JoeTaxpayer

A nice demonstration, but what have we learned, what will bring the changes we need?
Joe

If you have not yet done so, please read part 1, part 2, part 3, part 4, part 5, part 6, and part 7 of this series first, then read on.

I think we are at the point in this series where I should take a step back and offer a simple overview of how mortgages work. First, to show you how simple this topic is, I will offer you the “Rule of 72”. If you divide an interest rate (6% in most MMA examples) into the number 72, you get the number of years it takes money to double. 6 into 72 is 12. So at 6%, it would take money 12 years to double. Now, let’s look at the first lines of an amortization table for a $200K 30yr fixed mortgage at 6%;

Here, we see that the monthly payment is $1199. What would we save at the end if we sent $100 more to the mortgage? Well, 24 years is twice the 12 it takes to double, so at 6%, in 24 years we’d have $400, another 6 years, and it should be worth close to $600, right? Well, back to the amortization schedule and we see that if we pay an extra $200.10 along with the mortgage payment due for month 1, we actually get a full month ahead on our schedule. Agents selling MMA use the word ‘canceled’ for this process, saying that “MMA canceled $999 in interest in just one month.” And in a case that lies north of innumeracy, and south of hyperbole, they suggest that you got a 500% return on your money, instantly. You can see how on one hand, the math is pretty easy, you can get very close without even using a calculator, yet on the flip side, one who doesn’t understand the numbers can be convinced of something not true. $200 today is the present value of $1200 30 years hence at 6%/yr. So, you can look at this 2 ways, the extra $200 payment pays the payment #360 in advance, as it knocks off the last payment due, or looking at above, you’ve just paid payment #2, and next month, you are on line 3 of the table. The amount you prepay against principal doesn’t need to be any particular amount. If you have $100/mo extra, over one year’s time you will have paid your mortgage ahead by about 6 months. To be clear on this last thought, using a spreadsheet on your computer will give you exact numbers, but even a printed spreadsheet you track with a pencil is all most people actually need to get the job done.

Next week, we will continue and conclude our discussion of mortgage math.

Joe

I’m paraphrasing, of course from Shakespeare’s,”The fault, dear Brutus, lies not in our stars, but in ourselves if we are underlings.”
In a recent story, covered by ABC as “Movement to Scrap 401(k)s Gains Traction” it seems that instead of (a) prompting more disclosure regarding the high fees with an eye toward reduction, (b) education about asset allocation (as in “how to not lose 100% of your savings in an Enron-style implosion”, and (c) a bit of counselling on proper planning, amount that needs to saved, etc, they are proposing we scrap the system altogether.
The current state in which we find the financial markets doesn’t call for the abolition of retirement planning as we know it. In the old days, whenever they were, a defined benefit pension would have provided a nice income at retirement, with social security adding to supplement. As people stayed at a given job for fewer years, the pension system made less sense. The 401(k) on the other hand, was a great replacement vehicle. Those frequently changing jobs had the choice of moving their prior account to the new employer or to roll the account to an IRA.

There are bits I picked up from the article that I agree with:
Encourage/force disclosure and lower fees
Mandatory 5% minimum deposit and 5% company match
An offering of one fund that invests in the inflation+3% as the plan proposes

This would satisfy much of what this democratic proposal offers, only it doesn’t tie the hand of investors who wish to be more aggressive and it doesn’t create a socialistic investment pool. The article doesn’t address the source of the inflation+3% investment, where exactly does one get this return? How will the government guarantee this, and who will make the investment decisions on our behalf?

I’ll just say “no, thanks” to this one.

Joe

Now that the stock market is down over 40% from its recent peak, now may be the time to consider converting some of your IRA account to a Roth. When the market recovers, no further taxes will ever be due on the Roth account. For example, say last year, your IRAs were worth $60,000 but is now worth $36,000. In the 25% bracket, it will cost you $9000. As the value of the account passes $60,000 again, this sum will avoid any further taxation. See Fairmark if you are not sure what tax bracket you are currently.
Joe