An Engineering Approach to Money

Back in early March, I decided to fund our Roth IRAs for 2007. That’s right, this was not a late funding for 2006, I already did that back in december, this was early funding for 2007. By putting the money to work early we allowed it to begin compounding early. Given how well the market has been doing lately, I wondered how much that decision has been worth.

As I’ve said before, I keep all my financial information in Quicken, so it’s easy to go back and look at all previous decisions and see if they were good or bad. On March 9th we purchased $8,000 worth of the Vanguard S&P 500 Index Fund, that’s $4000 for me, and $4000 for my wife. The cost of shares back then was $129.62 and we purchased 61.718 shares. As of Friday (April 20th) shares closed at $136.77, so we made $7.15/share or $441.28 in a bit over a month. Sweet! Because this money is in our Roth IRA we will never owe any taxes on those gains, provided that money stays in the account until we turn 65.

Now we have $8441.28 instead of $8000 growing for the next 20+ years simply by putting that money in early rather than later. If we had waited to fund our Roth IRA we’d have missed that gain. But remember even those folks who waited to fund their 2006 contribution until April 15th missed that $441 gain, but they missed it with both their 2006 and 2007 contribution. Thus my wife and I are $882 richer than if we had waited until the last minute, because we funded early in both 2006 and 2007, and it’s all tax free, my favorite kind of money.

Let’s look at an extreme case, if you had funded your 2006 contribution on Jan 1st 2006 S&P 500 shares would have cost you $116.82/share, on April 16th 2007 those shares were worth $135.30/share. That’s the difference between a Roth IRA worth $9,265 and one worth $8,000. It’s actually even a greater difference because there would be reinvested dividends probably worth about another $100 or so.

Let’s not forget those tax advantages. If you had left that money in your taxable account you might have to report another ~$1300 in income at the 15% cap gains rate that’s another $200 in taxes you’d have to pay.

The moral is, when you are deciding where to invest your money, fund your Roth IRA first, get that money into the Roth Protection in a good safe long term investment as soon as you can, and out of your taxable accounts. The difference could be significant, you want every dollar out there working as hard as it possibly can. That way you won’t have to.

This post was included in this week’s Carnival of Personal Finance over at We’re in Debt.

Well, I just got my Tax Refund for 2006 back, just a bit over $2,000 this year.

I generally hate getting a refund that big, it means I planned wrong. But if you’re going to plan wrong, I guess it’s better this way than to owe Uncle a big bunch of money. Looking back on things there were a bunch of items that caused me to overestimate my withholding. Here are a few of them.

1. I took 12 weeks off work last summer, about 5 of them without pay. That reduced my earned income which kept me under the threshold of losing part of my $1,000 tax credit for both my kids.
2. I’m still burning off $3,000 each year in earned income from some fairly big investment losses back in 2000 and 2001. I did some careful selling at the bottom of the market. This allowed me to build up $15,000 or so in capital losses. Remember webvan? Well that cost me a few thousand dollars. I’m trying to use that negative to my advantage by not selling my current positions out so that I can use this $3,000 ever year to reduce my earned income.
3. I didn’t end up selling anything again this year, and my mutual funds didn’t distribute much in capital gains either. So my unearned income came in lower that expected. It can be very difficult to judge how much will show up in December and how much selling you’ll do over the year.
4. A fair spike in property taxes last year due to a reassesment. Paying the bill is painful, but the write-off it’s a nice bonus at tax time.

I used TurboTax for the first time this year, that worked out pretty well. It was very easy to get everything done. My Father used to do taxes professionally, and has done for me for the past 6 or 7 years. The new computer programs make in really easy. It also helps that things were not much different this year from last year, so I could go through last years 1040 line by line and make sure everything matched up this year, just with new numbers.

Once other tidbit, since I was due such a big refund I filed as soon as possible, back in Late February, so that my refund would arrive as soon as possible. I want my money back so that I can put it to work in the market. No, we’re not spending this money, I’m going to put it to work in the Market.

The other step to take is to readjust my withholding for this year so the same thing does not happen again. Because several of these items were one time issues, and I got a nice raise this year, I’m expecting that my current withholding is probably not that far out. My current plan is to check things in June and decide then if I need to change my withholding. Who knows, maybe I’ll be able to reduce my withholding, it will be like a mini-raise.

This post describes how I set up my personal short term accounts. I’ll talk about my long term stuff at a later date, that’s much more complicated, but this is just the basics that show how I set up the accounts how the money flows and how it allows me to get maximum interest, with the least pain.
I use a 3 tiered approach to my short term accounts.

1. Credit Union Checking
2. Credit Union Savings
3. Vanguard Short-Term Investment Grade Corporate Bond Fund

My paycheck gets direct deposited into my checking account twice a month. I then pay the bills for that half of the month and move the extra funds to savings as quickly as possible. This savings account doesn’t pay much interest, 2% or something, but it is convient and I can move money back and forth between there and Checking via the web, a phone call, or a visit to my local bank. There is also overdraft protection on my checking account so that they will pull money from my Savings account to cover me should it be needed. This happens every other year or so because of some screw up or other, and $1 for overdraft protection is much better than $30 for a bounced check. I tend to keep about $400 in my checking account, and let funds build up into my savings until I have $1000 or so to move over to my vanguard account.

The Vanguard Short-Term Investment Grade Corporate Bond Fund account is where I keep my cash cushion. It is also where I keep money that is waiting to invest long term. The balance in that account tends to fluctuate between $30K and $60K depending on how agressive I’m feeling about the market. If I want to be fully invested I’ll drain this down to my 6 month spending minimum, if not I’ll let it build up until the next time I’m ready to push some cash to long term savings. If I have big expenses comming up I’ll also let this grow. For example this is the account I used to purchase my last car. Generally when I need to spend some of this money I write a check and take it to the credit union and put it back into my checking or savings account, from there I can get a cashiers check for a large purchase if need be.

I chose this particular account for several reasons.

1. Vanguard is the low cost leader in this space.
2. My income is not high enough to put me in a tax bracket to want a tax free fund.
3. There is low risk to principle as the fund invests in short maturity bonds.
4. Investment Grade means that it invests in only stable solid companies.
5. The yield is much better than a money market, current yield is about 5% which is great for short term money.
6. The account has free check writing for checks over $500.
7. This is a joint account my wife and I share so we both have to sign all checks which forces us to touch base when drawing money out of this account to make sure we are on the same page.

Because this is not a money market account, the value of the money you put in will fluctuate, but because the maturity on the bonds is so short it will not fluctuate very much, I’ve held the account for several years and shares have varied from $10.34 to $11 or about 6.5% at the extremes, since I move money in and out fairly frequently it all balances out and the higher yield is worth it to me.

As the money comes in it normally flows into accounts with higher and higher yield (interest) until it is ready to be put to use in one of my long term accounts. I keep no more than a couple of thousand in my local Credit Union accounts which means that should someone ever clean out my checking account it would hurt, but not be devastating to me. Because this is short term money it is easy to access with a check and spend in an emergency.