barely beaten their local bank’s savings rate over the last forty years. Bad.

So, to begin:

My three options are Before Tax, Roth, and After Tax. I know you already blogged about traditional vs. Roth, but what’s After Tax mean?

The post that Steph references in her question can be found here.

After Tax is essentially the worst of both Roth and Traditional: You get taxed before and after. I can’t think of any situations where one would use this option, but if anyone suggests one in the comments, I’ll be sure to give you credit.

After I leave my company, what happens to my 401(k)? Does it just hang out until I’m 59 ½? Can I keep contributing to it through other jobs?

You would transfer the old 401(k) into your new one and continue along your merry way. Simple as that.

What if my next job is “brewery owner?” (Or for everyone else, what if I become self-employed in the future?) Say for whatever reason, we don’t offer a 401(k) at our brewery. What happens to my 401(k)? Does it just sit until I’m 59 ½? Or do I have to continuously contribute to it?

There are a couple ways this could play out, depending on how your business is handled. If you’re nothing more than “self-employed,” i.e. not considered an employee of your own business, there are self-employed 401(k)s available, but most people set up a Simplified Employee Pension Plan (SEP) IRA, which allows you to contribute up to 25% of your income up to $44,000. I assume you would simply roll your 401(k) balance into one of these retirement accounts.

If you decide to incorporate and consider yourself an employee of the company, then I believe you could simply sign up for the retirement plan that you offer through the company and roll your old 401(k) into that.

If you do not offer a retirement plan for your employees, I would first recommend fortifying your office against the inevitable employee uprising. Once the ramparts are made impregnable, then you could either let your old 401(k) sit, or roll it into an IRA.

It would be best if you did NOT leave your 401(k) where it is. If something in the plan changes, odds are good that you would never find out about it, and so a fund that you are earning good returns on could be eliminated from the plan without your knowledge. The balance from that fund would likely be transfered into a low-yield bond fund by default until you tell them what to do with it, which you would never do because you would never know anything was up. Not good. Roll your balance out of there into your own IRA.

When I enroll, it asks me to choose from 14 different funds. What’s up with that? What are they, and how do I know which ones to invest in?

You’re going to hate this answer: It’s up to you.

Your company should provide you with a packet containing a prospectus for each fund offered in the retirement plan. Read through everything, and if you feel like you know enough at that point to make a decision, then you’re probably God and I feel really stupid for having been an Atheist all this time.

Best thing to do: Go over the information with someone who’s done this before (in my sister’s case, that would be me). Barring that, talk to your human resources department and see if they can point you to a financial advisor to help you decide. Many companies will have one available.

The rule of thumb that I use is, subtract your age from 120 — That is the percentage of your plan that you should put into higher-risk but higher-yield funds. For me, that comes out to 93%, so I have 90% of my balance and contributions spread evenly across three high-yield funds: a small/mid cap domestic index fund, a large-cap domestic/international fund, and a purely international index fund. The other 10% is in a bond-based fund. I plan to start dialing the risk back a little when I turn 35 or 40, depending on how things play out.

Some companies, including my own, are beginning to offer “targeted” retirement funds, which basically do what I just explained for you. The plan might offer ten to fifteen funds targeted to investors a certain number of years from retirement, and you would pick the one that matches yourself most closely. From what I’ve seen, though, these are fairly new and don’t have much of an established track record yet. I’m paranoid, so I’m taking care of it on my own for now, but if thinking about this stuff makes you reach for the Maalox, these funds might be a good pick for you.

Okay, wrapping this up now…

Steph had one more question for me, but I have a feeling I’m going to have a lot to say about it, so I’m going to leave this post here now and answer that final question in its own post.

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The more I write these posts about sound personal finance, the more I realize how much people disagree with sound personal finance.

I can only say in so many ways how important it is to pinch your pennies and stay out of debt. If you’re set enough on buying a home or a car or whatever as soon as humanly possible, damned be the cost, there isn’t much I can do to convince you otherwise. For most of you, the only thing that will convince you is the consequences.

Buy that house. Please, do it. Spend all of your money. Run out of it. This isn’t reverse psychology, this is an honest-to-gods request.

Not even a year ago, I would have done the same thing. After all, why would I have ever needed to follow any such advice? I’m smart! I don’t need to listen to these people! I know that buying this house is a really good investment! Obviously!

And then, I ran out of money. Eewps.

I had my poor spending habits beaten out of me, maybe not so savagely as some of the other bloggers out there, but the sting of comeuppance had the same effect. I got my shit together for the first time in my life, and while I’m not in perfect financial shape right now, I’m certainly better off than I ever have been throughout my adult life.

If you don’t want to take my advice, then don’t. Most people won’t. That’s fine. That is your choice. You might not even fall beyond your personal tolerances by it, and if that’s the case, good for you. If you do, though, if you should, without noticing, take on more debt than you’re willing to accept, or wrack up higher monthly expenses than you feel your paycheck is equipped to handle, or myriad other things, then you will see.

I wish I could say that I won’t tell you that I told you so, but I refute that just by writing this sentence.

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Okay, so a lot of people seem to be focused more on the monthly payment than the actual cost. Fine. It’s shortsighted, but if you won’t budge from that, let’s at least look at the money that is “wasted” on rent vs. the money spent “building equity” on my home.

Below, you’ll find a tabulation of all money spent on living that disappears forever, i.e. rent, interest, etc, between renting and homeownership. Note that for interest, I’m basing my figure on what I currently pay in the second year of my two mortgages. This would of course decrease over time.

Apartment: Rent — $800; Utilities — $150; Total — $950

Condo (not counting repairs): Interest — $900; Utilities — $200; Association Dues — $185; Property Tax — $350; Total — $1635

By purchasing a home, I experienced a 72% increase in “waste” expenses, money that disappears from my pocket that I will never see again! Yes, you are wasting money on rent, but in many situations, you would quickly find yourself wasting a great deal more on homeowner costs.

That said, if you can put yourself in a situation such that the money that you “waste” on homeownership will either be less or become less within three or four years, even without coming up with 20%, then by all means, buying the home early might actually be the way to go. I feel like this will be a minority of people, though. In my case, if I stick to minimum payments, it won’t become less for another ten years or so. Yikes.

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