Posted in Budgeting, Investing, Personal finance, Savings, Spending

The SAFE plan – Simple, Automated, Flexible and Efficient

Safety in financial world is an oft-repeated word, and is mentioned in contrast to risk and growth.

We talk a lot about risk-return trade-off, safety of invested principal in long term and short term investments.

There is another way of looking at Financial Safety. The SAFE plan described below is a way of setting up financial life that is SAFE by design, not in the traditional sense of Safety vs. Risk but automatic habits that ensure you don’t stray from common sense.

Common Sense and Simplicity in Financial Plan is hard to achieve. True it is counter intuitive, but most people land into financial trouble due to complicated behavior – be it spending recklessly, chasing high unrealistic returns or simply throwing caution to the wind.

The SAFE Plan

Let me first present the 7 steps to SAFE plan.

  1. Invest in pre-tax accounts like 401k and HSA.
  2. Set up a direct deposit of the remaining taxable income to a checking account.
  3. Set up credit card payment to be auto paid from the checking account on the 30th of every month.
  4. Set up an auto-invest plan where 10-20% of the taxable income is diverted to a brokerage account or another IRA account (like Roth IRA). 
  5. Spend your monthly expenses on the credit card. Keep an eye on the credit card balance with the money left over in the checking account.
  6. Save the left over surplus, if any. 
  7. Continue and repeat next month … 

Simplicity

The above steps are nothing new. They have been suggested by numerous financial coaches and gurus. However the importance of the SAFE plan is how the steps are stitched together and flows through a seamless automation.

Since we have established the Simplicity of the SAFE plan, lets look at the Automation part and how to set this up. 

Automation

  1. You just need to figure out the % you want to put in 401k or HSA, and inform your payroll department. This can be decided based on the following factors.
    • Your cash flow needs after this deduction.
    • How much to invest to capture any employer provided matching contribution.
    • Max limits of the 401k or HSA.
  2. Direct deposit of the taxable amount to checking account.
    • This is handled by your payroll department automatically.
  3. Setup credit card auto-pay from your bank account for the 30th of every month.
    • This one if not done, can prove to be dangerous as missed payments are very costly.
    • The trigger will also help you pay-off something even if you have amassed a debt.
    • You can configure to pay off the entire balance, minimum payment or a fixed amount.
  4. Setup auto invest for 10-20% of the taxable income. The exact % can vary as it will depend on your household expenses.
    • Even if your budget does not allow this today, find at least a small amount ($50-$100) to divert automatically to an investment account.
    • This will build the habit and set you up for regular investment.
    • The amount can be increased over time as the budget frees up extra cash.
  5. Live within your means. This is again a cliche, but very difficult to be consistent month after month. You can manage it with some automation and discipline though.
    • setup a notification when your credit card balance crosses 90% of your projected expense for the month (or simply the money left in the checking account).
    • Put a Level 5 tornado/hurricane warning when it is crossing over the money left over in your checking account.
    • Typically the projected expenses can be simply set to the money left over in your checking account. You cannot spend more than that without incurring consumer debt or dipping into other savings/investments.
  6. Save the surplus – If you have surplus at the end of the month (that is, Credit card balance < Money in checking account) you can save it for future goals, short term and mid term.
    • I wish banks provided this facility, but it can be set up to transfer a fixed amount once you have an idea of your monthly expenses.
    • Some apps like Acorns or Digit automate this although in more complicated way. 
    • Do not leave the money in the checking account otherwise next month it will create an illusion that you can spend more.
  7. Let the automation run month after month. 

Flexibility

Once setup correctly, the basic version of the SAFE plan is low maintenance and enables an almost debt free living. 

Of course, we have not taken into account mortgage payments, prior debt pay down, saving for education – but these can also be fit into the plan. In the step where you are investing 10-20%, you will break that into smaller chunks of various debt pay down and remaining amount can be invested for various goals.

Thus the plan is also extremely flexible to adapt to individual situations. 

Efficiency

The last part of the SAFE plan is that it is efficient in managing money. 

The following good principles are built-in into the plan. 

  • Pay Yourself First – Pre and Post Tax investments are deducted in the beginning.
  • Low maintenance – no coupon cutting, daily budgeting etc. 
  • Keeps you debt free – just keep tab that your credit card balance is below money left over in checking account. 
  • Encourages more savings at the end of the month – creates a healthy race to increase it, by reducing your spending. 

The efficiency is evident if you do this for even one year. You will see the difference in your credit score, savings balance, net worth and above all, peace of mind. 

Conclusion

This plan has been working for me for a long time. The simplicity and automation helped me manage it seamlessly without getting distracted from my main job – which is not finance. 

And the in-built savings and investment discipline in the plan has helped me invest and accumulate cash for emergencies, short term purchases or just a cash cushion. 

Here is my version of the 7 steps of the SAFE plan (the % are approximate and rounded)

  1. Invest some in the Roth-401k and H.S.A. 
  2. Direct deposit first paycheck. (50% of monthly)
  3. Use the credit card from same account. Set up auto-pay on 30th of every month. 
  4. Investments/Pay downs
    • 10% to mortgage account
    • 10% to savings for property taxes, insurance and maintenance
    • 20% invest in mutual funds via brokerage account
    • 10% to a 529 Plan 
  5. Next paycheck direct deposit on 15th of month. (50% balance monthly paycheck)
    • Living expenses capped to 40-45% of monthly total. 
    • Pay off credit card balance within this limit – I make sure it is $0 as it enters following month. 
    • Sometimes it is hard to stick to the limit, then I have the cash cushion (from previous months’ savings, step 6) to dip into. 
  6. 5-10% savings for vacation/travel, fun, cash – diverted to a high-yield online savings account. 
  7. Keep track every Saturday morning using Y.N.A.B. 

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Posted in Personal finance, Spending

Good Buy or Good bye a house purchase

I had been thinking of upgrading to a bigger house for some time now. This is a difficult decision when you struggle to justify more debt, more wants and lifestyle creeps.

There are various factors to consider in deciding whether you buy that next dream house or say goodbye to your wants for a duration, till you are better prepared.

There are two aspects to this –

  • a numerical analysis
  • a behavioral analysis

Numerical Analysis

white graphing paper

What can you afford?

It is definitely not what the lender tells you in a pre-qualification or pre-approval letter.

You have to see the following numerical aspects in your finances.

  • Do you have cash for down payment? Usually 10-20% of the purchase price is a good thumb rule. 20% is better to avoid Private Mortgage Insurance, which will increase the monthly payment otherwise.
  • Add the mortgage payment to other costs like Property Taxes and Insurance.
  • Are there any up-front rehab costs? Can you get those repaired by the seller?
  • After adding up all costs, adjust your monthly budget to see where you will stand once you buy this house.
  • See the impact to your net worth and asset allocation once you spend the cash for down payment. Although it moves from cash to Home Equity, it can skew a previously well thought out asset allocation across stocks, bonds, real estate and cash.

What should you pay?

There are two main items where you have to shop around and get the best deals out there.

  • Purchase price. Since here we are dealing with numbers, the only thing that matters is whether you are paying too much.

    • List price offer or a multiple offer situation can quickly escalate the price and throw all deals out of the window.
    • Assess what all rehab needs to be done. It is better to get a contractor estimate during the inspection period, so that you can back out if found expensive.
    • Try to buy 10-20% below the price after subtracting any projected rehab expense.
  • Interest rates – This will depend on your credit score and the interest rates available in the market.

    • Getting estimates from various lenders will help compare the best rates.
    • Take into account closing costs and points as these can be significant and varies quite a lot across lenders.

What are the future costs?

A house purchase does not end with the closing. In fact, in terms of expenses it has just started.

Many people take on big house purchases only to realize later that the recurring costs or the holding costs of the property are too high and severely constraint their finances.

  • Holding costs

    • After you have accounted for the P.I.T.I (Principal, Interest, Taxes and Insurance), you need to make sure you still have enough slack in your budget to save for unforeseen expenses.
    • You need to have a cash cushion (preferably separate from your 3-6 months worth of emergency fund) for this property. The HVAC can go bust, the roof may get damaged in the next storm or there could be a disastrous water damage.
    • You also need to consider increase in Property Taxes and Insurance year after year.
    • To correctly account for the holding costs, you need to budget an amount every month and sock it away in the Home Maintenance Fund.
  • Future sale or rent value

    • No one stays in the house forever. You will also move at some point.
    • It is important to decide how you project the use of this house once you move out. Do you plan to convert it to a rental or sell it?
    • Decide on a tentative time frame when you may move out. Based on this and the neighborhood real estate projections, find out what the future sale value or rent will be.
    • Will the rent cover all the P.I.T.I expenses per month? Add a few more expenses like reserves for maintenance, capital expenditures (big expenses like roof),  property manager (whether you use or not, just budget for it). To effectively analyze this, learn about Cap rates, Gross rent value etc.
    • If you plan to sell it, will the appreciation rate be enough to justify your costs, with a sale commission of 6% and all the money you will spend on Property Taxes, Insurance and upkeep of the house over the years.

After you can define a good deal by satisfying most (if not all) of the above parameters, it is time to take stock of some behavior patterns.

Behavioral Analysis

woman wearing white dress standing near building

Do you really need to upgrade? What are you going to sacrifice?

Often it is our wants that itch us constantly to make that lifestyle upgrade. Whether it is keeping up with the Joneses or simply growing out of your current residence, it is a natural behavior trait for most people.

Answering the following questions may steer you to a better decision.

What is the motivation? A better neighborhood, schools or simply more space?

What exactly is the motivation? Is it due to moving to a better neighborhood, or moving to a better school zone? Or is it that the family grew and everyone needs more space?

This should be evaluated purely on basis of needs. For example, for more space can you rearrange or sell off unnecessary furniture and create more space in the process?

How will you clean and maintain the bigger house?

While buying a bigger house sounds exciting, think about maintenance. A bigger house brings in more maintenance headache. And we are not talking about money expenses here (we did that in the numbers section), but the overall energy you will need to keep it clean, mow the lawn and maintain the appliances, carpet etc.

Do you like more debt or want to manage debt?

For most people, buying a house with cash is not an option. So invariably you will take up a larger mortgage, whether you have one currently or not. Overall your debt increases. This has to be justified by the future stability of your job or the state of the industry or business you are dependent on. Or simply the peace of mind and how much debt will still keep you comfortable.

Is this going to be your long term buy?

If you buy a house (not an investor deal) and turn around to sell it, you will lose a bunch of money. Even after few years, it is difficult to break even. So if you are not staying in the house for longer, it will be another expensive switch few years down the line.

Thus it is better to justify all the needs and factors and make sure it will be a long term buy.

Can you rent first and then check out similar homes in the area?

Often the reason could be to just move to a better neighborhood for schools, or get more space. However instead of finalizing a buy, you can always rent a house in the desired area and then check out better deals as they hit the market.

This has the disadvantage of spending some money on rent, but in this section we are analyzing non-numerical aspects. Renting for a year or two will give better idea of the neighborhood, bigger house etc. and better justify the buy decision for a longer term.

Conclusion

All the above factors may seem daunting and may not be possible to satisfy to make a rational decision.

Some of the factors like rent to value ratio can be area specific. If your area is very expensive, then some of the numerical analysis will not give favorable results.

Hence it is important to consider other factors and take an overall informed decision.

This will also prevent the almost inevitable buyer remorse which is very common as you inch towards the closing date.

Once you take a decision, enjoy your mansion.

concrete building surrounded with flowers near roadway
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