Done To Zen

This post is dedicated to Chris Moran for being the first one to comment on my blog. :-)

For whatever reason, I thought I was wasting most of my income. I crunched some numbers today and realized that, no, I wasn’t actually wasting most of my money. Apparently, I was saving some of it, too.

Savings/Expense Breakdown: 

I’m saving 45% of my paycheck. 52% goes towards fixed expenses and 3% towards variable expenses. My discretionary spending amount is miserly .1% (let me repeat that: .1%) of my salary. That sucks.

I would much rather prefer the % to be something like: 60% savings, 30% expenses, and 10% discretionary. More than increasing my savings, I really, really want to decrease my fixed expenses. The two areas where I can realize the most savings is in taxes and mortgage interest. I have to figure out how, though. I was fortunate to buy my house at the right time, so my interest is really low already. But taxes…

Anyhow.

Savings Breakdown

My 401K contributions are embarrassingly small right now. I have a plan to steadily increase my contributions over the next couple of years until I max out the account. For the time being, though, I have to keep enough cash in my emergency fund to feel comfortable. I also need to save enough to meet the minimum ($3000) for opening an index fund account.

As far as the wedding fund goes, I’ve been hearing rumors that even simplest of weddings take about $25,000 these days, so I figure that now is the time to start saving for it. I’m not adding too much to the account right now — I plan on increasing the amount by a couple of hundred dollars annually.

Expenses Breakdown

I was amazed to find out how much tax I’m paying. Then I got depressed and mad and frustrated and a whole slew of negative emotions. I now know what I’m going to be researching over the next couple of months: studying the tax code to figure out how to minimize the amount of money I pay to Uncle Sam each year. One thing to note is that these calculations don’t take into account tax savings I get thanks to my home, which is a couple of thousand dollars.

Another thing to note is that these calculations don’t take into account my student loans, which I’ll have to start paying off starting in a month or so.

House Equity/Net Worth Breakdown

Right now, my home equity is worth about 60% of my net worth, which isn’t the suckiest aspect of my finances but comes kinda close. The recommended ratio ((house value - mortgage) / net worth) is around 20%. I have a long way to go, but I’m not too worried about this. Since I only recently bought my house (at a great deal, too), it makes sense that it would contribute the most to my net worth. What would be worrisome is if this ratio didn’t change for the better over 2008 and 2009.

Income Breakdown



Right now, most of my income (about 95%) comes from my day job while the rest comes from rent (I’m sharing my home with another girl). As I mentioned before in Is net worth the only statistic that matters?, I believe that passive income is one of the most important aspects of financial freedom. While I took a major step in the right direction this year (two years ago, all of my income was from my job), I think there is much to improve in this area…

Shannon, over at SavingAdvice, disagrees with the popular notion that you should hire others to do your work for less:

I am not against the idea of hiring someone to do work for me. In fact, I gladly pay people to cook for me the six or seven times a month I go out to eat and would do it much more often if I had a limitless income. I just don’t believe that my salary is the best criterion to use when deciding whether or not to do something myself.

I couldn’t agree more. I love going out to restaurants, and if I had limitless income and limitless health, I would be doing it thrice a day every day. But, alas, I don’t, so lets move on.

Shannon goes on to say:

Taking the argument of “hire someone to work for less than you do” to its logical extreme, if you make $40 an hour and you hire someone to cook for $20 per hour, someone to clean for $10 per hour, and someone to do your shopping for $20 per hour, each person makes less than your hourly rate, but you are already spending more than you earn.

Precisely. There’s nothing wrong with hiring somebody out to do your work for you even if you make only $10 a hour and the other person costs $10 a hour, if you can afford to hire them. On the other hand, just because you’re making $100 a hour doesn’t mean that you can afford to hire somebody at $10/hour. It depends on what the rest of your expenses look like.

You’ll never hear any financial advisor telling you to outsource work for less if you are making $10,000 a month but spending $12,000. But if you’re making $1000 a month and spend only $250 (if you are, contact me, I want to know how), then you can hire somebody who charges $50 a hour. If you want.

Which brings me to…

Do you like it or hate it?

Just because somebody can do it for less doesn’t automatically mean that you should outsource it. What if you don’t hate it? What if — gasp — you actually like it? Could that $25/hour x 10 times a month = $250/month be utilized for something better? No? Maybe you can invest it? $250 a month invested at 10% for 30 years will give you $542,830.27. Even you save only $25 a month, you will get $54,283.03 in 30 years.

Now tell me if you hate something enough to let go of that kind of money. It’s not a trick question. I hate cleaning the bathroom. If somebody asked me whether I would rather spend $250 a month to clean my house even if it will cost me $542,830.27 over the next 30 years, I’ll pick hiring the cleaning lady 10 out of 10 times. I hate cleaning and the joy I get every month that I don’t have to do any cleaning is far more important to me than the cost of losing half a million dollars. On the other hand, if somebody were to ask me to outsource cooking to someone for $250 a hour, I would not do it. It’s not even that I like cooking: I just don’t hate it enough to lose that kind of money.

I formally learned about the break-even point in my account class a couple of weeks ago. The class somehow managed to take a fairly simple idea and turn it into the dullest topic of all times. I figure it’s my turn to torture someone else for a change, so here comes a post that will test my soporific powers. I know you will stay with me to the end because you’re either brilliant or a glutton for punishment.

The break-even point is the point where total costs equal total sales. I.e., this is the point at which a company (or a person) is making neither a profit nor a loss; I.e., the point at which a company (or a person) “breaks even.”

Which brings me to:

How to calculate the break-even point of a house?

I find it much easier to do math with examples, so here are some numbers:

1. We bought the house for $200,000.
2. We have a mortgage for $180,000 at 6% for 15 years.
3. We lived in the house for 3 years (36 months) and want to sell it.
4. 10% of the sale price goes to the selling agent.
5. We don’t pay any closing costs.
6. We are in the 25% tax bracket.
7. We paid approximately $10,000 in interest each year over the past three years. (You can get more exact numbers at bank rate.)
8. The mortgage remaining (assuming we didn’t make any extra payments) is approximately $168,000. (Refer to the aforementioned link if you want more exact numbers.)
9. Our rent costs us $700 per month.
10. The house appreciates at 5% each year.

Given those, what do we do we have to sell the house for to not take a loss?

Without tax or rent savings:

How about this (costs on the left, revenue on the right):

(seller agent fees) + (taxes per year x number of years) + (total interest paid) + (remaining mortgage) = sale price 

OR:

(.10 x sale price) + (taxes per year x number of years) + (total interest paid) + (remaining mortgage) = sale price 

OR:

sale price = / .9

This means that, to break even, we’ll have to sell the house for:

sale price = / .9 = $205,500/.9 = $228,333.33

So, just to break even we will have to sell it for $28,333.33 more than what we bought it.

With tax savings and without rent savings:

But the tax savings we get each year for owning a house are not insignificant so let’s include them in our calculation. The equation would change to:

(.10 x sale price) + (taxes per year x number of years) + (total interest paid) + (remaining mortgage) = sale price + (total tax savings)

OR:

sale price =/.9

According to CCH Financial Planning Toolkit, tax savings for year number 1 come out to just over $3800. To simplify calculations, we assumed that we pay the same amount of interest each year. I’m happy to fudge costs but not revenues, we will assume that tax savings for year 2 are $3500 and year 3 are $3300. This means that, our new and improved sale price is:

sale price = / .9 = ($205,500 - $10,600)/.9 = $194,900/.9 = $216,555.56

Even now, we will have to sell the house for $16,555 more than what we bought it for in order to not have a loss.

With rent savings:

There are the rent savings to consider. If we had not had a house, we would presumably be paying rent over the time. Paying rent would have gotten us no benefits other than maybe some psychological ones (you do have more freedom when you’re renting as opposed to owning a home). Our equation with rent savings will now look like this:

(.10 x sale price) + (taxes per year x number of years) + (total interest paid) + (remaining mortgage) = sale price + (total tax savings) + (total rent expense)

OR:

sale price =/.9

So, for our example house, that means:

sale price = / .9 = ($194,900 - $25,200)/.9 = $169,700/.9 = $188,555.56

Finally! If you include the amount of rent you would have paid over the same time, you have to sell the house for only $11,444.44 less what you bought it for to break even.

What if we want to make a profit?

The equation should look stunningly familiar:

(.10 x sale price) + (taxes per year x number of years) + (total interest paid) + (remaining mortgage) + (profit) = sale price + (total tax savings) + (total rent expense) 

OR:

sale price =/.9

So, if we want to make $50,000 in profit, we will have to sell it for…

sale price = / .9 = ($244,900 - $25,200)/.9 = $219,700/.9 = $244,111.11

How long to wait to sell a house for a certain price?

Hmm. How about another equation?

sale price = (current value  x (1 + appreciation per year)number of years) 

OR:

(1 + appreciation per year)number of years = (sale price / current value) 

Eeh gads. It’s been a while since I had to solve equations with exponentials. If I remember correctly:

logb (an) = n x logb (a)

In our case, (1 + appreciation per year)^{number of years} (aⁿ) should equal sale price/current price (a). We can use whatever base we want. Let’s use 10. We want:

log

Yuck. Let’s say we want to sell it for $300,000 at 5% appreciation per . How long do we have to wait?

number of years = (log ($300,000/$200,000) / log (1.05)) = log (1.5) / log (1.05) = 8.3 years

So, if I did this right, we can sell our house for $300,000 in 2016. Or, if we just want $50,000 in profit ($244,111.11), we will have to wait for…

number of years = log ($245,000/$200,000) / log 1.05 = 4.15 years

Conclusion

There, I hoped I managed to bore you to death or at least confuse the hell out of you. Here are the final equations again:

Break even sale price without rent or tax savings
sale price =¹⁰ / .9

Break even sale price with tax savings and without rent
sale price =¹¹/.9

Break even sale price with tax savings and with rent expenses
sale price =¹²/.9

Sale price if we want to make a profit
sale price =¹³/.9

Number of years to wait for a sale price
number of years = log (sale price/current value) / log (1 + appreciation %)

It’s been years since I did math, so if I screwed up something, let me know!

1. taxes per year x number of years) + (total interest paid) + (remaining mortgage [↩]
2. $2500 x 3) + ($30,000) + ($168,000 [↩]
3. taxes per year x number of years) + (total interest paid) + (remaining mortgage) - (total tax savings [↩]
4. $2500 x 3) + ($30,000) + ($168,000) - ($3800 + $3500 + $3300 [↩]
5. taxes per year x number of years) + (total interest paid) + (remaining mortgage) - (total tax savings) - (total rent expense [↩]
6. $2500 x 3) + ($30,000) + ($168,000) - ($3800 + $3500 + $3300) - ($700 x 12 x 3 [↩]
7. taxes per year x number of years) + (total interest paid) + (remaining mortgage) + (profit) - (total tax savings) - (total rent expense [↩]
8. $2500 x 3) + ($30,000) + ($168,000) + ($50,000) - ($3800 + $3500 + $3300) - ($700 x 12 x 3 [↩]
9. 1 + appreciation per year)^{number of years}) = log(sale price/current value)

   OR:

   number of years x log (1 + appreciation per year) = log (sale price/current value)
   

   OR:

   number of years = (log (sale price/current value) / (log (1 + appreciation per year [↩]

10. taxes per year x number of years) + (total interest paid) + (remaining mortgage [↩]
11. taxes per year x number of years) + (total interest paid) + (remaining mortgage) - (total tax savings [↩]
12. taxes per year x number of years) + (total interest paid) + (remaining mortgage) - (total tax savings) - (total rent expense [↩]
13. taxes per year x number of years) + (total interest paid) + (remaining mortgage) + (profit) - (total tax savings) - (total rent expense [↩]