Retirement Accounts, Traditional vs. Roth

This post follows a previous one that I made on the basics of Traditional and Roth IRAs, in which I explained and modeled out the benefits of using a Traditional or a Roth IRA (versus a taxable investment account). After reading a post on Reddit about the benefits of Roth accounts, I actually took away the other conclusion - I was too gung-ho on Roth accounts, and that the traditional 401(k)/IRA deserved more credit than I gave it. This post elaborates a bit more on the Roth vs. Traditional decision (for both IRAs and 401(k)s) - and why perhaps the answer is most likely “a bit of both”.

why I still love roth accounts

To be clear, I walked into that post fully expecting a big dose of You’re Right! to feed my confirmation bias. The Roth is a more clear-cut case of guaranteed benefits versus a taxable account; you’re not paying any capital gains taxes and therefore sure to come out ahead. Plus, the Roth accounts were more powerful in their capacity to shield money from taxes - a post-tax dollar is inherently more money than a pre-tax dollar. I expect to land in the top tax bracket during retirement, hence there was no point in bothering with a traditional retirement account where any dollars I put in now could very possibly be withdrawn at a top marginal tax rate of around 35-40% (and perhaps even higher, depending on how government policies shift decades from now).

filling lower tax brackets during retirement

In short: my revelation on the value of the Traditional IRA/401(k) was around the fact that in retirement, if I wasn’t recognizing income I was missing an opportunity to pay lower tax rates. Suppose I had $5M in Roth accounts when I decided to retire and wanted to pull $200K annually from my accounts - I wouldn’t have any taxable income to report thanks to the origin of the money - a Roth account - and so I wouldn’t owe any taxes on that money. But note that the money I had contributed to the Roth account was post-tax money; perhaps the bulk of that money was contributed at a marginal tax rate of 30% or higher.

In contrast, imagine now that I had $3M in Roth accounts and $2M in Traditional accounts when I retired. I decide to pull $120K annually from my Roth accounts and the remaining $80K from my Traditional accounts. Now, I’m reporting my annual income is $80K during retirement, which I pay taxes on - but in all due likelihood my income is getting taxed much lower, thanks to filling up the lower tax brackets. I’m not exactly able to net out a full $80K; but contributing enough money to end up with $3M in a Roth account (using post-tax dollars) and $2M in a Traditional account (using pre-tax dollars) is substantially easier than contributing enough post-tax dollars for $5M in a Roth.

For the sake of argument, suppose that in order to net out a full $80K after withdrawing from a Traditional account and paying income taxes, I’d need to withdraw $100K from the account (in other words, I’m paying 20% income tax, on average) and that in turn I’d need $2.5M in my Traditional account upon retirement. I’d need to save up during my working years to have $3M in a Roth and $2.5M in a Traditional account. Noting my earlier assumption of 30% marginal tax rates for income during my working years, the Roth-only option is more difficult to reach than a combined Traditional/Roth split.

in conclusion

Roth retirement accounts are great - but they’re not so great that you should be fully gung-ho on using them (and only them) when it comes to saving for retirement. If you’re expecting future marginal income tax rates (in retirement) to be lower than what you’re paying today, the Traditional accounts merit a close look.

My strategy today of using only Roth accounts for my 401(k) and IRA won’t change yet, as I don’t think my marginal tax rates are so high yet to make the Traditional route more tax-optimal. However, in a future where I’m earning significantly more, I could see myself leveraging a backdoor Roth IRA (since Traditional IRAs have income limits on who can deduct contributions) and a mix of Traditional and Roth 401(k)s at work, including the mega-backdoor Roth 401(k).

I am not providing or intending to provide tax, legal, or accounting advice. This blog post is for informational purposes only, so please don’t rely on it for tax, legal or accounting advice. Consult your own tax, legal and accounting advisors before engaging in any transaction. I’m just a guy on the internet. Please don’t sue me.

What does it mean to be rich?

Bloomberg recently published a fantastic article from interviews with high-earners across the country (you can open up the link in incognito and you should be able to read it for free). It covers two important points for nerds like me who care about personal finance:

  1. How your cost of living changes from city to city (within the US)

  2. People with high incomes that don’t necessarily feel “rich”

Cost of living

It’s hard to compare salaries between e.g., downtown New York City or San Francisco to suburban Atlanta or Houston. Does a salary of $150K sound high to you? In Houston, it’s pretty good:

I use $149,999 since the calculator uses buckets to establish percentiles. Anyone earning $150,000 - $199,999 sees the same result.

$150K in Houston entails earning more than double the median household income as an individual. Let’s look at Palo Alto. Bloomberg doesn’t account for tax differences between states, so we can use this calculator from SmartAsset to adjust for the state income taxes you’d pay:

Income tax breakdown for a household income of $149,999 in Palo Alto, CA. This includes 1 state personal exemption.

In Palo Alto, your $149,999 gross salary has ~$10K in state taxes that someone in Houston isn’t paying - so let’s see where $139,755 gets you in Palo Alto:

At a national level, things don’t change (the bracket that Bloomberg uses goes from $100,000 to $149,999). At a local level, you’re right in the middle of household incomes (again, as an individual) and the percentage of your paycheck going to housing has more than doubled.

people that don’t feel rich

There’s a (very dry) book called The Millionaire Next Door, where the authors (Stanley and Danko) write ad-nauseam about two archetypes of people: UAWs (Under Accumulators of Wealth) and PAWs (Prodigious Accumulators of Wealth). The branding could probably be improved; the overall story is clear - some people (PAWs) save their money and feel financially strong, other people (UAWs) spend most of what they take in, have fully succumbed to lifestyle creep, and don’t feel rich. I’d take it a step further - people who spend every dollar they take in aren’t rich, regardless of their annual income. They’re on a spending treadmill; losing their job could easily mean ruin. They’re keeping up with the Joneses - fast cars, nice homes, using “summer” as a verb, etc. - but they haven’t cracked achieving mental freedom from financial worry. In fact, money worries them, because they know how precarious their situation is.

The survey from Bloomberg based on 1,000 responses from folks making at least $175,000 a year. Even in the highest cost-of-living areas, that’s above the median income (though I note that incomes are for larger metropolitan areas, and $175,000 in the urban core can be very different from $175,000 in the suburbs). The fascinating results from this study aren’t the folks that feel comfortable or rich. It’s the people who feel poor despite their high incomes that matter; pay attention to the black bars.

The black bars tend to not have $500,000 saved up - and they worry about money.

They also tend to not have saved up for retirement:

Money is an especially emotive topic; not seen in the graphs are incredibly important factors like age, health status, family status (kids change the equation quite a bit, I’d imagine), and spending level. You don’t see how history and culture shape individuals’ feelings about money; people will overindex to what they’ve experienced.

While reading through the article, I was noticing how people defined “feeling rich”. The primary theme was that it entailed not worrying about money — worries which could arise from future expenses, debt, or concerns about job stability; worries which could be mitigated from more cash in the bank.

I’ll leave you with a few reading materials that I found throughout my personal finance journey:

Two Nonlinearities in Personal Finance

I wanted to share two rather incredible nonlinearities in the world of personal finance that have rather profound implications for how we treat money.

Nonlinearity 1: Avoiding Lifestyle Creep

  1. Suppose that Dave takes home $65,000 a year after taxes, and spends $60,000 a year maintaining hislifestyle - retirement savings, rent, food, transportation, travel, etc. Dave’s able to save $5,000 a year, which covers one month’s worth of expenses. My old roommate used to talk about earning runway, not dollars. Dave’s earning a month of runway per year. After 12 years (if Dave doesn’t invest at all, and ignoring inflation), Dave could go without income for a year.

  2. Now suppose that Dave gets a raise to $75,000 a year (post-tax). His overall salary went up by $10,000, or about 15%. What happens if Dave doesn’t change his lifestyle at all? He’ll now be savings $15,000 a year; 3x as much as before. Dave’s runway accumulation rate is now 3 months per year (or 0.25 years of expenses/year), it’ll only take Dave 4 years to earn a year’s worth of security.

  3. But what if Dave did in fact adjust his lifestyle, such that he now spends $70,000 a year? With a modest spending increase of 17%, he’s still saving $5,000 a year as in the beginning, but his runway accumulation rate is now only 0.07 years of expenses/year.

  4. If we go back to the beginning, and Dave is earning $65,000 a year post-tax, but he finds a way to cut $10,000 of spending per year, then Dave is able to save $15,000 per year, as in point 2 — but Dave is now earning runway at a year of 0.3 years of expenses/year.

Even modest percentage increases in income or expenses can have massive impacts on the percentage change in your runway accumulation rate.

Nonlinearity 2: Diminishing Marginal Returns

One of the most important concepts in economics is diminishing marginal utility, the idea that the first thing (a car, a meal, a backpack, whatever) might you make quite happy, but the tenth likely less so. It’s intuitive, then, that a study that tried to answer “does money buy happiness” found that emotional well-being tended to saturate at income levels of around $75,000, and a logarithmic relationship between income level and life satisfaction (the nuances of what emotional well-being is versus life satisfaction can be found here - also, it’s tough to conduct research on money and happiness, not just because studies are difficult to replicate, but also due to how easy it is for popular media to misinterpret results). Increases in spending may not actally much you that much happier; certainly a 15% increase in income is unlikely to make you 15% happier [1]. I’m curious as to whether the relationship is cleaner when you look at people’s household spending versus emotional well-being and life satisfaction (though that data is likely hard to come by).

[1] This probably doesn’t hold true for the lower ends of the income scale, where more money is legitimately the cure to most problems.

Backdoors and the 401(k)

In a previous post, I wrote about the basics of both Traditional and Roth IRAs. At the time, that was all I cared about knowing, since I hadn’t yet started my full-time job (and so there was thus no reason to worry about what a 401(k) was, or about Roth IRA income limits). Seeing as I now understand a bit more about retirement accounts, I’ll give my best effort at trying to clarify some of the things that I’ve learned so far.

what’s a 401(k)?

Assuming that you’ve read my previous post, it’s a tax-advantaged account very similar to an IRA. Like the IRA, the 401(k) comes in Roth and traditional flavors that function similarly - the Roth 401(k) contributions are made with post-income-tax money, while traditional 401(k) contributions are made with pre-income-tax money (that is then taxed at withdrawal). Growth within the account, however, is tax-free, so you won’t pay capital gains taxes on assets within your 401(k). Like IRAs, there’s an annual contribution limit, though the amount is different: $19,500 for 2021 (though I’ll explain below how the “mega-backdoor Roth” can make this much higher). Unlike IRAs, 401(k) plans, Roth and Traditional, have no income limit.

The key difference is that it’s offered through your employer, as opposed to an IRA where you’re totally in control. This means that contributing to your 401(k) is done via a deduction on your paycheck, as opposed to you depositing money from one account into another [1]. It also means that the different securities you can invest in may be limited. Finally, there’s the possibility of employer matches coming into play - basically free money from your employer when you contribute to a 401(k). The exact specifics of the 401(k) vary from plan to plan, which means that they vary from employer to employer. My employer’s plan, for example, offers both a Roth and Traditional 401(k) option, has no matching, allows me to contribute up to 75% of my paycheck into my 401(k), and only allows me to invest in a handful of funds from Vanguard (at least there are good, low-fee options available).

the Backdoor Roth

The backdoor Roth refers to a two-step process by which you can contribute money to a Roth IRA, even if you’re over the income limit - first by contributing to a traditional IRA, then by converting your traditional IRA balance to a Roth IRA. There are a few considerations, though this article is a helpful resource for the process. Each year you use the backdoor Roth, you’ll have to fill out Form 8606.

the Mega-backdoor Roth

The mega-backdoor Roth is a process by which you can drastically increase how much you contribute to a Roth 401(k) - up to $58,000 (in 2021). Despite the similar name, it’s actually a completely separate process from the “normal” backdoor. Because 401(k) plans vary from company to company, it’s impossible for me to give specifics on the exact process, and in fact it requires that your company offer a third kind of 401(k) called an after-tax 401(k) account (that’s separate from the Roth 401(k), which is also an after-tax 401(k) account) - I’ll call this the “non-Roth after-tax 401(k)”. At a high level, the general process is:

  1. Contribute to your non-Roth after-tax 401(k).

  2. Convert your non-Roth after-tax 401(k) into a Roth 401(k).

This article is quite helpful for learning more.

[1] Suppose that I have $1,000 that I’d like to invest for retirement. While I can deposit this money into an IRA, I can’t do this with a 401(k). I must have that amount deducted from my salary. I graduated college in May and started my job in August, which meant that I had only 5 months during which I could allocate a portion of salary to my 401(k). Depending on my salary and on the maximum amount that my employer would let me contribute, I might not have been able to hit the 401(k) annual contribution limit.

I am not providing or intending to provide tax, legal, or accounting advice. This blog post is for informational purposes only, so please don’t rely on it for tax, legal or accounting advice. Consult your own tax, legal and accounting advisors before engaging in any transaction. I’m just a guy on the internet. Please don’t sue me.

I’m Trapped in a Subpar Index Fund (Possibly, for 365 Days)

For most of the people reading this, the S&P 500 is basically the stock market. At least in the United States, it’s the benchmark against which fund performance is judged.

And then I read this article by Schwab that lays out the discrepancy between what people thought they were getting and were actually getting with their index fund ETFs. I’ll let you read the article on your own (but seriously, read the article). There’s this great table in there with some familiar faces:

stocks being added.png

The smallest components of the S&P 500 index, by the way, have market caps in the one-billions of dollars. Even if the Schwab 1000 inclusion should logically come before a “Top 500” index inclusion, these all outrank players in the S&P 500.

I knew that I didn’t want the S&P 500; I wanted the Top 500 and assumed that the two were equivalent. But any subjectivity in the process edges toward stock-picking, which is (with the sole exception of Warren and his breakfast meals from McDonald’s) suboptimal. Schwab lays out this difference in the table below:

To be clear, there is inherently more risk in a Top 1000 index versus a Top 500 index. If I had more time and interest, I’d probably look at the difference in performance between the S&P 500 and a Top 500 fund, but I’m lazy and the I trust the table.

Which brings me to my dilemma: how do I switch over, in a tax-efficient manner? Capital gains (the profit on your investments) are taxed at two different rates, depending on how long you’ve held the investment (the cutoff is one year). Is the right strategy to immediately ditch all of my holdings in the S&P and switch everything over to the Schwab 1000? Is it to move over stuff as it gets classified as long-term? Is it to just never sell and delay paying taxes as long as I possibly can? I don’t think the first strategy is right – the difference in return over the course of 365 days is highly unlikely to outweigh the extra taxes I’d pay for impatience. I ended up going with the second strategy, since I know that even a couple tenths of a percent over the long run can result in an appreciable difference after a couple of decades. Here’s how that manifests using the 25 year numbers with an initial investment of $250K:

point 2 percent.png

Perhaps someone more knowledgeable in the dark arts of tax accounting could guide me.

I am not providing or intending to provide tax, legal, or accounting advice. This blog post is for informational purposes only, so please don’t rely on it for tax, legal or accounting advice. Consult your own tax, legal and accounting advisors before engaging in any transaction. I’m just a guy on the internet. Please don’t sue me.

Almost a Tesla-naire

In case you’ve been living under a rock since March, here’s what’s happened to Tesla stock over the course of 2020.

The stock is up an insane amount. If you’re wondering how Tesla shares started the year at $100 a share, this is all after the 5-for-1 split that occurred around August. Tesla stock is now worth hundreds of billions of dollars – the market cap is now roughly worth Ford + Honda + BMW + GM + Daimler + Volkswagen + Toyota, combined (to be fair, it’s unlikely that the same statement could be said about enterprise value, which is a much more representative measure of a company’s worth). The P/E ratio is stratospheric. Elon himself said that he thought that the stock price was too high… back when the shares were worth a fifth of the present value.

This post isn’t about the current valuation of Tesla, though. Whether it’s too high or too low or just right isn’t an argument I could confidently have a strong opinion on. What’s interesting is seeing articles like these on Bloomberg: “Elon Musk Has Made Millionaires Out of His Most Loyal Fans”. It’s strange to hear these kinds of stories – people going full-send into a company that was up until earlier this year viewed as innovative as it was volatile; risky as it was exciting; dangerous as it was futuristic. I’ve heard stories of friends of friends that YOLO’ed their cash into single stocks that happened to pop: QuantumScape was the most memorable (due to my interests), though I also heard of people that owned Moderna among others. Bitcoin and cryptocurrency is somewhat similar: there are the stories of kids who HODL’ed Bitcoing or Ethereum or some random esoteric coin that happened to explode in value.

I’ve been privileged to a point where I’ve been investing since I was 12. Throughout that time my strategies have transformed from “I didn’t know what the fuck I was doing, I was 12” to “let me try picking stocks because I clearly know more as a high schooler and Reddit lurker than people that spend 60-plus hours a week doing research” to “okay I guess index investing is the way to go”.

I was “nearly” a Tesla-naire. I went full YOLO into Tesla Motors Inc., and at some point I had 85% of my entire net worth being in this small little California car company that I heard of through a web comic that used the phrase “Ferrari that got porked by a luck dragon”. Eventually I realized that I was being incredibly brash – the level of volatility I had voluntarily introduced into my portfolio was insane. Even before Elon talked to the Saudis to take the company private at $420 a share (a personal favorite episode of mine), I recognized that the distribution of outcomes had a very real possibility of backruptcy.

And so, I decided to sell out. Every last share I had ever owned got sold, with the final trade happening after the Cybertruck unveiling. I was fine with a botched demo, though I was less okay with the “unique” and “avant-garde” design. And here I am, just 13 months later, not driving a Model 3 Performance or with 7 figures inside of a Schwab account.

Maybe all of this is post-fact rationalization, but I’m okay with the choices I made. Not being a millionaire at the age of 23 is surprisingly acceptable, and I still assert that, 13 months ago looking at all possible worlds, the decision I made to end the gambling period and move to the relative safety and boredom of index funds was a good one. For every video on YouTube of a day trader making thousands in a day, there’s another one that didn’t get posted with a similar magnitude loss. For every kid that earned $100,000 by “investing” in Bitcoin or WSBHypeStock, Inc. there’s another one that lost their life savings. Survivability bias is real; why would you hear about the story of your friend’s friend that bet their life savings on Nikola Motors? Who wants to admit that they lost $10,000 on Dogecoin?

There’s this amazing book called Fooled by Randomness by Nassim Taleb, with the basic idea that people confuse their own luck for skill. Am I unlucky? Do I lack investing skill? Whatever the answer, I think I’ll stick with index funds.

P.S. I debated for a bit whether to put this in the finance section or the main blog section of my website, since I feel like the themes are relevant to either section.

Affective Forecasting and Dream Cars

I’ve had two friends of mine tell me that they want to buy a car after they graduate. Here’s a couple of scenarios - more real than you’d expect.

Marie is about to graduate with a degree in electrical engineering. She’s done well with recruiting and will start her tech as a software engineer soon at BookFace, Inc. in Menlo Park, CA. Her base salary is $110k per year, she’s been given an excellent benefits package, and she’ll even get a $70k signing bonus (this was not made up). She wants to pay her parents back for tuition over the college years, and could probably purchase the family’s Ford Fusion plug-in hybrid (at least a 2013) for about $10k. However, she’s a true Musk enthusiast, and has been eyeing a new Model Y. She likes black wheels, and although she doesn’t feel like she needs the performance model, she really likes the red brake calipers. Of course, the car must have the white interior (MSRP $60,990). She feels like she’ll get the car eventually, why not do it now?

Tom has been working as a security guard throughout school, and is also about to graduate. His options are open - perhaps he’ll continue working a fairly lucrative gig guarding a library; perhaps he’ll join the military. In any event, he’s managed to save up $25k in cash. He’s currently driving a 2012 Toyota Tacoma, but wishes it had 4WD. He’s heard great things about the 4Runner - it looks great, is highly capable, and is bulletproof reliable. He’s eyeing the TRD Pro model (MSRP $50,470).

Let me be clear: I’m a car guy. I like cars for a lot of reasons, especially the fact that we as humans are able to build en masse (about 100 million a year!) these major machines that weigh thousands of pounds and can safely transport multiple people and their stuff basically hundreds or thousands of miles across the country on a whim. I like fast, sleek sports cars and convertibles; I like rugged boxy SUVs; I like efficient and futuristic EVs. My desktop background is a slideshow of various cars that I find cool or interesting in some way shape or form. If I find a magic wand and can suddenly have any car I want in the world for free, you’ll see me cruising around in a Porsche Taycan Turbo S.

Nevertheless, I find it hard to justify the notion of buying a new car, and in this post, I’ll talk about the (many) reasons why that is.

my current car is more than fine

I currently drive a 2012 Ford Focus that my dad used to have. It’s got just over 127,000 miles, but Ford’s terrible tranmission aside, I really don’t see any reason why it couldn’t surpass the 200,000 mark (which seems to be the new standard for longevity). I’ve developed a weird kind of emotional bond with it that makes me want to see it go the distance, though my car is also nicer than your standard Focus. My dad had the foresight of giving me a car that could parallel park itself (something that never ceases to amaze others in the passenger seat), and I don’t really care much about Tesla’s 15” touchscreen as long as Bluetooth does its job. In a world without new cars, I’d honestly be content with my existing car; the desire to upgrade to something new is merely a function of other, newer products coming onto the market.

people suck at “affective forecasting”

I’m currently in a fantastic positive psychology class [1], and one of the most important takeaways I’ve gotten out of it so far is that people aren’t good at forecasting the emotional effects of future events (affective forecasting), in fact there’s a general bias toward overestimating the emotional impact that an event will have (the impact bias, I’d highly recommend skimming the Wikipedia article and reading this post by James Clear).

Back to cars and personal finance: a new car (let’s say a Tesla Model 3) probably wouldn’t make me as happy as I think it might. Sure, it’s fun to rocket from 0-60 in 3.2 seconds, or to use Autopilot for a long road trip, but as far as the way I actually use my car - weekly grocery trips to HEB and the various trips across town to grab food or spend time with friends - a Model 3 won’t do the job that much better or faster.

cars are really expensive

The average price of a new car sold in the United States was just under $39,000 in December of 2019. That’s absolutely insane when you consider the case of a median household income of something around $62,000 (after accounting for payroll and federal income taxes, you’re looking at 9.6 months of “disposable” income).

For me at least, it’s hard to justify spending $50,000 or so on a new Model 3 when I know what else I could do with that. My current, in-college annual cash burn is about $20k or so, plus another $12k for rent. So a $50,000 car represents over a year and a half of every single last expense for my life. If you gave me $50,000 in cash, I certainly wouldn’t buy a Tesla - I’d probably spend a month somewhere in Colorado and spend a few weeks hiking and biking with friends (and then pocket the rest of the $46k). I bet that that’d be far more memorable and happiness-inducing than having my car make farting noises everytime I tried to make a left turn.

nice cars have headaches of their own

My dad got a nice car back in 2015. Since then, he’s developed a habit of parking away from other people in parking lots, since he’s afraid of dinging the car doors. He spent a few hundreds of bucks on getting a clear bra in case anything chips the front. He’s obsessive with cleaning it, to the point that he pays $20 or so for an unlimited car wash pass. Tires are expensive, maintenance is expensive, insurance is… expensive.

I tried parallel parking my Focus one time and accidentally scraped a traffic pole. No biggie. I don’t car much about rock chips or car washing, I just vacuum the interior every now and then. I can park at the front of the HEB parking lot if I find a space - if someone hits my car when opening the door, it’s whatever. Cars are tools. Use them.

new cars have the steepest depreciation

I’m not sure why, but people that I’ve talked to have a really strong aversion to buying things used. I’ve bought my laptop and phone and watch used; they work fine. I got my car used (from my dad), and it hasn’t yet exploded in the garage or left me stranded on the side of the road. I’m not really sure why there’s such a strong pull toward a new car, to be honest.

Car depreciation (the loss in your car’s value with time and mileage) is super steep, especially at the beginning. NerdWallet’s article sums it up best:

“Your car’s value decreases around 20% to 30% by the end of the first year. From years two to six, depreciation ranges from 15% to 18% per year, according to recent data from Black Book, which tracks used-car pricing. As a rule of thumb, in five years, cars lose 60% or more of their initial value.”

What’s the value in buying a new car over a used car? Taking the example in the chart above and doubling it for my $50,000 Tesla, is it worth $24,478 to get a 3-year newer car with no miles on it? If I were to crash my car tomorrow, the jump from a Ford Focus to just about any Tesla will be larger than the jump from a MY2018 Model 3 to a MY2021 one [2].

What I’ll do when it’s time to buy a car

There’s a bunch of different ideas on how much one should spend on a used car. I’ve heard various rules of thumb tossed around like the 20/4/10 rule, but I’m not yet fully sold on that yet (at the very least, it’s probably much better than what your average car buyer is doing). It’s very likely I’ll end up buying a 3-year used Model 3 when I do eventually decide to give up the Focus - but it’ll hopefully be quite a while before that happens.

[1] There’s an absolutely marvelous talk by Dan Gilbert on some of our decisions biases that I’d highly encourage everyone to watch.

[2] This is pretty imperfect, since Teslas in particular hold their value somewhat better than other cars, and the fact that a MY2018 Model 3 would be super early as far as production goes, which makes reliability much more suspect.

Gross Salary vs. Take-Home Income

My friends are unfortunately being forced to recruit at what’s probably the worst time in a decade, and it’s honestly awful. Career fairs are being replaced with awful abominations of Zoom calls and Q&A sessions; the recruiting pipeline is drying up, and even the biggest firms on the market are hesitant to recruit.

Don’t feel too bad for them - most of them are still CS majors, and I’m sure that they’re doing better than 90% of the country right now. A few of my friends have started to get their offers in, and some of the numbers are pretty staggering. The lowest base salary that I’ve heard so far is over $100k, which, needless to say, is a lot of money for a 22 year old to make right out of a state school (Hook ‘em Horns!).

The catch is that while the gross salary number sounds really attractive, the reality is that their paychecks won’t be remotely as extravagant as their imaginations might desire. Here’s what happens to a “standard” $120,000 salary in San Francisco:

After taxes, you’re taking just under $3,000 home every two weeks.

That seems pretty crazy to me, honestly. Over 35% of the salary is lost to taxes, which brings each of the 26 paychecks to $2,964.19. On top of that, this person hasn’t actually saved any money yet. Let’s pretend that this person is really on board with saving money for an earlier retirement/more freedom later in life, and puts away the full $6,000 a year toward a Roth IRA, and the full $19,500 a year toward a Roth 401(k). Alternatively, perhaps our worker is trying to pay off their student loans quickly - in any case, $25,500 is gone each year, post-taxes.

After saving $25,500 a year in a Roth 401(k) and a Roth IRA, your paycheck drops under $2,000.

We’re now at $1,983.42 each paycheck, or a hair over $4,000 a month. Median rent in SF was well beyond $2,500 pre-COVID for a one-bedroom apartment, and we still haven’t covered the basics of transportation, groceries, etc. Donating to charity seems tough with these case prices and savings rates.

Going remote: life in austin

I decided to run similar numbers to show how things change in Austin (seeing as it’s a favorite destination for people leaving the Golden State, and the fact that it’s home to UT). In short - no state income tax, no local income tax, and no state insurance taxes puts almost $1,000 back in your pocket each month:

Just over $2,400 in each paycheck now.

Austin median rent for a one-bedroom apartment is about $1,280, which is a downright bargain by comparison. That creates a ton of headroom for tacos, entertainment, transportation, and the rest.

explore more

I used this calculator to run through all of the numbers - it’s certainly worth playing around with.

gross salary, take-home, and discretionary income

The major point of all of this is to show just how different three numbers can be: (1) your gross salary, which is (loosely) what your offer letter says you make, (2) your paycheck after taxes are deducted, which is what I refer to as take-home pay (and others call disposable income), and (3) discretionary income, the amount of money available for you to actually use after covering things like food and rent. Where you live has a huge effect on how much of your gross salary you get to actually enjoy.

I am not providing or intending to provide tax, legal, or accounting advice. This blog post is for informational purposes only, so please don’t rely on it for tax, legal or accounting advice. Consult your own tax, legal and accounting advisors before engaging in any transaction. I’m just a guy on the internet. Please don’t sue me.

IRAs

I’m not here to talk about the Irish Republican Army - instead, I’m going to talk about something even more revolutionary: TAX LIABILITY ON RETIREMENT INVESTING. It’s a very exciting topic, one that I’ve spent far too long trying to read about, despite the fact that the basics could probably be covered in a few minutes.

the status quo

To understand why any of this is important, it’s worth understanding the tax landscape for investing, without using any of the “tax-advantaged accounts” available. The default scenario is that you get taxed twice: first, when you earn income (income tax), and second, when the money you’ve invested grows (capital gains tax). This ends up being pretty expensive, as we can see in the (imperfect) model I’ve built below (click on the image to expand it fullscreen):

Years 26-55 aren’t shown, but they’re still there in the model. “Allocation” refers to how much of your paycheck you allocate to saving (before paying income taxes). The “Contribution” column is how much you actually end up investing.

The big takeaway: you paid $97,714.29 in upfront income taxes and $131,976.26 in capital gains taxes, for a total of $229,690.55 in taxes paid (yes, there’s time value of money, but we’re going to table that for now). After all is said and done, you now have under just under a million dollars.

with a roth ira

A Roth IRA is a tax-advantaged account that doesn’t require you to pay capital gains taxes. Money you contribute is still post-income-taxes, but other than a few rules around using the account, that’s the basic idea to understand.

Those rules aren’t unimportant - there are limits on how much you can contribute in any given year; there are income limits that determine if you can even use a Roth IRA in the first place; there are rules around when you can withdraw money from the account. These can shift over time, so it’s worth checking on your own what they are, either by going directly to the IRS website or to some other reasonably reliable source (perhaps your bank or Reddit’s r/personalfinance). The current rules are (if we leave out the details) that you can’t contribute more than $6,000 a year [1] (if you’re under 50), you shouldn’t touch the money until you’re 59-and-a-half, and if you’re earning more than around $120k, you’re going to need a “backdoor Roth” IRA instead (I found this link helpful).

Let’s see how the above model works with a Roth IRA:

Again, years 26-55 aren’t shown, but they’re still there in the model.

This is basically the same as last time, except since you don’t pay capital gains taxes, you end up paying $131,000-and-change less in taxes and pocketing it all. Your account is now past $1.1 million, just by setting up a different account.

with a traditional ira

A Traditional IRA is a tax-deferred account that, like the Roth IRA, doesn’t require you to pay capital gains. However, money you contribute is pre-income-tax, at the cost of having to treat withdrawals from the account (even once you’re retired) as income, when you’ll then pay income taxes on. Here’s how that shapes out:

Since we don’t pay taxes upfront on income when we contribute, we end up having to allocate less of our paychecks to the account, which saves us $97,714.29 in income taxes over the course of the model. Again, we don’t pay capital gains taxes - but w…

Since we don’t pay taxes upfront on income when we contribute, we end up having to allocate less of our paychecks to the account, which saves us $97,714.29 in income taxes over the course of the model. Again, we don’t pay capital gains taxes - but when we do withdraw money, it’s treated as ordinary income, which means we’re paying much more in taxes overall (assuming the same 30% tax rate).

It looks like the traditional IRA is doing worse than the default, don’t-do-anything-special model we originally built. That’s not totally a fair comparison - since we’re allocating less of our paychecks to investing, we can take the extra cash that we would have allocated and invest that. Adding the extra in, here’s what we’re left with:

We can invest the extra $2,571.43 that we would have otherwise paid in income taxes each year and grow that in an ordinary brokerage account. Some of that money still goes to income taxes, but in the end we’re left with $292,759.65 after paying capi…

We can invest the extra $2,571.43 that we would have otherwise paid in income taxes each year and grow that in an ordinary brokerage account. Some of that money still goes to income taxes, but in the end we’re left with $292,759.65 after paying capital gains taxes on the “additional” money. Then, we add the post-tax money from the traditional IRA to net a bit under $1.1 million - not quite as much as the Roth IRA, but still better than doing nothing at all.

Now, the playing field looks much more even between a traditional IRA and a Roth IRA. When you’re allocating $6,000 or less per year, you actually end up with the same results no matter which IRA you choose. The only reason the Roth performs better in the examples I’ve listed is because the annual salary allocation is higher than the contribution limit to the Traditional IRA, which in turn forces the use of a non-tax-advantaged investment account for the remainder of the money.

Let’s recap everything here:

Summary Table.jpg

so, which one do you use?

That’s a question that largely depends on tax rates, and what you think will happen in the future. No one’s perfect at forecasting, however. The idea is that if you think your marginal tax rate now is higher than the marginal tax rate you’ll have in retirement, you should use the traditional IRA. If you think that your current marginal tax rate is lower than what you expect your future marginal tax rate to be, you should probably go with the Roth.

Income limits play an important role in the effectiveness of an IRA. Traditional IRA plans have income limits for being able to contribute pre-tax dollars (if you have a retirement plan at work, more details are available at this link). Contributing to a traditional IRA can also reduce the future effectiveness of the backdoor Roth IRA due to the pro-rata rule - again, see this link for an explanation of why.

model assumptions

When I built my Excel model, I assumed that you’d be perennially in a 30% marginal tax rate for your entire life - which is highly unlikely to happen. Your income will change, and so will the political situation on taxes. I’m also assuming constant growth of 7% on invested money, and a 15% tax rate on capital gains. None of this is supposed to really mimic the real world perfectly, but rather to give a general idea of the power that an IRA can have.

tax rates

I found some great videos that explain marginal tax rates from Vox and YNAB. This article from The Balance does a great job of explaining the capital gains tax.

[1] The contribution also needs to be earned income. If you earned $4,500 in a year, then you’d only be able to contribute up to $4,500.

I am not providing or intending to provide tax, legal, or accounting advice. This blog post is for informational purposes only, so please don’t rely on it for tax, legal or accounting advice. Consult your own tax, legal and accounting advisors before engaging in any transaction. I’m just a guy on the internet. Please don’t sue me.

Starting Off: Building Credit with Credit Cards

The first post I ever wrote under the personal finance umbrella was on the basics of credit cards - not because it was the most important part, or because it was the first thing to do in personal finance, but because it was the “sexiest” topic that was the easiest to talk about. The flowchart helps get the big picture [1]; balancing a budget to track inflows and outflows is probably the most important… but no one really gets excited about either of those things. On top of that, it’s more fun to write about credit cards than it is to write about other topics, mainly because the basics of money in = money out don’t change. Even if there’s other stuff going on in the world beyond coronavirus and the 2020 election, most people would rather write about something exciting. I carry the same biases.

Anyways, a friend asked me the other day about how you’d get started with credit cards, a topic I purposely strayed away from last time due to length. Doing the topic justice would have distracted from the flow of everything (and required more effort than I was ready to give at the time). Let’s dive in.

why would you want to build your credit score?

So I’m really, really into cars. I’m a huge fan of Tesla, and one day I’d like to get my own Model S or Model 3. So like any other Friday, I took a look around Carvana and found this sweet ride:

models carvana.jpg

$50,000 is a not-insignificant amount of money, however, so at the present, I’d need to finance the car if I wanted it (to be clear, I don’t endorse 22-year-olds buying $50k cars, nor do I endorse financing a car either). Here are screenshots of how much I’d have to pay each month, with the same amount of money down ($34,100) on a 36 month loan, for four different credit scores: 580, 630, 680, and 780:

Here are the highlights: the difference in APRs is nearly 8% - translation, I’d be paying a lot more interest: the difference between the highest and lowest credit score payments is $828 per year, or $2484 over the course of the loan. When it comes time to buy a house, which I’ll almost certainly need to take out a loan for, the money on the line is going to be a lot more. I went on Redfin on found a ~$400,000 home for sale in Austin, TX, and looked up mortgage payment for 5 different credit score ranges, from 660-679 to above 740:

This time the difference is smaller between scores: only about 80 points or so. But that difference translates to a 0.75% APR difference, which works out to $1,632/year (an entire payment and then some), which in turn is $48,960 over the course of the 30 year loan (I could buy a Tesla for that!).

Building your credit score now helps you get more favorable interest rates in the future. It also helps get you access to better (read: more rewarding) credit cards, and credit scores also play into housing applications.

I should be clear: credit scores aren’t the only thing that matters in the big picture of personal finance - but it is a factor, and a good one is nice to have.

credit isn’t pay to play

A misconception that I’ve heard a few times is this idea that you need to take out loans and pay interest to build credit. In no way should you need to pay money to build credit. You don’t need to take out student loans for the sole purpose of building credit - if you need a loan, take out the loan, but don’t include “building credit” in the pros list. As I mentioned in my first post, you also don’t need to carry a balance to build credit - carrying a balance isn’t responsible use of a credit card. This post on r/personalfinance is gold.

you shouldn’t get a credit card if…

If you don’t know about credit cards and how they work, you should start off by figuring that out. While I’m more than happy to plug my own stuff (I think it’s great, if I say so myself), r/personalfinance is a gold mine, and this wiki is particularly helpful.

The caveats are simple: don’t get a credit card if you don’t have money to pay for your expenses (and you should probably try and figure that one out, fast), and don’t get a credit card if you know you can’t handle it. In other words, unless your parents are financially carrying you through college, if you don’t have an income, if you don’t have a budget, if you have poor spending habits… don’t get a credit card. You should also have some form of emergency fund before you start off.

The only way to properly use a credit card is to pay it off, in full, each month.

getting started

Okay, you’re in a solid-enough financial place to get a credit card. Congratulations! How you get started if actually pretty straightforward: find a card, apply for it, get approved, and use it responsibly. The “get approved” step is the hard part, so I’ll first discuss how to tackle that.

authorized users and the piggybacking pathway

If you’re lucky and have parents that have their financial houes in order, then you should consider becoming an authorized user (AU) on their credit card. Basically, it’s still their credit account, but you’ll get your own card. To use an analogy that’s perhaps a bit too millennial/Gen Z, you’re all sharing the same Netflix account, but everyone has their own profile. If you make a purchase, they’re still on the hook for it, not you - but how you and your parents work out paying for things and splitting rewards is for you to figure out.

The advantage of becoming an AU is that (1) you’ll be able to use whatever credit cards your parents have, which perhaps you wouldn’t be able to get on your own just yet, and (2) as long as your parents use their credit cards responsibly, their good history and on-time payments will make their way into your good history and on-time payments [2].

The downside to this route, however, is that you’re tied to your parents’ habits. If they miss a payment, it’ll look like you missed a payment also. Only go down this route if you know that your parents are financially responsible. Some people might have reservations about being more dependent on their parents - while this isn’t something I can personally relate to, don’t do anything that makes you feel uncomfortable. Finally, there may be a fee associated with adding an AU (at least on the higher end cards) - whether your rewards make up for that is something you’ll need to calculate.

This option only gives a minor benefit, but it’s worth taking to help get started.

the diy route

Regardless of whether you go down the AU path or not, it’s worth exploring options on your own. The general beachheads are: (1) the bank that you already use, (2) starter/secured cards, and if you’re a student, (3) student cards.

the bank you already use

My first credit card was a fairly basic one from Charles Schwab, where I banked at the time. Even though I had no credit beforehand, Schwab approved me basically on-the-spot (the rewards were also automatically direct-desposited into my account, which was pretty nice). In general, you might have some luck with the bank that you already use. Just make sure that you aren’t paying any fees for it, and see what luck you get.

student credit cards

Student credit cards are available to (you guessed it) students, and while they won’t be top-tier in terms of rewards, they’re a good starting point. I’d look into what Discover offers, and Citi’s student card is a bit of a wildcard with their rewards that could be quite beneficial if you have a bunch of small purchases (it rounds up each purchase to the next 10 points).

secured credit cards

I have no personal experience with secured credit cards, but from my understanding the basic idea behind a secured credit card is that you put down some amount of money, which then becomes your credit limit. Secured cards, generally speaking, aren’t too great since they don’t have great rewards and some have fees associated with them (which is stupid, given that you’re literally putting down your own money). Reddit tends to recommend the Discover It Secured, which actually seems pretty decent - but I’d say that the category in general is a last resort.

additional resources

The r/personalfinance Credit Building wiki is fantastic.

Appendix: How Credit Scores are Calculated

If you’re interested, there are 5 factors that play into your credit score. Technically speaking, there’s no one credit score out there - virtually every single lender has their own version of a scoring system that weights certain components differently, but the components are usually the same, and some are routinely more heavily weighted.

  1. On-Time Payments: This is pretty straightfoward: what percentage of your payments are on time? Just one late payment can harm this, so your goal should be sure to keep this at 100%. This usually the most important factor in your score.

  2. Credit Utilization: What percent of your credit limit are you using? This is calculated in the aggregate (i.e. the total amount of credit you’re using across all cards, divided by the total amount of credit you have access to, across all cards). Lower is better - you don’t get any benefits from keeping a high balance on your cards. This is also an incredibly important factor in your score.

  3. Average Age of Accounts: How long have your credit lines been open, on average? The longer your accounts are open, the more data available for a lender to have on your payment patterns, and so lenders feel more comfortable giving you credit. Nothing can improve this but time. This is usually of moderate importance.

  4. Total Accounts: How many accounts do you have? This includes both credit cards and loans, and creditors usually like to see both loans and credit cards. This is usually of moderate importance.

  5. Number of recent credit inquiries (“hard pulls”): Every time you apply for a credit card, the creditor will usually perform a “hard pull” to get your credit report. Each one impacts your score slightly in a downward direction, so don’t apply for new credit just before you need to take out a loan.

If you want to read more, here’s a solid post on the r/personalfinance wiki.

APPENDIX: MONITORING YOUR CREDIT

If you want to monitor your credit score, then I’d recommend finding something that does it for free - there’s no need for pay for anything. Many credit cards offer free credit score checks, and there are other services out there that’ll let you do it. Personally, I use Mint.

[1] I didn’t make this - it was stickied on the r/personalfinance sidebar years ago, but it’s basically my go-to when it comes to covering everything in one image.

[2] The exact process varies from card to card - from what I can tell, some cards will transfer over the entire history, while others will just enable you to build credit from the time you get the card forward. One of my friends has a card that says “Member Since ‘94” on it, despite the fact that he’s not 26 years old.

The Chase Sapphire Reserve is Metallic Arbitrage

My Uber credit card finally transferred over to the new (inferior) rewards system, so I haven’t touched it at all lately (I wrote more about that stuff here). As a result, I was charging basically everything except groceries to my Citi Double Cash card. While the marginal extra rewards I would have earned weren’t worth all that much, I did apply for the Wells Fargo Propel card [1]; after a week of waiting, a call to Wells Fargo, discovering that my application was in a weird limbo state, and another day of waiting, I was finally denied, on the grounds that I had opened up too many accounts in the past year.

Seeing as that situation wouldn’t change for the next 5 months or so, I decided to look around for something that perhaps might make money moves. I had recently been added as an authorized user on my parent’s Schwab Amex Platinum [2], so I started looking into the Amex Gold card to see if that’d make sense for me. As it turns out, the answer to that was a resounding no for me - I don’t spend nearly enough on eating out or Doordash to negate the $250 annual fee [3]. No to Amex it was.

And so I discovered the Chase Sapphire Reserve, which I assert is the biggest arb in the credit card world, under a few circumstances. It recently got revamped with a more favorable (for college students, at least) rewards structure:

  • $550 annual fee

  • $300 annual airline credit, which will work for plane tickets [4]

  • 3 points per dollar on “travel and dining”, which apparently is quite generously interpreted

  • 1 point per dollar on everything else

  • 1 point = 1.5 cents when redeemed on flights through Chase’s portal. I don’t like the idea of booking indirectly, but if it’s the same price then who cares?

  • Some random perks like free Global Entry and a network of airport lounges

  • DoorDash: $60 in credit per year until 2021, plus DashPass for a year

  • Lyft: Lyft Pink for a year (15% off on rides). 10x points until March 2022.

It’s that last line that really moves the needle. Saving 15%, and then earning 15% back on top of that is basically ~28% off on Lyft. My thoughts are that if you can use the full $300 of airline credit, you’re functionally bringing down the annual fee to $250, and so if you happen to spend more than about a $1000 a year on rideshares, the credit card starts to look incredibly attractive. Most people don’t spend that much getting around town - but if you start calling rides for your friend group going downtown, the math changes very quickly in your favor. Given my current baseline, the additional cash from eating out and Lyft rides should more than make up for things.

Now, I’m biased, since I’ll be spending the summer at a consulting firm, which means I’ll be eating and riding around more than most. I also think the fact that Lyft and Doordash perks expire after a year or two is a bit strange, but (1) I don’t care about Doordash, (2) March 2022 is a hair over two years away, and (3) I’ll probably still get value out of the card after the ludicrous 15% back category reverts to 4.5%.

In short, if you’re going into consulting, you should almost certainly be looking at this card. If you’ll end up flying around and eating out a ton, you should take a glance. If you use Lyft frequently, this thing is pure arb.

[1] Highlights: 3% on eating out, gas, rideshares, flights, hotels, car rentals. No annual fee, and the card is metallic, which is cool. Link is here if you’re interested.

[2] The Schwab version of the Amex Platinum is basically the normal version, but with the ability to cash out points at 1.25 cents/point (in addition to the normal options), and an annual bonus depending on the value of your assets with Schwab. If you have a Schwab account, it’s an objective upgrade over the normal version. In any scenario, it’s not worth it from a strict cash perspective unless you spend literally thousands of dollars a year on flights - but since you can transfer points from one Amex card to another, it can increase the value of other cards (which is why I considered the Amex Gold in the first place). Link is here.

[3] If you already use Doordash, or eat out at Shake Shack / The Cheesecake Factory every month, the Amex Gold card becomes far more valuable with the monthly credits. I, however, was concerned about whether I’d just start eating out more.

[4] This is an important distinction, since while Chase’s airline credit is good for fees and tickets, Amex’s credit is only good for fees. As a result, the Amex credit is basically worthless to me, since I prefer to fly Southwest.

How to Track Your Spending

I’ve already written about the relatively-sexy, “free-money” topics of credit cards and HYSAs, and as much as I’d like to continue talking about quick-wins and the interesting things, at some point someone has to talk about the boring, unsexy core of personal finance: understanding your habits so that you can set goals. While it’s usually pretty easy to understand your habits on the income side of things (perhaps you’re getting paid bi-weekly for a salaried job, or maybe you’re a student without income, like me for most of the year), understanding where that money goes is usually another story. I used to have no idea where my money went - I just knew that overall, I wasn’t at risk of becoming bankrupt. As I dug into things more, however, I started to realize a couple of things:

  1. I eat out a lot more than I thought I did.

  2. I underestimated how much larger purchases made up my spending.

Figuring out these kinds of things is step -1 in the Big Financial Picture. It lays the foundation for being able to budget where your money is going to go so that you can stash cash away for retirement, that trip to New Zealand, or paying off loans. The point of tracking your spending isn’t to go materially-celibate and not pay for anything under any circumstances. It’s to figure out where your money is going, and if that aligns with what you value. I love technology and usually end up buying a laptop about every year or so - and that’s mostly fine by me. Eating out, while incredibly enjoyable with others, isn’t something that’s necessary for me to do every single day for lunch during the school year, so I could probably cut back there by starting to pack sandwiches.

In this post, I’ll talk about how I track my expenses and some of the tools that I use.

MY SPENDING SNAPSHOT (excel)

Personally, I use Excel for anything financially-related. It’s what I’m comfortable with, enables quick-and-dirty visualizations, and I can usually get Excel to do exactly what I want. Here’s a screenshot of the Excel workbook that I built to track where I’m spending my money. It covers the past four months of spending (which is when I started):

In this Excel spreadsheet, I can expand any of the categories to view by spending breakdown by merchant. As it turns out, I buy a lot of electronics from Amazon.

In this Excel spreadsheet, I can expand any of the categories to view by spending breakdown by merchant. As it turns out, I buy a lot of electronics from Amazon.

I also have a pie-chart-view of where my money is going, for a more visually-impactful take on things (click on the chart for a larger view).

At a glance, I can tell two things right away:

  1. How much money I’m spending on different categories (It looks like electronics, clothes, and eating out make up the lion’s share), and

  2. Which categories I could try cutting my spending on, if I chose to do so (I probably could avoid betting, and I spend a lot of cash on electronics and clothes).

All of this information is derived from a transactions list that includes the date, category, merchant name, and a dollar amount (along with a section for notes to myself).

getting transactions (mint)

It’s obviously a major pain to keep track of your transactions manually - either you have to fill in each one yourself as soon as you spend money, or you’ll have to somehow remember all of the important details for later. I’m a huge fan of Mint [1] for taking care of all of this for me - I just link my credit card accounts/Venmo to Mint, and Mint compiles all of my transactions together into one long list that can be easily exported as a .csv file.

Some transactions over the past few days, as they appear in Mint. There was a lot of Black Friday shopping.

Some transactions over the past few days, as they appear in Mint. There was a lot of Black Friday shopping.

I don’t change my categories for transactions in Mint, so I have no idea what the hell “Business Services” are all about.

Mint can sometimes mis-categorize some transactions (e.g. most things that show up as “fast food” aren’t), and sometimes I feel like I want more granularity. However, it’s much easier to let Mint remember all of my transactions than keeping track of them myself. You can also easily change the category for a transaction in Mint so that it’s correct moving forward.

Mint actually has its own charts and graphs that you can use, if you so choose. The interface isn’t the prettiest, but it gets the job done. If I were to start tracking my spending today, I’d probably start by trying to use only Mint, because it’s nice to have everything in one place. I personally haven’t done that since (1) I really like Excel, and (2) for situations where you pay for dinner and have someone else Venmo you back, you can’t (as far as I know) edit the amount of the transaction to reflect your share of the expense, which in turn means that (i) your summary charts will be a bit off, and (ii) when you’re looking at transactions, you’ll see paying for something and getting paid back on different lines, which can be confusing.

In any case, you should try things out for yourself to see what works best for you. A good system can’t just be easy-to-use, you have actually use it.

what’s next?

After you’ve established a solid understanding of where your money is going, you can set goals/targets/budgets for each category moving forward. I might say that I plan on spending $350 on food per month, which sounds reasonable based on the above table (I’m already spending about $400 monthly on eating out and groceries, so making sandwiches at home for lunch should be able to bridge the gap). That’ll be covered in another post (likely much, much later).

[1] Mint is owned by Intuit, which is the company that builds TurboTax. Seeing as they already have all of the information needed to file my taxes, I don’t really incur a marginal privacy risk using Mint. Mint is free because of advertising, so just expect that you’ll see a few on the platform if you start using it.

The Uber Card is Soon-to-be Irrelevant (Cancelling a Credit Card)

Don’t throw it in the trash though. It’s plastic, right? That’s recyclable.

Anyways, the Uber card, which was previously one of the better no-annual-fee credit cards, is now fairly useless due to how the rewards changed. It’s now a 5-3-1 rewards structure: 5% on Uber purchases (e.g. your standard Uber rides, but also Uber Eats and Jump bikes/scooters), 3% on hotels, airfare, and dining, and 1% on everything else. Both online purchases and dining lose 1% of rewards in order for Uber products to gain 3%. They’re also killing off the $50 subscription bonus. How the math works out depends on your personal spending profile and what other credit cards you have (for example, I don’t care about the rewards reduction in online purchases, since all my online purchases go on a different card), but I’d wager it’s going to be net negative for most people.

The real problem is that you’re not getting true cash back. You’re getting Uber cash, which could be nice if you use Uber and Uber Eats a ton, but US Dollars are accepted at far more places than Uber Cash. Uber is essentially trying to lock you into their ecosystem of services - and honestly, it’s a fairly smart business move, since most people aren’t going to cancel their credit cards over this, and many people will start to use more and more Uber services.

For what it’s worth, the transition isn’t immediate. I got an email today saying that the old rewards structure would stay in place until February. Maybe that’ll change

So, what do i do with my card?

Suppose that the card is actually functionally dead for you - you don’t plan on using it anymore. Should you cancel your card? Should you cut it up and throw it in the recycling bin? For the latter: yes, if you’re seriously committed to never using the Uber card anymore, go ahead and cut up into several pieces (and don’t forget to make sure the chip is cut into pieces also).

That said, you probably shouldn’t cancel it. There’s no annual fee to the new Uber card, so it won’t cost you anything to continue having the credit card on your credit report. Cancelling a credit card will probably harm three factors that play into your credit score:

credit utilization

Basically, the percentage of available credit that you use each month. As an example, let’s suppose that you spend $600 each month on your credit cards, and like a responsible credit user, you pay off your bills at the end of each month. If you have 2 cards, each with a $2,000 limit, you’re using 15% of your total available credit (you have $4,000 of credit available; $600 is 15% of $4,000). If you cancel one of your cards, you’d now be using 30% of your credit (you have $2,000 of credit available; $600 is 30% of $2,000). Higher credit utilization is worse.

This won’t be as important if you already have a ton of credit available. Going from 3% to 5% utilization isn’t going to affect anything; and realistically you could always just pay off your bills twice a month to avoid any harm.

Number of total accounts

If you close an account, you’ll have fewer open accounts. This means fewer data points for lenders to use, which harms your credit score. That said, this isn’t the most important factor in your credit score, so preserving this isn’t all that important.

average age of accounts

Depending on how long you’ve had the Uber card for, your average age of accounts (AAoA) may increase or decrease. I’ve only had my Uber card for 7 months, which is shorter than my AAoA. As a result, closing my account would increase my AAoA (which is actually good for credit score). However, if you’re thinking about closing an account that has been open longer than your average account, know that that’ll probably hurt your credit score in the short term.

I used Mint to access the age of all of my accounts. The Uber Card shows up as “BRCLYSBANKDE”.

I used Mint to access the age of all of my accounts. The Uber Card shows up as “BRCLYSBANKDE”.

With all of that said, a few points on your credit score won’t matter all that much. Whether you keep the Uber card or get rid of it should really only depend on how much you’d be able to use Uber Cash like cash.

alternatives to the uber card

Unfortunately, there isn’t much in the way of no-annual-fee credit-cards great for dining and travel the same way that the old Uber card was. A friend recommended the Wells Fargo Propel Card as a solid alternative. While it’s only 3% back on dining, it preserves the 3% on hotels and airfare, and adds several other 3% categories (gas, transit, car rentals, and streaming services, among others). There’s no 2% category for online purchases - the base earning rate is 1% for other purchases. Apparently, the card is metal (something I’ll confirm in a few weeks once my friend gets his in the mail). The only downside I can see to the card so far is that it’s unclear how non-Wells-Fargo-customers can redeem points - while I’d imagine that it’s possible to redeem points for a statement credit, I haven’t seen anything that confirms this hunch. My personal views on Wells Fargo don’t help convince me.

Beyond the Propel card, there are plenty of cards that offer 3% on restaurants: the CapitalOne SavorOne card comes to mind, or if you’re well-off enough to the point where you have cash lying around and are a Bank of America customer, the Bank of America Cash Rewards can be pretty solid (though you need at least $20,000 for the first bump in rewards). Honestly, though, I just don’t know that it’s worth getting these cards if you already have something that gets you 2% back across the board (e.g. the Citi Double Cash). 3% isn’t bad, but it’s only a 1% improvement over baseline that makes me question the value of the marginal rewards.

If you’re willing to pay an annual fee, the American Express Gold Card and Green Card seem attractive, but then you’re earning points without a straightforward cash back system. Even with The Points Guy’s valuation of 2 cents per point, you’re still looking at a fairly high breakeven point versus something like a Citi Double Cash, and that’s assuming (1) that you can get maximum redemption value, and (2) you’re willing to deal with putting in the effort to do that.

It’s probably best to just suck it up, and accept the fact that the Uber card is soon-to-be irrelevant.

A Primer on High Yield Savings Accounts

My last post was on credit cards, why you should get one, and how to not suck at using them. Working down the list of things-I’ve-learned-about-and-feel-comfortable-talking-about and not the list of actually-important-things-to-do-in-order, I wanted to write about high yield savings accounts (HYSAs), which serve as a place to park things like emergency funds or savings for near-term large purchases.

A Bit of Motivation: Free Money?

Last time, I talked about how credit cards were “free money” and then some, due to the rewards and perks you can get from using them responsibly (again, always pay off the full balance each month). HYSAs aren’t really “free money” per se due to inflation (which I’ll touch on later), but they’re much better than standard savings accounts.

Before I got my HYSA, I had all of my cash in a Schwab “High Yield Investor Savings” account. Despite the words “High Yield” and “Savings” in the name, I was only earning a 0.23% interest rate – and even then, I was doing exceptionally well. The Schwab account outperformed many competing offerings from other banks (chances are, if you don’t use an HYSA, it’ll beat yours too):

Schwab Bank Comparison.png

But the Schwab account wasn’t a real HYSA. Real HYSAs, in my mind, have 2 defining features:

  1. They’re earning an interest rate that’s about where the federal funds rate is.

  2. They’re insured by the FDIC.

Understanding what the “federal funds rate” is isn’t important. What is important is that right now, most HYSAs are earning around the neighborhood of 1.90% interest, roughly 8x what I was earning previously. Put another way, for each $10,000 I had saved up, I’d be earning $157 more per year in interest, or a Netflix subscription – HYSAs are free Netflix (This one weird trick saved him hundreds! Netflix hates him!). If you have money saved up, you should find out what interest rate you’re earning on that cash, and compare it to the HYSA rates available.

What’s a FDIC?

Essentially, the FDIC-insured label means that if you have a savings account with money in it and the bank holding that money goes bankrupt, you won’t lose your money. The FDIC is a government corporation, so everything’s fine unless the US government starts to have issues (and at that point, you’ve got bigger problems). This only applies to FDIC-insured accounts. While companies (e.g. Schwab) offer “money-market funds” that can earn an interest rate around the neighborhood of HYSAs, money-market funds aren’t FDIC-insured, which means that you lose one layer of insurance in case another Great Depression happens.

Inflation, and why it’s less Free Money and more Not Burning Money

Intuitively, we all know about inflation. It’s why Subway doesn’t have a $5 footlong any more, why the dollar menu at fast-food joints has been steadily replaced with a “value menu”, and why you remember things being cheaper across the board when you were younger. Prices steadily increase over time for most things, and that’s just the way the world works. So, while an HYSA probably won’t beat inflation (at least, it doesn’t today), it’ll at least beat a standard savings account, where your money will just stagnate. With a standard low-yield savings account, you won’t see any noticeable gains on your money at all, which means you won’t be building up a buffer against inflation. With an HYSA, at least your interest earned will partially offset what inflation eats away at.

What’s all of this for?

HYSAs are a great place to store liquid cash that you need to hold its value. While you’re investing your retirement, you want money to grow, and you don’t really need the liquidity, so you probably shouldn’t be using an HYSA to invest for retirement. There are two categories of things I can think of where an HYSA makes sense:

  1. To hold your emergency fund.

  2. To hold cash for a purchase you’re about to make soon that you don’t want to be subject to market volatility.

There also might be something that I’m missing. On the first point, there are stories on stories on stories on stories of why you need an emergency fund – and an HYSA is a great place to keep it. On the second point, if you’re about to buy a new laptop, car, or some other relatively-large purchase, you’ll want to sleep well at night by not worrying on whether you can afford it or not. Markets go up and down on a daily basis. Investments can be volatile. Money in the bank, however, shouldn’t be – and that’s where the HYSA comes in.

Some Options I Found

Like my last post, I wanted to specifically call-out some of the options I’ve seen throughout my research. For full transparency, I’ve only recently moved my money into an HYSA, so my total experience is about a couple of days at this point. Nevertheless, hopefully the following shortlist will be helpful.

Marcus

Marcus is a new arm of Goldman Sachs that’s focused on normal-people instead of Goldman’s normal clients. I ended up personally going with Marcus as my HYSA, and I can’t say I have any complaints here. At the current time, I’m earning 1.9% on my money, and I generally like the web interface (there’s no apps for Android). Customer support is available 7 days a week, though not 24/7. There’s no debit card you can get, nor are there any ATMs you can use to access your money. You also can’t easily deposit checks, due to the lack of a mobile app. With all of those caveats in mind, I’d note that, for most people, none of them will really matter.

American Express Personal Savings

American Express, in addition to their credit products, also has a Personal Savings arm that more or less does the exact same thing as Marcus – same interest rate, same limitations, same lack of fees and minimum balance requirements (while there’s an American Express app, there’s no way to access the Personal Savings side of things, as far as I know). I’ve heard that the web interface isn’t as nice, but Amex’s support is available 24/7, and at least on their credit cards, it’s phenomenal.

Ally Bank

Ally is often recommended on Reddit, as it (like Marcus and Amex) has no fees, a competitive rate, and solid 24/7 support. Right now, they’re paying 1.80%, though you shouldn’t worry about the 0.1% difference too much. Unlike Marcus and Amex, they do have a mobile app with a check-deposit feature, and they’ll also allow you to use out-of-network ATMs. Ally is a bit of a curious case, since user reviews online are mostly-negative, though everyone on the Personal Finance subreddit seems incredibly happy.

You Don’t Need to Chase Partial Percents

In the grand scheme of things, it probably isn’t all that important to chase tenths or hundredths of a percent when you look for an HYSA. A 0.1% difference translates to less than a dollar per month per $10,000, so it’s unlikely that it’s really going to be worth your time to chase the highest rate.

Rates will change periodically, both up and down, to adjust to what the government sets as the federal funds rate. It’s not worth moving your money around from one bank to another just to earn a few extra hundredths of a percent – as long as your bank is fairly competitive and you like the support, there’s probably not much of a reason to worry.

Never Pay Fees, Don’t Accept Minimums

This is quite simple, really – just don’t pay fees. If a bank is charging you to hold onto your money, whether through transfer fees, monthly fees, or monthly minimums (requiring you to keep a certain amount of money in the account for it to be valid), you should probably look for another bank. Fees eat away at your interest, which means you’re effectively earning a lower rate than you should be. Citibank, for example, requires a balance of $500 to avoid getting hit with a monthly fee.

Some Other Resources

As always, the personal finance subreddit is a wonderful place to start. They’ve also compiled a helpful list of banks and credit unions they recommend.

Update: A friend told me that I left out Robinhood Cash Management, which is FDIC-insured and is currently advertising a 2.05% interest rate. While things look good on paper, it’s not an actual product yet (at the time of writing), so I didn’t include it on my shortlist. Nevertheless, it could be pretty interesting.

A Primer on Credit Cards and Rewards

Over the past months, I’ve gone on a personal finance journey. Mostly, I’ve just learned the basics – how to properly analyze your paycheck, a bit about credit, some stuff on budgeting and expense tracking – but I’ve also realized one other thing:

Virtually no one my age knows much about personal finance.

To put it nicely, this is scary. Most of my friends and classmates are incredibly smart individuals, yet are completely lost with the basics of how a credit card operates. I’ve heard people give advice that was bad, or even actively harmful, and sound 100% confident that they were right while doing so. Personal finance isn’t really even about money, it’s more about having the mental stability during a recession, or when you lose your job. It’s about being able to enjoy the things you want to do and focus on the stuff that actually matters to you instead of worrying about if you’ll be able to retire at the age of 45 or 65, or if you can make the mortgage payment this month. It’s a lot easier to avoid getting into a financial hole if you have the right habits; recessions suck a whole lot more if you aren’t financially set-up to weather the storm.

So, seeing as my blog gets about a couple hundred views for a bad post and near a thousand for a good one, I’ll leverage the only loudspeaker I have to write about something that’s fairly boring, but important nonetheless. I’m going to start with credit cards, as it’s something that I feel relatively knowledgeable about, but not because it’s the most important thing.

A Bit of Motivation: Credit Cards are more than Free Money

The usual advice is that there’s no such thing as a free lunch. Free Money doesn’t exist. You can’t get something for nothing. That advice is correct 99.99% of the time. However, it’s not fully true for credit cards, because provided that you use a credit card responsibly, you can actually get some pretty nice rewards/points/cash back from using them. Here’s a look at the rewards I’ve earned so far:

  • Credit Card #1: $176.40

  • Credit Card #2: $431.57

  • Credit Card #3: $291.34 - $95 in fees

Total: $804.31, after taking out the $95. This doesn’t include money I’ve earned from referring other people, and it doesn’t include current points I’ve earned but not yet redeemed. This is, 100%, just the money I’ve picked up from using my credit card instead of using cash. In case you’re wondering how this is possible, Vox put out a great video explaining how this all works.

Rewards are just one of the many benefits that credit cards offer. As this Reddit post explains, it’s safer, builds credit, offers purchase protection, and you can even get other perks for using one…

But You Have to Be Responsible

Credit cards are like knives: they’re useful tools in the hands of someone who’s knowledgeable about what he/she is doing, and completely dangerous in the wrong hands. The only way to properly use a credit card is to pay it off, in full, each month. That implies the ability to pay it off in full each month, which implies that you can’t spend money you don’t have. You’re not magically paying your bill at a restaurant with a piece of plastic, you’re just having someone else pick up the tab for you now so that you can pay them back later.

I also wonder if I make purchases that I wouldn’t have otherwise made due to the ease of swiping or tapping the card versus paying cash and carrying around bills and coins. Either way, the point is that self-control is important when you decide to get and use a credit card.

What I’m not Going to Talk About

For brevity, I’m going to focus on the more important things (in my mind). Credit is an incredibly broad topic and credit cards are just one aspect of it; therefore, I’m not going to write about credit reports or credit scores or building credit. I won’t write about interest rates (since, if you’re using a credit card properly and paying off the entire balance every month, you’ll never pay interest in the first place) or churning. This post is just the basics of understanding cash back rewards. I don’t talk about “points” as much (mostly because it’s a whole additional level of complexity).

Evaluating a Credit Card: The Terminology

In order to understand the world of credit cards, you have to speak the language. Thankfully, the language is mostly simple. Each credit card belongs to a network like Visa, American Express, Mastercard, Discover, etc. This determines where you’re able to use the card (while most people think that American Express isn’t as widely accepted, I’ve personally never had any issues).

For the purposes of using credit cards to gain benefits, there are 3 important qualities: (1) fees, (2) points and perks, and (3) redemption options. Fees are pretty simple: you’ll pay an annual fee each year to have that card (many cards exist without an annual fee, while more “elite” cards can run you $95 or $550 each year). Some cards may also have international fees associated with using the card overseas, but the chances are that 99% of transactions will stay within the US, so it’s not worth worrying about.

The perks side is where things get interesting. Certain credit cards offer certain rates of earning points on different categories. For example, a credit card might offer 5 points per dollar spent on groceries, 2 points per dollar spent on eating out, and 1 point per dollar spent on everything else. On top of that, credit cards might have certain perks associated with them, such as access to airport lounges or stolen phone coverage. Finally, credit cards might have signing bonuses, which give you a one-time bonus once you get the card and charge $X to it within the first Y months. Converting points earned into cash in your pocket depends on the redemption options – typically, cash back cards offer about 1 cent per point (though this might change from card to card). Some cards might allow you to turn points into airline miles or something else, but I personally prefer to just focus on cash back due to the ease and simplicity of understanding what exactly I’m getting.

My Credit Cards

While I’m not exactly a complete expert on the topic, I can at least offer my own personal insights into the credit cards that I have. Currently, I have 4 credit cards in my portfolio:

Citi Double Cash (Mastercard)

My “default card”, the Citi Double Cash credit card offers a flat 2% back on all purchases. This is a very-straightforward, no-nonsense credit card, and I think every credit card “portfolio” ought to have at least one strong across-the-board cash back card. There’s usually no signing bonus for this, but there’s also no annual fee, which makes it a pretty straightforward calculation.

This is one that you should try to have in your wallet. It’s your catch-all for online purchases, and random shops where you want to buy something that doesn’t fit into one of the categories covered by other cards.

Schwab Investor Card (American Express)

My first credit card that I ever got, the Schwab Investor Card is (I believe) open to virtually anyone with an “eligible account” from Schwab. It’s similar to the Citi Double Cash card in that it offers a flat, across-the-board 1.5% cash back, but it has a $200 signing bonus if you spend $2,000 in the first three months and no annual fee. It’s an American Express card, and all cash back is deposited directly into your Charles Schwab account without you having to do any work.

Compared to the other cards on this list which probably require some level of credit history to obtain, the relative ease of getting this makes it one of the better “starter” cards out there. The rewards are pretty solid and straightforward.

American Express Blue Cash Preferred

The first credit card I ever got with an annual fee ($95), the Blue Cash Preferred gives 6% cash back on groceries and streaming subscriptions (e.g. Netflix, Spotify), along with 3% on transportation (e.g. Uber/Lyft, public transit) and gas (and 1% on everything else). If you cook at home, this is probably worth getting, but you should definitely crunch the numbers to make sure you’ll get your money’s worth. I used Mint to download a list of transactions I made in the past year and calculate how much incremental rewards I would earn, and for me the math came out in favor. There’s a signing bonus of $250 if you spend $1,000 in the first 3 months, but if you get a referral or open up the link above in an incognito tab, the signing bonus increases to $300, which means you functionally offset 3 years of your annual fee right from the get-go.

The Blue Cash Preferred is great for people who cook and eat at home, but it’s probably not very helpful if you tend to eat out much more.

Uber Card (Visa)

The Uber card is probably one of the best no-annual-fee cards out there. It grants you 4% cash back on dining and restaurants, 3% on hotels and airfare, 2% on online purchases, and 1% on everything else (due to occasional issue with how an online purchase is encoded, I normally just use the Citi Double Cash card to make purchases 95% of the time). It also has a $100 signing bonus after you spend $500 in 3 months, and a $50 “subscription credit” after you spend $5,000 each year (a benefit that I mostly ignore, thanks to the Blue Cash Preferred).

The Uber card is amazing for people who eat out.

[Update: On October 28th, 2019, Uber and Barclays announced that the Uber card was going to be refreshed, and the new version is pretty bad. I no longer recommend getting it, and this post details why.]

About that Signing Bonus

If you’re thinking about whether you can hit the signing bonus or not, I’d consider looking at all of your expenses on a month-to-month basis to figure out how much you spend in total each month. At least until your signing bonus is earned, you should probably try charging everything to that card, despite the lower percentage cash back. I also made sure that I’d pick up the tab whenever I ate out with my friends (and had them Venmo me after). If worse came to worse, I could have always put a rent payment on the card (though there’s usually a fee associated with that).

Think About Marginal Rewards

It’s also worth mentioning that in considering a new card to add to my portfolio, I only think at the margin. If a new credit card came out that offered 5% on eating out, groceries, hotels and airfare, and gas (and 1% of everything else), it actually wouldn’t be all that attractive to me anymore because I already earn 4% on eating out, 6% on groceries, and 3% on hotels, airfare, and gas. If there’s no annual fee on this card, that’s great – I’ll probably stop using my Uber card altogether as a result – but if there were an annual fee, I couldn’t calculate the rewards I’d earn as 5% on those categories; I’d have to look at if the incremental rewards that I wouldn’t have already earned would be worth it. For this example, I’d have to see if an extra 1% on eating out and 2% on hotels, airfare, and gas is worth paying an annual fee for this hypothetical new card.

Some Other Resources

The best resource for anything personal finance related is probably going to be r/personalfinance. Reddit is an amazing resource for just about anything; personal finance is one of the site’s most popular subreddits. The wikis on credit cards and credit building, in particular, are fantastic.

For credit cards in particular, I’ve heard a lot of talk about The Points Guy, but I’m honestly not a huge fan. For one, he’s way more travel-focused than I personally am (though if your priority is actually travel, maybe he’d be more relevant). His evaluations of credit card points usually require booking flights on a particular airline, as opposed to redeeming them for straight cash-back. Like I said earlier, I’m not going to touch on points, as it’s a whole other world of complexity, but I’ve personally been content with “just” straightforward cash back that’s easy to understand. Also, the business model behind the website seems to be built on referrals and partnerships, so there’s potentially a conflict of interest. There are a ton of other websites that will pop up if you just Google things.

If you’re interested in reading more, I wrote about a post about getting started here.

This post was originally written on October 17, 2019. I might update it occasionally, and I’ll mark when/where that happens, but information might easily become outdated.