130: Modular Financial Planning 08: Paying Down Low-Interest Debt and Building Taxable Savings

[00:00:00] Intro: Do you think money takes up more life space than it should? On this show, we discuss with and share stories from artists, authors, entrepreneurs, and advisors about how they mindfully minimize the time and energies. Spent thinking about money. Join your host, Jonathan DeYoe, and learn how to put money in its place and get more out of life.

[00:00:33] Jonathan DeYoe: Hey there, and welcome back to Mindful Money. We’re in the late to middle stages of describing the Mindful Money modular financial planning process. Last time we talked about the importance of saving and investing specifically for financial independence, what we used to call retirement.

[00:00:48] Jonathan DeYoe: Financial independence is the one goal that it’s required of all of us. At some point in each of our lives, we’re gonna be called on to support ourselves without working for an income. If we do not plan on this, then all we [00:01:00] will have is social security and the kindness of family or strangers. Every financial decision we make shows up in our retirement income. If we drive expensive cars, send the kids to private schools, take big expensive vacations, and live in too much house.

[00:01:14] Jonathan DeYoe: Without considering the savings and investments needed to create the income that rises to match our rising cost of living and then lasts the rest of our lives, then we simply won’t have the income we need when we retire. Financial independence requires planning, understanding trade-offs. And then making the trade-offs.

[00:01:32] Jonathan DeYoe: And once you have that particular goal dialed in, once you know the amount you need to save and are saving it in your retirement programs, either personal IRAs or retirement programs at work, then you can start to refine your plan. For our purposes today, that means. Talking about paying down or paying off low interest debt and or building taxable savings focused on additional retirement savings, other goals, or just building the nest egg for whatever may [00:02:00] come.

[00:02:00] Jonathan DeYoe: This episode is the eighth in our 10 part series, which covers everything you need to know to get started creating your modular financial plan. About 40,000 people visit Mount Everest Southern Base Camp every year. Only 800 make the summit. Getting to base camp at 17,600 feet is a long and difficult trek, and the views at Base Camp are better than almost any other place in the world, but they’re not the summit.

[00:02:27] Jonathan DeYoe: So our brief step-by-step guide to personal finance that started seven weeks ago has brought us comfortably to the financial equivalent of basecamp. We have discovered what’s worth seeking. Developed a vision of a well-lived life, embraced the savings habit, built an emergency fund, eliminated bad.

[00:02:45] Jonathan DeYoe: That’s high interest debt, and we are saving and investing for retirement. For many people, even these six small steps will feel like a stretch.

[00:02:54] Jonathan DeYoe: About 36% of Americans earn less than $50,000 annually. If you are in this category, [00:03:00] steps one and two are a painful reminder of things you can’t imagine. Be patient with yourself.

[00:03:05] Jonathan DeYoe: Remember to keep moving forward, keep working hard, develop new skills, and work on ways to increase your income. We are all in the process of becoming and you’ll get there. According to the Federal Reserve Bank of St. Louis, the median US household income in 2023 was $80,610 and only.

[00:03:22] Jonathan DeYoe: 18% of individual workers and 34% of families earn over a hundred thousand dollars in the United States. So for the vast majority of Americans, the simple lessons in the six steps we’ve already covered are gonna be enough. Once you’ve completed one through six, you’re gonna be on a path to the fulfillment of the vision you created, , for your life in the second step.

[00:03:44] Jonathan DeYoe: , it’s a simple issue of giving the efforts enough time to bear the fruits that you’re seeking. What we’ve done so far can be good enough, and for most of us, it’s all we’ll ever need for the rest of us, myself included. There are a few more steps, refinements really to [00:04:00] take, , to accelerate our successes and fulfill our life plans.

[00:04:03] Jonathan DeYoe: Some of us are gonna attempt the summit. Anyone who gets to Basecamp is hugely accomplished already, and you should be super happy for being this far along. You’re enjoying some amazing views and you’re ready to push towards bigger goals. Now we wanna accelerate these efforts. We want to do more for us.

[00:04:18] Jonathan DeYoe: There are three additional steps on the way to the summit. First, becoming debt free and adding taxable savings. Second, keeping investments simple. And finally optimizing our portfolios , with a few little additional tricks and tools.

[00:04:33] Jonathan DeYoe: Today we want to cover two steps in particular. We wanna cover the choice between paying down low interest debt and saving in a taxable non-retirement account. Everyone talks about being debt free, and I agree it’s an admirable goal. but as you get better with money, you begin to understand that it’s not the most important financial goal, and it certainly shouldn’t come first.

[00:04:52] Jonathan DeYoe: Once you’ve paid off the high interest debt, all the buy now pay, later balances are gone, credit cards are paid off monthly. There’s no personal loans [00:05:00] outstanding, and your retirement savings are on track then, and only then do you begin shedding that low-interest debt. Those debts with low to medium single-digit interest rates, often collateralized by large purchases like houses or cars.

[00:05:14] Jonathan DeYoe: But frankly, even at this point, you may want to wait longer once the high interest debt is gone and you’re solidly on the path to its financial independence. It’s more about building net worth than it is specifically about debt reduction. So there are two remaining ways to build net worth. You continue down the path of paying down that low interest debt, or you can begin to save into a taxable investment account.

[00:05:37] Jonathan DeYoe: Now we’re always pushing to increase our income, you know, earn more in the current work, find higher paying work, or take on side gigs. The question I get asked is, what do I do with the excess income? Now? How about now? Or now as you grow your income, you move from step to step along the order of financial operations.

[00:05:56] Jonathan DeYoe: Again, that order is emergency fund, high interest, debt, [00:06:00] retirement savings, and then comes this choice between, paying off, low interest debt, or , saving additionally into taxable savings. This is a personal preference. If you’re not fully funding your retirement savings programs, then you should focus on maximizing those before turning your attention to these questions.

[00:06:15] Jonathan DeYoe: But when you are fully funding your retirement and you have additional excess and want to focus on becoming debt free, then start with any low-interest consumer debts first. Things like furniture, electronics, appliances and cars, any items with depreciating values, and then start with the high-interest consumer debts and work your way down to the lowest ones.

[00:06:32] Jonathan DeYoe: After eliminating consumer debt, move on to the big debts such as the student loans and the mortgage. In most cases, it’s better to leave your house for last, and depending on the rate, you may never want to pay it off. I refinanced my mortgage in 2020 into a 15 year 1.75% loan, and I plan on making the minimum payment for as long as they’ll let me.

[00:06:53] Jonathan DeYoe: That means it’ll be paid off in the year 2035 because that’s free money. 1.75% is less than the rate of [00:07:00] inflation. It’s because real estate typically increases in value and the mortgage will typically be the lowest interest rate you’re gonna have on anything since it’s collateral is so strong. So a gradual increase in your home’s value can offset much, if not all of the interest rate you pay on your mortgage.

[00:07:16] Jonathan DeYoe: Plus, don’t forget, your mortgage has some tax breaks associated with it as well. So debt costs you money, so you’re generally better off without it, but. Not investing comes with opportunity costs. In other words, not investing costs you money in terms of the form of, , potential compound interest.

[00:07:36] Jonathan DeYoe: You wanna make sure you’re getting the most bang for your buck. It often comes down to personal preference, but it might be financially optimal to keep some low interest debt while putting the rest of your excess cash flow to work in a taxable investment account. So you have a choice of paying off a 4% or a 5% loan or investing in a taxable portfolio with a likely long-term return of 7%.

[00:07:58] Jonathan DeYoe: The math suggests you’d be better off [00:08:00] adding to the portfolio.

[00:08:01] Jonathan DeYoe: So you may have heard the story of the wise older gentleman asking the children in a high school classroom the following thought provoking question, would you rather have a penny a day doubling every day for 30 days, or receive $1 million right now?

[00:08:19] Jonathan DeYoe: The class, you know, quickly splits into two groups. Team instant Millionaire was enthusiastic about the immediate allure of a million dollars. They envisioned all the luxuries they could acquire, , homes, cars, vacations. You know, why wait for pennies when you can have the wealth today? They shouted. Team penny doubling was, you know, contemplative, pondering the idea of patience and growth.

[00:08:41] Jonathan DeYoe: Let’s think this through. One voice called out, what if the penny really multiplies? When team Penny doubling does the math, they discover on day one, they get, you know, the 1 cent, but on day two it doubles to 2 cents. On day three it’s 4 cents. Day four it’s 8 [00:09:00] cents. Day five, it’s 16 cents. It’s kind of, it’s pretty slow.

[00:09:03] Jonathan DeYoe: But as they continue, everyone watched as the numbers grew on day 10, penny Doublers had $5 and 12 cents. On day 20, they’re sitting on $5,242 88 cents. And then the last four days get really interesting. On day 27, team Instant Millionaire was still, you know, in the lead. The penny Doublers had only $671,089, but their doubling still had three more days.

[00:09:30] Jonathan DeYoe: On day 28, the doubling had surpassed the million received by the other group. The penny doublers had $1.312 million. On day 29, the doubling penny was now $2.684 million, and on the final day, the value of the penny doubling every day, , for 30 days stood at five point. Three $7 million. The penny doublers had over five times the instant millionaires.

[00:09:58] Jonathan DeYoe: So the revelation is that [00:10:00] while a million dollars may seem appealing at first, the true power lies in patience and compounding. The penny represents not just money, but this idea that small consistent efforts can lead to extraordinary results. The decision to choose the penny was not merely about money.

[00:10:16] Jonathan DeYoe: It was about embracing a mindset of patience and understanding the value of gradual growth. Instant rewards are almost always tempting. It feels good to be debt free and waiting for something greater. Something that boosts your compounding engine can yield far more than you may imagine. So I will almost always recommend building taxable investments before paying off low interest debt.

[00:10:40] Jonathan DeYoe: So investing in a taxable non-retirement account to further build your assets can be just as important and useful as becoming a hundred percent debt free. Certainly before doing this, make the maximum contributions to your employer sponsored retirement plans, 401k or 4 0 3 B, and your individual IRAs.

[00:10:56] Jonathan DeYoe: If you’re already maxing these tax shelter retirement accounts and you have [00:11:00] additional savings, then a taxable non-retirement, sometimes people call it a brokerage account, is worth considering

[00:11:05] Jonathan DeYoe: asset building. Another phrase that basically means saving and investing is arguably the best route to financial freedom once you establish a pool of compounding assets.

[00:11:15] Jonathan DeYoe: You’ve immediately increased your chances of getting financially ahead in life. Over time, the magic of compounding grows your asset base at ever increasing rates. Adding more as soon as possible will accelerate this compounding process. The additional savings can either, , bring your moment of financial freedom and financial independence closer, or it can bring some of your other stretch goals, financial goals, travel, sabbaticals, or starting your own business into view.

[00:11:41] Jonathan DeYoe: Obviously you don’t wanna completely ignore debt, but when you do the math dollar cost averaging into, a taxable account often comes out ahead. Even if you can only add 50 or $100 a month into a taxable account, it’s worth it and it adds to long-term compounding. One of the added benefits of building [00:12:00] taxable assets is you can always, if you’d like, I’m not sure why you’d want to do this, sell an asset to pay off even the lowest interest debt.

[00:12:09] Jonathan DeYoe: In the next episode, we’re gonna talk about simple, basic, mindful investing. But for now, Let’s keep a couple things in mind for the taxable portion of your portfolio. Because your taxable accounts are taxable. They’re not protected from taxes like your retirement accounts. 4 0 1 Ks, 4 0 3 Bs, and IRAs.

[00:12:27] Jonathan DeYoe: They are subject to tax consequences with every transaction you’re subject to. Capital gains taxes when you sell the security for more than you originally, , paid for it. That’s the cost basis and income taxes when you receive a dividend or interest income. So you wanna maintain your taxable investing with low transaction process.

[00:12:45] Jonathan DeYoe: I. This is exactly what we’re gonna talk about in the next section, in the next session, and you’re gonna have to keep in mind that all investing involves risk, including the possible loss of principle. Personally, I would suggest that not investing involves even more risk. IE not having the [00:13:00] retirement income, not having assets readily available when you need them, et cetera.

[00:13:05] Jonathan DeYoe: So you need to be mindful of how you invest again. Next week we’re gonna talk about how to keep these investments simple and on task. Another really big benefit of having a taxable investment portfolio is the control you have over the source of your spending when you start drawing from your, accounts, all of them, when you have a taxable account along with a traditional IRA and maybe a Roth, IRA.

[00:13:27] Jonathan DeYoe: All of which are taxed differently. You can choose where to get the bulk of your spending when you retire. This choice gives you wiggle room around taxes when you take money out of a taxable investment account. Any trades to free up cash or tax at capital gains rates. Since the capital gains rate is lower than your ordinary income tax rate, you can in effect choose your tax rates by keeping your withdrawals from IRAs and other, , retirement portfolios to a minimum.

[00:13:53] Jonathan DeYoe: You keep your income to a minimum. This. Proves to be an enormous benefit over say, 30 years of retirement. [00:14:00]

[00:14:00] Jonathan DeYoe: So depending on circumstances, we often recommend withdrawing no more than the required minimum distribution from your non-taxable accounts. Or if you’re charitably inclined, you can give your required minimum distributions directly to charity.

[00:14:11] Jonathan DeYoe: This is known as a qualified charitable distribution. By doing so, you might eliminate your income tax and retirement, enabling you to focus solely on capital gains and qualified dividend income. Keeping your tax rates nice and low. This is one area of your financial lives where a professional can be, you know, invaluable.

[00:14:29] Jonathan DeYoe: So once you move on to paying down low interest debt, or preferably saving in a taxable account, you’ll be a little closer to meeting all your big life goals, not just the retirement goals. And in the end, the true benefit of financial planning turns out to not be financial. It’s just a life well lived.

[00:14:45] Jonathan DeYoe: As always, thanks for listening. Next time, I look forward to describing the easiest possible path to the best possible investing outcomes. I wanna share with you a way to invest that doesn’t require any time or really any major analysis that minimizes your taxes and [00:15:00] helps you reach all your financial goals.

[00:15:01] Jonathan DeYoe: So hope you’re gonna tune in next time to learn about simple, basic, mindful investing. Thanks.

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