The Value of Living Beneath Your Means
The Value of Living Beneath Your Means
There are more benefits to living beneath your means than just financial savings. Some people rediscover the simple things — the joys of an after-dinner walk instead of working out in a crowded, impersonal gym, or waking up to the smell of freshly roasted coffee in your own home instead of grabbing an expensive cup of joe on your way to work.
Slow down, pay attention, save money. Food tastes better when freshly sliced, diced and prepared at home. Eschew expensive entertainment and rediscover the pleasure of a good book. Recognize, too, that cutting back doesn’t necessarily mean cutting out. For example:
- Find a less expensive hair salon
- Trade an expensive gym membership for a community recreation center
- Plan lower-cost vacations, like renting a cabin at a state park
- Encourage your children to attend in-state colleges for lower tuition
- Start shopping at small, lower-cost grocery stores like Aldi and Trader Joe’s
- Get rid of cable and start frequenting your local library for books and movies on DVD
Perhaps the greatest value of living beneath your means is the ability to consistently save, month-in and month-out, to work toward the goal of having an emergency savings account and a substantial nest egg that exceeds your needs. This alone can help provide financial confidence that far outweighs the temporary pleasures of an expensive vacation or slick sports car.
Know What You Spend on Investment Fees
The primary focus of investors is typically performance, but there are good reasons why fees also warrant close attention. Sure, when share prices rise and your account balance is booming, fees aren’t top of mind. However, when prices decline — as they will do periodically — fees matter and can drag down performance.
Fees not only reduce the value of an investment, but they also cut into money that could have been compounding over the years.1
To put this into tangible numbers, let’s say you have a $100,000 investment that earned 6 percent a year for 25 years. At the end of that timeframe, you would have earned around $430,000. However, let’s say you pay 2 percent a year in fees and investment expenses. This means your average annual return would be about 4 percent, so your portfolio would earn only $260,000 throughout the same time period. That’s a loss of $170,000, or 40 percent of your account value, strictly due to the fees you paid.2
Some investors ignore fees because they believe higher fees mean higher quality investment management. Again, the numbers don’t support that misperception. According to a recent Vanguard study, higher-cost mutual funds generally underperform lower-cost funds.3
The following are a few tips to help you keep an eye out for how much you’re spending on fees:4
- Some mutual funds charge a low expense ratio but make up the difference by charging high front- or back-end sales charges.
- Don’t fall for an “introductory” or short-term expense ratio that increases later. This is like getting a low interest rate for six months when you apply for a new credit card, but the rate increases substantially thereafter. Remember, investing is a long-term commitment, so low short-term fees aren’t much of an advantage.
- Some fund families may charge lower fees for some funds and higher fees on others. Never assume fees are the same across different funds.
New Tax Provision
In the past, some investors may have been able to deduct investment advisory fees and expenses from their taxes. This deduction was available for taxpayers whose itemized deductions exceeded 2 percent of their adjusted gross income. The Tax Cuts and Jobs Act that went into effect on Jan. 1 eliminates the investment fee deduction altogether.5
However, the IRS permits investors to authorize investment fees and expenses to be paid directly from the retirement accounts that charge them. In the case of qualified retirement accounts — such as a 401(k) plan or traditional IRA — those fees will be paid using pretax funds contributed to the account.6 So in a sense, the investor does receive the equivalent of a tax deduction for the fee, but they also give up tax-deferred growth on those dollars.
As for a Roth IRA, it is better to pay investment expenses with funds not held in the account because the Roth accepts only after-tax funds. Therefore, any fees taken out will lose the opportunity to compound tax-free. In the long run, this can impact the investment’s total return.
The hypothetical example does not represent any particular investment and is for illustrative purposes only. It should not be deemed a representation of past or future results, and is no guarantee of return or future performance.
Neither our firm nor its agents or representatives may give tax advice. Be sure to speak with a qualified professional about your unique situation.
1 Vanguard. “Don’t let high costs eat away your returns.” https://investor.vanguard.com/investing/how-to-invest/impact-of-costs. Accessed June 12, 2018.
5 Fidelity. 2018. “What tax reform means for your advisory fee.” https://www.fidelity.com/managed-accounts/tax-reform-advisory-fees. Accessed June 28, 2018.
The Value of Good Credit
A recent analysis by the real estate research website Zillow.com revealed how much more a person with an excellent credit score (above 760) applying for a mortgage would benefit compared to a borrower with a fair credit score (640-679).1
Here’s what the research showed for a median-priced U.S. home ($213,000) with a 20 percent down payment:2
30-year mortgage rate:
- Excellent credit — 4.25%
- Fair credit — 5.1%
Extra expenses incurred by fair credit homeowner would be about:
- $720 more per year in mortgage costs
- $21,000 more over 30-year mortgage