Taxes, Frugality and Investments

In the world of FIRE, it becomes easy to see how all things financial (decisions, transactions, etc.) are interrelated. When I was working on our tax returns for 2016, I could see easily that “bad” news from TurboTax meant that there was good news with investment results. And we would not have the investment results that we do without Captain Frugality at the helm of our financial ship.

2016 Taxes

No Tax evasion here. Just tax planning

Imagine my horror when I discovered that we owe (GASP) $1,563 to Uncle Sam and $800 to the state. But actually, the fact that we owed a little more this year means that we had a good 2016 financially. And although I would rather not owe $2563, it’s far better than getting a refund. Essentially we got what amounts to a $2563 interest-free loan from the US Treasury and the State of Oregon. Thanks, fellow citizens!

Many years ago I received a $6,000 refund and thought I hit the jackpot. It was during my Horrors of Car Debt (and other debt) phase, and I could have used that cash to pay something off or invest. Of course, I spent it.  Treating a tax refund as “found money” and using it to fund a vacation or buy a new flat screen TV is a sure way to keep punching the clock until a ripe old age.

Taxes When the Grumbys Retire

One of the most eye-opening bits of information I have read in the blogosphere (?) is by keeping spending and income low, minimizing or avoiding taxes is pretty easy.  GoCurryCracker wrote this article about it, and he is in his 4th or 5th year of full time world travel with a wife and small child, living on his investments and paying no taxes.

As you may have read in another post, 2017 will be our last full year of employment. We plan to work 4-5 months into 2018, after which our tax liability should plummet. Here’s how:

  • We can earn up to $20,700 of ordinary income before the tax tables kick in. (Standard deduction is $12,600, plus personal exemptions of $4050 x 2  = $20,700.)
  • In addition, we can earn an additional $75,900 (!) in long term capital gains and qualified dividends, with ZERO federal liability. Look it up. Let’s see how much Mrs. Grumby and I can have to spend in retirement tax free:
  • $20,700+$75,900=$96,600!!!

Now, the idea that Mrs. G would want to spend $96,6000 is completely ridiculous, and that amount is unnecessary for our lifestyle, especially since we live on less than $60k now. But by running the numbers and applying a strategic withdrawal strategy we can control our tax liability.

Thankfully, a tax bill of $2563 is just a bump in the road for our 2017 expenses. We’ll easily be able to make up for it by tightening our frugality belts in other areas. Mrs. Grumby will offer some ideas in the Monthly Downsizer post for March.”

Is Frugality Really Necessary?

To some people, the word “frugal” means being a cheapskate, or living in poverty and eating Ramen Noodles every night. The “norm” is to throw money at shiny things that that really bring little or no value to our lives, eat out 3-4 times a week and buy new cars every few years. There is a lot of skepticism that reducing expenses can make a difference, but the truth is pretty obvious.

By reducing spending by only $2500 per year and investing that money at 7%, you will end up with $112,000 in 20 years. If that doesn’t make a substantial difference in your retirement planning, I’ll eat my hat, as long as it is a hat made out of bacon or Cocoa Puffs. Double that to $5,000 and you’re looking at a quarter million in 20 years!

How can most middle-income Americans find $5,000? Here are some easy, relatively pain free ways. The amounts shown are what the average American spends per year.

  • Daily coffees – $1,100 per year. What, you’re too good to brew your own?
  • Cable – $960. Get Netflix, Hulu or Amazon Prime.
  • Dining out 3 times a week – $2700. Go out twice a month and learn to cook some easy, healthy meals.

Total = $4,760. Bingo! Put it in VSTAX every year and you will be rich.

As a past frugal shamer, I understand the tendency to associate frugality with misery and deprivation. For you, here is an excerpt from in interview with Mr. Money Mustache in Marketwatch:

 

Q: Some people might think so much cost-cutting is akin to living like Scrooge and not having any fun. How would you respond to that?

 MMM: If you tell yourself that is how it will be, then you will create your own truth and life will not be fun. But if you understand the fundamentals of what it means to be a happy person, you realize that buying more stuff for yourself has no relationship at all to how happy you are. These fundamentals include things like close relationships with other people, health, rewarding work, a chance to be creative and help others.

 

So while it’s easy to make excuses justifying frugality-avoidance (I think I just invented a new condition- Frugality Avoidance!), excuses solve nothing. I used to be that person, and can tell you first hand that drastically reducing wasteful spending has had a dramatic positive impact on my financial health.

Managing Our Own Investments

Mr. Grumby is king of all he surveys after vanquishing the bloodthirsty tax and investment hordes

Frugality also makes a difference when it comes to investing. Fees paid to planners and embedded in mutual funds are the hidden monster in the closet. What you save on investment expenses goes directly to your returns.

After many years of working with a financial advisor, we decided to set out on our own. We were paying 1/2 % to the manager, plus exorbitant expenses in some of the funds, as high as 1.86%! Why is this important? The simplest way to look at it is your rate of return is essentially reduced by the expense ratio. A fund earning 7% with an expense ratio of 1.86% nets you 5.14% after fees are deducted. In a $500k portfolio earning 7% for 10 years, that can cost you $140k or more.

High fee funds do not perform better over all. For example, the Vanguard VTSAX fund, with a .05% fee, performs better than most actively managed funds at a fraction of the cost. Jim Collins’ book The Simple Path to Wealth and other sources, such as The Frugalwoods, Mr. Money Mustache and others inspired us to step out on our own. Managing our investments requires work and a little research, but it does not have to be complicated or expensive.

How are you managing your taxes and investments? Are you intimidated by the do-it-yourself idea?

  2 Replies to “Taxes, Frugality and Investments”

  1. Kathleen
    March 22, 2017 at 10:04 pm

    I will have a ridiculously ginormous overpaymentof taxes this year, but have opted to apply it to next year’s taxes instead of having it sent to me. Now for all my estimated tax payments I make this year, I’ll put the remainder of what I would have had to pay into investments. Of course notoverpaying in the first place would have been better, but this works, too.

    • Mr. Grumby
      March 23, 2017 at 8:49 pm

      That’s a good idea, and I assume you pay quarterly because of your self-employment status. I wonder if most retirees pay quarterly?

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