Net Worth Challenge

There are a lot of people that dislike the thought of having liabilities and owing money to someone (or some company) — my wife is one of them. Her thoughts about liabilities are probably very common with many other people in society. Her philosophy on loans is to pay them back as quick as possible and pay as little interest as possible. In short, she is scared of liabilities.

I do not follow this train of thought, even though it was taught to me by family and friends. Instead, I try and maximize the gain to my net worth by utilizing liabilities in the most efficient ways possible. If you refer back to our current financial situation in October, you’ll probably notice that my wife and I have a sizeable chunk of money in our taxable brokerage accounts. This money could be used to pay down many of our liabilities (ie, house mortgage) very quickly, but this action would actually hurt us more than help us in the long-run. Since this post is merely explaining the liabilities I do have, I’ll have to save the discussion about my “liability strategies” for another day (but I did want to briefly introduce the fact that I have a strategy).

Below are the liability accounts that we had for the month ending September 2006 and an explanation of what each line-item represents.

Credit Card Balances - At the end of every month we pay our credit card balances in full. In the past I did “float” some money by carrying a balance on 0% interest credit cards and kept the money in an interest-earning money market account. However, since my wife and I are looking into purchasing a new home in the near future, I thought it best to maximize our FICO credit score and get rid of those balances. So now the only reason this item exists is because until a bill is received for our monthly purchases, a payment will not be made (we want to maximize our reward points). Due to the timing of receiving bills and the end of a month, small balances may get listed in this item. We will pay the balance in full when a bill is received, though.

House #1 Mortgage - We have a 30-year fixed rate mortgage on our duplex with a rate of 5.5%. At the time of purchase, my wife and I put down a 20% down payment on the home. Each month we only pay the principal and interest that is required by the bank and nothing more. Instead of paying more on the loan, I put a little extra money each month in our money market account. This money gets marked as “home mortgage prepayment fund” in that money market account and will eventually be used to make payments on the home mortgage —- but that time is far, far into the future.

Student Loan - I suppose a better title for this item would be student loans, since both my wife still owe money for our college education. Our education was worth every penny and has certainly given us a career boost and pay boost now that we’re in the “real world.” My wife’s student loan balance has a fixed rate of 2.875% and my student loan has a fixed rate of 1.875%. Since these liabilities have such a low rate, it makes economic sense for us to only make the minimum principal and interest payments each month. As with our home mortgage, I also set aside an extra bit of money each month into our money-market account. This money gets marked as “student loan prepayment fund” and will eventually be used to make payments on our student loans — again, this will be far, far in the future.

General Loan - This is an item for which I claim responsibility, because it predates my wife completely. I have a “general loan” from my grandparents that was used for various items several years ago. Right now my rate on this loan is 0% and there is no specified final payment date. Since I do not have to pay interest on this loan — there really is no benefit to me paying off this loan entirely. This is where my conscience sets in, because it is money that I owe my grandparents. I feel guilty not making payments, especially since this is family and they did offer me a great loan when I needed it (the word “need” could be debated). Therefore, I am making payments on this loan each and every month. I’m not sending large payments, but it is just enough to establish that I am making “good” on my debt obligation.

Other Liabilities - Along with my mortgage payment (princial and interest) each month, I also set aside money for home insurance and property taxes. I do not have the bank keeping this money in escrow for me, so it is my own responsibility to make these payments when the appropriate payment date comes up. So the money I set aside gets put into our money market account and gets marked for the appropriate category. While the money is held in our money market account (which is an asset), I still recognize that these bills will be due at some point in year. Therefore, these items need to be correctly tracked as liabilities — and this item on the liability list is used for that purpose. There are some additional categories that fit in this item besides home insurance and property taxes. In total, this item contains several categories: duplex tenant security deposits, home insurance fund, car insurance fund, and property taxes fund.

Well that’s it for our liabilties. While I look forward to seeing these amounts decrease each and every month, I’m not that worried to be carrying liabilities in the first place. All of these liabilities were thought out before we incurred them (well, perhaps not the General Loan) and we have a plan for meeting these debt obligations in the future.

After graduating college, my wife and I wanted to get a good start in building our “financial foundation.” Both of us had been good savers in college and we planned on continuing our savings habits after starting our new jobs. I’ll admit it was tough to resist the temptation to spend our larger, post-college, real-job paychecks at first — and instead devote a large chunk of our new income to items such as retirement and other long-term savings goals. But after a short while we both became used to the new savings habits and started realizing how much it would help us in the future. Flash forward two years and it seems that our asset accounts are growing and the plan we created is working well for us.

In the last post I listed these asset accounts along with our liability accounts for the month ending September 2006. Now I would like to dive a little deeper and explain what each line-item represents:

Cash & Savings - The main account I use as a “starting point” for all my financial activities is my checking account. I use this account for direct deposit of paychecks, paying credit card bills, writing checks, and moving money from my different investment accounts. In addition to a checking account, I also maintain a savings account at the same bank. I only keep the bare minimum in the savings account because I can get a higher rate of return elsewhere. I also have a PayPal account for accepting online payments. This account usually has a small balance in it that I periodically transfer into my checking account. Finally, I also keep track of the money I carry around in my wallet (and the money in my wife’s purse). Although the amounts of cash in our wallet and purse are usually small, I still like to track it so that we know exactly where our money gets spent. Overall, I try and manage the balances in our checking, savings, PayPal, and wallet accounts so that only a bare minimum is stored here. Since I can earn a higher rate of return in a money market account, I generally store more money there and less money in the Cash & Savings accounts.

Taxable Brokerage Accounts - This item is comprised of my non-retirement Ameritrade, Sharebuilder and Vanguard accounts. I use the Ameritrade and Sharebuilder accounts for trading stocks, ETFs, and options contracts. I use both accounts because each one has an advantage that I try and utilize as best as possible. The Ameritrade account has lower commission charges and gets used for trading options contracts and for purchasing stocks that do not pay a dividend. The Sharebuilder account gets used for purchasing stocks that pay a dividend, since they offer dividend reinvestment for free. I try to set aside some money each month for investing in the stock market, which is separate from my retirement savings. As of lately, much of my investing in these accounts has been in small-cap and mid-cap stocks. I have been investing in these categories in order to better diversify my overall investment holdings. I also maintain a Vanguard account for short-term and long-term purposes. Instead of storing short-term money in my checking account, I keep this money in a Vanguard money market account. My money market fund at Vanguard holds money for items such as our vacation fund, home insurance fund, car insurance fund, property tax fund, and other such items. I also use Vanguard to purchase mutual funds for longer-term goals. Our house fund is invested in a mutual fund that is riskier, but typically has a higher rate of return than the money market account.

Roth IRA - Although I did not start my Roth IRA account at age 18, the first year available for me to join, I did start at a reasonably young age. My goal has always been to contribute the maximum allowable amount into my Roth IRA each year. When my wife and I were married, I was quick to setup an account for her and began contributing the maximum amount for her as well. I consider investing in our Roth IRA a high-priority. Both of these accounts are held at Vanguard and are invested in Vanguard mutual funds.

401(k) - My wife and I have 401k accounts at both our companies. We setup these accounts as soon as we began our full-time jobs and began contributing money into these accounts from day one. At the bare minimum, our goal has always been to contribute enough so that we earn the maximum matching amount from our companies. Lately, however, we have been putting away much more into these accounts because of tax planning. Because of tax planning, I hope to contribute the maximum allowable amount ($15,000) in my 401K this year. I would like to do the same with my wife’s 401K account, but her company has a limitation on her contribution rate. Therefore, it is impossible for us to contribute the maximum allowable amount for her account while she is at her present employer.

House #1 - Rental/Primary - In addition to starting our savings for retirement when we began working full-time, we also purchased a home shortly after graduating from college. We did not go the traditional route, however, and instead purchased a duplex with the intention of living in one side and renting the other side out. Now that we have lived there for a little over two years, we may start searching for a new home next Spring. We plan on keeping this duplex for many more years and will rent out the side we had been living in after moving to a new home.

Other Assets - The only assets this item currently tracks is the value of our two vehicles. While our cars may not be easily convertable to cash in the future, they are still considered assets and I do feel they should be included. I used the Kelley Blue Book website to determine the fair market value of our cars at the end of last year. I do not plan on making changes to the value of our cars on an ongoing basis each month, but rather once a year at the end of December.

Overall, I am proud of the values of each asset account because it represents progress that my wife and I have been making over the past two years. Believe me, they didn’t automatically start out looking so strong. It will be exciting for me to track the progress of these accounts in the future and to talk about strategies for maximizing the rate of return I am earning on these accounts.

Although I am just starting out with this blog, I am not just starting out with my plans to grow my net worth. In my last post I talked about the long-term goals I have set — in reality, I set these goals about two years ago. Since that time I have been trying to alter my saving/spending habits in such a way that I am able to move forward towards those goals.

Starting today, I will begin each month by listing my updated assets, liabilities, and net worth. This accomplishes two things in my mind: (1) it will give you a chance to see where I am at financially in relationship to my goals and (2) it will force me to make this calculation each and every month. And thankfully, it just so happens that I was able to finish totaling up my assets and liabilities today! Here is my current financial situation:

At the end of September 2006, my net worth was $107,674.19. In the next couple of posts I hope to dive deeper into each category and explain the numbers further.