With 2018 coming to close, it’s time to look back and see what happened on the site during the previous twelve months. For those of you that aren’t familiar, each year I put together an annual reflection (see here for the 2016 report and 2017 report) where I highlight the profit / expense / purpose of the site.
Why? Because I think it’s a good idea to catalog what happened over the previous year and because I think it’s important to highlight the conflict of interest that exists for anyone writing about money.
While most of you know that I’m a practicing M&A lawyer in NYC with a healthy income from my day job (i.e. no need to sell you out), I’d rather expose the conflicts of interest so that you can evaluate the information on this site and make your own informed decisions.
Plus, I like to remember why I started this crazy project in the first place.
First and foremost, big love to all of the readers, many of whom come here regularly. I love your emails and the conversations we have. Who knew that there were so many lawyers interested in digging out of the financial grave that is your student loans and finding a piece of the good life. I may not respond immediately but I read each one and try not to let any slip through the cracks. If you haven’t heard back from me, feel free to email again. I don’t mind.
Without the emails, comments and in person interaction, I doubt I’d have the motivation to keep the site going for so long. But each time I hear from someone who gets super passionate about personal finance thanks to coming across this site, I feel like the whole project is worth it.
I specifically want to thank all the people who have linked to the site, who shared the site on social media and who recommended the site to their colleagues. It’s really the best way to get more lawyers excited about getting started with their own person finance journey.
Why Does This Site Exist?
The Biglaw Investor has a three-fold mission:
Education. Help lawyers, law students and other professionals learn about personal finance, investing and financial independence. This means we cover Biglaw, MidLaw, SmallLaw, SoloLaw and GovernmentLaw (and any others I forgot). Lawyers may have diverse starting incomes but the ideas in these pages are applicable to everyone. Simple and consistent investing wins the day for everyone.
Community. Form a community to connect readers with similar readers, so we can learn together. I don’t pretend for an instant to know everything. In fact, the deeper I dive into subjects it’s more likely that I expand my understanding of what I don’t know. But over time we’re putting together a comprehensive set of information on this site with the collective knowledge of thousands of people, including experts in their particular field or experience. Even better, as the site grows – and after tons of filtering – we’re starting to connect with the “good guys” in the financial services industry. Believe me, they do exist! Working in law can be an isolating experience, regardless of whether you have a high salary or a low salary. We’ve each worked hard to earn a JD (or other professional degree) and get admitted to the bar (or otherwise licensed) and I’d like to see everyone achieve financial security as a result.
Entrepreneurship and Creativity. I am motivated to express my entrepreneurial spirit. That is to say, to make money for me, my family, and allow me to create as many jobs as possible. The site is a “for-profit” venture as much as typing into the internet counts as “for-profit”. As I’ve said before, I make plenty of money at the day job so you don’t have to worry about me selling you out for a $100 paycheck, but I still think it’s important for you to know how the site makes money so you can evaluate the recommendation appropriately. I know that’s why a lot of you are reading down this far anyway – does this guy actually make any money with this site?
Readership. This year the site had over 288,000 pageviews (compared to measly 385,000 pageviews last year) generated by over 224,000 visitors (nearly a quarter-million – we will surpass that next year). There’s been a lot of readers even with the dip in productivity described below. I attribute that to the fact that each day a new lawyer finds the site and decides to join the journey, even if there hasn’t been as much content as I would like to produce in the second half of 2018.
Productivity. I managed to hammer out 43 posts in 2018, which is dreadfully lower than last year. While the corporate M&A work certainly played a role in the lack of posts (it was a busy year for M&A across the board), most of the damage came from my wife’s pregnancy. I haven’t written about it on the site but we are days away from welcoming our first child into the world and we will be one of the rare sets of parents that look forward to the sleepless nights with an infant as a respite from the pregnancy. I look forward to destroying the myth that children are expensive and to establishing a new rhythm that allows for more writing than I was able to produce in 2018.
From the beginning, I’ve disclosed that this is a “for-profit” venture. I generated a whole $5.18 in revenue in the first year of blogging, so I didn’t (and still don’t) expect to get rich from typing words into a keyboard for a website. Yet, the business side of blogging is fun and the money keeps me motivated, even if it’s not exactly a particularly financially valuable use of time.
I continue to turn away 90%+ of people who want to advertise on the site. In fact, the soon-to-be-released redesign of the site (shh!) gets rid of the side bar entirely. I didn’t like the way it looked. I imagine you didn’t like either. In a world where we are bombarded with ads, I didn’t want to contribute to that by having a sidebar screaming for your attention while you read the content that brought you to the site in the first place.
Additionally, the sidebar didn’t really make sense. One of the quirks of this site is that I get a lot of requests from readers for financial professionals that can help with things like financial planning, student loan strategies and insurance products. In hindsight these requests make sense. The financial services industry is full of people who will gladly “help” you by taking your a slice of your money. The problem is sorting through the sea to find the good people and that’s exactly what I’ve been doing over the past two and a half years. Those people show up on the site and are people that I would (or have) worked with to solve a particular financial need.
I’m in no hurry to exploit those relationships as I want to find partners that will provide value to readers for years to come (in essence, a win-win-win situation).
This year those relationships added up to $27,889 in annual revenue. Nearly all of that money was reinvested back in the site. I haven’t tallied up my final expense numbers but I doubt there will be much profit. While I could cut the expenses to the bare minimum and take the cash for myself, I’m much more interested in building a sustainable site that can live here as a resource for future law students and lawyers.
This year that hobby led to revenue equal to about 7.6 weeks of work as a summer associate in a Biglaw firm. Not bad.
Conflicts of Interest
As I mentioned earlier, the conflicts of interest in writing about finance and investing are impossible to avoid. I think about them, document them here and try to do what I can to minimize them. Yet, even if the site was “non-profit” I would still have conflicts in deciding how to answer some of the questions below. What are examples of some of these conflicts?
This site makes money thanks to its student loan advertisers. Is refinancing your student loans best for you? For the vast majority, I think it makes sense to refinance your student loans if you intend to pay them off. On the other other hand, if you’re pursuing PSLF or some other forgiveness program, it doesn’t make sense to refinance your student loans. Because I write about student loans I have a financial interest in you deciding to refinance! That’s not ideal. I’ve reduced this by negotiating cashback bonuses with the student loan refinancing companies so that you get most of their advertising budget but this hasn’t eliminated the conflict.
What order do I put the student loan companies or other affiliate partners? Do I organize them by the best cashback offer for you? By the lowest interest rate? By the ones that pay the site the most? See what I mean. Someone has to decide how to order them and the order does matter, since readers are more likely to examine the first few rather than the last few.
I may have described my foray into real estate crowdfunding as more interesting / fun and less stressful than it actually is.
I have referred a few of you to Amazon to buy books that you could have checked out for free at the library. You might have spent more money at Amazon than you intended, thus increasing unnecessary consumer spending.
Should you get a 0% down PMI-free mortgage just because you’re a lawyer? It’s definitely going to cost more than putting down 20% for a conventional mortgage but if you’re going to buy a house with less than 20% down is there a better option?
I may have suggested that you need life insurance when you don’t really need it.
As you can see, there are conflicts everywhere. One thing I try really hard to achieve is that while we may not be completely aligned, we’ll be mostly aligned every step of the way. Regardless, you should know about these conflicts when making your decisions about financial products. So many sites do absolutely nothing to tell you about these conflicts besides throwing up a tiny disclaimer link.
The Roadmap Ahead
New Visual Identity / Site Redesign. One of the toughest things about blogging is that what you see on the site is truly the tip of the iceberg. I receive enough emails that I could easily just keep answering them and it’d keep me busy for the rest of 2019. Unfortunately, that isn’t very good for the vast majority of you that are just looking for a resource on the web! On top of the admin stuff, I’be buried myself deep in a project redesigning the site. I wanted to create something permanent and I’m excited about what we’ve done so far. Unfortunately, it’s not quite ready to share just yet so you’ll have to trust me. I hope it’s something I can share with you in Q1.
Running A Business. Last year I said I’m starting to treat this site more like a business. If that’s true, I can’t say I’m doing a great job but I do think I’m getting better. There are now several people who have their hands in this project, from keeping WordPress fresh and backups on the shelf to making the glossy exterior A+ (trust me, you’ll see it soon). It’s been fun to learn project management skills completely outside of the legal world. I have a newfound respect for everyone that is running a team out there!
How You Can Help
This site grows by word-of-mouth.
You like it. You tell your friends. They like it and they tell their friends.
Then you get to talk to your friends about financial independence and we all win.
There are over 1.3 million lawyers in the United States (plus 110,000 law students), so we’ve only begun to scratch the surface. It’s the students that could use the financial education the most, as most law schools do not have classes on personal finance. Please take a moment to forward (or post on an appropriate forum) the The Biglaw Investor to someone you think could benefit from the site. Sharing the site is the single biggest thing you can do to spread the word.
Again, I’d like to thank the readers. I know this isn’t the typical post but I hope the disclosure and discussion increases your trust in the information provided on the site. Given that the web is the Wild Wild West, when I’m visiting sites I often find it difficult to understand whether the information is biased by the fact that the author is receiving some form of compensation. I hope that by writing it down for you – and by knowing I’ll be writing these posts each year – it keeps the conversation clear, so we can get back to talking about finances and investing.
Many people fall victim to the trap of focusing on reducing taxes in April of each year as they prepare their tax returns. Unfortunately, they soon discover that by April it’s too late to implement anything. Your bill is simply due and you must pay.
The real opportunity to reduce next year’s tax payments comes in the steps that you can take this year and even though November is almost over, there are a few more things you can do. It’s what you do between now and December 31st that counts.
Here are eight ideas to help you jumpstart your tax savings planning.
Max Out 401(k) Retirement Accounts
If you’ve been reading this site, you’re probably already maxing out your 401(k) account. For high-income lawyers, stuffing as much pre-tax money as possible into a 401(k) account is a great way to reduce your tax bill today. But what if you have been contributing but haven’t been maxing it out? Or what if you don’t have a 401(k)?
For 2018, the IRS set contribution limits for most investors at $18,500 (if you’re over 50, you may be able to make catch-up contributions of up to $6,000). If you haven’t fully maxed out your 401(k) already this year, you still have a few more weeks and paychecks to contribute as much as possible. Many employers will let you contribute up to 80-100% of your paycheck to a retirement account.
If you have savings in a cash account and would like to “contribute” it to a 401(k) (which can’t be done), by contributing 100% of your remaining paychecks to a 401(k) account and using the cash savings as living expenses, you’ll achieve the same result.
If 100% seems too aggressive, try contributing 50% of your paycheck while living off the cash savings.
If you feel that it’s too late to max out your 401(k) this year but would like to do so next year, don’t wait until January 2019 to get started. Use the rest of 2018 as a trial period for 2019. Determine how much you would need to contribute every month in order to max out your 401(k) in 2019, then adjust your current savings to meet that monthly rate (e.g. if you need to contribute 10% of your paycheck in order to max out your 401(k) in 2019, begin contributing 10% of your paycheck starting today). This will allow you to test out living on lower take-home pay for a short amount of time and ensure you’ll be able to hit the ground running – or rather, saving – in 2019.
2. Max Out Traditional IRA or Roth IRA Accounts
Similar to 401(k)s, you can also max out other retirement savings vehicles to help boost tax savings. Traditional and Roth IRAs are ways for workers to save either in addition to or in place of employer-sponsored plans.
Your income will dictate if you can use these vehicles and which contributions are taxable versus tax-free. In general, with a Roth IRA you pay taxes on the amount you contribute today, but you get to withdraw your savings tax-free in retirement. In contrast, with traditional IRAs you make contributions on a pre-tax basis, but you have to pay taxes on withdrawals in retirement.
For many lawyers at certain income levels set by the IRS you may not be able to contribute to a Roth IRA or make tax-free contributions to a traditional IRA. If this is the case, you can probably make a “backdoor Roth IRA” contribution. This will allow you to save an additional $5,500 in a tax-protected account this year. If you have a spouse, you can also make an additional $5,500 contribution in your spouse’s account regardless of whether that spouse has any earned income this year.
You may think of your Health Savings Account (HSA) as just a way to use pre-tax money to pay for qualified medical expenses in the current year. HSAs are more powerful than that, however.
HSAs are triple-tax-advantaged, meaning the money isn’t taxed when contributed, as it grows or when it’s used (if used on qualified medical expenses). Even better, HSAs aren’t “use it or lose it” which means that you will always have access to your HSA and if you never use it for qualified medical expenses, you’ll be able to withdraw the money in retirement without penalty as if it were a traditional IRA.
These accounts have relatively low contribution limits, but if you have a high-deductible medical plan it probably makes sense to maximize your contributions each year. Many investors are treating these as Stealth IRAs.
4. Understand How Taxes are Impacting Your Decisions
If you’re already dominating your retirement accounts, the end of the year is a great time to think about how the tax code impacts other life decisions. For example, what are the state and local tax rates where you live? Is there anything you might consider doing that could reduce those?
This year I finally took my own advice and we moved out of NYC to the surrounding area. Not only did my commute dramatically improve (surprise!) but for seven months we haven’t been paying the 3.85% NYC income tax. We used that money to increase our standard of living in what I’ve been telling everyone is a “revenue neutral lifestyle upgrade”. It’s been nice to let the City of New York pay for our nicer apartment by moving outside of the City of New York.
Are there similar decisions you might be making in the near future?
5. Take Advantage of Tax-Loss Harvesting
The stock market goes up and the stock market goes down. All we seem to know for sure is that historically, over long stretches of time, the stock market goes up. When the market goes down, those of us in the accumulation phase of life are generally happy to buy stocks at a discount but there’s another tactic available to catch a tax break when the market takes a dive.
Each year you are allowed to deduce up to $3,000 in net investment losses on your tax return. In other words, if you lose money in the market, Uncle Sam is there to share in your pain. That $3,000 loss can be applied against $3,000 in income, thus eliminating the need to pay income taxes on the $3,000 that you earned.
But who wants to lose money, right?
If you have $10,000 invested in the market and stocks fall by 30%, your portfolio is now worth $7,000 and you’ve incurred $3,000 in paper losses. If you sell that investment and purchase a similar asset, you’ll lock in the $3,000 loss, which you can now use to offset $3,000 in income.
If the securities recover to their original position, you’ll now have a portfolio worth $10,000 and a capital gain of $3,000 (the gain from your purchase price of $7,000 to the value of $10,000). You’ll have to pay capital gains taxes on the $3,000 but those capital gain tax rates will probably be 15%. Meanwhile, you’ll have saved paying taxes at ordinary income tax rates.
Save paying taxes on $3,000 at ordinary income tax rates and later pay taxes on $3,000 at capital gains tax rates? That’s a trade I’d be willing to make every time. This is known as tax-loss harvesting.
6. 529 Contributions
For some reason, tuition for higher education in America keeps rising much faster than the rate of inflation. One way to help your offspring potentially avoid crippling student loans, while realizing some tax benefits for yourself, is to open a 529 account.
With a 529, you can contribute dollars (taxed by the federal government but not taxed by your state) into an account that grows tax-free and can be withdrawn tax-free if used for qualified education expenses. These plans are sponsored by states, although you don’t have to use your state’s plan.
529 plans don’t have the obvious benefits that you get from retirement accounts. For one, you’re only saving on the state and local income taxes. Live in Texas or another state with no income tax? The value of a 529 drops tremendously. Live in NYC where you’re paying both state and city tax? They start to look a little more appealing.
I would prioritize retirement account contributions first, but if you have additional money to save and either have children or are planning to have children, 529s are worth investigating.
7. Stay on Top of the Tax Code
I know that staying on top of the tax code and recent change in the Tax Cuts and Jobs Act of 2017 is probably not your idea of a good time. But we made it through civil procedure, right? With the last weeks of the year slipping away, take this opportunity to dive a little deeper into next year’s tax code. Patience and determination are your friend here.
Here’s a few of the highlights coming next year:
The child tax credit doubled to $2,000 per child under 17
There are incremental changes to the seven individual tax brackets as outlined below
8. Evaluate Business Expenses
If you run your own business (and really, everyone should), keep in most of your business expenses are deductible against your business income. Don’t get caught into the trap of thinking that running your own business means having a auto repair shop on the side.
With the gig economy in full stride, if you’re participating in most of those activities, you’re likely working as an independent contractor and receiving a Form 1099 at the end of the year. That means that you’re already running your own business, even if it’s just as a sole proprietor.
Businesses are allowed to deduct their expenses. You can reduce next year’s tax bill if you start to track you’re expenses this year. Now is a great time to begin paying attention if you hadn’t thought of this before. Even if you only made $1,000 last year driving Uber, shouldn’t you reduce the portion of that income that is taxable by as much as possible? Expenses like gas, repairs and your cell phone bill are likely deductible.
Let’s talk about it. Which of these strategies are you currently using? Which do you need more information on? Let us know how you plan on using the last few weeks of the year to maximize your tax savings.
This might be a little basic for some readers but I receive plenty of questions relating to Roth IRAs where people just want a simple step-by-step guide on how to open one at Vanguard. If that’s you, here’s what you need to do.
First, a little background on the Roth IRA.
The Roth IRA is one of the tools you have to fund your retirement. You contribute with post-tax money, which means no up-front tax benefit today but that all of your investment growth (e.g. dividends and capital gains) will be tax-free.
Besides this obvious tax advantage which makes the Roth IRA an appealing investment vehicle, here’s a few other benefits:
No required minimum distributions. There’s no requirement to take money out of your Roth IRA as you get older. This is different from Traditional IRAs and 401(k)s which require you to start taking mandatory distributions when you reach age 70 1/2. This is valuable for tax planning purposes later in life.
It eliminates tax rate risk as the money will be tax free in the future (i.e. you don’t need to worry about whether tax rates will go up or down in the future).
Perfect vehicles for tax-inefficient investments like REITs, taxable bonds, bond funds, peer-to-peer lending or TIPS that are often taxed at your ordinary income rate.
Unlike a 401(k), Roth IRAs can be invested in virtually any investment that interests you because you set up your own account.
In many states, Roth IRAs are exempt from determining your assets should there be a liability judgment against you.
Anyone who has earned income can contribute up to $6,000 (starting in 2019) to a Roth IRA and another $6,000 to your spouse’s Roth IRA (whether or not your spouse is working).
However, there are a few complications if you make “too much” money:
You can only contribute to a Roth IRA if you’re a taxpayer and either earn below $122,000 if you’re a single filer and $189,000 if you’re jointly filing (note this limit changes yearly)
These restrictions are easy to bypass by making a “backdoor contribution” which involves converting a non-deductible Traditional IRA into a Roth IRA.
In this guide, we’ll be talking about how to open a Vanguard Roth IRA account if you’re below the single filer or married filer income limits mentioned above. If you need further insight into the “backdoor contribution”, be sure to read this article.
By clicking “Open an account online” you’ll be provided with an overview of the account opening process and will be guided through a brief questionnaire on how you plan on funding the new account.
You can fund the account in three ways:
Check or transfer from your bank or another Vanguard account.
Rollover from an employer plan.
Transfer from a financial institution.
After choosing the option that makes sense for you, you’ll then be notified of the key information you’ll need (routing and your account number at your bank, current employer’s name and address) to open an account as well as the overall account opening process.
Following this page, you’ll go through five steps in order to complete opening an account and selecting your appropriate Roth IRA fund.
Create a profile
The first step in the process is choosing the specific account you’re looking to open.
In this case, start by selecting Retirement as the reason for why you’re investing followed by selecting the Roth IRA as your account type.
Following this page, you will need to fill out your profile – providing basic information such as your name, gender, birthdate, SSN, email, mailing address, citizenship status, and employment information.
After completing your account profile, you’ll be asked for bank account information so Vanguard can help pull the necessary funds into your account. Here, start by choosing your desired funding method, whether that’s an electronic money transfer, check, or simply skip the step to add funds in later.
For the screenshot below, I’ve illustrated the information you’d need to move funds via electronic money transfer. Note, for this process, the funds will be withdrawn from your bank account within 1 to 2 business days after your account has been approved.
After entering the necessary banking information, the next step is determining the initial contribution amount for your Roth IRA account (note that the screenshot shows a maximum of $6,500 because the limit in 2018 was $5,500 plus there is an additional $1,000 contribution amount available if you’re over 55).
This will lead you to a screen where Vanguard will ask whether you’d like to reinvest your dividends and capital gains or transfer the money to a money market settlement fund. Select Reinvest.
Review and e-sign
Now that you’ve completed filling in your application for opening up a Roth IRA, it’s time to review. Be sure to check the details over and if at this point you’re wondering when you’ll be selecting what to invest in, don’t worry this will happen later in the process.
Sign up for web access
The next step will be to quickly register for online access so you can control your account online, change your profile information as needed, view your transferred funds, and carry out other functions.
Next steps after you open the account
After 1 – 2 days, Vanguard will notify you via email that your account has been confirmed and that they’ve received your funds. In this email, they’ll illustrate next steps and walk you through how to select the specific fund you’d like to invest in. But basically, your money is sitting in a Roth IRA settlement fund (i.e. it’s in cash) and you need to decide what to use that cash to purchase.
A Roth IRA account is a powerful wealth building machine and a great investment vehicle. By following the above steps, you should be on your way to successfully opening up your Roth IRA and having your money work for you.
In the 1973 book, “A Random Walk Down Wall Street,” Princeton University Professor Burton Malkiel made the controversial statement that “A blindfolded monkey throwing darts at the newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts.” From what I understand, most people didn’t take the statement too seriously, and certainly, over the years the asset management industry continued to grow substantially.
But ever since then a debate emerged around active versus passive funds, and if active managers are really worth the expense ratios they charge.
As evidence has mounted that it is incredibly difficult for active managers to outperform their indices, especially over the long-term, more money flowed into index funds given their low expense ratios.
Recently Fidelity surprised everyone by introducing a new “zero fee” index fund with no minimum investment.
So, lower expense ratios mean better, right?
Is Fidelity’s Announcement Revolutionary or Just a Marketing Ploy?
In August 2018, Fidelity announced the launch of two new zero-fee, zero-minimum account balance funds. The first two funds were US-based Fidelity ZERO Total Market Index Fund and internationally-focused Fidelity ZERO International Index Fund. In September 2018, it launched two more: Fidelity ZERO Large Cap Index Fund and Fidelity ZERO Extended Market Index Fund. These funds have 0% expense ratio and no minimum investment amount.
Market participants poured more than $1 billion into these funds in just a few weeks. In the fee wars between index funds, it seems like Fidelity may have won. However, even with this swift inflow, Vanguard continues to be the market leader with $5.1 trillion in assets under management (AUM) far outpacing Fidelity’s $2.1 trillion AUM.
It seems to me that Fidelity is making a marketing ploy here. In a crowded index fund market where firms have been trying to gain market share by lowering fees, they are offering a loss leader. They are willing to take a hit on the administrative expenses of running these funds with the expectation that they will make money on other products. This may help them chip away moderately at Vanguard’s market share, but I believe there’s more to an index fund than its expense ratio.
Still, the idea that you could own an index fund with zero fees interested me because perhaps smart investors should take advantage while eschewing Fidelity’s other high-priced products.
How Do Fidelity and Vanguard Funds Compare?
Vanguard also offers index funds that are representative of the asset classes the new Fidelity funds cover: US stocks of all market capitalizations (Total Market Index), international stocks, US large cap stocks and US mid and small-cap stocks (Extended Market Index). However, there are many differences between the two fund shops.
As explained in the intro, the new Fidelity funds have a 0% expense ratios and no account minimums. Vanguard still has expense ratios and minimums; however, these vary depending on which share class you are invested in: Admiral, ETF or Investor Shares. Admiral shares typically have the lowest fees but highest account minimums whereas investor shares typically have the highest fees but the lowest account minimums. Fees and account minimums for ETF shares are in between the two other share classes.
Currently, the new Fidelity funds are only available as index mutual funds. In contrast, the Vanguard funds are available as index mutual funds and ETFs (exchange-traded funds). Some people prefer ETFs to mutual funds, but I’m happy to invest in mutual funds.
What’s Really Important When Choosing an Index Fund?
Index funds seem to have become the default investment vehicles for people who don’t want to think much about their portfolios. However, even those investors who just want to own the index still have decisions to make: Which asset classes? Which fund families? How to diversify? How often to rebalance? While investing in index funds may seem lower stakes than choosing actively managed funds, given the lower expense ratios, there are still many factors that influence wise investors’ decisions:
Yes, expense ratios are important. However, the real savings come when you switch from the average actively managed mutual fund to a low-cost index fund not when you switch between two low-cost index funds. On average, actively managed mutual funds have expense ratios that range from 1.3% to 1.5% whereas index funds have expense ratios that are considerably lower at 0% to 0.20%. For example, for a $10,000 portfolio, you would pay $150 in annual expenses for the industry-average mutual fund versus $20 for the index fund, netting you a savings of $130 by switching to the index fund. For the same portfolio, if you switched from the 0.20% fund to the 0% fund, you would only save $20.
Index Fund Composition
Index funds often don’t hold all of the securities in an index. Instead, they are constructed as a representation of the index, including sampling and optimization. In general, a broader, more comprehensive representation of an index is better for investors who are trying to mimic the performance of the index. A more concentrated portfolio with fewer holdings may not be as representative of the performance of the index. Vanguard’s funds include more securities (i.e. 3,654 vs 2,500 companies) and therefore are more likely to closely resemble the market versus Fidelity’s funds. Granted, the extra 1,154 companies are probably very small, but I’d rather own the whole market if possible.
Expense ratios aren’t the only fees that these funds can face. Taxes count as fees if the funds are held in a taxable account. An investor may incur taxes if the fund experiences capital gains during periods of rebalancing. Historically, Vanguard’s funds have been relatively tax efficient. It’s unclear whether the new Fidelity ZERO funds will be as tax efficient as their Vanguard counterparts. The smaller portfolio composition could potentially lead to higher taxable events if index rebalancing results in more capital gains being passed to investors.
Fund managers love (or are forced by the SEC to love) the disclosure, “past performance is no guarantee of future results,” so I know that a longer track record doesn’t mean one fund is better than the other. However, there is currently no proof that the new Fidelity funds will mimic index performance as promised. Fidelity is a good fund shop and they know what they’re doing. They likely back-tested the fund extensively before launching it. However, I’m still holding off for a little more evidence of how the new funds perform.
You can buy index funds on various brokerage platforms. There is typically a fee for each transaction, whether you are buying or selling, although this may vary depending on your account size. Some funds have restrictions on where you can buy them, and if you want to invest in multiple fund families, you may have to have multiple brokerage accounts. Currently, the Fidelity ZERO funds can only be purchased directly through Fidelity.
Both funds seem to take their fiduciary duty seriously and operate with the best interests of their investors front and center. However, I’m partial to Vanguard given the culture that founder Jack Bogle instilled in the firm. The company is owned by its funds, a structure which is thought to better align the interests of the company and its investors. Fidelity is a privately-held company. This is not a bad thing. It just makes transparency around firm-level decisions a little more complicated.
Why Am I Sticking with Vanguard?
The ZERO funds from Fidelity are certainly an interesting market development. It remains to be seen if other fund families follow suit and if this trend significantly impacts Vanguard’s market share. However, given my current asset allocation, size of portfolio and stage of investing, I’ll be sticking with Vanguard.
The difference in fees alone is not enough to convince me that a switch is worth the hassle. I’m not willing to incur the transactions fees associated with selling one index fund and investing in another. Also, other factors mentioned above such as fund composition, tax efficiency, track history and ownership structure weigh heavily in my investment decision.
I’m also curious about Fidelity’s strategy going forward and where they are looking to boost profitability in order to make up for the losses they are incurring with the ZERO funds. The president of Fidelity’s personal investing business, Kathy Murphy has been quoted saying, “It is not a rebate, it is not temporary, it is not a promotional offer. It is permanent.” I expect there may be higher cost services pushed, along the lines of advice for investors, higher-margin money market accounts or access to their digital investing platform. Again, this is not necessarily a bad thing, if these services truly deliver value to customers (or if you simply avoid purchasing them while taking advantage of the ZERO funds).
Ultimately, it’s not surprising that this day has come. As index fund providers kept lowering fees, it was a race to the bottom and now the no-fee fund is here. What are your thoughts about this development? Do you think Fidelity’s announcement is game-changing or just a marketing stunt?
(Biglaw Investor: Welcome back after a long hiatus! One of the greatest sins in blogging is failing to post consistently, so apologies for the lack of updates. If you needed a reminder that I work in Biglaw, consider yourself reminded. With the summer deals wrapped up and fall (winter?) quickly upon NYC, I’m back in the writing saddle and have a lot planned for the coming months. Sometimes it’s frustrating that the readers can only see the tip of the iceberg when it comes to publishing a site like this. There is so much that goes on behind the scenes, and despite the lack of posts, I’ve been working hard on the blog. Recognizing that I’ve hit the limit as to what I can realistically accomplish by myself, I’ve been setting up systems and processes that should allow the site to scale in the future, along bringing in help to handle some of the more mundane blog tasks like WordPress management and image formatting. I’m looking forward to sharing updates with you soon. But until then, let’s take a look at how much money I lost thanks to having to pay extraordinarily high student loan interest rates …)
I didn’t want to write this article.
Ever since I paid off my student loans, I’ve been focused on the future. But a part of me has always wondered: just how much interest did I pay while eliminating my student loans? What if I had been able to refinance my student loans? How much interest would I have saved and what would that have been worth had I invested it in the markets?
Here’s my loan story.
I graduated law school in 2009 in the midst of the Great Recession. Luckily for me, my firm deferred us a few months until mid-January 2010 rather than revoking our offers. When I started working in 2010, I had $191,985 in student debt: six different loans with interest rates ranging from 6% to 8%. At that time, the student loan refinancing companies didn’t exist. You were stuck paying a higher interest rate than Greece. Sure, you could consolidate your loans, but consolidation bundles your loans into one to simplify your payments (and typically rounds up your interest rate by 1/8 of a percent).
With no other option, I focused almost exclusively on paying off my student loans, averaging payments of $2,878 per month from my first day on the job until paying off the last loan.
I kept good records during this awful time. In my first year of working, I paid $12,278.06 in interest alone. I kept such good records because the sheer anger made me want to preserve the number as some future war story I imagined telling (am telling?!).
That’s more than $1,000 a month in interest payments. At a marginal tax rate of near 40%, you need to earn about $1,665 (or $20,000 a year) to tread water by covering the interest payments.
By the time I paid off my loans, I had paid a sickening $49,837 in interest alone! This doesn’t even touch the $191,985 of actual debt. The $50,000 is merely a “thanks for letting me borrow all this money” tip left on a nearly $200,000 bill.
So here’s the math I’ve never done before: what if I had been able to refinance? I could have escaped the brutal 6% to 8% rates. That would have meant less interest overall. It also means that more of my payments would have gone toward the principal from the very beginning.
Refinancing makes a lot of sense once you know that you’re going to repay your loans (i.e., you aren’t pursuing any forgiveness program). By my third year in law school – after having secured an offer from an AmLaw 200 firm – I know that I would be repaying those loans. So, ideally, the best time to refinance would have been as soon as I borrowed the full amount for my 3L year.
I’ll save you the suspense. I would have saved about $22,000 in interest.
How did I get to that number?
First, in 2019, the amount of debt I graduated with would have been a bit smaller, since the balance would have accrued less interest during my 3L year. When prospective law students are calculating their total cost of attendance, they often forget that those loans will be accruing interest while you’re in school.
If I had refinanced during my 3L year, I would have graduated with $187,769 in debt (that’s a savings of more than $4,000 right there.)
Over the life of that loan – assuming I would have made the same average payments of $2,878 a month – I would have shelled out $27,967 in interest.
$49,837 (what I really paid) – $27,967 (what I could have paid with a 3L refi) = $21,967 in interest savings.
What does paying $22,000 less in interest mean?
Let’s lay out some possible knock-on consequences. I finished paying off my loans at the end of 2016. So if I had refinanced as a 3L, in January of 2017, I would have had $22,000 more to invest. At a pretty reasonable 7% rate of return (which factors in inflation), after 30 years that $22,000 would have been worth $178,556.
And what if I could get an 8% rate of return? That would mean $241,010 in 2047.
Let’s split the difference and call it $200,000 in inflation-adjusted dollars. That’s one-fifth of a million dollars wiped off my balance sheet thanks to a ridiculous government program gauging me on interest rates.
What would I have done with $200,000 in 2047?
I have no idea. I’m not 66 yet. But here’s what the younger version of myself thinks $200,000 could mean:
Four fewer years of working (if you’re saving $50,000 a year)
A vacation condo close to the beach in Florida
Opening up an artisanal taqueria just for fun
Paying for college
Starting 529s for the grandkids
Multiple around-the-world trips
$8,000 in extra annual retirement spending indefinitely
The point is, you can do a helluva lot with $200,000. That’s why I didn’t want to write this article. It’s too late for me. I’ve already paid the interest.
It’s (Probably) Not Too Late for You
For several months, I’ve been telling the folks over at CommonBond that they should figure out a way to get comfortable lending money to law students with an offer letter in hand. Without even doing the math, I know that it’d be an excellent deal for future-millionaire-lawyers-in-the-making looking to pay less interest and to pay off their student loans a little sooner.
Well, I’m happy to announce that CommonBond realized this was a win-win scenario and, starting now, you can now jump-start your refinancing plan a year early, based on the strength of your job offer. CommonBond’s offer of loan refinancing for third-year law students is a first in this business. Now, your accepted job offer is proof enough that you’re a safe bet.
That’s huge because every year that you can reduce interest will mean substantial savings (in my case, I would have saved $4,000 during my 3L year alone).
And no, when you refinance during your 3L year, you don’t have to start making payments right away. You still get a six-month grace period after graduating before you begin repayments.
Still not convinced? Refinancing now also allows you to lock in interest rates if you’re worried they’re going to continue to rise. CommonBond calculates your interest rate based on the income in the offer letter, so you should expect the same rate that you’d get if you were refinancing your loans during the first few months of starting a job.
This is an exceptional opportunity offered by a lending team that is paying attention to the market and crafting niche products to benefit you. I can’t think of anything more specific than an offer pitched to 3Ls!
You guys have it lucky.
I want my $200,000 back.
Let’s talk about it. Are you a law student who’s been thinking about refinancing? Are you a recent graduate who has financed with a different company? Let us know about your experience.
It seems like big news, so let’s get to it: we left New York City. That’s right, we are no longer New York State residents. It’s something that I didn’t think would ever happen but here we are … no longer living in NYC.
A bit of background
I first moved to New York City, or more specifically Brooklyn, in the summer of 2008 when I was a summer associate. That summer was right before the Great Recession and so everything seemed to be going well in the world. The housing market had cooled but wasn’t imploding and nobody had heard of the concept of frozen credit markets. I liked Brooklyn so much that after living there for three months, I knew I wanted to stay.
When I returned to NYC after my third year of law school, Brooklyn had a lot of advantages. For starters, it let me feel like there was separation between work and home, even if it was only physical separation. I appreciated having smaller buildings and smaller shops and less people on the weekends and during the evening when I wanted to decompress from working at a major law firm, rents were slightly cheaper than Manhattan, but not cheap enough that you could say I was living in Brooklyn to save money.
It just seemed like the perfect home for me over the years. I moved to different apartments and to different parts of Brooklyn, but I always stayed within the borough. I figured if I ever left New York, it would be to a completely different location in the US and so always assumed that I would stay in Brooklyn as long as I lived in New York City.
Everything was going fine with that plan until water started leaking into our apartment from a hole in the roof. This had been an ongoing problem for several years and each time we complained the building management figured out a way to solve the immediate problem and made the cosmetic repairs to patch the drywall. This would work for several months, sometimes up to nine months before we’d have an extremely heavy rain storm or series of rainy days, and the problem would reappear. Again, to our surprise, the building owners never knew about this condition and when we finally raised it directly with the landlord, they fired the property management company and decided to do something about it.
By this time we were tired of dealing with their problem and only wanted out of our lease. Luckily they were accommodating and let us leave our lease, which I think bought them some time to actually fix the property properly. Before putting it back on the market, I decided to take the opportunity of having to move because of a leaky roof as an opportunity to reevaluate our living situation.
On “Lifestyle Inflation”
As I’ve written about many times before, lifestyle inflation is a one way street and it only goes in one direction: up.
It’s very hard to walk your lifestyle back when you’re looking for a new place to live. There’s a chance for you to reevaluate all the things that are important to you and see if you can potentially save money. At the same time, when we started to look around, I also knew that it was time for a bigger apartment. We had outgrown our one bedroom and needed more space.
So how do we get more space but keep our spending in check? We make sure that the move was revenue neutral.
What is a revenue neutral move? I’m glad you asked.
I presented the same concept to my wife one evening in the form of a spreadsheet that looked at our current rent payment along with various other services we used to make ends meet. For example, gym membership, cleaning services, etc. I told her that if we move to one of the fancy “luxury” buildings, we might be able to cut certain expenses and redirect those funds toward nicer amenities and that I would be fine upgrading our lifestyle as long as we didn’t spend any more money than we’re spending now.
It’s not easy to upgrade your lifestyle without spending more money, so I took this as a personal challenge to find a better living situation for us with more space, more amenities, and more of the things that we wanted without actually spending any additional dollars.
The biggest factor on the spreadsheet was whether we could move outside of the five boroughs of New York City and no longer pay the New York City income tax. New York City is one of only a handful of cities in the United States that charges its own income tax.
If you read my tax analysis from a couple of months ago, you would see that it’s actually more burdensome to live in New York than it is to live in California despite California’s image as a high tax state. The reason for this of course, is because in addition to federal and New York state taxes, you also have to pay a 3.85% income tax to the city of New York.
Contrary to popular opinion, the New York City income tax does not apply if you live outside of NYC but still work in NYC. There seems to be a lot of confusion among what I would call “real New Yorkers” who have lived here their whole life because previously, until about 2000, there was a law in place that required commuters who lived outside of New York City, but worked inside of New York City, to pay the New York City income tax. Therefore, a lot of people assumed that as long as you live work in New York City, you have to pay the tax regardless of where you live.
Thankfully that’s not the case.
Having already done the math, I knew that if we were able to live outside of New York City, we would save something close to $1,000 a month in taxes, which meant that we would directly have an additional $1,000 a month to spend on living expenses.
I’ve often said that taxes are a public policy tool. The purpose of which is to shape and guide individuals to make certain decisions in the market. I don’t think that taxes by themselves would cause too many people to move from one place to the next, but when you are considering a move, why wouldn’t you keep taxes in mind with an additional $1,000 a month?
For us, we wanted to see whether living outside of the five boroughs would make sense. Would the free upgrade in lifestyle be worth the potential downsides of living farther away from the city? Would saving living farther away only make us miserable because we were isolated from friends, family, and potentially subjecting ourselves to an hour commute?
The easiest way to solve this problem was to begin exploring, so that’s exactly what I did.
On the weekends, I hopped onto the trains and started exploring areas outside of New York.
The hunt begins
One thing I quickly realized – and I’m ashamed to say I didn’t know existed — is that New Jersey is just right across the Hudson River (I joke of course. I knew it existed but had never really considered it as a place to live).
The “Jersey” right across the Hudson is nothing like Jersey Shore. In fact, it’s basically an extension of New York itself. People have been calling Hoboken the sixth borough for many years. For that reason, it was one of the first borough’s I visited. The crowd seemed a little young and we were looking for more peace and quiet, so I kept looking.
That’s when we discovered Jersey City, which is directly west of the world trade center. It didn’t take more than a couple of hours of walking around before I realized that it ticked many of our boxes. There were multiple transportation options to Manhattan. You could take the path or the ferry. They had plenty of restaurants, many of which Yelp said were fantastic and wonderful places to eat. There were grocery stores and wine stores and little taquerias everywhere.
Also, it wasn’t like we had just discovered the place. Goldman Sachs moved their headquarters to Jersey City to 30 Hudson Street in early 2008.
Those workers had been commuting into Jersey City for years and likely infusing the local economy with tons of cash. There were Starbucks everywhere, a sign that you’ve definitely made it to a gentrified area. The one thing that seemed to be missing was the number of people. At first I thought because it was a Saturday that perhaps they were still sleeping or hiding away in their apartments, but as I visited more and more, I realized there’s just a lot of space and while there were still plenty of people, my expectations for living in a dense area similar to Manhattan, we’re completely out of whack with reality.
It felt like we could breathe or like the Washington DC version of New York City without the toxic politics, armed with a revenue neutral spreadsheet, the knowledge that we would be saving nearly a thousand dollars on taxes. We set out to find some options in our price range in Jersey City – unlike Brooklyn, which used to be considered slightly cheaper than Manhattan, but which is actually similarly priced at this point, Jersey City offered real value.
Now I’m not saying that Jersey City is super cheap like if we were searching for apartments in Kansas City, but Jersey City was definitely cheaper than anything you would find in Brooklyn or New York. For those of you that don’t know, luxury buildings are all the rage and New York, which basically means that they try to be all inclusive in the services they offer for you – that was a standard we were looking at.
Well, when we found a building overlooking liberty state park, a local marina and the Statue of Liberty, we thought that it probably couldn’t get any better than this. When we found out we could get a two bedroom, two bathroom, 1200 square foot apartment in a building with a gym, a concierge that handled packages and dry cleaning along with a roof deck that included grills and a pool, we knew we wanted it less than 12 hours later. We put in the application and secured the apartment.
Now that I’ve been living here for a couple of months, I wonder why I didn’t move sooner.
I think it’s important to have moments like this where you challenge your understanding of the status quo because those are the moments when you can have real opportunities for growth.
For us, this meant essentially a cash free upgrade and lifestyle, one that we’ve been thoroughly enjoying ever since. I wouldn’t suggest that a first year associate who had never lived in New York start by living outside of NYC unless you know that’s what you really want to do. But a fifth year associate who is think about other financial goals and wondering what they could do to accelerate their progress?
As a side note, one of the other motivating factors for moving to Jersey City is that I actually improved my commute by moving physically closer to my office. And now I no longer have to ride the New York City subways!
So the point isn’t that you just need to move farther away to upgrade your lifestyle. It’s that we should constantly be evaluating our decisions to make sure they are right for us. As you go through your career, your needs will change and you should make sure to adapt with those changes. If you do, I might one day see you on the ferry on our way to midtown.
(Biglaw Investor: Today’s guest post comes from Paul Carlson, founder and partner of Seventy2 Capital Wealth Management. His post is a reminder that we’re halfway through the tax year and that while there is a lot everyone is still figuring out about the new tax code, there’s some things you can be doing right now to lower your tax burden. I have no financial relationship with Paul Carlson or Seventy2 Capital Wealth Management.)
It’s officially summer, the start of midyear tax planning. With six months left in the tax year, it’s the perfect time to make some tax moves that could reduce your 2018 tax bill.
You might be feeling a bit confused about how the recent changes to tax laws will affect your returns. The December 2017 Tax Cuts and Jobs has created significant confusion for many. While the new law doesn’t impact this year’s tax return, it will impact financial planning for millions of Americans.
The news for individuals and businesses seems to be mixed. For those who itemize, many deductions have been altered or eliminated altogether, and charitable giving might now be more complicated. Tax preparers and the best wealth management firms are acclimating to the new law themselves while fielding questions from clients trying to understand how their finances will be impacted.
“What remains to be seen is who will be the ‘winners’ and ‘losers” of tax reform. We’ve seen estimates where a number of our clients may end up paying more than in previous years,” says Paul Carlson, Founder and Partner of Seventy2 Capital Wealth Management. “Until the IRS regulations are final, it’s going to make it hard to plan around certain charitable giving and investment strategies.
Here are some initial thoughts on potential tax strategies to start thinking for next year.
1. Forecast Your 2018 Taxes and Refund
It’s a good idea to have your accountant or tax professional model different 2018 returns after this year’s forms are finished. While many of the rules have yet to be written, the IRS and others have online calculators that can forecast your 2018 tax refund based on your 2017 tax return.
2. Revisit Your W-4
You may need to revisit your W-4 and adjust your withholding for 2018 in response to the new law. On January 11, the IRS published a new withholding table that eliminates personal exemptions as required under the new law. It should be noted that the new table doesn’t reflect all changes that could impact taxpayers under the new law.
3. Know That A Number of Deductions Have Been Eliminated
A number of standard deductions or exemptions were eliminated in the tax overhaul that will impact individuals and businesses. For example, it used to be possible for individual tax filers to claim a $4,050 exemption for themselves, spouses or dependents, but that exemption is now eliminated. Also gone are tax deductions for moving expenses, tax preparation and wealth management fees. Similarly, businesses that have deducted entertainment expenses are no longer allowed to which may offset some of the benefits of the reduced corporate tax rate.
4. SALT Deductions Are Being Adjusted
The new law places a $10,000 cap on state and local income tax (SALT) deductions. The new law does increase the standard deduction to $12,000 for single filers and $24,000 for married couples filing jointly, but residents could pay substantially more in high-tax, high-income states such as California, New Jersey and New York. According to the New York Department of Taxation and Finance, the cost to New Yorkers alone could be $14 billion.
5. Home Equity Loans May Get More Expensive
One particular area where the new tax law has caused confusion is how interest on home equity loans and lines of credit can be deducted. The tax overhaul lowered from $1 million to $750,000 the amount on which interest expense on “acquisition indebtedness” could be deducted- — for loans. The new law also eliminated the interest deduction on loans that are not used to “buy, build or substantially improve” a home.
6. Bundle Your Charitable Giving
For people who donate regularly, one way to navigate the new SALT limit is to bundle several years’ worth of donations into one. If you itemize, charitable donations are still deductible on federal tax returns and can raise married taxpayers filing jointly above the $24,000 standard deduction hurdle. By bundling several years’ worth of donations into a donor-advised fund, it is possible to take the deduction the year the money was transferred, but distribute the money to charity over several subsequent years. If you are interested in this approach, please reach out to us.
7. State and Federal Law Differ on College Savings Plan Uses
The tax overhaul allows greater flexibility for using tax-exempt 529 college savings plans to pay for education costs prior to high school graduation. However, some states do not follow federal guidelines for using these savings vehicles. While federal guidelines will now allow families to use 529 funds for K-12 expenses, a state government may actually penalize that practice.
8. Fewer People Will Be Affected By the Alternative Minimum Tax
The Alternative Minimum Tax served as a system to ensure that tax filers who received numerous breaks or exemptions still pay some federal tax. However, under the new tax law, fewer people will need to calculate their tax liability using the AMT guidelines. The exemption is now raised to $70,300 for single filers and to $109,400 for married couples.
What to do now?
At the end of the day, the farther ahead you plan your tax situation, the better your chances of significantly reducing your tax burden – and better planning your financial future. Remember that no one fully understands the new law, and even the IRS and seasoned investment professionals are still trying to understand its implications. “We are monitoring IRS guidance for developments that impact our clients’ estate and retirement planning, charitable giving and overall investment strategies. But, it may take months and years before there is a consensus about the best strategies to navigate the provisions of the new tax law,” says Carlson.
Do you have any recommendations for providers for a small-firm 401(k) plan? It’s just another lawyer and me. There’s currently no 401(k) plan, and I’d like to get one started. Are there any companies that can put together a 401(k) plan for not a lot of money? I don’t think I’ll be able to convince the partner unless it’s cheap.
Starting a 401(k) program at a small firm is a great idea. The 401(k) is one of the best options available for saving sizable chunks of money, particularly given the $18,500 annual contribution limit (or $24,500 if you’re over the age of 55). Regardless of whether you go with the Traditional 401(k) or the Roth 401(k), I hope you can convince the other lawyer that having a 401(k) in place is worth the fees. Since a 401(k) has costs for the business owners, when making this decision you’ll need to weigh those costs and expenses against the benefits to determine whether establishing the 401(k) is the high choice.
When I started researching this question, I wasn’t sure what I would find in the market. Employee benefit plans are complicated stuff subject to a host of regulation, so I wasn’t sure if it would be reasonable to find an administrator who would handle it for a low cost.
I know from my previous research into Solo 401(k)s that the leading brokerage firms are willing to act as a plan administrator to get your business. It looks like they’ve all “done the math” and figured out that it’s worth the hassle of taking on the administrative burden. I quickly realized that these providers aren’t interested in administering your small firm’s 401(k). For that, you’ll have to look somewhere else.
Specifically, you’re looking for a provider that can perform four core services: (1) Third-Party Administration; (2) Recordkeeping; (3) Custodian; and (4) Investment Management.
Finding a Competent Third-Party Administrator / Custodian
Third-Party Administrators (TPA) provide a specific role in establishing a 401(k) plan. They handle most of the administrative burden of running a 401(k) plan, including plan design, administration, and (often) recordkeeping. TPAs do not provide you with investment advice, so you and your employees won’t be able to call them and have them help select and manage your investments. Most likely, your TPA will set you up with a Safe Harbor 401(k) since those are relatively easy to administer.
When evaluating TPAs, one of the most significant concerns is going to be fees. TPAs typically make money in two ways: assets under management (AUM) fees or fixed fees.
AUM fees don’t seem like a big deal at first. An asset under management fee in the 0.04% – 0.08% range doesn’t feel like a lot, but they add up over time and will ultimately become a significant expense as your assets grow. To correctly compare the difference between the flat fee model / AUM model, you’ll want to do a detailed analysis of the amount of money that will be contributed to the plan, along with the amount of time those assets will live inside the plan.
Fixed fees are easier to understand and will probably depend on the types of services offered and the number of plan participants (along with a standard one time set up fee).
In addition to the TPA, you’ll need some hold to hold the plan assets (i.e., the custodian). Some TPAs include the custodian fee in their fees. In fact, during my research, I found that it was often the case that the TPA bundled the custodian fee within its price. However, keep in mind that the custodian fee could be unbundled so you’ll want to make sure you understand how the custodian fee is being handled with whoever you go with.
There shouldn’t be any other fees charged by the TPA or the custodian.
Fiduciary Obligations / Investment Manager
After your TPA establishes your plan, as the plan sponsor you will be named as the fiduciary. As the fiduciary, you are responsible for doing what’s best for the plan participants. That may seem like a low risk, but plan participants can sue plan sponsors for breaches of fiduciary duty (see LaRue v DeWolff), so it’s a risk you may want to offload.
To offload the risk, you can appoint a fiduciary advisor to take advantage of the fiduciary adviser safe harbor.
There are two types of fiduciary advisors: the 3(21) fiduciary and the 3(38) fiduciary.
The 3(21) fiduciary is an investment advisor offering investment advice to the plan participants. However, the 3(21) is only a co-fiduciary. The ultimate decisions for investment selection remain with the plan sponsor (i.e., you). You still have a fiduciary responsibility to the plan participants. Having a 3(21) fiduciary offer investment advice to your plan participants is useful if you’re not comfortable yourself but doesn’t relieve you of any liability.
On the other hand, a 3(38) fiduciary takes responsibility for the management of the plan’s assets. The 3(38) fiduciary can accept liability for investment selection and portfolio management, therefore relieving the plan sponsor of such responsibility.
Small Firm 401(k) Providers
While I’ve never set up a 401(k) plan myself, two providers stood out during my research: Guideline and Employee Fiduciary.
Like many FinTech companies, Guideline’s value proposition is two-fold: (1) technology to make your life easier and efficient administration; and (2) low fees. Their business model is based on developing an efficient tech operation to handle the administrative and record keeping aspects of 401(k) management, which they believe they’ve achieved. Guideline charges a one-time $500 setup fee and then $8/month per participant (with a minimum charge of $40 per month, so essentially you pay for five employees whether you have that many or not). There are no AUM fees. Custodian fees are included in the pricing, so the only other expenses you’ll pay are those of the underlying investments, which happen to be mainly low-cost index funds (also note that Guideline charges a $50 disbursement fee if you leave the company and need to transfer your 401(k) balance out of the plan).
Guideline also integrates with many of the FinTech payroll processing platforms like Gusto or OnPay, so if you’re using one of their integration partners (there are many more), administration of the 401(k) contributions should be even easier.
If Guideline is the shiny FinTech company with low fees, Employee Fiduciary is the Vanguard that’s been around in the industry for a long time (and often recommended on places like Bogleheads). Employee Fiduciary charges a $500 establishment fee along with a $1,500 annual base fee (which covers up to 30 employees) plus a 0.08% custody fee of plan assets.
For the extra bottom line cost as compared to Guideline, what do you get? Well, for one you get a lot more options: Profit Sharing Plans, 457(b) plans, defined benefit and cash balance plans. If you need something that is more customized, Employee Fiduciary will probably be able to help you. They use a checklist during the onboarding process to determine what type of 401(k) plan you’ll need.
Employee Fiduciary also has a broader range of investment options. In addition to the standard vanguard index funds, you’ll also have access ETFs and self-directed brokerage accounts if you want to customize your investment options.
Employee Fiduciary can also act as a 3(38) fiduciary if you want them to.
(Biglaw Investor: Today’s guest post is from Andrew, a New York lawyer who decided to invest in out-of-state real estate without even visiting the property. He blogs at Living Rich Cheaply. Andrew and I have no financial relationship.)
I’ve always heard that investing in rental real estate is a great way to build wealth. It is hard to deny the benefits of investing in real estate, with cash flow from rent payments, principal pay down by the tenant, the use of leverage, appreciation of the property as well as rents, and the ability to depreciate the asset. Living in New York City, I thought my real estate investment would be relegated to buying a REIT fund. Housing costs here are prohibitively expensive and even if I could afford a property, would it even cash flow? Of course, I’m not saying real estate investing doesn’t make sense in NYC. I’m sure those who bought properties in up-and-coming neighborhoods in Brooklyn are doing just fine. However, solely relying on appreciation is speculation.
When I read about real estate investors in other parts of the country buying houses for $100,000 and renting them out for $1,000, I was pretty envious. I wish I could invest there, but I’d have to research what neighborhoods make sense for rentals. I’d have to find a realtor, find the property, hire and manage a contractor to get the property rent ready, and manage the property from afar or hire a property manager. For someone with a full-time job and little experience in real estate investing, it was not something I could take on.
Enter turnkey real estate providers
After reading the Biggerpockets blog and forum as well as blogs of people who invested long distance through turnkey providers, I started to think I could also invest in real estate. These providers provide a solution to this common problem to out-of-state investors. Generally, a Turnkey provider buys a property at distressed prices, renovates it, and sells them to investors. They also provide property management: screening and placing a tenant as well as dealing with the day-to-day operations of the property. It is a one-stop shop for your real estate needs. They generally charge about 10% of monthly collected rents to manage the property. While investing in real estate is never truly passive, this is as close as it gets. You check your owner’s dashboard online to see that you got paid and if there were any repairs needed. he property manager contacts you if the repair is above a preset amount.
Turnkey real estate investing sounds like it is too good to be true. While there are many benefits, there are also some things to watch out for.
You Are Paying a Premium
Many experienced real estate investors aren’t fans of buying property from a turnkey provider. They prefer to buy properties at distressed prices, fix them up and then rent them out. With this method, they have much more equity in the property. When you buy a property from a turnkey provider, you are most likely paying market value. There is a reason turnkey providers are selling the house at market value. They did the all the work and took on the initial risk. I don’t necessarily see anything wrong with this business model. However, many out-of-state investors look at these houses in the South or the Midwest sold by turnkey providers and say, “wow, they’re so cheap!” Be careful though, as cheap is relative. Sure, you might think the property priced at $150,000 is cheap but if all the comparable houses sell for $125,000, you’re overpaying. Many times, the turnkey property will be higher priced than many properties in the neighborhood because the turnkey provider has completely renovated it. Paying market value is not necessarily a bad thing, but just come in knowing that fact. If you have to sell soon after buying the property, you’ll likely lose money, unless it has appreciated in value. (Biglaw Investor: Which seems unlikely in most of these markets.)
Some turnkey providers seem to sell properties in lower-priced neighborhoods. Maybe it’s because it makes the numbers look good on paper: Buy a $50,000 house that rents for $800! However, sometimes a house is really cheap for a reason. If it’s a really cheap house, it’s possible that it is not a great neighborhood, in which case the prospective tenants might not be financially stable or have other issues. While it’s possible to make money investing there, it might not be the best move for an inexperienced investor who does not live in the area. Furthermore, that type of neighborhood will likely see less appreciation so make sure you do your research.
Run the Numbers
Some people have taken the monthly rent and subtracted the monthly mortgage payments (including tax and insurance) and the property management fee and say that’s how much they will cash flow. That may be true for some months, but you better take into account vacancies, repairs, and capital expenditures when you do your calculations because those costs will come up. Run the numbers yourself and don’t just rely on the pro forma statements provided by the turnkey companies. (Biglaw Investor: The numbers I’ve seen have all been pretty “rosy” as well. The pro forma statements are essentially the marketing copy that a turnkey provider will use to sell the property. It doesn’t mean that they’re lying to you since any reputable turnkey company that inflates numbers will soon find itself out of business but you definitely need to run your own numbers. Nobody cares more about your money than you.)
When I decided I would invest in a rental property out-of-state, I narrowed it down to cities where housing was relatively affordable and where it would cash flow, but also a city where the economy was strong. I contacted turnkey investors to see how their experiences went. Ultimately, I chose a turnkey provided in Kansas City, Missouri. One main reason was because it offered a “hybrid approach” where I would have more equity from the start. The company I worked with first acted as my realtor in bidding on properties, generally foreclosures. Then it acted as a project manager in hiring and managing the contractors in making renovations to the property. I purchased the property at foreclosure for $60,000 and the renovations cost about $11,000. It appraised for $83,000 and a tenant was placed paying $850 a month. The closing took place at the cafeteria of my work place during lunch with a mobile notary. Things are going relatively well but I would say that there have been more repairs than expected which have taken a significant bite out of my monthly cash flow. In 2016, my repair costs totaled $2500 and in 2017, $1400. From what I hear from those who bought a property from a pure turnkey provider, they had much less repairs as with this model, the company supposedly does a complete renovation of the house whereas the route I went, they did repairs to make it rent ready. I am still happy with the investment as I had much more equity going in and it has also appreciated since that time. Then rent has also increased to $895. If it wasn’t for the appreciation, I might not be too happy with this investment and I’m not sure if such strong appreciation can be expected going forward.
This company no longer does this “hybrid approach” as the real estate market there as well as many other places are pretty hot and very competitive. There are still companies which will help you buy a distressed property, renovate it for you, and then manage it for you. However, you will likely have to pay cash and then refinance afterwards.
I still think turnkey real estate investing is a good idea for someone who lives in an area where there is no cash flow, someone who is inexperienced and wants a little more hand-holding, and someone who is too busy to be a landlord. Just make sure you do your due diligence and research before you make your investment. You can always take a more hands-on approach later on but at least get started investing in real estate.
This year seems like I’m purchasing a lot of insurance products. I’ve already written about protecting myself while renting a car (after I found out that California car rental companies will let you drive off the lot without the state required minimum liability insurance). Today I’m writing about umbrella insurance.
Why have I been stacking up the insurance policies lately? Well, in general, I prefer to self-insure for most risks. Despite what some people may think, it’s not a financial catastrophe if my iPhone is destroyed or stolen. Neither is it a big deal if my laptop breaks down and I need to replace it. Self-insuring means that I’m taking on the risk myself. As the insurance company, I’ll have to pay out of my pocket if I need to replace something, but on the flip side, I don’t have to pay anyone premiums. If you do this with enough stuff, you should come out ahead in the long run (at least that’s what happens to the insurance companies selling you the policies).
However, there are significant financial catastrophes that could change your life (and not for the better). I’d like to take these risks off the table, particularly when it doesn’t cost a lot to do so. As we’ll see, umbrella insurance is one of those cheap policies that only cost you a few dollars a month. The insurance company isn’t expecting to pay out, and you’re not planning to use it, so the premiums are low.
What are some other examples of financial catastrophes? Here’s the list of the big ones:
Loss of expensive property (house, car, etc.)
Occupation related liability (malpractice)
Non-Occupation related liability
Life, disability and health insurance are typical products in the marketplace owned by a lot of lawyers. If you have a mortgage, you can’t skip buying homeowners insurance. While states only require you to have a minimum auto liability insurance policy, most people carry some comprehensive collision coverage as well that would replace the value of a destroyed car. Malpractice insurance? I know you have that.
The problem with the auto liability insurance and the home insurance is that their liability coverage might be quite low. New York’s auto insurance laws only require $25,000 of liability insurance for one person. You don’t need to be an emergency doctor to know that the healthcare industry will burn through that $25,000 by the time you make it to the emergency room.
Many homeowner insurance policies have liability limits of around $100,000. While that’s more generous than an auto policy, the average 3-day hospital stay is about $30,000. If you generate liability that leads to an 11-day hospital stay, that extra day is on you.
The easiest solution to increase your liability protection is to increase the liability coverage under your auto and homeowner policies. Increasing my renter’s insurance policy from the minimum liability coverage to $1,000,000 of liability coverage only cost me $37.10 a year. That’s not a typo. This is cheap stuff. The same is true for my non-owner’s car insurance policy. Going from the state-mandated minimum payments to $300,000 of coverage costs an extra $89.04 a year. I can’t think of any lawyers where $126.14 a year is going to impact your budget negatively. In exchange for a few bucks, you get extended liability coverage that could prevent some unforeseen event from wiping out years of asset accumulation.
These are the kinds of risks that are great to take off the table. When the outcome is catastrophic, and the premium is minimal, eliminate the threat. It’s silly to focus on a $250 deductible on your collision coverage while cutting corners on the liability portion of the policy.
By now you’re probably thinking: Okay, but what could happen that is going to blow through hundreds of thousands of dollars of liability coverage? The five most common home insurance liability claims are: (1) dog bites; (2) home accidents; (3) falling trees; (4) intoxicated guests and (5) injured domestic workers. If any of those sounds possible to you – and you can eliminate the risk for hundreds of dollars a year – why not take the risk off the table?
So, how much coverage should have? Well, how much stuff do you own? If you’ve built up a lot of wealth, you’re going to need a lot of coverage. If you’re a law student with a negative net worth, the insurance is perhaps a little less critical since you have less to lose. But not only do you need to protect your assets, you’ll also need to hire a lawyer to defend yourself in a potential suit, so you’ll need to throw in the cost of the defense to your policy as well. Don’t forget that any potential litigant will assume that you’re a rich lawyer too, so you already have a target on your back.
After you’ve bumped up the coverage under your existing auto and homeowner (or renters) policies, the easiest way to protect against a financial catastrophe is an umbrella policy that sits on top of all of your other policies. The umbrella policy covers the costs when the other policies are exhausted. If you have a $300,000 homeowners insurance policy and a $1 million umbrella policy, you have $1.3 million of total coverage.
Most well-protected lawyers carry an umbrella policy of at least $1 million, although bumping it up to $2, $3, $4 and $5 million isn’t uncommon as your assets continue to grow. Since umbrella insurance is the last line of defense before coming after your assets, it’s dirt cheap. I bought a $1 million umbrella insurance policy this year for a little over $300 annually. In general, you pay based on where you live and factors like whether you’ve bunched your insurance policies with the same insurer. Umbrella insurance generally requires you to have an auto policy and a homeowners/renters insurance. If you don’t own a car, you can pick up a non-owners auto policy as I did.
The important thing when it comes to insurance is to focus your dollars on the parts of the policy where it will make it a big difference. The iPhone protection plan? That’s fine if you feel that you need it. But if you’re insuring against the loss of an iPhone but neglecting against the possibility of a financial catastrophe, you should rethink your priorities!