YFP's Trusted Partners
Search
Close this search box.
Book a Discovery Call

Author: yfpadmin

YFP 169: Helpful Tips for Getting a Mortgage

Posted on by yfpadmin


Helpful Tips for Getting a Mortgage

Tony Umholtz, a Mortgage Manager at IBERIABANK/First Horizon shares helpful tips for getting a mortgage and what you need to know when financing a home purchase or refinancing your home. Tony also breaks down the difference between pre-approval and pre-qualification, how interest rates are calculated, different types of home loans and everything you need to know about escrow accounts.

About Today’s Guest

Tony graduated Cum Laude from the University of South Florida with a B.S. in Finance from the Muma College of Business. He then went on to complete his MBA. While at USF, Tony was part of the inaugural football team in 1997. He earned both Academic and AP All-American Honors during his collegiate career. After college, Tony had the opportunity to sign contracts with several NFL teams including the Tennessee Titans, New York Giants and the New England Patriots. Being active in the community is also important to Tony. He has served or serves as a board member for several charitable and non-profit organizations including board member for the Salvation Army, FCA Tampa Bay and the USF National Alumni Association. Having orchestrated over $1.1 billion in lending volume during his career, Tony has consistently been ranked as one of the top mortgage loan officers in the industry by the Scotsman’s Guide, Mortgage Executive magazine and Mortgage Originator magazine.

Summary

Tony Umholtz, a Mortgage Manager at IBERIABANK/First Horizon joins Tim Ulbrich on this week’s episode to dig into a huge piece of the home buying or refinancing process: financing. He breaks down several key components of financing such as the differences between pre-approvals and pre-qualifications, loan types and how interest rates are calculated.

Tony recommends that someone begins talking to a lender before they begin looking for a house so that they can learn about different loan products and get a pre-approval letter. A pre-approval letter is needed from the lender when you make an offer on a home. It communicates to the seller that you are able to finance a home and that your credit has been checked. If you’re not quite ready to shop for homes, Tony mentions that a pre-qualification can be run as a cursory overview of someone’s income and debt. A pre-qualification doesn’t pull credit, however it does use your debt to income ratio and could be helpful in the beginning stages of the process.

Tony talks through different types of loan products including conventional, FHA, VA and jumbo loans. Regardless of the loan product you chose, your mortgage will have an interest rate. That interest rate fluctuates based on many factors, like the market itself, individual factors such as credit score and the type of property (single family vs condominium).

IBERIABANK/First Horizon offers a loan option for pharmacists called the Pharmacist Home Loan (aka the Doctor’s Home Loan). This loan allows you to buy a home for 3% down if you’re a first-time homebuyer (5% down for subsequent homes) and pay no mortgage insurance. Full disclaimer: this is not the case for every homebuyer. There are certain restrictions to qualify (maximum loan amount and minimum credit scores) and certain property types where the down payment rates can differ.

Mentioned on the Show

Episode Transcript

Tim Ulbrich: Tony, welcome back to the show.

Tony Umholtz: Tim, thanks for having me.

Tim Ulbrich: It’s almost like you’re a regular now, number three that we’re doing this. So glad to have you back. How are things going down in Florida?

Tony Umholtz: You know, we’re doing great down here. And Tim, always good to be here with you. And you know, it’s hot and humid down here in Florida.

Tim Ulbrich: We are finally on the tail end of that heat here in Ohio. I feel like we’re getting the beginnings of some fall weather, which I’m biased, of course, but some of the best weather I think in the country comes in September and October in Ohio. So excited for that time of weather here and just enjoying that with the family. So Tony, before we jump into I think what’s going to be a great discussion on helpful tips for those that are going through the financing part of the process, looking at obtaining a mortgage, I don’t want to make an assumptions that our listeners heard both of our previous episodes that you were in, so give us a little bit of background on you and the work that you do at IBERIABANK/First Horizon

Tony Umholtz: Yeah, sure, Tim. I’ve been with IBERIABANK/First Horizon now, gosh, two and a half, almost three years with IBERIABANK/First Horizon and I run a team that handles mortgage originations for purchase transactions, refinances, across the country. We can handle most states, 48 states. And I’ve been in the industry now almost 20 years — I can’t believe I’m saying that, Tim. But I’m aging myself — nearly 20 years. And my background, of course, through college was finance. I was a finance major and did an MBA as well. But I’ve just really enjoyed helping people, helping families, with the home buying process. I have several kids. I have three children. I have a daughter who’s about to turn 12, I have a 10-year-old, and we recently adopted a 2-year-old girl last fall.

Tim Ulbrich: Always appreciate having you on, sharing your expertise, I know a topic that is of interest to so many of our listeners that may be in a first time home buying position, might be moving, might be in a refinance situation, especially given the market and the landscape of what we have. And we had you on, as I alluded to, Episode 136, Ins and Outs of a Pharmacists Home Loan, and Episode 154, Getting a Home Loan in a Pandemic, so I’d reference our listeners to those two episodes for more information. But today, we’re getting a bit more specific in the home buying to talk about mortgages and to learn tips really when navigating the financing part of the process when it comes to home buying and refinance. And just for some background, the nature of how we came to this idea for an episode is I was reflecting, you know, having gone through the home buying process twice and having gone through the refinance process twice, most recently just a couple months ago here with our home in Columbus, which I’ve talked about on a previous episode, honestly, I feel like I still have a pretty elementary level understanding of everything that is involved with the lending process, and I feel like each time I have gone through that, I’ve learned something new. And so just like we do with much of our content on the Your Financial Pharmacist podcast, I feel like any education we can share with pharmacists so that they’re better prepared as they’re going through it, hopefully the better. You know, we believe firmly that the more educated you feel, the more empowered you are in the process, the more involved you are in the process, the better the outcome is. So that’s really the nature and the background for this week’s episode. So Tony, I want to in a moment start jumping into some terminology that I think often folks may get hung up on or wondering about, but my first question for you, as somebody who is perhaps listening looking for their first home, so going through the home buying process the very first time, when do you typically recommend somebody begins engaging in a conversation with the lender? As they’re out perhaps looking at homes or looking at Zillow or Redfin or wherever, when do you want to get the lending piece of the process moving forward?

Tony Umholtz: Tim, great question. I always believe that you want to get the dialogue with the lender going immediately, even before you’re out there looking at homes. I mean, it’s OK to be looking around on Zillow or Realtor.com a little bit, but before you start entering into homes, a majority of realtors out there are going to want to before they show you a house, a listing agent will allow you into the house, they’re going to want to know you’re pre-approved. And I always find knowledge is power. You know, knowledge is power. Knowing what you can and can’t do as far as affordability is critical. And you might be surprised, with the rates where they are today, you may be able to afford more home than you realized. But I would always engage with a lender first. I think that that’s a critical first step.

Tim Ulbrich: I’m glad you said that, Tony, because the other thing that jumps out to me here, as we’ve talked about before on previous episodes that you and I have discussed on the show is really the importance of you as the individual setting your home buying budget and really understanding how this fits into your monthly cash flow as you’re looking at all of the other goals when it comes to your financial plan. So you know, as you begin to get serious of looking at homes and you’re starting to obviously get excited about the process, I know through firsthand experience, the budget can quickly go out the window as you start looking at homes, or at least that can be challenged. And so having a good pulse on that and really understanding what would that loan look like and talking to the lender, what might that mean from a down payment, from rates, from month-to-month payment I think can really help understand and set expectations as you’re going into the actual process of evaluating homes and hopefully getting excited about what lies ahead. Tony, you mentioned pre-approval, and that was one of the questions I had for you is I know the terms pre-approval, pre-qualification, often get thrown around. Talk to us about the difference of those terms and why that’s important to lenders.

Tony Umholtz: Sure, sure. So the pre-qualification is actually — a lender will just do a cursory overview of your income and then your stated debts. So typically, a client will say, “I don’t want my credit pulled at this time, but I’d like to know what I can afford.” The risk here is we don’t — when we run your credit report, we know your actual score, we know exactly what those debts are. But we get an estimated amount or what you’re paying on it, and then we take usually a pay stub or a client will give us a tax return, and we can see what their earnings are and we can run what’s called a debt-to-income ratio. And if it meets that property, in that loan on the property, it meets the debt-to-income ratio, you can get a qualification. And a pre-approval is really just a little deeper dive. We actually run credit and then we review a pay stub or a tax return if you’re self-employed. So it’s really the difference between the two is the credit report is added on the pre-approval.

Tim Ulbrich: OK, Tony, so we have the difference then there between the pre-qualification and the pre-approval, so my natural question then as I’m thinking about this from the view of somebody that may be in the buying process is which is better? And does that matter in the process?

Tony Umholtz: Well, you know, typically most real estate professionals, realtors, are going to want a pre-approval letter that the buyer’s credit has been reviewed. So typically, that’s going to carry more weight in the real estate world. In today’s day and age, it’s a very competitive market, and knowing that you have a pre-approval is going to carry a lot more value when you’re up against other people who have a pre-approval and cash buyers. So I would say it carries a lot more weight. But if you’re still a ways out from purchasing, there’s nothing wrong with a pre-qualification. But if you’re serious and you’re really — you may make an offer, I really would advise, you know, I think having a pre-approval is the right way to go.

Tim Ulbrich: I think it’s worthy, Tony, that we’d spend a few moments talking about the different types of mortgages or loans that are available. Obviously we started the conversation with talking about when we might work with a lender, we talked about pre-qualification/pre-approval, but there’s more than one option that is out there that could have significant implications on not only rates but also down payments, how inspections are conducted, so talk to us at a high level about the different types of mortgage lending options that are out there for a home buyer.

Tony Umholtz: Great question. So we have the three main products that you’ll hear out there are conventional loans, FHA loans, and VA loans. And then of course there’s jumbo loans. And I’ll kind of go through at a high level what each of these are. Conventional mortgages are typically backed by Fannie Mae and Freddie Mac, not to get too technical and boring on this call. I don’t want to — I won’t get into the details of the secondary MDS market. But they’re essentially insured by government-sponsored entities because Fannie Mae and Freddie Mac are generally considered as government-sponsored entities, so when they insure a mortgage, an investor who buys that security has the — basically the intrinsic value, knowing the intrinsic value that the government’s going to back that investment. So if the home buyer were to default, the government’s going to reimburse the investor. So they are pivotal to the keeping our home mortgage market vibrant. Fannie and Freddie purchase so many loans. If we didn’t have those, it would be very much in trouble. The FHA is the Federal Housing Administration, can be very attractive. It has some programs for home buyers that may have a little bit of a challenge with credit or a little bit more flexible situation. So the FHA serves a big need. Typically, there’s home, there’s a cap per county, meaning that each county in the U.S. has a cap on the size of an FHA loan that’s allowed. And again, this is a government-backed mortgage as well. Then there’s VA loans, which VA loans are a great program, but it is kind of isolated to just a small sliver of the population who served our country. It would be for any veteran or active military. So that’s kind of what a VA loan would be. And it has its own guidelines as well. And then there’s jumbo loans. And what those are are loans that are above the conventional or conforming loan limit for a county or area. So the majority of counties in the U.S. had a $510,400 loan cap currently. Now that may change the beginning of the year 2021, but currently, that is where the limit is in most counties. You know, for example, in California, areas in California around San Francisco, Los Angeles, northern Virginia, Alexandria, Washington, D.C., New York City, you have a higher conventional loan limit in those markets, sometimes up over $700,000 depending on the county. But anything above — generally above $510,400 loan amount is considered a jumbo loan amount. And the significance of that is it’s not backed by Fannie or Freddie. So it’s not backed by one of those government-sponsored entities. It’s more private capital at risk, whether it’s a mortgage REIT, private like investment fund or a bank’s balance sheet. So a lot of jumbo loans are written by banks and are held on the balance sheet like just any other asset. So they’re just viewed with a different lens. So hopefully that was a high level, I didn’t want to get too technical.

Tim Ulbrich: No, that was great. Succinct. And I would reference our listeners to if you go to YourFinancialPharmacist.com/homeguide, all one word, we have a home buying guide that goes through several steps of the home buying process but also talks about each of those loans in more detail and I think builds upon the quick summary that you gave, Tony. And I think as I alluded to, it’s so important that our listeners understand these options. I think ideally before they even get too far down the path of searching for homes and beginning to think about where this home buying decision fits in because it will have significant implications on things like down payments, on rates and other types of factors. And so it’s an important decision to weigh and to understand. And we’ll talk in more detail about the pharmacist home loan option as I know that’s going to be of interest to many folks that are listening, how that compares to some of the options that you discussed, what that means in terms of down payments and credit scores and maximum loan amounts, which you already alluded to here a little bit, so hang with us and we’ll get there in just a little bit. Tony, you threw out the term REIT, and I know that’s something we haven’t talked a lot about on the show before. So I don’t want to go down a REIT discussion necessarily — we can cover that in more detail on a future episode — but for those that heard and may be wondering or hearing that for the first time, can you quickly define the REIT concept?

Tony Umholtz: Real Estate Investing Trust is what a REIT stands for. And again, we won’t go down too much into this rabbit hole, but that can encompass — a REIT can actually own real estate, right, can be publicly traded. They can own apartment complexes and all these different real estate assets, tangible assets, office buildings, shopping malls, data centers, you name it. There’s different sorts of REITs out there, and some are publicly traded, some are private. But there are actually what’s called a mortgage REIT. And there’s many that are publicly traded. And I’ll just throw out one, it’s called the Redwood Trust and it’s publicly traded. They are known for buying nonconforming jumbo mortgages. So that’s when I referenced that, there are actually REITs that buy mortgages that they have to originate them per their guidelines. But they are — they will essentially, if you originate it following their underwriting guidelines, they purchase the loan. That’s for jumbo mortgages.

Tim Ulbrich: And I want to spend a little bit of time talking about rates and something that it’s obviously a part of the lending process, people focus on it for good reason as I talked about on sharing my most recent experience refinancing our home with IBERIABANK/First Horizon rates matter. And we were able to go from a 4.625%, we bought here in the peak really of the market and rates in Columbus back in fall 2018 and refinanced that to a 30-year 3%. And my usual disclaimer will be inserted here as we talk about rates as we’ll talk about the makeup and nature of rates, it obviously can be and is very different based on the time period, based on what’s going on with rates and the economy, as well as based on factors that are specific to the individual. So as I mentioned, 3%, in no way am I trying to imply that that is what somebody may or may not get. We actually may see rates that are lower. Currently, some may be higher based on their own situation. But a general discussion about the makeup of rates is warranted as I know that’s such an important part of this process. So Tony, how is a rate determined? Kind of building off my point that it can and is different from person to person. And what factors are considered when somebody’s rate is being calculated?

Tony Umholtz: Great question. There’s a lot that goes into the interest rates. And the big factor is the market itself. So the interest rates are calculated really not by the Fed. Now, the Fed has a huge influence. And traditionally, I mean, I go back when I first started in the early 2000s in this business, the Fed had less power than it even does today as far as what they’re doing as far as mortgage securities. And that’s what they’re doing with buying bonds directly, which really keeps rates down. But the trading of the mortgage-backed security market is what dictates interest rates. So that is really why it can move from day to day. Right now, we’re in an economic crisis. I think the Fed has done an amazing job coming in and just stopping what could have been — as bad as things are, imagine if the Fed didn’t do what they did providing PPP to business owners, doing all of these things that they did to really backstop the economy. And I think that that’s been a really blessing for the U.S. But as a result, rates are very low, and the MBS market is what controls interest rates. We hear talk about the Fed Funds rate. The Fed Funds rate might be pretty much 0% right now, but that’s not really what dictates the mortgage rates. So it’s called MB — Mortgage-Backed Securities is what dictates where interest rates are going to go. But there’s a lot that goes into it. So the other big piece is of course the borrower themselves.

Tim Ulbrich: Yes.

Tony Umholtz: So their credit score is going to matter. It’s very highly sensitive to credit score. It also can be sensitive to loan-to-value. And what that means is what your home is worth compared to the mortgage amount. That can influence the interest rate you receive. A refinance compared to a purchase, oftentimes purchases receive a slightly better rate than a refinance will. The other factors are the property type. Condominiums are considered a riskier asset in the eyes of the lender than a single family home generally. You see a small increase in interest rate for a condominium. You also may see a small increase in interest rate for a multifamily property versus a single family property. And what I mean by that is a multifamily is considered to be a duplex, which is two units, a triplex, which is of course would be three units, and a quadplex, a four-unit property. Those can carry slightly higher interest rates than a single family home because of the property type. But even as a buyer, you know, if you purchase a condominium, there’s potential for risk for any of us. So the due diligence a lender does in assessing the condo’s what’s called warrantability, meaning its approvability as a condominium, just supports the buyer. It’s really like Big Brother looking over your shoulder when assessing a condo because the lender is going to assess the budget, they’re going to assess the viability of the project itself, make sure that the condo docs are in order. Essentially, they’re going to make sure it’s a viable project and protect both the buyer and the lender, but especially the buyer from special assessments. So condos are just looked at a as a little bit of a riskier asset class versus a single family home, generally. Also then the multifamily properties, duplex, quadplex, triplex, as we referenced, they’re going to potentially have other renters in the project and could add a little bit of a risk rate. So that’s why they have a slightly higher rate.

Tim Ulbrich: And I’m glad you differentiated that, Tony. I know — I feel like in a time period like this where rates are so low and it’s garnering so much attention, so many news articles out there about great time to buy, great time to refinance, everyone’s talking about rates. It almost becomes like a cocktail conversation, you know, where people are like, oh, you got what rate? You got what rate? And I think just reminding folks that at the risk of perhaps oversimplifying, what I heard you say there is that the rate, really three main buckets I hear is determining the rate: the market factors, which are changing of course day-to-day, you talked about the mortgage-backed securities, the individual factors of the borrower themselves in terms of their — looking at their credit scores, their debt-to-income ratio and obviously we know that’s different from one individual to another. And then the third bucket I heard there would be the actual type of lending and what’s unique to that specific property, whatever they’re looking at. So single family home versus the multiunit versus condos and then you even mentioned how it can be different on a purchase versus a refinance. So again, great summary and a good reminder that of course we’re looking at rates, we should be thinking about them, we know how they can impact a monthly payment, but really understanding that that can be different from one individual to another. So if I’m in a position, I found a house I want to purchase, and I’m looking to move forward with essentially writing up a purchase agreement, what things can or cannot be included in a purchase agreement? And the reason I’m asking this question, Tony, is I know we have had a couple folks from our community working through this process that may have realized some of this for the first time. And it’s worth talking to others about as well. So things that can or cannot be included in a purchase agreement.

Tony Umholtz: You generally when you’re going to — this is pretty universal for all lenders, you want to try to keep your purchase contract to the collateral, which is the actual piece of real estate that you’re looking to purchase. And you know, oftentimes, you’ll see a lot of other furniture, stereo systems, whatever, you name it, referenced in the contract, other items outside of the real estate that aren’t tangibly connected to the property. You don’t want to keep those in the contract for the appraiser or for the lender because we’re not there to finance personal property. We’re there to finance the actual real estate. So you have to be careful to keep that out. You can have another agreement for personal property with the seller. But you don’t want that to be part of the collateral for the appraiser view or for the lender. A lot of more experienced realtors will know this, but not everybody is aware of it. And if you’re buying a for-sale-by-owner and you’re working directly with a seller, it’s very common to see that.

Tim Ulbrich: Yeah. Tony, I want to go one step back before we talk about escrow accounts and then dig into the pharmacist home loan product in more detail. One of the things you mentioned that I think is of interest to our listeners is you mentioned the impact of credit scores on rates and how sensitive that can be. Can you give us some more information about what do you mean when you say how sensitive it can be? And perhaps that can help also guide or get folks thinking about strategies as they look at improving their credit and how that can impact the lending process.

Tony Umholtz: Another good point. So credit scores are — especially in conventional loans, especially on long-term fixed rates, so 30-year fixed especially — are going to be highly sensitive to credit. So someone that has a 680 credit score compared to a 740 credit score is going to have a different interest rate, clearly. And it’s even as granular as 700 to 720 or 740.

Tim Ulbrich: OK.

Tony Umholtz: There can be different movements in rate. One could have an eighth or a quarter higher rate because their score is 20 points below that 740 factor or if you start going into the 600s, it could be much lower than a 740. So it is highly correlated to credit score. And we actually have a program that we use for our clients where we’re able to boost the client’s credit score about 30 points in the processing time. Again, it just allows them to see — we have a program that will allow them to when we run their credit or give us what their credit score could be if they handle a few things on their credit, whether it’s paying down a credit card, paying down an installment debt, and that’s been a really good tool to help maximize not only qualifying but getting better rates. It’s highly, highly sensitive to — and certain programs have credit score minimums, right? You can’t go any — and it’s very sensitive on jumbo loans. A lot of jumbo loans will not go below a 700 credit score. It’s a big adjustment to both qualifying and interest rate.

Tim Ulbrich: Yeah, and as you mentioned, an eighth or a quarter of a point, that’s a big deal on $300,000, $400,000, $500,000, you know.

Tony Umholtz: Right.

Tim Ulbrich: Obviously people can run the numbers. So really being able to see that difference or being able to do some things to shore up that credit score could make a big long-term impact on the amount of interest that they pay over the life of the loan. Tony, let’s talk escrow. I know I mentioned this in detail when I talked and shared my refinance experience with IBERIABANK/First Horizon, but I think it’s one of those topics that for many, myself included, is just still kind of fuzzy in terms of really understanding how escrow works, pros and cons of pulling out of escrow, who may or may not have that options, what that would look like, what they should be thinking about. So give us kind of the main talking points around escrow. What is it? What’s the purpose? And what pros or cons may come from somebody looking to waive escrow?

Tony Umholtz: So escrows are just simply going to be your taxes and your insurance. Another word that is floating around are impounds is another word you’ll sometimes. But escrow essentially is just the taxes, your homeowners insurance, your flood insurance if you’re in a flood zone. So things that you’re going to pay no matter what, right? Even if you paid cash for the home, you’re going to owe your county or municipality or your state, and you’re also needing to pay for insurance to make sure your asset’s insured. So essentially, what lenders look for is typically at a 80% loan-to-value, a lot of lenders, I don’t want to say it’s universal because not all programs will allow it. But you know, some programs will allow you to actually waive escrow. What that means is you are paying the taxes and the homeowners insurance on your own. Now I want to say one thing about flood insurance. If you’re in a flood zone and you have a mortgage, even if you waive your escrow, like your homeowners insurance and your property taxes, you still have escrow for flood. That’s a federal mandate that lenders can’t get around. But you can waive the other two. You can have the homeowners — homeowners insurance is also called housing insurance, and you can waive those two items if you’re under 80% loan-to-value. If you’re over 80% loan-to-value, which a lot of first-time home buyers are, a majority are, you cannot waive them. The lender is required to escrow them. There really is pros and cons to having escrow. The majority of, again, of first-time home buyers are going to be over the 80% limit. So they’re going to typically be required to escrow. And a majority of people, even below 80%, I find want to have the escrow. And the reason behind that is you’re responsible for paying those lump sums on your own if you waive your escrow. So if you have an $8,000 annual property tax bill, and let’s say it’s due in November, which a lot of municipalities are, you’re paying $8,000, right? And if you have a $3,000 homeowners insurance bill around the same time, you’re paying $3,000. So most people like to have that spread out over the 12 months. And all the lenders doing is collecting each month 1/12 of your payment each month. Now, the cons are — of that is you don’t control it. Right? Meaning the lender does, and they’re holding the money for you. And right now, it doesn’t matter as much because interest rates are so low on deposits. So if you hold your money in the bank, you’re not really making much on it. But when interest rates go up and you can earn 2.5% on a Money Market account or more, the bank is holding your money and you’re not. So you can essentially earn interest off the money. That’s one of the cons I would say. And then the other thing would be just when you’re going to refinance, especially late in the year — and this is a key point I think people who are refinancing need to understand — if you’re getting close to the time when your taxes are due, the lender is going to have to collect a lot of tax. And it’s going to look like they’re rolling — I mean, if you were to refinance now, you’re almost rolling a year’s worth of tax into your mortgage. Now, the existing lender is going to give you back a check for everything they’ve built up in the escrow account.

Tim Ulbrich: Right.

Tony Umholtz: Right? So it will be a wash, but it’s going to look like a lot of money. Where if your escrows are waived, it’s a little bit cleaner. You don’t have all of that lump sum being moved back and forth. So that could be another pro to waiving escrow. But majority of people like the simplicity of having the lender take care of it, it’s one less for them to have to worry about, and just the ability of not having to stress over having to make lump sum payments on time.

Tim Ulbrich: Yeah, and I think, Tony, great points. And for those that do decide to pull out of escrow, you know, you mentioned being ready for that big payment or here, it’s divided into two payments. So you know, obviously there’s some strategies that can help that in terms of essentially creating a sinking fund for your taxes and insurance and every month contributing to that so you’re not caught off guard by that. But I think for everyone, individual situation, weighing the pros and cons and evaluating that as you’re going through the process if they have that option available to you based on loan-to-value.

Tony Umholtz: The one thing I did want to mention about escrow — sometimes, you’ll hear hey, there’s an escrow waiver fee or my rate is a slightly higher if I waive escrow.

Tim Ulbrich: Right.

Tony Umholtz: And some programs do have this adjustment. And the reason why is I mean, if you technically didn’t pay your taxes or your insurance, there could be risk to the lender. I mean, in some counties and states, if you don’t pay your taxes, someone could buy your tax deed. So there’s risk to the lender potentially if you didn’t do that. So I just wanted to make sure I outlined why there’s that fee that you’ll commonly see in the industry.

Tim Ulbrich: Great stuff. I’d like to wrap up our time together by talking about the pharmacy home loan as one option that folks may consider as they’re going through the home purchase process. And we’ve talked about it before on episodes 136 and 154. But I think it’s an opportunity that many of our listeners likely will want to consider and evaluate as they’re looking at all of their options. And what we know is one of the biggest barriers to pharmacists being able to purchase a home is student loan debt. And for most conventional types of loans, this obviously can greatly impact their debt-to-income ratio and certainly could affect someone’s ability to even get a loan or greatly reduce the amount that they could get approved for. So Tony, talk to us about the professional mortgage loan that IBERIABANK/First Horizon offers in terms of what it is, minimum down payments, term, max loan amounts, and things that they should be thinking about as they’re evaluating this among other options available to them.

Tony Umholtz: The product for pharmacists is going to — it’s going to be under that conventional loan bucket, essentially, even though it’s kind of a specialized product, because it’s not an FHA loan or a VA loan. But what it is is it’s got the ability for a pharmacist to purchase a home, if you’re a first-time home buyer, you can put as little as 3% down. If it’s a subsequent purchase, it would be 5% down. So very little down payment, and there’s no mortgage insurance. And I find that the rates tend to be better than normal conventional products by a bit of a spread, which can vary. But I find that can be a better rate than you can get ordinarily, even if you put 20% down. The max loan amount if $510,400, so it does kind of follow along — currently, that’s what the product we offer has a max of $510,400. It’s eligible for both a purchase transaction and a refinance transaction for both. But the real benefit’s just very little money out of pocket and the no PMI and a very competitive interest rate. So kind of the ability to have both of those makes it a very viable option for many. So that would be the biggest pluses. There is a biggie — you referenced student loans. It’s a little bit more lenient on the student loan calculation versus like some of the normal conventional products, I would say, like Fannie Mae-backed. It has a little bit more of a lenient way that they look at the student loan debt as well.

Tim Ulbrich: And talk about credit score impact here as it relates to the pharmacist home loan product.

Tony Umholtz: There is a minimum credit score of 700 with the pharmacist loan product. So you would have below 700, we couldn’t do the loan program. But 700 is the minimum. That is one thing we do have to keep in mind. So credit is important.

Tim Ulbrich: And I’m assuming just like other lending options, obviously the better the credit score, you get above 740 and beyond, I would assume then, you know, again, different person-to-person, but rates would be expected to get better.

Tony Umholtz: Right, right. The rates are going to be better at 740 up. I’ve even seen sometimes when you get higher credit, people will even get what’s called a lender credit for their rate too, which is kind of a rebate from the lender towards closing costs because there’s some add-ons or adjustments that are positive for better credit scores. So you’ll see that sometimes even as well, Tim. I think that yeah, credit scores really do impact the pharmacist product. 700 is going to be not quite as good as 740 or 720. Also as a kind of mini — if you are putting 3% or 5% down on a condominium, it may have a slightly higher interest rate than if one of your colleagues bought a single family home. So it’s something else to be aware of with the pharmacist home loan. And then same thing with a multifamily. I think this might be a good time to address that too is the — a multifamily is going to require a little bit more money down on the pharmacist product as well. It’s not going to be 3% down let’s say. A duplex might be 15% down. So you have to be very prepared for a much larger down payment if you try to buy a multifamily type property with this program.

Tim Ulbrich: Tony, one of the things you mentioned before we hit record that I think is — it would be helpful for our listeners to hear a brief overview that just highlights I think some of the unique circumstances that can happen based on trends that are occurring in the market at the time. Currently, you mentioned some of the things that you’re seeing around the quality of appraisals and how that can impact the lending process and the timeline moving forward. So tell our listeners a little bit more about that.

Tony Umholtz: Yeah, you know, in our dialogue there, Tim, just some of the things we’re seeing — and we do loans in a lot of different areas of the country, so it’s not subject to one market. But we’ve been seeing this inventory type. We don’t have quite enough inventory out there.

Tim Ulbrich: Right.

Tony Umholtz: I think home builders will eventually catch up, but right now, that’s the situation we’re in in many markets around the country. And you know, appraisals are starting to be done and they might be coming in a little bit higher values, and values are kind of going up at a pretty good rate right now as far as property appreciation. And in certain markets, there’s just not enough sales. And you’ll see some appraisals, every appraisal is scored. So they have a scoring mechanism that a lender’s analysts will look at, and that’s based upon comps in the area, adjustments in the appraisal, time since the last sale, so there’s a multiple things — I don’t want to get too technical on the appraisal side. But that’s how appraisals are scored. And oftentimes, lenders are required to do like a secondary review, which is called a field review or sometimes they’re required to even order another appraisal, depending on the lender or the situation. I’m kind of speaking in general because I’m trying to think of my whole industry here holistically. You know, the one thing that we have to be aware of is these field reviews. And appraisers are so busy with the volume right now between the purchase market and then the refinance market that they’re not always as timely as they used to be. So we used to be able to get a field review within a few days or two days. It might be a week. So it’s not that I’m seeing it on every transactions, by no means the case, but we’re seeing more of them lately. And it’s just — I think it’s because of where we are in the market cycle and the fact that there just isn’t that much inventory. So one thing to keep in mind is the appraisal is reviewed and is reviewed for quality. And sometimes those things come up too. So there is a multitude of factors in the lending process. And that’s why I always joke with people about this. There could be some — it’s like the airline flight with turbulence. There could be turbulence in the flight, right?

Tim Ulbrich: That’s right.

Tony Umholtz: But we’ve got to land safely is the key. And you never know. Sometimes it’s perfectly smooth sailing, but then there’s other things like this that are out of everyone’s control. But it’s just something to be aware of, you know, that these things can come up, even around the quality of the report. And if you hear that word, field review, that’s what it is. It’s a secondary look, and lenders are required to do that.

Tim Ulbrich: Tony, as always, great stuff. I feel like you provide great education, you succinctly explain what could be a very difficult process and appreciate you taking time to share your expertise. What is the best way for our listeners to reach out to you if they have questions or considering the pharmacist home loan product with IBERIABANK/First Horizon. What’s the best way to get in touch with you?

Tony Umholtz: Email is fine. I’m also old school, I do like phone calls, so I’m always welcome a phone call. I have a team of staff, some very hardworking and diligent individuals on my team that can also answer questions. Phone or email are always welcome. Those would be the best ways to reach me.

Tim Ulbrich: Awesome. We’ll link both of those in the show notes for our listeners, which you can access by going to YourFinancialPharmacist.com/podcast, find this episode and you’ll see that information listed in the show notes. And to learn more about the steps in consideration to getting a home loan, make sure to check out the post on the YFP site titled “Five Steps to Getting a Home Loan” by visiting YourFInancialPharmacist.com/home-loan. And as always, if you liked what you heard on this week’s episode of the Your Financial Pharmacist podcast, please leave us a rating or review on Apple podcasts or wherever you listen to the show each and every week. And if you’re not yet a part of the more than 6,000 pharmacy professionals across the country that are joining us in the Your Financial Pharmacist Facebook group, please make sure to check that out, join a community that is committed to helping and empowering one another on their path towards achieving financial freedom. Have a great rest of your week.

 

Current Student Loan Refinance Offers

Advertising Disclosure

[wptb id="15454" not found ]

Recent Posts

[pt_view id=”f651872qnv”]

YFP 168: How Blake and Zac Analyze Real Estate Deals

Posted on by yfpadmin


How Blake and Zac Analyze Real Estate Deals

Blake Johnson and Zac Hendricks talk about how they joined forces to build a successful real estate portfolio and investment strategy. They talk about their individual roles when investing in properties, the make-up of their current portfolio, and why they chose to focus on real estate investing. Blake and Zac lay out all the secrets on how to analyze real estate deals and break down the numbers on two of their own investment properties.

About Today’s Guests

Blake Johnson is a 2013 graduate of the University of Arkansas for Medical Sciences. Upon graduation, he married his wife Kristyn and he began working in a small town independent pharmacy. He worked there for 2 years and is now working in Conway, Arkansas at a local independent pharmacy. Upon graduation, Blake decided that paying off student loans would be a top priority, while still being able to travel and save for his retirement. After three and a half years, he was able to pay off his and his wife’s student loans. Since then, Blake has been able to increase his savings and start purchasing rental property. In his spare time, he enjoys traveling as much as he can and teaching others about finances.

Zac Hendricks is a 2013 Bachelor’s of Business graduate from University of Central Arkansas with an emphasis on Innovation and Entrepreneurship. Zac worked as an intern for a financial advising firm while finishing his degree at UCA. This is when he bought his first property. Upon graduation Zac got a job working in logistics at Maverick Transportation. While moving up in the ranks at Maverick he and his wife Mav purchased 7-8 more properties which eventually led to their finding financial freedom to change careers and working in the family business—Hendricks Remodeling. Zac and Mav find their most joy in using their business skills to fund missionaries in the 10/40 window and expanding the Kingdom of God.

Summary

Blake Johnson and Zac Hendricks met 7 years ago at a church they were both attending and decided to join forces as partners in real estate investing. Blake handles the financing and acquisition of properties, analyzes numbers and focuses on networking and finding deals. Zac assesses the homes with a quick inspection to determine rehab costs and rehabs the properties. They run numbers together to see if the deal is a good one. Zac’s wife manages the properties. Together they own 14 rental properties and a lot. They are currently renting 13 of the properties and are in the process of rehabbing one.

Blake breaks down their process for analyzing real estate deals and shares that there are several areas that need to be looked at, including accounting for capital expenditures, vacancy, and property management. Blake and Zac share the numbers from two very different real estate properties they purchased and the rehab process for each.

Mentioned on the Show

Episode Transcript

Tim Ulbrich: Blake and Zac, thanks for joining the show, and welcome to the podcast.

Blake Johnson: Good to be on here.

Zac Hendricks: Yeah, hey.

Tim Ulbrich: Appreciate you guys taking time. Excited to dig into this topic as we’ve been talking on the show for some time now wanting to bring more real estate investing content and happy to do that with Blake, who was on the show, Episode 082, with the ultimate mentor, Joe Baker, to talk about how he and his wife paid off $150,000 of student loans in 3.5 years. So excited to have him back on the show to talk about another part of his journey as real estate investing. And we’re also going to have his partner in real estate investing, Zac, join us to talk about how they work together, how they collaborate, what are their goals related to real estate investing, and my hope is as we have with other stories, that those that are interested and just hearing this for the first or second time, learning more, or perhaps taking that next step that these stories will not only be something that you can learn from but also something that you can take action. So Blake, it’s been awhile, how’s the debt-free life been treating you? And what have you guys been up to?

Blake Johnson: Debt-free life is incredible. I guess since the last time we spoke, my wife and I have done a lot of traveling, a lot of investing. It seems like when you’re out of debt, you can invest more. I guess that’s part of the reason to get out of debt. One of the big things that’s happened with us, we were able to adopt a child from birth, private adoption. And being out of debt made that a lot more smoother process. That was probably the most excitement that we’ve had in a long time. He’s actually turned a year old today.

Tim Ulbrich: That’s awesome. And congratulations. I know you and I had a chance to talk about that a couple weeks ago. I think just another example of the power of being debt-free and what that means for goals and being able to free up some of the cash flow and achieve some of those other things that are important. So Zac, excited that you’re able to join us today and really excited to hear more about your real estate journey and specifically how you and Blake are working together. Tell us a little bit more about yourself and ultimately why you got into real estate investing.

Zac Hendricks: Yeah, so we — my wife and I actually got into it kind of accidentally. My brother and I, whenever we were in college, we bought our first house together. We had no credit at all, I mean, we were broke joke. But we had a banker that we were close with. He said, “Hey, if you can bring some money, you can buy this house together.” So he helped us kind of get credit for that and then helped us buy the first house. My wife and I ended up buying that property from my brother when we got married. And we lived in it for a little while. Then we started moving around with the company I was with. And we had hardly any equity. It just didn’t seem like — it was so close to the university, the house was so close to the university that we said, it’ll be worth a lot more later on, so let’s hold onto it. So we rented it out and we didn’t know anything. My family has rental properties, my parents, but we didn’t know anything about it. So we got started in it and made a ton of mistakes. The first mistake was my wife let me be the landlord. That was a nightmare. We ended up with attic ladders torn out of the ceiling, three pitbulls left in the backyard, and about three dump trailer loads of trash in the backyard. So that was when my wife fired me from being a landlord, and now she does all of that. And anyway, so since then, we were moving around. We went to North Carolina, then we went Texas for a little while. And while we were moving, we decided, hey, let’s buy another property, just see how it is. So we bought one site unseen from North Carolina. It seemed like a pretty straightforward, easy deal, so we just bought it. And we realized that we could manage these properties from wherever we were and that it was really not that hard as long as you had the right systems in place. So when we moved to Texas, we ended up buying three or four more properties while we lived there and just realized, man, this is an awesome way to have some extra income, it’s a great way to just build wealth and at the time, we had set salaries so kind of like, well, this is the best way to kind of get ahead of the game. So in that time, we realized also if we’re not going to be doing ministry full-time, this is a great way for us to be able to support missionaries and other people that are local, and we can do a lot more in real estate than we can just with our regular 8-5 jobs.

Tim Ulbrich: So Zac, if I understood you correctly, you still have properties in multiple states? And then you guys are doing the property management for those?

Zac Hendricks: OK, yeah, let me clarify that. So actually, while we were moving around, we were buying properties in Conway. We lived in North Carolina and Texas. But we bought the properties in Conway.

Tim Ulbrich: Got it. OK. When I heard property management and how easy it was at a distance, I was like, oh, that’s interesting, love to hear more. So that makes sense. You were buying properties in Conway while you were in different locations. And Blake, talk to us about where your experience in real estate investing met Zac’s experience, ultimately how and why you guys came together — I’m assuming there’s some shared vision, perhaps different skill sets — and tell us a little bit more about what that collaboration and partnership looks like.

Blake Johnson: So Zac and I met about seven years ago at the church that him and his wife were attending at the time. And like he said, they moved off because of jobs. And funny thing happened, my wife and I were looking at rental properties, and we moved churches in Conway. And the first Sunday that we were there, Zac and his wife were visiting that church. And one thing led to another, we ended up in the same small group. And I can remember it vividly: We went out fishing on a local lake, and I started to express my love to want to get into rental property. So we talked back and forth, and we left it at, look, if you can find some properties, we can partner up. And so that started from there, and then our first deal, we landed two homes within the first deal. And so we’ve been there ever since.

Tim Ulbrich: And Zac, building off that, if we had to kind of divide roles and responsibilities that come with both acquiring, finding the deal, running the numbers, perhaps overseeing any work that needs to be done and then either renting it or selling it, how would you divide the roles and responsibilities and what each of you bring to the table.

Zac Hendricks: Yeah, so it was really interesting. My wife and I had kind of prayed about like the opportunities to find other people to get in with, and it just never really came. Blake and Kristin kind of came out of nowhere, and it ended up being just the perfect partnership because before, I was always the one finding the deals, and my wife was excited about it. She was ready to buy every house that we looked at, and I always had to tell her no or maybe, you know? Because she was just so excited about it. And then when Blake and Kristin came along, Blake just really dove into the acquisition side of things and also the financing side of things. So you know, I already had relationships with banks, he had relationships with some of the same banks, and so we both were kind of — we both still kind of handle the financing, but Blake analyzes things way more than I could ever dream of doing. He’s just so much more analytical than I am. His main thing is networking with people, talking with people, whether it’s wholesalers, whether it’s realtors, just other landlords, he’s really good about just meeting people, telling them what we’re doing, and then out of that, we found some deals, even networking with some local attorneys has helped. So then my role now, I mean, people ask me how we find deals, and I go, well I don’t know, you have to have a Blake, because I don’t look for deals anymore. You know, I’ll go and look at houses whenever we, whenever Blake finds one. I can kind of quickly do a ballpark of how much it’s going to cost to rehab or if it’s something we shouldn’t even be looking at or whatever and kind of a quick inspection of the property. But really, that’s the end of acquisition for me. And then we run the numbers together, so Blake usually has a — he can run numbers in his head super fast, so he usually just runs the numbers and tells me, yeah, let’s just do it. Let’s go for it. And then we kind of work from there. And then my wife, like I said before, she fired me from landlording, so she is the property manager. And so it really works well. We have two children, a 4-year-old — an almost 4-year-old and a 1.5-year-old. It’s great because she stays home now. She used to be a schoolteacher, now she stays home and manages properties full-time and then works for me with our remodeling company. So it’s really great because she handles the property management, she gets to be the bad guy and good guy where I just go in and I can fix things that are broken. So it works out really well.

Tim Ulbrich: So our listeners can understand before we go into the two recent purchases and kind of hear behind the scenes of how you guys think through and analyze those properties, if you could each talk for a moment — Blake, if you could start, and then Zac, talk about what is your portfolio — and I’m guessing there’s a lot of overlap, so feel free to clarify that. What is your portfolio? And types of properties you’re generally looking at investing in or specializing in as it looks to your portfolio? And then ultimately, what is some of the purpose, the vision, the why behind what you hope to gain from real estate long-term? We’ve heard a little bit of that, you just mentioned, Zac, what some of that has afforded to your family in opportunities, and Blake, I know you and I have had this conversation one-on-one. But I think it would be really helpful for our listeners to hear not only a little bit more about your portfolio and strategy but also what the why and purpose is for you and your family as it relates to real estate investing. So Blake, you want to start us off?

Blake Johnson: Yeah, I can start off. Zac and I, I don’t have any properties by myself. All of our properties that I’m involved in are in our LLC. Currently, we own 14 properties and the lot. So we can get into that later. That one’s a fun example. But anyways, we have 14 homes right now. 13 are rented, and one we’re rehabbing. And that’s where we’re at. Ultimately, my purpose down the road would try to get to 40 or 50 properties and have those paid off by the time I’m 50. I always want to be a pharmacist. I always want to be in the community. That’s what I went to school for. But if times get tough or if something happens health-wise, this is a fallback plan for replacement of your income and for retirement down the road. You never know how the economy’s going to be. People always have to rent homes. So this affords us a different avenue outside of the stock market. Asking about our purpose for the business, funny you ask that. Our corporate name is IHM Properties, which stands for In His Name. So our purpose for the creation of this business is not only to provide for our family financially down the road but also to be able to give back to missionaries overseas or to people locally. The wealth that we create is not only ours, but it’s to give to others.

Tim Ulbrich: And Zac, for you and your family and for the overall business, again, I’m sensing a lot of overlap, but anything else there to add?

Zac Hendricks: Yeah, no, he pretty well covered it. That’s our main goals, just to be able to have the financial freedom for ourselves but not just keep it to ourselves, be able to give back to others.

Tim Ulbrich: Awesome. So let’s dig into two recent purchases that you made as a part of your LLC. Talk through how you analyzed those deals to determine that you ultimately would move forward with them. And again, I think as we talk through some of the numbers and talk about your thought process, I think this will help our listeners see that are either building a portfolio or looking at that first one or just here to learn more get a little bit more information to hear from those that have been down this path. So before we crunch some numbers, Blake, give us a bird’s eye view of how you analyze deals. What’s your process? What are you looking for when a property comes your way? Where are you looking for properties? I heard Zac mention earlier some networking and things that are going on. Are you looking at the MLS? Are you primarily getting these from wholesalers or in contact with realtors? Numbers that you run? Talk us through not only where those properties are sourced from but then your thought process when you’re evaluating one of those.

Blake Johnson: OK, that sounds great. I think the first thing before we dive into the how and to the where and all that type of stuff is just to talk about a few figures that’s used in the rental business. There are just only a couple of them, but when evaluating a property, there’s three things that I look at. One of them is called capital expenditures or if you ever dive into the literature, that’s shortened for capex, which basically means your normal maintenance and also your long-term maintenance of the property. So your long-term maintenance is your roof, your heating and air units, your water heaters, all that type of stuff. So capex is one of the numbers that we look at. Another number that you have to run is one called vacancy. People always don’t stay at your house, and that would be nice if we had people stay there for 20 years straight. But your turnover is every couple of years, you’re going to have get new people in. You’re going to have to rehab it in between tenants. And so vacancy is a number that we run into our calculations. And the last one, if you have it — and I always recommend people to put it in there anyway — property management. Most people that start out kind of manage their properties themselves. They get tired of it anyway. So we always run that in all of our numbers. How we run numbers, when we find a house, the big thing we are looking for is the net cash flow. We’re not trying to pull any money off the business, but we want to make sure that these homes pay for themselves and has a little bit of room of a cushion so if interest rates go to 10 or 12%, there’s enough room in the numbers to cover that. So when we look at a house, we usually take — instead of looking at the purchase price, we look at what we think it will rent for and we take percentages off that gross rent. So for instance, if we use a home that we think will rent for $1,000, we use a 10% for capital expenditures, 5% for vacancy, and then 5% for property management. And so off that $1,000 rental home, we would use a number of $800 as our I guess gross margin. So if that gross margin can cover the payment, your taxes and your insurance and still net around $100 to us, that’s a good deal. And in any market, whether it’s an up or down market, you’re going to stay afloat. It’s a very conservative number, and it helps keep us — helps us sleep at night. So that’s how we run numbers. The second thing would be is a purchase price. I think Zac mentioned, we love to purchase all of ours with 0 money down, and that sounds intriguing, but the only way to get in homes $0 down is to have homes that need remodeling. So let’s take that $100,000 home, most banks if they’re local or small banks will lend up to 85% of the appraised value of the house. I would put appraised value in parentheses because appraised value is the value it appraises at after the repairs are done. Let’s use that $100,000 house, say we find it for $50,000. We go in it and see that it needs $20,000 worth of repairs, we can take that repair list to the bank, they’ll get it appraised, and the appraiser will say, “Hey, we’re putting in new flooring, we’re putting in new paint, I’m going to appraise this house at $100,000 after the repairs are done.” And so the bank on this home would loan up to $85,000. So as long as we can keep our repairs under the $85,000, so if it’s $20,000, we’re able to get in that house with $0 down. Still got really good equity.

Tim Ulbrich: And real quick on that, Blake, to me that also just goes to an important point about building some of those relationships. So what is the strategy there, you know, for folks that are looking to start their first or second property and not only is the analysis side of it or perhaps other pieces of it overwhelming, but then to begin to think about how those relationships are formed, what was your strategy in forming those relationships? And was it one bank that you were primarily working with? Or did it take you some time to find that lender that was a good fit?

Blake Johnson: I think one of the biggest advantages pharmacists have is our W2 income. The average salary across the United States is around $120,000, you know, that’s 3x the average wage for any normal working family. So that’s an advantage to pharmacists because what banks look at is not what your profit is from stocks or your profit is from bonuses. They want to know what your W2 income is. They look at what your salary and wages are. So as pharmacists, we have an advantage when we walk into a bank to forge that relationship. They want you. You’re a safe investor. You’ve got extra income coming in each month more than most people. And so that was an advantage for me. But on the relationship side, Conway’s a very small town. And we’re involved with a pretty good size church, and so out of our church, there’s two local bankers that I’ve developed relationships with. And those are the ones we use. And they’re local banks, so they’re real easy to work with. So we started working with them, and because of our conservative ways to approach purchasing homes and also just the income side, it makes financing homes pretty easy as far as that.

Zac Hendricks: Yeah, and I want to piggyback off that a little bit. With the finding a bank, if somebody’s new to investing and they’re trying to find a loan, find a lender, Blake hit on it, but the small bank, the small, local bank is perfect. A lot of the big banks just can’t — they don’t even care about you. And I don’t mean that in a terrible way. They have bigger fish to fry. The small banks, they care about their community, and they care about that you’re fixing up the neighborhood or that you’re just buying in the neighborhood. They care about that a lot more than they care about you. And so I’ve found that when you go to a big bank, you’re not going to find anybody that really cares a whole lot. But when you go to the small, local banks, they’re going to want to invest in a lot more.

Tim Ulbrich: So Zac, I can jive as Blake is talking about running numbers and analyzing and crunching it, like that’s speaking my language. What is not speaking my language is what I perceive to be your role, which is estimating rehab costs and kind of seeing that piece through. So talk us through when Blake calls you or messages you and says, “Hey, I think we’ve got a good one. I need you to look at it,” where does that knowledge come from that you feel comfortable walking through a property to estimate those costs? Where did you acquire that knowledge? What are the things that you’re thinking about, looking at? And you know, obviously also to protect yourself against some of the bigger items, I’m sure often what you expect and what is reality may not always line up. So talk to us about not only your process of doing that but also how you account for some of the margin of error that may happen just from the unknown.

Zac Hendricks: Yeah. So it’s been a learning process. I will say, I have an unfair advantage. My dad is a remodeling contractor. And so he’s owned — I actually work for him now — Hendricks Remodeling in Conway since 1987. So and he’s been in the business for longer than that. So there’s a little bit of an unfair advantage there because I’ve been around it my entire life. He put me to work for free whenever I was like 6. And so I’ve been around it, I’ve seen it, but the cost I didn’t always understand. I always knew what work went into a remodel, but I didn’t really understand the cost. And so that came in later, really with the first — whenever we were in Texas, we bought our first rehab project. And if anybody’s on here that listens to Bigger Pockets, they use the term BRRRR: Buy, Rehab, Rent, Refinance, Repeat. So that’s the strategy we’ve been at ever since that first rehab project. So before, we were just putting money in. And then we found that first rehab and we were like, oh wow, this is incredible. We don’t have to put money in. On that project, we lived in Dallas, and my brother at the time was working for my dad. I said, “Hey, run an estimate for me. How much is it going to cost to remodel?” And so I think we picked the property up for like $55,000. And then he went over there and he said, “Yeah, I mean, I think it’s going to cost blah, blah, blah.” I think the total cost was like $30,000. So I had him kind of walk me through what he was looking at as far as estimating goes. And so really, between my brother and my dad, they helped me understand the cost of things. And then from then on, it’s been experience. It’s just been we take one, we make some mistakes, now we know more. Now we know we’ve got to check the sewage every time. Now we know we’ve got to check the roof every time, the HVAC, there’s so many things now that we go, oh man, if I would have known that, that would have been better. So it’s really just getting into it. You can’t learn it without doing it in this business. You can’t just read a book or books. There is a really good resource called that Jay Scott wrote, it’s “How to Estimate Rehab Costs” is what it’s called. And double check me on the title. It is really good. It just talked about going from the top down for rehabs. I think he’s talking about mainly flips. But I read through that, and with some of the stuff I already knew, it really helped to just kind of oh yeah, I never really checked for rotted facia or whatever it is. I probably need to start checking that. And so he kind of gives you a little bit of a checklist — I don’t want to use a checklist, but whenever we walk through a house, I’m constantly just looking, just trying to figure out what issues there are. And then a lot of times, now me and Blake will walk into a house, and I’ll say, well, it’s going to cost this, this, this. And Blake will go, oh come on, we could do it for cheaper on this house. So there’s a little bit of back-and-forth there, and then we eventually come to a number.

Tim Ulbrich: That’s the sign of a good partnership. So appreciate that story. And I’m glad you mentioned the BRRRR concept as well, it’s one of the Bigger Pockets resources. We will link to those in the show notes, the estimating rehab costs book that you mentioned, the Bigger Pockets podcast, the Bigger Pockets blog. I’m sure we’ll talk about another Bigger Pockets resource at some point in the rest of the show. So we’ll link to those in the show notes, great resources. And I’m glad you mentioned BRRRR because Blake, it triggered my memory. One of the things I wanted to come back to, when you said nothing down, point of clarification: Are you referring to that when the deal was done at the point of refinancing, you didn’t leave any cash in the deal? But you ultimately had to obviously come with cash to purchase the property and do the rehab? Or do you have some other source of funds that you actually aren’t bringing cash up front to get started? Because I think that’s a hangup point for many folks getting started, even if they’re looking at a refinance down the road is that they still have the time period where they’ve got to purchase the property and fund the rehab and they may or may not be ready with that cash.

Blake Johnson: So yeah, that’s most of our properties that we do, the banks will let us come to closing with 10% of the purchase price of the home. But like I said, they’ll loan up to 85% of the appraised value. So the two local banks that we use, as long as the improvement plus that 10% down plus the purchase price is under the 85%, we’re able to pull our money back out. So on that $100,000 home, we’ll get it under contract, we’ll go to closing, the bank will provide the purchase price is $50,000, they’ll provide 85-90% of that, and then we’ll have to bring 10% of the purchase price down. But after closing, we have a pool of money that we can pull from to pay ourself back and also do the improvements. So you do have to have some money to come to the table to purchase the deal. But if you run your numbers and you can get your rehabs under that 85% margin, you can get your money back.

Tim Ulbrich: Got it. Thank you for that clarification. OK, let’s dig into a couple properties as examples of what you guys have been working on. One will be a little bit more traditional, the second we could categorize as maybe more interesting and creative, just to give two different examples and the contrast of how you approached each. So Blake, let’s start with the traditional property. Tell us about this one. How did you find it? Bedrooms, bathrooms, square footage, purchase price? And then we’ll have Zac talk through some of the rehab costs.

Blake Johnson: So most of our properties, I guess to clarify in the beginning of the question, all of ours are single family homes. We’ve tried a few duplexes. We’re actually looking at a few now, but we’ve looked at three and never made any of the numbers work. So all of our properties are all single family homes. And the first several came from the MLS. Up until about a year and a half ago, you could look on Conway’s website about once a month, find a deal. But it’s now been flooded with young investors, so the time of looking and finding a good deal on the MLS has really kind of gone away. So I’ve got relationships with a few lawyers, a couple of wholesalers in the area, and of course a bunch of realtors. And so the last several deals we’ve had have been from off-market deals from realtors or an estate type thing or an auction. So the first house that we’ll talk about is actually an estate purchase from a lawyer that I know. He’s the one that handles all of our LLC stuff. And I was discussing with him about how we were looking to buy some properties and if they ever have an estate sale come up where they’re needing a home purchased, we would be glad to do that. And about a day later, he texted us back about a house he had that was a four-bedroom, two-bath house. It was 1,800 square feet. And the guy had passed away over a year ago. The children were wanting to sell the house. So we went and looked at it. It’s 1,800 square feet, like I said, four-bedroom, two-bath. And we purchased it for $78,500. I’ll have Zac talk about some of the improvements that we made. But anyways, it appraised at — with the improvements — at $134,000. We put $20,000 into it and took a little bit more extra on the loan to cover a couple other projects we had going on. So our loan amount on that is $105,000. The good thing about that is our loan-to-value or how much we owe and how much it appraises for is 78%. So out the door on this one, we came out with 22% equity, which is music to our ears because anything below 80% loan-to-value ratio is really good and makes banks happy. So we’re pretty happy with that. It rents — we were excited; we got it rented for $1,350. So if you do the whole —

Tim Ulbrich: Wow.

Blake Johnson: Yeah, if you do the whole calculation like we talked about, the principle taxes and insurance on that is like $822. The capex or the 10% in rent is $135. And then the 5% for vacancy and property managing are $67 each. And so that one rents each month $258. So that’s one of our better deals there.

Tim Ulbrich: That’s awesome. And Zac, do you want to talk through a little bit of the rehab and what was included in there and what was or was not on budget along the way?

Zac Hendricks: Yeah, so this one is an oddball because we budgeted for a lot more than we ended up spending. Somehow or another, we ended up saving a lot of money. I think some of the subs that we used ended up being a lot cheaper than what we had used in the past. I think we budgeted like $27,000 for the rehab, and it ended up being like $17,000 or something like that. So that was a — we saved a lot of money on that one. Yeah, so it was really just a lipstick remodel is what I call it, anyways. We just — floors, paint, the guy had dogs, and they peed all over the floors. It’s a slab — it’s built on a slab, the house is. But somewhere along the way, somebody did a little addition on the front and had a little, a small — I don’t know if you can even call it a crawlspace, but it’s kind of a crawlspace, and it had wooden subfloors. So we had to tear all that out because the dogs — I mean, that smell is just terrible. So we tore out all the subfloors and then redid those. But that’s really, I mean, we just kills the whole house, and then it smelled like a brand new house. It wasn’t so bad. The next property that I think you’re wanting to talk about is a lot more interesting. This one was really basic: floors, paint, we put some granite countertops in, built a closet to make it an official bedroom, I mean, that’s really it on that one.

Tim Ulbrich: Yeah, and I think what was helpful about this one was just for folks to hear the numbers but also Blake, I like what you said about when I hear about you investing in Arkansas and I think you hear those numbers, 1,800-square foot, 4-bed, 2-bath, $78,500, obviously it needed some work, but there’s other people listening in other parts of the country that are like, I don’t even see those numbers exist, you know, in our part of the country. But what I heard you say is, you know, the relationships are really important. And here was a good example of a relationship with a lawyer. But you know, not necessarily just thinking you’re going to be able to find deals on the MLS but getting out to local meetups, taking advantage of those relationships, being a part of a community and getting creative in different ways to be able to find these types of properties and deals. So let’s dig into the other recent purchase. I guess again, you could categorize this as being more interesting, more creative, than the traditional one. So why don’t you start us off, Blake. Talk to us about this property. Why was it more interesting and I guess more nontraditional?

Blake Johnson: Sure. Before we dig into that, funny thing about the last house as far as rehab. We had to replace the ceiling fans. They had miniature ceiling fans in there. And pretty sure that Boeing sent some of their propellers into this place.

Zac Hendricks: Yeah, that was funny.

Blake Johnson: That thing was the loudest and most powerful fan I’ve ever seen in my life. It would just blow you away. The one other thing with that last house, something that you could let people know when they’re looking at homes is that one had two living rooms. It had the main living room and then there was an addition onto the house. Most of the time, you look at your rent, how much you’re going to charge for rent based on bedrooms and baths, and so that one already had three bedrooms, two baths, but we were actually able to spend $1,000 extra to frame in a closet, and we were able to increase our rent by about $150 a month. So if you run your return on investment there, it took us only eight months to recoup our costs in putting in a closet. So when you’re looking at a property, you’ve got to be creative because small additions like that can get you pretty good return. So let’s talk the second home. This one is really cool. So we bought this one at an auction. We actually paid cash for this. First auction we ever went to, nobody showed up at all. It was an auction that a local — the lawyer that sent us the first one told us about would be coming up. So we showed up on a Tuesday morning at 10 a.m., thinking that were going to be a whole crowd of people. About 9:59 rolled around, nobody rolled up, and then finally, we saw a guy, a gentleman walking up with a clipboard. He came up and I said, that’s got to be the guy. And sure enough, it was. Nobody else showed up, so we said, “What’s opening bid?” He said, “Open in bid is $35,500.” So we had to bid $1 over that. So we bought the property for $35,501. It was the craziest thing, he said he’s never seen where nobody shows up. So apparently we were lucky then. So this home is a two-bedroom, one-bath house. It’s around 1,100 square feet. But it’s in a really desirable area of downtown Conway. It’s right by downtown, a lot of people were tearing down homes, building up new ones, rehabbing them, I guess it’s like in your traditional Old Town downtown for people who are wanting to redo them and make them real nice. And so this one’s a two-bedroom, one-bath. I don’t want to spoil the fun, but we’re actually turning it into a three-bedroom, two-bath. Zac can talk about that. So we bought it for $35,500. Our rehab on the house is going to be right around $60,000. But the total value of the house is $125,000. So our loan on this house will be around $85,000, so we’ll have about $40,000 in equity.

Tim Ulbrich: Wow.

Blake Johnson: Yeah, the funny thing is — and we didn’t even know about it, when we purchased the house, we had gone and looked through the windows and some stuff, just to check it out because you can’t get in them at all. So we purchased the house, the next day we drove by, and Zac goes, Blake, this is big enough to split a lot off. I said, “There’s no way.” Sure enough, it was. We spent $1,000 and got it zoned off to have an additional lot. That additional lot is worth about $35,000, which is the same price we purchased the house for.

Tim Ulbrich: Wow.

Blake Johnson: This rezoning the lot paid for the purchase of the property. So our plans with that once lumber goes down the next year or so, is to build a new house there and rent that out. Anyways, that’s a fun part of that. I don’t know if you want to dive into the rent, all the numbers now or if we want to talk about the rehab and go on from there.

Tim Ulbrich: Yeah, let’s talk about the rehab and then we’ll come back to the rent. So Zac, do you want to talk about some of the rehab and the costs and what was involved and some of the creativity to turn that into a three-bed?

Zac Hendricks: Yeah, you bet. So yeah. So whenever we got this, we realized we could either tear this house down and really build two really nice houses. Or we could figure out how to make this house work. It was two-bedroom, one-bath. Those just don’t really rent that great. They do, but we prefer a three-bedroom, two-bath. And so we were trying to figure it out, my company, we have an in-house interior designer. So I just kind of put him on the task. I was like, man, we’ve got to figure out how to move some walls. I’ll work on the structure side of things, you do the interior part, make it look pretty. So he messed around with it, we went through probably five or six different design changes of how we’re going to do it. Finally, we figured it out, the best way to do it. We had to tear out two interior walls. So I’ll back up a little bit. I didn’t want to do an addition, a full-on addition, because I didn’t want to build out of the house and have to do all that. We can do that, but I’m in the business, I know how much it costs, I just didn’t really want to mess with it on this property. And so we said, if we’re going to do anything to add bedroom and bathroom, it’s got to be within the walls. So we tore out two interior walls and then were able to build a bedroom on the front side of the house and then build a bathroom in between the other two bedrooms — the original two bedrooms. And so — which we’re still in the process of that. So we just got done framing. But with that, we had to move front door, we had to add a window, change out a window, just to make it all right because the front door originally would have been right in the middle of the bedroom, of the new bedroom. So we had to move that over about 5 feet and put a window back in that bedroom for egress purposes. And then we ended having to reside the whole front. And then it’s in the historic overlay district of Conway, so if you’re doing anything to the exterior, it has to go through committee, a design committee. So they had a couple suggestions to make it look better. So with that, we ended up doing a little bit more than what we planned on. But it’s actually going to make it look really great. So can’t hate them for it. Yeah, so we’re in the process of the crawlspace, and it had a lot of foundation issues. Thought we’d fix them all on the front end, and then whenever we tore out some of the walls, found even more foundation issues. So we had to stop working on framing and work on the house for a little while. But now it’s actually a great house. Most of the lumber is new in that house now.

Tim Ulbrich: I guess it’s hard to go wrong when you mentioned the discovery of that extra lot that could be parced off that would have value equal to what you paid for it up front. So awesome bonus, but it sounds like it would have been a good property regardless, and obviously the creativity you had really helped in that. Blake, run the numbers for us on this one.

Blake Johnson: One of the questions you had is how did we finance it. So we paid cash for it, and then we went to a bank with an improvement list, and our total loan on this is going to be $85,000. So our projected rent is going to be around $1,200. The payment with taxes and insurance will be about $650. Our capex on $1,200 is $120, vacancy is $60, and then property management is $60. This is our best deal to date. And so just on the one home alone, we’re going to net profit around $316 a month. And that’s saving back for all those unknowns. So this is — normally we’re trying to get $100 a home, and this one, we’re getting 3x that amount.

Tim Ulbrich: That’s awesome. And I think for our listeners to hear two different examples — and obviously these are just a couple properties in your overall portfolio. And certainly want to mention that we’ve given two examples where the numbers are really good and you guys have been really successful overall. But you’ve also invested a lot of time, a lot of energy, a lot of effort, lots of relationships, lots of learning, lots of experience, lots of good connections. And so I don’t want to make this sound easier than it necessarily is but also don’t want to underestimate the work that you guys have put in to be successful and certainly I’m sure there have been some difficulties along the way. I do want to wrap up, Zac and Blake, I know we’ve talked about Bigger Pockets as a great resource. Other resources, books, podcasts, blogs, local meetups, what recommendations would you guys have for people that are looking to get started?

Blake Johnson: For me, the biggest thing, like we’ve mentioned, was Bigger Pockets. If you go on their website, they endorse several books. If you’re wanting to do your own landlording, Brandon Turner’s got a book that he wrote. They’ve got note investing on a home, so any facet of real estate you want to get into, there’s a book, there’s a blog or something you can get into. So if you want to educate yourself and get you a real estate degree or a doctorate in real estate, you can go on that website and come out pretty smart.

Tim Ulbrich: What about you, Zac? Other resources?

Zac Hendricks: Yeah, I mean, Bigger Pockets is probably the most. But part of it is getting inspiration from other people. So you know, reading books on it. We’re both — me and Blake are both big readers, so we’re reading about real estate as well. I went through a period where I think one year I read like 35 books just on real estate. And that was my college education for it, you know? I needed somebody else’s skills to kind of learn it. So there was a lot of them. I can’t name them all, but one of them I would say for inspiration purposes not for — I wouldn’t say it’s good for life goals, but it’s “Rich Dad Poor Dad.” It’s a great book for the overall goal of real estate and financial freedom and just really a business. But there were so many more good books out there. “Think and Grow Rich” is another good one. But there’s a lot of great books out there that people can read. But Bigger Pockets has a lot of resources. And honestly, going to Bigger Pockets and getting on the forums and saying, “Hey, I’m running into this issues,” I mean, there’s 1,000 people that can say they’ve had the exact same issue. So that’s where I’ve learned a lot is just saying, “Hey, I’m getting turned down on this,” or, “This isn’t working out,” or, “I’ve had this weird floor plan,” you know, people get on there and love to answer. And so that’s a great resource.

Tim Ulbrich: Great recommendations. We’ll link, again, to those in the show notes, Bigger Pockets website, Bigger Pockets podcast, they just launched recently a Real Estate Rookie podcast, which I think is fantastic. We’ll link to “Rich Dad Poor Dad,” Robert Kiyosaki, I think you mentioned “Think and Grow Rich,” Napoleon Hill, great recommendations. And I like what you said earlier, I can’t remember Zac or Blake, that you know, learning has its place and certainly there’s wisdom in getting that education, but I think — I’m only a property in, but I felt like I learned so much from that first property that the learning was helpful, but I felt like I was at that point where more books and more learning, I just needed to jump in and kind of figure it out and recognize that I was going to make some mistakes along the way and that it was a learning process and you build from those. And obviously here you guys are with a handful of properties and I’m sure many more ahead of you. And each one I’m sure the process gets a little bit more refined. I love seeing successful partnerships like this, you know. Not to say there hasn’t been challenges along the way. If there haven’t, awesome. But I’m a big fan when there’s shared values, when there’s shared vision and there’s good relationship, the value that can come from a partnership, especially when you have complementary skill sets and just being able to bounce ideas off of one another, to be able to move that forward, especially here as you guys have a shared vision for what you’re trying to do as your why behind real estate investing. Really cool to see and highlight this as an example. So Blake, Zac, really appreciate you guys taking time to come on the show and share your story with the YFP community.

Blake Johnson: Appreciate you having us on.

Zac Hendricks: Yeah.

Blake Johnson: It was a blast.

Zac Hendricks: Absolutely.

 

Current Student Loan Refinance Offers

Advertising Disclosure

[wptb id="15454" not found ]

Recent Posts

[pt_view id=”f651872qnv”]

YFP 167: Must Know Real Estate Terminology

Posted on by yfpadmin


Must Know Real Estate Terminology

David Bright, a pharmacist, pharmacy educator and real estate investor talks about why he views real estate investing as an important part of his financial plan, how he got started in real estate investing, and key real estate investing terms and concepts.

Summary

David Bright teaches at Ferris State University and loves his job, so the idea of getting into real estate investing didn’t come about as a way to retire early or to escape a career he didn’t enjoy. David’s family dabbled in real estate properties and he saw how those properties supported his family members’ retirement income, especially after the mortgage was paid in full. David and his wife decided to pursue real estate investing as a way to diversify their retirement income and to fund life experiences such as vacations along the way.

David shares his journey in real estate investing which began with a fixer-upper he and his wife purchased in 2009. They sold the property 5 years later for more than what they paid for it. They moved to Michigan and purchased a HUD foreclosure condo that they did some work to and were able to rent out when their family outgrew the condo. House prices increased in their town so they looked elsewhere for their next property and purchased a home in Muskegon, Michigan that they were able to BRRRR (buy, rehab, rent, refinance, repeat).

David also breaks down some key concepts and terms in real estate investing like the 1% rule, BRRRR, appreciation and short sale, among others.

Mentioned on the Show

Episode Transcript

Tim Ulbrich: David, welcome to the show.

David Bright: Hey, thank you.

Tim Ulbrich: So long time in the making, you and I have known each other for a long time, all the way back to our PGY1 community pharmacy residency days here in Ohio. And we’ve had an opportunity to know each other further in the academic pharmacy circles and more recently with some real estate investing opportunities. So really excited to have you on the show to share some of your pharmacy journey but also some of your experiences in real estate investing as we really use this episode to highlight some of the key principles and terms of real estate investing. And we’re going to do that through some examples and stories. So David, before we jump into the weeds on the real estate investing part of the episode, give us some of your backstory in your pharmacy career.

David Bright: Absolutely. And thanks for having me on. This is a lot of fun, and it’s fantastic to see what Your Financial Pharmacist has done over the past few years to help people in their journey to financial freedom, financial independence and financial literacy. So yeah, as you mentioned, the pharmacy career story, we both went through the residency route. I had been involved in community pharmacy practice really since I was 16. One of my first jobs was a pharmacy technician in a drugstore at 16. And worked in drugstores through pharmacy school and community pharmacy residency, so that was really my passion. I love those opportunities to interact with patients and that kind of direct patient care where you’re having a lot of conversation, a lot of educational opportunity, a lot of that direct patient care that I really loved at a community practice. That led me to an academic position where some of those same kind of teaching aspects of community pharmacy certainly play into that academic pharmacy and also got to focus research on pragmatic implementation and improvement of non-dispensing pharmacy services that often took place in a community pharmacy or in am care. So that was a lot of fun. Spent five years at Ohio Northern and then since then, have taught at Ferris State University in Michigan.

Tim Ulbrich: Awesome. And got to give a shoutout to the Polar Bears. I actually hear from — as a Polar Bear alum myself, every once in a while, I’ll hear from other Polar Bear alums that say, “Hey, I love when you give the Polar Bears a shoutout on the podcast.” So here we are with another ONU connection. So great background, David, in terms of the community residency, the transition to the academic world, the work that you’ve done in advancing patient care services. And we’re going to approach this episode — we are both educators in terms of our work. Obviously I’m at Ohio State, you mentioned you’re working at Ferris State. But also just how we approach this topic, whether it’s financial education, literacy at large, here we’re talking about real estate. We are both teachers, and we know that we could talk about terms and go through them one-by-one and define them, but I don’t think that sticks well, right? We know that from our experience. So we’re going to use stories, we’re going to use examples, to really hopefully make some of these terms and concepts come to life. So David, first off, why real estate investing? You’ve got a full-time job, you’re busy. Why take on another job, side hustle, whatever you call it, in terms of the time it takes but also what this potentially means for your financial plan and your family?

David Bright: Yeah, that’s a great question. For me, I love my job. I love teaching Ferris, and so I’m not one of these folks that is looking to escape that and to do something else. Like I really love what I do. At the same time, I don’t want to be teaching at Ferris when I’m 85 years old. I hope to retire at some point. So my wife and I, we both had kind of extended family on either side of the family that have dabbled in owning a few rental properties and just kind of seeing that from a distance and hearing stories of how they bought a property or two in their 20s and 30s and with a 30-year mortgage, by the time they were retirement age, they had a paid-off rental house. They saw that as a way to diversify their retirement savings. And that just kind of stuck with me. It made a lot of sense as a diversification plan. And you know, in addition to that, one of the things they shared with me is that at the end of the month, if you can buy well, there’s hopefully a little bit of money left over after between the rent that you take in and the mortgage payment that you pay. And that little bit of money can fund other things. And my wife and I, we really value those experience, memory-making opportunities with the family. And so we thought, if there would be a little bit of that cash flow left over at the end of the month, we could save that up and help with the cost of vacation or other things. So not purely as a retirement play, but just kind of as a diversification for our overarching financial plan. So at the same time, you mentioned that some of this real estate work can be time-intensive if you let it. For me, I’m not remotely handy. Like I’m barely qualified to change a light bulb. Like you’re not going to find me swinging a hammer and doing things, like that’s just not me. I can’t do that. I’m a pharmacist. And so I’ve come to learn that there’s some things that I’m good and there’s some things where I’m not good at all. And so one of the nice things about real estate investing is that you don’t have to be good at swinging a hammer. Like you don’t have to be able to hang cabinets or do electrical work or any of the other things. Like by buying properties or looking at things that don’t need a ton of work, like what we’ve done, it makes it just a lot less intimidating when we’re hiring a lot of that work out. Like I’ve really not done much more than painting myself in the evenings, which is I think something that a lot of folks have done. So it’s been nice to find a way to diversify our retirement without it taking a ton of time.

Tim Ulbrich: Yeah, and one of the things, David, that I like about that — and certainly for folks that are handy, and I’m with you in the non-handy camp, probably even to a greater degree. You know, I’ve learned to accept my limitations and lean on my strengths, which are not being handy. But I think for folks that are, certainly if it’s something you enjoy and perhaps there’s some cost savings, great. But one of the things I’ve really enjoyed observing your path in real estate investing is that you really have done a nice job of building a system and a process that factors that in, you know? And really, I would argue then even becomes more scalable because it’s not dependent on you, which could work with one or two properties. But as you’re talking about longer term goals and a bigger portfolio, building a system and a property, analyzing deals and including things like property management fees, I’m working with contractors, and not all of that depending on you I think reminds me of how somebody builds a long-term successful business that is positioned for growth. So I think folks that are just starting, as you’re beginning this path, is there an opportunity to begin this path with some of that and some of the end in mind? And that may perhaps be minimizing some of your role and involvement in that. So David, you shared a little bit of the why real estate investing. So let’s jump into the how did you begin. So talk us through that first property. And then as you’re talking through that, I’ll pick up on some of the terms and concepts, and we’ll break some of those down after that.

David Bright: Yeah, definitely. Even when talking about properties in general, like it seems like there are very few people anymore that buy a property when they’re in their 20s and they live there for 60 years and then they sell it. Like most people over time are going to own several houses, at least most people in this podcast are probably going — or listening to this podcast — are going to own several houses over time. So I think getting in that mindset of what am I looking for in these. When my wife and I, we bought our first house in 2009, and when we did that, that was at a time in the market when those like house flipping were starting to come on TV, and it was like, oh, that would be fun. I could do that. Even though I totally — like no. But we thought we would look for something that was a little bit of a fixer upper. And looking back on it, a house that needed a little bit of paint probably wasn’t the definition of a fixer upper. But that was what we looked for. And so we bought a short sale property in 2009. And over the few years of living there, kind of like most people do, we fixed it up a little bit over time. We painted it, replaced some carpet, finished the basement, those kind of things. And that was what I would consider a live-in flip because we bought the house, we fixed it up while we lived there, and then when we moved to Michigan about five years later, we were able to sell it — in between the market improving a little bit and these fixes increasing the value — we were able to sell the house for more than what we paid for it.

Tim Ulbrich: OK. So the live-in flip, you had that for about five years, is that correct?

David Bright: Correct, yeah.

Tim Ulbrich: OK. And then I know we’re not attempting to play accountant or taxes, so disclaimer, this is not tax advice. You should consult your own accountant. But talk to us broadly about what does that mean for folks that are either in a live-in flip situation or considering a live-in situation? You mentioned being able to sell that, and I believe you sold it for tax-free profit. So is there a certain time period that folks need to be thinking about in terms of the time they’re in that house before they sell?

David Bright: Yeah, so again, I’ll repeat the disclaimer that a tax attorney or anything like that.

Tim Ulbrich: You taught me that disclaimer.

David Bright: Well, and even thinking through like if people listening to this in the future should certainly consult professionals at the time. But at least at the time that we were doing this, the advice that we got was that if you live in the property for at least a two-year period and then two out of the last five if you keep it as a rental or something like that, that two-year mark is when it becomes tax-free. So you’re right, the folks that are out in these house flipping, they’re probably paying quite a bit in taxes when they buy and then immediately resell these houses. But by doing it slowly, living in the house for a few years, that became essentially tax-free gain, which helped us to buy the next house.

Tim Ulbrich: It’s amazing, David, right? When’s the last house flipping show — when did you watch the last house flipping show that talked about the taxes they paid on the properties? Never mentioned, right?

David Bright: Yeah, exactly. Exactly.

Tim Ulbrich: So you mentioned also that you bought it via short sale. So I want to break that down for our listeners. What is a short sale?

David Bright: Yeah. A short sale, they seemed to be more prevalent back in that ‘08-’09-2010 kind of realm because a short sale is where someone has a loan on the property that the loan balance is greater than what they’re able to sell it for. And in that situation, a lot of people refer to that as being upside down on the property because you owe more than it’s worth. And so when you go to sell that property, your option is either to bring that extra money to closing or if you don’t have the money to bring to closing, then the bank can agree to accept whatever you sell it for as payment in full, and they consider that a short sale.

Tim Ulbrich: OK.

David Bright: So it’s presumably going to damage your credit pretty good because you’re not paying back the loan in full and all those kind of things. So I can’t really recommend it for people as a way to sell a house unless you’re really backed into a corner, which is the situation with the seller. He had bought this house as a brand new house just a few years before, so it worked out really well in the buyer side because we were able to get a practically new house that really just needed some kind of minor fixes, but that’s also the danger of some of these $0-down loans and some of those things that were going on back at the time.

Tim Ulbrich: And that typically — correct me if I’m wrong, David — that typically is a step before foreclosure, right? The short sale?

David Bright: Correct, yeah.

Tim Ulbrich: OK. So you mentioned the live-in flip in Ohio. You’re there for five years. And then you had alluded to your move up to the state up north not to be mentioned. So what was the game plan when you moved to the state up north? What did you guys do from there?

David Bright: Yeah, so when we were moving, we didn’t really know west Michigan at all. And so the advice that we were given is if you don’t really know the area, there’s a lot that you pay when you go to sell a house in terms of realtor fees and closing costs and all that. So if you’re not absolutely sure you want to be in that house for awhile, you probably don’t want to buy and then immediately move and buy again. So the advice we got was if you’re going to move to a new town, just rent for awhile, get to know the town, figure out where you want to be, and then buy.

Tim Ulbrich: Yep.
David Bright: And that made a lot of sense until we started looking at the math. And specifically in west Michigan, we were looking at homes that we could rent, and it was at the time in the neighborhood of even upwards of $2,000 a month to rent a house in the area where we wanted to be. But then we looked at there was a condo complex just barely outside the area where we wanted to be, and there was a three-bed, two-bath condo for sale for $55,000. And so we thought, two years of $2,000 a month seems remarkably similar to just buying this $55,000. So we thought, OK, we’re going to buy the condo.

Tim Ulbrich: Math sounds good.

David Bright: So we ended up in the condo instead of renting.

Tim Ulbrich: I’m assuming foreclosed property had some work to be done. Did you put work into that? And was that an additional investment?

David Bright: Yeah, this property, the short sale kind of got us warmed up to doing a little bit of work, and so we were looking for that same kind of thing. We found a foreclosed property that was actually a HUD home. So HUD homes are where the prior owner would have had an FHA mortgage. And when there’s a foreclosure on an FHA mortgage property, the government then takes it and sells it through the HUD process, through HUDHomeStore.com. The nice thing about a HUD foreclosure is that there’s some provisions in there to help owner occupants buy these. So they’re not swooped up by investors and that kind of thing. So as an owner occupant, we didn’t have mountains of cash and some kind of big track record of house flipping or anything like that to really go in and be competitive in that space. But we were going to live there. So we thought, this is a good opportunity to buy a foreclosure. It needed some drywall work and it needed all new appliances and new flooring and paint and some of those kind of things. So it was a decent step up but still didn’t require a ton of work. It wasn’t a super intimidating failed foundation and holes in the roof or anything like that like you see on TV. It was just a foreclosure that needed a little bit of work, and so we had a great agent that helped us buy the place. The agent knew some great contractors that we were able to hire to come in and do a lot of the work before we moved into it. It ended up being a great way to get into a much more affordable living situation than a $2,000 a month rent.

Tim Ulbrich: And for a moment, I want to put some of the pieces here together. You know, you disclosed earlier that you’re not necessarily handy. And even though this property, as you mentioned, didn’t require massive work, you still mentioned drywall, other things, had to work with a contractor. And I think just that step, right — I know for me hearing that, for folks that might be starting this for the first time, that alone seems somewhat overwhelming of, OK, I’m buying a property that needs work. I’ve got to find a contractor, I haven’t hired a contractor before. Who do I trust? Do I get multiple bids? How do I even navigate this? Am I going to get ripped off? So what advice would you have for folks — you mentioned an agent connection, maybe that’s a key people can pick up on. But for the folks who are looking to get some work done as a part of a model like this or another investing scenario, how can they approach that contractor relationship to find somebody hopefully that is trustworthy, that is quality, that’s reasonably priced, with the idea that perhaps it can continue to work with that person in the future?

David Bright: That’s a great question because I think we’ve all heard the stories of some contractor that did terrible work or took the money and didn’t show up or all these kind of horror stories, right? But we found the opposite. We found — like the quote that I heard recently is that rockstars know rockstars. And so by finding a fantastic agent, that fantastic agent had a library of different contractors. Like hey, you need a plumber? Call this person, tell them I sent you. They do fantastic work. I’ve recommended them several times, they’ve done work on my home. Everybody loves this plumber. Like great, that just got really simple. So we found a plumber that way. And same with someone that could do drywall and lay flooring. I’d asked that same kind of question, they said, “Hey, call this person. They’ve done work for us, they’ve helped other people.” So it got really easy by finding that first good person and then I’m just a big believer in referrals like that because yeah, you can Google and I don’t know what you’re going to find. But referrals are really powerful for us.

Tim Ulbrich: Yeah, and I think relationships, referrals, I think this is where the value of like local real estate meetups can come in. And Bigger Pockets does a great job of this, and you can find some in your community. But I’m with you, like if there’s somebody that I value and trust and have had a good relationship and they are able to recommend somebody, and then you’re starting that conversation with, “Hey, I know David, and David recommended you.” That all of a sudden builds some of the expectations of that continued good work on the part of the contractor. So I think that’s great input and advice. So you renovate your condo, David, what’s the next move then for you as it relates to your investing journey but also the personal living situation?

David Bright: Yeah, so we — at the point where we had lived in the condo for about a year, we were thinking that my kids were going to start school and we were thinking we probably want to be in a different school district and want to be a little bit closer to work, wanted to cut down the commute time and some of those kind of things. So while the condo was great for us for that season, it was a season where it wasn’t really as good of a fit anymore, so we were able to find a house and buy a house that was a better fit for us at that point, particularly after getting to know the area for some time. At that point, we thought, well, we’ve been observing family that have owned a few rentals, and it was good for them. We thought, it’s a pretty big step to go out and buy a rental property. It’s a much smaller step to just not sell a house and instead, try it out as a rental because we figured if it didn’t work out, we could always still sell the house. Like it just felt like about as low risk as we would ever have. And even a lot of the finishes and things that we did to the property, one of the recommendations that we got from, again, one of just the rockstar real estate agents that we worked with is when you’re fixing up properties, particularly at that kind of price point where for a $55,000 condo, you’re not going to go in and do $15,000 worth of super high-end granite countertops or something, you know? The quote that we heard was go Chevy, not Cadillac.

Tim Ulbrich: That’s great.

David Bright: That helped us just to kind of keep the budget in mind and some of that. But with that, at the end of all that fixing up, it was in pretty decent shape. We thought, you know what, let’s try it. Again, going back to the just busy world of a pharmacist, we didn’t really know where to start with all that, so that’s where you already mentioned Bigger Pockets, and I had found Bigger Pockets just kind of Googling around online looking for how do you rent out your condo, like trying to learn this. Found a few books and just tried to figure this out kind of in the evenings, talking with my wife. And we knew of a couple people that were looking for a place to rent, so we kind of started there, just friends of friends, just kind of putting the word out that we’re looking to do this. But after about a month, we couldn’t really find anyone to rent the condo. And we thought, this isn’t going well, and it’s probably because we’re trying to do this on the side. We’re just busy people, we just don’t have the time for it. So that was our point where — just kind of like with construction work, you don’t want me replacing countertops, you don’t want me like flooring, none of that. So we had found a professional to do that. And we just did the same thing here, we found a professional property manager that was, just like we’ve been saying, a recommendation from another rockstar, and we found a rockstar property manager. She came in and met with us and walked us through what the process would be like. She took some photos and a few days, she had a showing where she bought three people through the condo. Two of the three signed an application, one of the two put down a deposit immediately. And right away, we had a tenant moving into the property. And from a numbers standpoint, we were — the property manager was able to get $150 more a month than what we couldn’t get and the property manager fee to do that was $130 a month.

Tim Ulbrich: Winning.

David Bright: Yeah. Like she ended up doing all of the work and made us more money than us trying to do it all ourselves when we just clearly didn’t have time to do it ourselves. So it ended up being a fantastic fit.

Tim Ulbrich: That’s awesome. A couple things I want to break down there, and you didn’t mention the 1% Rule directly, but I want to bring that forward as I know people may have heard that before or if they’re working at a similar situation where OK, as you had mentioned, it’s easier to not sell than perhaps buy your first rental. What is that 1% Rule as folks are trying to just gauge — and of course this is market-specific and so many nuances, just like we talked about with many of the parts of the financial plan — but as folks are trying to determine OK, what might be rent? What am I currently — what’s the house worth? How do you even begin gauge roughly what might be a valuable rental situation that somebody might determine to keep the property and turn it into a rental?

David Bright: Yeah, the 1% Rule is one that I know we’ve talked about, and it’s stuck with me over time because I first heard it from my wife’s grandfather who told me that when he was buying — like he had heard this 1% Rule. When I was later Googling around on Bigger Pockets and I read it in another book that this 1% Rule. So it’s really stuck with me. And that’s where, just for round numbers, if you have a house that’s worth $100,000. If you’re able to rent it for $1,000 a month, 1% of the value of the house every month is rent. That’s a decent rule of thumb of the math will probably work so that your rent will cover the mortgage and then some of the additional expenses like the insurance and property manager, some of those things. And you’re right, it’s a really good disclaimer that that doesn’t work in all markets, it doesn’t work in all situations. But it’s a nice rule of thumb that you know, if there’s a pharmacist out there that has a $500,000 house that they can rent for $1,500, that’s probably not going to cover the mortgage.

Tim Ulbrich: No bueno. No bueno.

David Bright: Probably not going to work. But in our case, it was a $55,000 condo and so if it rented for a little over $1,000, that more than met the 1% Rule and that was kind of how the math worked out. At the end of the month, there was a couple hundred bucks left over between the rent that came in and then the mortgage that we paid, which is kind of for us was some safety. I know a lot of pharmacists are pretty risk-averse and so we thought if there’s more money coming in through the rent, at the end of the month, that will help to take care of what if the furnace goes out? Or what if the toilet gets clogged? Or what if all of the things that — like what if a lightswitch goes out? Like I can’t fix that. I have to hire someone to do that. So to have money for those kind of expenses that would come up — and like you said earlier, hopefully we could save some every month and then vacation or whatever using that.

Tim Ulbrich: Yeah, and we’ll get into in the future — again, focus here we want to introduce some terminology– but you’re mentioning some important pieces that I think when folks are analyzing a deal, I think it’s easy — almost like when people are looking at I currently rent versus what would my mortgage be and they forget to think about property taxes, homeowner’s insurance, what about all of the lawn equipment I need, taking care of my own, increasing utilities, the list goes on and on, right? Here, same type of thing, you know, as you’re looking at a real estate investment property, what are the things that you need to be thinking about in terms of repairs that need to be done, big projects over time, a roof, water types of issues, if you think about vacancies, all of those are factored in when you’re analyzing a deal. And hopefully the plan is that you’ve still got some positive cash flow after that. So David, we started with your live-in flip, we talked about the condo that you were able to do some renovations on and then turn into a rental. What was the game plan after that?

David Bright: Well that first rental was a great learning experience for us. And as much as the 1% Rule and some of the math — and certainly as pharmacists, we can get really nerdy into the math real fast, right. And there’s some great resources out there that can help that. You know, another shoutout to Bigger Pockets, they have some great kind of calculators and things that help you to make sure that you’re factoring in all of those expenses like property management, like the inevitable vacancy that you will have at some point, like the general repairs and the larger expenses, like taxes and insurance. But beyond all that, part of our goal with this condo was — and again, you and I are educators and we really just wanted some education in this. And we figured this is the best way to do it. So in our minds, it didn’t have to be a fantastic investment that would make all the metrics. It was really just how do we learn this to see if this is a fit for us as a part of our long-term financial plan? And that helped us to learn even other things like I didn’t know at the time that there were rental inspections and things. And once we hired the property manager, the property manager helped walk us through that and some of the local things that you need to know. And again, by bringing in a professional rockstar, like she was able to help make sure that we had all of our ducks in a row, that this was all done appropriately, correctly, safely, which again, pharmacists in health care definitely want things to be safe. And so that really helps. There’s a lot of learning that went on with that condo. And so after owning that for a couple years, it really seemed like it helped us to build some confidence that we could do this again. Over time, we started thinking about what point is it worth trying to do this again?

Tim Ulbrich: Sure.

David Bright: Again, this rockstars know rockstars? We were looking around at other places and trying to find people that were doing this and learn from other people. One of the things that happened in Grand Rapids, where we live, house prices just accelerated like crazy, which I think we had all kind of seen from about 2015-2020 that house prices have gone way up across the country. And certainly Grand Rapids is no exception.

Tim Ulbrich: Yeah, and I remember, David, seeing Grand Rapids like on “Top Places to Live in the Country,” raise a family, I’m guessing that contributed to it as well.

David Bright: Oh, for sure. Yeah. And then shoutout to Grand Rapids, it is a beautiful place. And as far as those memory-making experiences, we were out on the kayaks with the kids last night and just a lot of fun things to do around here. So I know growing up in Columbus, I also at one point referred to it as a state up north, but now that I live here, it’s really beautiful. So the good side was some property appreciation. The bad side was it was hard to find these 1% properties where it would make sense as a rental. We didn’t really want to go out and buy a $250,000 house that would rent for $1,000 or $1,500 a month. It just didn’t make sense. So a friend introduced us to the city of Muskegon, Michigan, which about 45 minutes or an hour from where we live. And little community out by Lake Michigan, great little place, and there were some properties there that met this 1% Rule. And so we were able to buy a house out there that between the short sale that we bought first and the condo, we’re getting a little more confident in being able to fix some things. This house needed a little bit more work, it needed a bathroom remodel, it needed paint inside and outside and flooring and some other fixes like that. But I guess we’re getting desensitized to it or something like that over time. And I think also, there’s some confidence in knowing other rockstars that can do a lot of this work. We were able to hire some contractors and buy a property. So a friend introduced us to what I’ve heard referred to as a tired landlord, someone that had rented out the house and just was done with it, you know? And I don’t know what the situation was, if they had an eviction or something like that that just soured them to the property, but they were just done with it and wanted out. And so we were able to buy it in still pretty dirty condition, it needed some work, and we were able to hire some contractors to go in there and fix it up. And so this property — just as an example from a numbers standpoint, we were able to buy a house for just under $30,000 and put roughly $15,000 into repairs. So we were all into it for a little over $40,000. And then at the end of that process, it appraised for just under $60,000. So that helped us because we were then able to refinance the property at 75% loan-to-value — and we can certainly walk through a lot of these terms in a little more detail — but 75% loan-to-value refinance. We were able to get back out of it almost every dollar that we had into the property from a purchase and a rehab standpoint.

Tim Ulbrich: That’s awesome.

David Bright: Yeah, that also felt like a way to reduce risk, again, pharmacist that doesn’t love a lot of risk, because then we didn’t have to save for years and years to make this enormous down payment on a house that might have a little bit of return every month. We didn’t have to have a lot of money into this property. But yet one more aspect of a long-term financial plan.

Tim Ulbrich: Well, and then if this works out as planned, here’s a great example, and we’re not trying to say this is all roses and cupcakes, you know, there’s a lot of education, a lot of relationship-building, a lot of things you did to make sure that this was a good deal and mitigate your risk, and there’s always things that could be unforeseen. So I don’t want folks walking away thinking, alright, let’s do this tomorrow. I mean, if somebody’s ready, awesome. But making sure we’re looking at both sides of the equation. So here though, David, this is a great example, I remember hearing about the BRRRR concept on Bigger Pockets, and it was one of those moments where I almost drove my car off the road. You know, one of those like Aha!, like oh my gosh, I just never being exposed to real estate investing, wasn’t even thinking this way, almost like reading “Rich Dad Poor Dad” for the first time. And then hearing this and the concept of getting all of your money or close to all of your money back out and being able to repeat that process potentially and grow the portfolio while you still have some built-in equity in the deal. So break that down for us briefly. What is the BRRRR model as folks may be hearing that for the first time? And I think the example property you just walked through is a great example of it.

David Bright: Yeah, so the BRRRR model — and I would agree, this is one of those things just kind of reading Bigger Pockets or part of my work here — for those that know Michigan, I live in Grand Rapids and Ferris State is located in Big Rapids, which is a city about, depending on where you live in town, it’s about 30-45 minutes away. So with that kind of drive, had some time to listen to some podcasts. I think a lot of folks listening to this podcast are probably in the same boat where you’re listening to things and trying to learn. And yeah, the BRRRR method also really struck me. And that’s that BRRRR: Buy, Rehab, Rent, Refinance, and Repeat. So the goal here is to buy a property that for whatever reason, whether you get it from a tired landlord or you buy it as a foreclosure or you buy it as a house that needs work or any or all of those, you buy it at some kind of discount because it’s something no one else wants to touch or something. You then rehab it, where you go through and you hire a contractor to do painting or whatever other work. At the end of that process, it is an attractive house where you can rent it out. So you can then rent it out, tenant, property manager, all those kind of things, refinance it at that point where you’re typically able with most banks to borrow 75% loan-to-value on what the property is worth. So not necessarily what you paid or what you paid plus your construction costs or anything like that, but what it appraises for that day. You can borrow 75% of the appraised value. So refinancing it allows you to get some of your investment back out of it and by doing that, if all the math works really well like this example — and like you said, not everything is rainbows and unicorns — but in this example, it did work pretty well where we had a little over $40,000 into it and it appraised just under $60,000, so 75% of just under $60,000 got us right just about all of our money back out of it.

Tim Ulbrich: And I think, David, this example really highlights well, you mentioned some of the things with loan-to-value, and if I’m understanding you correctly, with a 75% loan-to-value in a cash out refinance, you’re essentially then remaining 25% of the equity in the property. So you know, a lot of times you hear people talk about leverage with real estate investing. And for those of us that certainly want to make the most of an investment opportunity but also don’t want to find ourselves upside down on a mortgage, in this situation, you’ve got some built-in equity in the home so if something were to change market-wise or you run into a 2008 example of the market dips, you know, you’ve got some protection in there. You mentioned getting your cash back out in this deal, and obviously there’s fees as a part of the process that need to be considered so you can hopefully continue on with this. And then obviously from a rent situation, you want to make sure that it’s cash flow positive. So here, it checks all of those boxes. And I think, David, correct me if I’m wrong, but for those listening hearing this as one example and one path forward that they may consider, the rate limiting step here beyond just the understanding of the process and feeling comfortable and confident would be having that upfront cash to purchase the property, correct?

David Bright: Yes. Yes, because a lot of times, if you’re buying a house that is in pretty rough shape, it may be difficult or even impossible to get a traditional mortgage on that property. So certainly you see the folks on TV that are trying to flip these houses in California or something, they’re spending $1 million on these houses, that’s not something that I’m able to do.

Tim Ulbrich: Right?

David Bright: But you know, buying a house under $30,000 is a very different story.

Tim Ulbrich: Yeah, and I think that’s just something for folks to consider and I think why the first one and this example or this model may be the most difficult. But if you’re running this right, the numbers look good, once you’re able to save up for that first one. And obviously as we talk about all the time on the show, so important to reinforce here, real estate investing for those that are considering it should be looked at in the context of the rest of the financial plan. So where are you at with your student loan debt? Where are you at with your emergency fund? Where are you at with your retirement, credit card debt, other goals? And does this make sense, in this example, to be saving up a bunch of cash to purchase this property? And for some, the answer may be yes, and for others, maybe it’s no for the time being. So we have — and we’ll hopefully revisit, David, at a future point on another episode, I think we’ve thrown a good amount of information at the listeners, but you know, we’ve kind of dodged around some of the benefits of owning real estate and rental properties. Obviously the opportunity for cash flow, of course the appreciation of the properties, we haven’t talked about in detail the tax benefits, but certainly that’s a consideration, the fact that somebody else is essentially helping pay down the mortgage, being able through the cash flow to achieve other financial goals, perhaps even having an opportunity for diversification of income and if folks are predominantly saving in a 401k or a 403b where those funds are essentially locked down to 59.5, you’ve got some options here in real estate. And so we’ll come back and approach some of those more in the future. One of the things I want to wrap up with, David, is you mentioned Bigger Pockets as a resource and the Bigger Pockets calculator, which I certainly would attest to as well. Are there any other resources that you would recommend either a great book, a website, a community that really has been instrumental in your own journey that other folks may be able to apply as they’re getting started?

David Bright: Yeah, you know, we both reference Bigger Pockets, and I think podcasts are just really accessible for folks with a commute or things like that. So I would definitely recommend that. You’ve also mentioned the “Rich Dad Poor Dad” book, which I think really helped me to see, just see investing and a financial plan in a different way than I had previously thought, so that was another big resource that helped. And then “The Millionaire Real Estate Investor.” I believe that’s a Gary Keller book, that’s another one that was a little more nuts and bolts as far as how to look at properties, how to do some of the math and certainly pharmacy math nerd, I dove into some of that. And so that was helpful. I thought of the “Rich Dad Poor Dad” as more of a mindset book.

Tim Ulbrich: Yes.

David Bright: And “The Millionaire Real Estate Investor” as more of a tactical book. And so both of us, an audiobook here and there on the commute, and it was helpful there. I think that one of the other things that helped me to learn from just a mindset thing too is that I think some of this can certainly be a lot of — it can just be intimidating for people with a full-time job, busy life, family, kids, all those things. Like it can be certainly intimidating. And both of those books and then talking with other people in the area, other people doing this — going back to the rockstars know rockstars — talking with real estate agents and contractors, like one of the things that oddly enough, has helped us too is buying a house that’s an hour away.

Tim Ulbrich: Yeah.

David Bright: I’m not tempted to go drive by it and try to paint a room or something. Like I’m able to really detach from it and not let it take a bunch of time, which has been really, really helpful because I think that, again, typical pharmacist, little bit of a control freak. It’s hard to detach from some of these things, but it’s just been really healthy I think to do that and to trust property managers, to trust contractors, and yeah, just it allows it to be something that we can do as a part of our financial plan without it really taking a ton of time.

Tim Ulbrich: And I think that’s a nice recap of what we had talked about before briefly of I think one of the benefits of long distance real estate investing, whether that’s an hour or a different state away, is it really helps kind of force your hand in building some of the systems and processes that hopefully pull you out of the equation in some regard. Again, I’m thinking about this as somebody would be building a business and thinking about with the end in mind. The other resource — and actually one that just came to mind as I was just mentioning that Bigger Pockets does have a book on long distance real estate investing. So if folks are in a market where deals are harder to find and you’re looking at other areas of the country, I recommend that resource. Another one, David, I know Bigger Pockets just came out with I think it’s “The Real Estate Rookie” podcast, which I’ve enjoyed listening to. I know they’ve done so many episodes on their main show now and sometimes those stories, for new investors may seem just massive and overwhelming as people are talking about having 150 properties and their journey over the last 10 years. And I think that “Real Estate Rookie” podcast is a good segway introduction for folks that are just getting started. So David, really appreciate you taking the time to share some of your journey but also help break down these concepts. And we will link to some of the resources that we’ve mentioned in the show notes. And as a reminder to the listener, you can access show notes for this episode as well as any other episode, by going to YourFinancialPharmacist.com/podcast. Find the episode and in there, you’ll find a transcription of the show as well as a link to the resources and notes that we talked about. And don’t forget to join the Facebook group, over 6,000 members strong, pharmacy professionals all across the country, committed to helping one another on this path and goals towards achieving financial freedom. And last but not least, if you liked what you heard on this week’s episode, please leave us a rating and review on Apple podcasts or wherever you listen to your show each and every week. Have a great rest of your day.

 

Current Student Loan Refinance Offers

Advertising Disclosure

[wptb id="15454" not found ]

Recent Posts

[pt_view id=”f651872qnv”]

YFP 166: Why Negotiation is an Important Part of Your Financial Plan

Posted on by yfpadmin


Why Negotiation is an Important Part of Your Financial Plan

Tim Baker and Tim Ulbrich talk all things negotiation. They discuss what it is, where it can be used, why it’s important to your financial plan, the goals of negotiation and tips and strategies for different parts of the negotiation process.

Summary

Tim Baker joins Tim Ulbrich on this episode to dig into all things negotiation. Negotiation is the process of discovery and a way to advocate for yourself and what your needs are. Tim Baker explains that negotiation is an important part of your financial plan for many reasons. He explains that settling for a lower salary can have a significant impact on your present and future finances because you may accrue less in retirement savings and potentially other investments. However, negotiation doesn’t just lie in your salary. You can also negotiate benefits like flex scheduling, paid time off as well as potentially parental leave and professional development opportunities, among others.

Tim Baker shares that 99% of hiring managers are expecting new hires to negotiate and build their initial offer as such. Many don’t end up negotiating because they don’t want to risk the offer being revoked, but Tim says that the majority of the time you should present a counter offer.

Tim then digs into the stages of the negotiation process that include the interview, receiving an offer, presenting a counter offer and accepting the offer and position. He shares many strategies and tips for each stage as well as additional techniques to use throughout the process.

Mentioned on the Show

Episode Transcript

Tim Ulbrich: Tim Baker, welcome back to the show.

Tim Baker: Yeah, happy to be here. How’s it going, Tim?

Tim Ulbrich: It’s going. Excited to talk negotiation, something we discuss a lot in presentations, a lot I know that you discuss with clients as a part of the financial plan, but we haven’t addressed it directly on the show before. So I’m excited that we get a chance to dig into this topic. And we know that negotiation can carry a lot of power and can be used across the board really in life, right? It could be negotiating terms for a new or existing job position, buying a car, buying a house, negotiating with your kids or spouse — kidding, not kidding as we’ll talk about here in a little bit. So we’re going to focus predominantly on salary negotiation, but really these techniques can be applied to many areas of the financial plan and really life as a whole. So Tim, I know that for you, negotiation is a key piece of the financial plan. And you and our CFPs over at YFP talk about negotiation in the context of financial planning, which I would say is probably not the norm of the financial planning industry and services. So let’s start with this: Why is negotiation such an important piece of the financial plan?

Tim Baker: Yeah, so I think if we look at YFP’s mission, YFP’s mission is to empower pharmacists to achieve financial freedom. So I think the building blocks of that really is kind of what we do day-in and day-out with clients at YFP Planning. And what I typically, or the way that we typically approach a financial plan is we really want to help the client grow and protect their income, which is the lifeblood of the financial plan. Without income, nothing moves. But we know that probably more importantly than that is grow and protect the balance sheet, the net worth, which means increasing assets efficiently and decreasing liabilities efficiently and ultimately moving the net worth number in the right direction. So those are both quantitative things. But then qualitatively, we want to make sure that we’re keeping all the goals in mind, so grow and protect income and net worth while keep the goals in mind. So to me, that’s our jam, you know? So when I say — when somebody asks me a question like we do the Ask a YFP CFP, and I always say, “Well, it depends.” A lot of it really depends on those foundational, like where are we at with the balance sheet and where do we want to go? Meaning what are our goals? What’s our why? What’s the life plan, what’s a wealthy life for you and how can we support that with the financial plan? So to go back to your question, my belief is that the income is a big part of that.

Tim Ulbrich: Yes.

Tim Baker: And what I’ve found working with many, many pharmacists is sometimes pharmacists are not great at advocating for themselves. You know, most of the people that I talk to when we talk about salary negotiation, they’re like, eh, I’m just thankful I have a job, and I’m in agreement with that. But sometimes a little bit of a negotiation and having some of the skills that we’ll talk about today to better advocate for yourself is important. And a lot of this stuff is not necessarily just for salary. It can be for a lot of different things. But to me, what I saw as a need here, same thing like most financial planners don’t walk you through kind of home purchase and what that looks like because most financial planners are working with people in their 50s, 60s and 70s. So that was a need for a lot of our clients who were like, “Hey, Tim, I’m buying this house. I don’t really know where to start. So we provide some education and some recommendations and advice around that. Same thing with salary, I kept seeing like well, maybe I took the job too quickly or I didn’t advocate for myself, so that’s really where we want to provide some education and advice, again, to have a better position from an income perspective.

Tim Ulbrich: Yeah, and I think it’s a great tool to have in your toolbag, you know. And I think as we’ll talk about here, the goal is not to be an expert negotiator. There’s lots of resources that are out there that can help with this and make it tangible and practical, one of which we’ll draw a lot of the information today, I know you talk with clients, a resource I love, “Never Split the Difference” by Chris Voss. But I’m glad you mentioned, you know, I think there is often a sentiment — I know I’ve felt in myself where you know what, I’m glad to have a position, I’m glad to be making a good income. But that can be true and you still can be a good person and you still can negotiate and advocate for yourself and the value you bring to the organization.

Tim Baker: Yes.

Tim Ulbrich: So I hope folks will hear that and not necessarily think that negotiation is bad and as we’ll talk about here in a moment, I think really can have a significant impact when you think about it as it relates to earnings over your career and what those additional earnings could mean. So Tim, break it down for us. What is negotiation and really, digging further, why is it important?

Tim Baker: Yeah, so negotiation, you know, it’s really a process of discovery. It really shouldn’t be viewed as a battle. It’s really a process of discovery. It’s kind of that awkward conversation that you should be obligated to have because you know, if you don’t want to advocate for yourself professionally, who will? And maybe you have a good mentor or something like that, but to me, the negotiation, again, is really to discover what you want and kind of what your counterpart, which might be a boss or a hiring manager or something like that. And it’s really important because settling for a lower salary can have really major financial consequences, both immediately and down the road. And you typically — raises that you receive are typically based on a percentage of your salary, so hey, we’re going to give you a 3% raise this year, a 5% raise. If you start off with a salary that you’re not happy with, then obviously that’s a problem. Accrue less in retirement savings, so that TSP, that 401k, 403b, again, you typically are going to get some type of match in a lot of cases, and then you’re going to put a percentage. So again, that could potentially be lower. But it’s not just about salary. It can be — I think another mistake that sometimes people make is that they’ll say, oh wow, I was making $125,000 and I’m taking a job that’s paying me $135,000 and they take a major step back on some of the non-salary things like benefits and flex scheduling and time off and things like that. But you know, you really want to make sure that compensation package that you have, you know, you’re happy with. Because underpaid really can make you feel resentful over the long run. So you want to make sure that you’re, again, right now we’re filming in the midst of a pandemic and the economy and the job market is tough, but you still want to advocate for yourself and make sure you’re getting the best compensation package that you can.

Tim Ulbrich: Yeah, and as we’ll talk about here in a little bit, I think if we frame this differently, then maybe our understanding, our preconceived beliefs — you know, you mentioned it’s not a battle, you know, I think the goal is that you’re trying to come to an agreement or an understanding. And as we’ll talk about here, many employers are likely expecting this. And that number, in terms of those that are expecting versus those that are actually engaging in the conversation from an employee standpoint is very different.

Tim Baker: Sure.

Tim Ulbrich: So I think that might help give us confidence to be able to initiate some of those, and we’ll talk about strategies to do that. I do want to give one example, though, Tim, real quick. You had mentioned obviously if somebody earns less and receive small raises or they accrue less in retirement savings, that can have a significant impact. And I went down the rabbit hole prepping for this episode of just looking at a quick example of this where you have two folks that let’s say they both start working at the age of 28, they retire at their 65, so same starting point, same retirement age. Let’s assume they get a 3% cost of living adjustment every year for their career just to keep it simple. The only difference here is that one starts at $100,000 and one starts at $105,000. So because of either what they asked for in negotiations, whatever be the case, one starts $5,000 greater than the other. And if you play this out, same starting age, same ending age, same cost of living adjustments, one starts at a higher point, when it’s all said and done, one individual has about $300,000 more of earnings than the other. And this of course does not include differences that you also have because of higher salary. If you had a match, that would increase, that would compound, that would grow. If you were to switch jobs, you’re at a better point to now negotiate for a higher salary, all other benefits that aren’t included. But the significance of the starting point I think is something to really look at those numbers that often where you start can inform where you’re going, not only from cost of living adjustments but also future employment, right? So we know that where you start if you get a 3% raise, it’s of course going to be based off that number. If you decide to leave that employer and you go to another one, what do they ask you? How much did you make? You’re using that number. So that starting point is so critical, and I hope that new practitioners might even find some confidence in that to be able to engage in discussions knowing how significant those numbers can be over a career. So in that one example, that starting point is a difference of about $300,000. Crazy, right, when you look at it over a long time period.

Tim Baker: Yeah, it’s nuts. And I’d play the devil’s advocate, on the other side of that is again, so much — just like everything else with the financial plan, you can’t look at it in a vacuum. We’ve had clients take a lot less money and really, it was because of the student loans and how that would affect their strategy in terms of forgiveness and things like that.

Tim Ulbrich: Yes.

Tim Baker: So it is multifactorial. It’s definitely something that it should really be examined. And I think, again, when you look at the overall context of the financial plan. But to your point, Tim, that starting salary and really how you negotiate throughout the course of your career is going to be utterly important. And again, what we say is — we kind of downplay the income because I think so much of what’s kind of taught is like, oh, six-figure salary, you’ll be OK. And that’s not true. But then it is true that it is the lifeblood of the financial plan, so I think if you have a plan and you’re intentional with what you’re doing, that’s where you can really start making moves with regard to your financial outlook.

Tim Ulbrich: Yeah, and I’m glad you said that about salary shouldn’t be looked at in a silo. I mean, just to further that point, you’ve alluded to it already, these numbers don’t matter if there’s other variables that are non-monetary that matter more. Right? Whether that be time off or satisfaction in the workplace, opportunities that you have, feelings of accomplishment. I mean, the whole list of things you can’t necessarily put a number to, I mean, I would argue if those are really important, you’ve got to weigh those against whatever this number would be. And there’s a certain point where the difference in money isn’t worth it if there’s other variables that are involved, which usually there are. Hopefully we can get both, right? Salary and non-salary items.

Tim Baker: Yes.

Tim Ulbrich: So interesting stats about negotiation, I’ve heard you present before on this topic, but I’d like you to share with our audience in terms of managers that are expecting hires to negotiate versus those that do. Talk us through some of those as I think it will help us frame and maybe change our perception on employers expecting and our willingness to engage in these conversations.

Tim Baker: Yeah, and I really need to cite this one. And I believe this first stat comes from SHRM, which is the Society for Human Resource Management. So I think this is like the biggest association for like HR and Human Resource personnel in the country. And the stat that I use is that 99% of hiring managers expect prospective hires to negotiate. So if you think about that, you know, the overwhelming majority expect you the prospective hire to negotiate. And they build their initial offers as such. So the example I give to clients is like, hey, we have a position that we could pay anywhere from $110,000 to $130,000, knowing that you know, Tim, if I’m offering this job to you, knowing that you’re probably going to negotiate with me. I’m going to offer it to you for $110,000 knowing that I have a little bit of wiggle room if you kind of come back with a counteroffer. But what a lot of my clients or people do that I talk with is they’ll just say, yes, I found a job, crappy job market, happy to get started, ready to get started. And they’re either overly enthusiastic to accept a job or they’re just afraid that a little bit of negotiation would hurt their outlook. So with that in mind is that you — the offers I think are built in a way that you should be negotiating and trying to, again, advocate for yourself.

Tim Ulbrich: Yeah, and so if people are presenting positions often with a range in salary expecting negotiation, I hope that gives folks some confidence in OK, that’s probably expected and maybe shifts some of the perception away from, this whole thing could fall apart, which it could, right? At any given point in time, especially depending on the way you conduct yourself in that negotiation, which I think is really, really important to consider. But I think what we want to try to avoid, Tim, back to a comment you made earlier, is any resentment as well. I mean, if we think about this from a relationship standpoint, we want the employee to feel valued, and we want the employer to have a shot at retaining this individual long-term. So it’s a two-way relationship.

Tim Baker: Yeah, and it kind of comes up to where we were talking about what is the goal of negotiation. And really, the goal of negotiation is to come to some type of agreement.

Tim Ulbrich: Yeah.

Tim Baker: The problem with that is that people are involved in this. And we as people are emotional beings, so if we feel like that we’re treated unfairly or we don’t feel safe and secure or if we’re not in control of the conversation, our emotions can get the best of us. So that’s important. So again, there’s some techniques that you can utilize to kind of mitigate that. But you know, to allude to your point about negotiating, the fear to kind of potentially mess up the deal, there’s a stat that says 32% don’t negotiate because they’re too worried about losing the job offer.

Tim Ulbrich: Yeah.

Tim Baker: I know, Tim, like we can attest to this because with our growth at YFP, we’ve definitely done some human resourcing, to use that as a verb, and hiring and things like that of late. And I’ve got to say that the — I think that some of this can be unfounded just because there’s just so much blood, sweat and tears that goes into finding the right people to kind of surround yourself with and bring into an organization that to me, a little bit of back-and-forth is not going to ultimately lose the job. So typically most jobs, there’s — obviously there’s an application process, there’s interviews, there’s second interviews, there’s maybe on-site visits, there’s kind of looking at all the candidates and then extending offers. If you get to that offer stage, you’re pretty — they’ve identified as you’re the person that they want. So sometimes a little bit of back-and-forth is not going to derail any such deal. So it’s really, really important to understand that.

Tim Ulbrich: Yeah, and as the employer, I mean, we’ve all heard about the cost statistics around retention. So as an employer, when I find that person, I want to retain them. That’s my goal, right? I want to find good talent, I want to retain good talent. So I certainly don’t want somebody being resentful about the work that they’re doing, the pay that they have, and so I think if we can work some of that out before beginning, come to an agreement, it’s a good fit for us, good fit for them, I think it’s also going to help the benefit of hopefully the long-term relationship of that engagement. So it’s one thing to say we should be doing it. It’s another thing to say, well how do we actually do this? What are some tips and tricks for negotiation? So I thought it would be helpful if we could walk through some of the stages of negotiation. And through those stages, we can talk, as well as beyond that, what are some actual strategies to negotiation. Again, another shoutout to “Never Split the Difference” by Chris Voss. I think he does an awesome job of teaching these strategies in a way that really helps them come alive and are memorable.

Tim Baker: Yeah.

Tim Ulbrich: So Tim, let’s talk about the first stage, the interview stage, and what are some strategies that those listening can take when it comes to negotiation in this stage.

Tim Baker: Yeah, so when I present these concepts to a client, I kind of said that the four stages of negotiation are fairly vanilla, you know? And the first one is that interview. So when you get that interview, what I say is typically you want to talk less, listen more and learn more. Typically, the person that is talking the most is not in control of the conversation. The one that’s listening and asking good questions is in control. And I kind of think back to some of our recent hires, and you know, the people that we identified as like top candidates, I’m like, man, their interviews went really well. And when I actually think back and slow down, it’s really — I think that they went really well because it’s really that person asking good questions and then me just talking. And that’s like the perception. So in that case, the candidate was asking us good questions and we’re like, yeah, this was a great interview because I like to hear myself talk or I just get really excited about what we’re doing at YFP. So I think if you can really focus on your counterpart, focus on the organization, whether it’s the hospital or whatever it is and learn and then really pivot to the value that you bring, I think that’s going to be most important. So you know, understanding what some of their pain points are, whether it’s retention or maybe some type of care issue or whatever that may be, you can kind of use that to your advantage as you’re kind of going through the different stages of negotiation. But the more that the other person talks, the better. I would say in the interview stage, one of the things that often comes up that can come up fairly soon is the question about salary. And you know, sometimes that is — it’s kind of like a time savings. So it’s a “Hey, Tim, what are you looking for in salary?” If you throw out a number that’s way too high, I’m not even going to waste my time. And what I tell clients is like you typically, you want to — and we’ll talk about anchoring. You really want to avoid throwing a number out for a variety of reasons. So one of the deflections you can use is, “Hey, I appreciate the question, but I’m really trying to figure out if I’d be a good fit for your organization. Let’s talk about salary when the time comes.” Or the other piece of it is it’s just you’re not in the business of offering yourself a job. And what I mean by that it’s their job to basically provide an offer. So, “Hey, my current employer doesn’t really allow me to kind of reveal that kind of information. What did you have in mind?” Or, “We know that pharmacy is a small business, and I’m sure your budget is reasonable. What did you have in mind?”

Tim Ulbrich: Right.

Tim Baker: So at the end of the day, it’s their job to extend the offer, not you to kind of negotiate against yourself, which can happen. You know? I had — we signed on a client here at YFP Planning yesterday, and we were talking about negotiation. I think it had to do with a tax issue. And you know, he basically said this is what he was looking for and when he got into the organization, I think he saw the number that was budgeted for it, and it was a lot more. So again, if you can deflect that — and I tell a story, when I first got out of the Army, I kind of knew this. But when I first got out of the Army, I was interviewing for jobs. I was in an interview, and I deflected and I think the guy asked me again, and I deflected. I think he asked me for like — maybe he asked me four times, and I just wound up giving him a range that was like obnoxious, $100,000-200,000 or something like that. But to me, that — and the interview didn’t go well after that, but to me, it was more about clearing the slate instead of actually learning about me and seeing if I was a good fit. So you never want to lie if they ask about your current salary, you never want to lie. But you definitely want to deflect and move to things like OK, can I potentially be a good fit for your organization and then go from there.

Tim Ulbrich: Yeah, and I think deflection takes practice, right?

Tim Baker: Yeah.

Tim Ulbrich: I don’t think that comes natural to many of us.

Tim Baker: Absolutely. Yeah.

Tim Ulbrich: This reminds me, so talk less, listen more for any Hamilton folks we have out there, which is playing 24/7 in my house these days, the soundtrack. I’m not going to sing right now, but talk less, smile more, don’t let them know what you’re against or what you’re for. So I think that’s a good connection there to the interview stage. So next hopefully comes good news, company wants to hire you, makes an offer. So Tim, talk us through this stage. What should we be remembering when we actually have an offer on the table?

Tim Baker: Yeah, so I think you definitely want to be appreciative and thankful. Again, when a company gets to a point where they’re an extending you an offer, that’s huge. I remember when I got, again, my first offer out of the Army — because again, you didn’t really have a choice when you’re in the Army. Well, I guess you do have a choice, but they’re not like, “Here’s a written offer for your employment in this platoon somewhere in Iraq.” But I remember getting the first offer. I’m like, man, this is awesome. Shows your salary and the benefits and things like that, so you want to be appreciable and thankful — appreciative and thankful. You don’t want to be — you want to be excited but not too overexcited. So you don’t want to appear to be desperate. What I tell clients, I think the biggest piece here is make sure you get it in writing. And I have a story that I tell because if it’s not in writing, and what I essentially said is it didn’t happen. So again, using some personal experience here, first job out of the Army, I had negotiated basically an extra week of vacation because I didn’t want to take a step back in that regard. And I got the offer, and the extra week wasn’t there. So I talked to my future boss about it, and he said, “You know what, I don’t want to go back to headquarters and ruffle some feathers, so why don’t we just take care of that on site here?” And this was the job I had in Columbus, Ohio. And I said, “Yeah, OK, I don’t really want to ruffle feathers either.” The problem with that was when he got replaced, when he was terminated eight months later, that currency burned up fairly quickly. So I didn’t have that extra week of vacation. So if it’s not written down, it never happened. So you want to make sure that you get it in writing and really go over that written offer extensively. So some employers, they’ll extend an offer, and they want a decision right away. I would walk away from that. To me, a job change or something of that magnitude, I think it warrants a 24-, if not a minimum 48-hour timeframe for you to kind of mull it over. And this is typically where I come in and help clients because they’ll say, “Hey, Tim, I got this offer. What do you think?” And we go through it and we look at benefits and we look at the total compensation package and things like that. But you want to ask for a time, some time to review everything. And then definitely adhere to the agreed-upon deadline to basically provide an answer or a counteroffer or whatever the next step is for you.

Tim Ulbrich: Yeah, and I think too, the advice to get it in writing helps buy you time, you know? I think you ask for it anyways. And I think the way you approach this conversation, you’re setting up the counteroffer, right? So the tone that you’re using, it’s not about being arrogant here, it’s not about acting like you’re not excited at all. I think you can strike that balance between you’re appreciative, you’re thankful, you’re continuing to assess if it’s a good fit for you and the organization, you want some time, you want it in writing, and you’re beginning to set the stage. And I think human behavior, right, says if something is either on the table or pulled away slightly, the other party wants it a little bit more, right?

Tim Baker: Yes.

Tim Ulbrich: So if I’m the employer and I really want someone and I’m all excited about the offer and I’m hoping they’re going to say yes and they say, “Hey, I’m really thankful for the offer. I’m excited about what you guys are doing. I need some time to think about x, y and z,” or “I’m really thinking through x, y or z,” like all of a sudden, that makes me want them more. You know?

Tim Baker: Sure.

Tim Ulbrich: So I think there’s value in setting up what is that counteroffer. So talk to us about the counteroffer, Tim. Break it down and some strategies to think about in this portion.

Tim Baker: Yeah, so you know, the counteroffer is I would say — the majority of the time, you should counter in some way. I think you’re expected to make a counter. And again, we kind of back that up with some stats. But you also, you need to know when not to kind of continue to go back to the negotiating table or when you’re asking or overasking. So I think research is going to be a good part of that. And what I tell clients is like, I can give them a very non-scientific — I’ve worked with so many pharmacists that I can kind of say, eh, that sounds low for this community pharmacy industry, or whatever, hospital, in this area. So your network, which could be someone like me, it could be colleagues, but it could also be things like Glass Door, Indeed, Salary.com. So you want to make sure that your offer, your counteroffer is backed up in some type of fact. And really, knowing how to maximize your leverage. So if you are — if you do receive more than one substantial offer from multiple employers, negotiating may be appropriate if the two positions are comparable. Or if you have tangible evidence that the salary is too low, you have a strong position to negotiate. So I had a client that knew that newly hired pharmacists were being paid more than she was, and she had the evidence to show that and basically they went back and did a nice adjustment. But again, I think as you go through — the way that we kind of do this with clients is we kind of go through the entire letter and the benefits. And I basically just highlight things and have questions about match or vacation time or salary, things like that. And then we start constructing it from there. So if you look at, again, the thing where most people will start is salary is you really want to give — when you counter, you really want to give a salary range rather than like a number. So what I say is, if you say, “Hey, Tim, I really want to make $100,000.” I kind of said it’s almost like the Big Bad Wolf that blows the house down. Like all of those zeros, there’s no substance to that. But if you said, “Hey, I really want to make $105,985,” the Journal of the Experimental Social Psychology says that using a precise number instead of a rounded number gives it a more potent anchor.

Tim Ulbrich: You’ve done your homework, right?

Tim Baker: Yeah. You know what you’re worth, you know what the position’s worth, it’s giving the appearance of research. So I kind of like — it’s kind of like the Zach Galfinakis meme that has all of the equations that are floating, it’s kind of like that. But the $100,000, you can just blow that house over. So and I think — so once you figure out that number, then you kind of want to range it. So they say if you give a range of a salary, then it opens up room for discussion and it shows the employer that you have flexibility. And it gives you some cushion in case you think that you’re asking for a little bit too high. So that’s going to be really, really important is to provide kind of precise numbers in a range. And oh, by the way, I want to be paid at the upper echelon of that.

Tim Ulbrich: So real quick on that, you mentioned before the concept of anchoring, and I want to spend some time here as you’re talking about a range. So dig into that further, what that means in terms of if I’m given a range, how does anchoring fit into that?

Tim Baker: Yeah, so we kind of talk about this more when we kind of talk some of the tools and the behavior of negotiation. But the range — so when we talk about like anchoring, so anchoring is actually — it’s a bias. So anchoring bias describes the common tendency to give too much weight to the first number. So again, if I can invite the listener to imagine an equation, and the equation is 5x4x3x2x1. And that’s in your mind’s eye. And then you clear the slate, and now you imagine this equation: 1x2x3x4x5. Now, if I show the average person and I just flash that number up, the first number — the first equation that starts with 5 and the second equation that starts with 1, we know that those things equal the same thing. But in the first equation, we see the 5 first, so it creates this anchor, creates this belief in us that that number is actually higher.

Tim Ulbrich: Yeah, bigger, yeah.

Tim Baker: So the idea of anchoring is typically that that number that we see really is a — has a major influence, that first number is a major influence over where the negotiation goes. So you can kind of get into the whole idea of factoring your knowledge of the zone of possible agreement, which is often called ZOPA. So that’s the range of options that should be acceptable for both sides, and then kind of assessing your side of that and then your other party’s anchor in that. So there’s lots of things that kind of go into anchoring, but we did this recently with a client where I think they were offered somewhere in like the $110,000-112,000 area. And she’s like, I really want to get paid closer to like $117,000-118,000. So we basically in the counteroffer, we said, “Hey, thanks for the offer.” And we did something called an accusation, which we can talk about in a second. But “Thanks for the counteroffer, but I’m really looking to make between” — you know, I think we said something like $116,598 to all the way up into the $120,000s. And they actually brought her up to I think she was at $117,000 and change. So it actually brought her up closer to that $118,000. So using that range and kind of that range as a good anchoring position to help the negotiation.

Tim Ulbrich: Yeah, love it.

Tim Baker: There’s lots of different things that kind of go into anchoring in terms of extreme anchoring and a lot of that stuff that they talk about in the book, but again, that kind of goes back to that first number being thrown out there can be really, really integral. And again, when you couple that on top of hey, it’s their job to make you an offer, not the other way around, you have to really learn how to deflect that and know how to position yourself in those negotiations. But that’s really the counteroffer. And what I would say to kind of just wrap up the counteroffer is embrace the silence.

Tim Ulbrich: Yeah.

Tim Baker: So Tim, there was silence there, and I’m like, I want to fill the void. And I do this with clients when we talk about mirroring and things like that. Like people are uncomfortable with silence. And what he talks about in the book, which I would 100% — this is really kind of a tip of the cap to Chris Voss and his book, which I love, I read probably at least once a year, where he talks about embracing the silence. We as people are conditioned to fill silences. So he talks about sometimes people will negotiate against themselves. If you just sit there and you say, “Uh huh. That’s interesting.” And then in the counter, just be pleasantly persistent on the non-salary terms, which can be both subjective and objective in terms of what you’re looking for in that position.

Tim Ulbrich: Yeah, and I want to make sure we don’t lose that. We’re talking a lot about salary, but again, as we mentioned at the beginning, really try to not only understand but fit what’s the value of those non-salary terms. So this could be everything from paid time off to obviously other benefits, whether that be health or retirement. This of course could be culture of the organization, whether it’s that specific site, the broader organization, opportunities for advancement.

Tim Baker: Mentorship. Yep. Mentorship.

Tim Ulbrich: Yes, yes.

Tim Baker: Yep, all of that.

Tim Ulbrich: And I think what you hear from folks — I know I’ve felt in my own personal career, with each year that goes on, I value salary, but salary means less and those other things mean more. And so as you’re looking at let’s just say two offers, as one example, let’s say they’re $5,000 apart. I’m not saying you give on salary, but how do you factor in these other variables.

Tim Baker: Yeah. Well, and I think too — and this is kind of next level with this, and I’ll give you some examples to cite it. I think another thing to potentially do when you are countering and when you’re shifting to some of maybe the non-salary stuff is really took a hard look at your potential employer or even your current employer if you’re an incumbent and you’re being reviewed and you’re just advocating for a better compensation, is look at the company’s mission and values. So the example I give is like when Shea and I got pregnant with Liam, she didn’t have a maternity leave benefit. And when she was being reviewed, we kind of invoked the company — and I think it’s like work-life balance and things like that — and we’re like, “Well, how can you say that and not back that up?” And again, we did it tactfully. Because you’re almost like negotiating against yourself, right? So when I present this to clients, the Spiderman meme where two Spidermans are pointing at each other, and she was able to negotiate a better, a maternity — and we look at us, and I give these, one of our values is encouraging growth and development. So if an employee says, hey, and they make a case that I really want to do this, it’s almost like we’re negotiating against ourselves. So I think if you can — one, I think it shows again the research and that you’re really interested and plugged into what the organization is doing — but then I think you’re leveraging the company against itself in some ways because you’re almost negotiating against well, yeah, we put these on the wall as something that we believe in. But we’re not going to support it or you know. Or at the very least, it plants a seed. And that’s what I say is sometimes with clients, we do strike out. It is hard to move the needle sometimes, but at least one, we’ve got an iteration under our belts where we are negotiation, and two, we’ve planted a seed with that employer — assuming that they took the job anyway — that says OK, these are things that are kind of important to me that we’re going to talk about again and things like that. So I think that’s huge.

Tim Ulbrich: Good stuff. So let’s talk about some tools that we can use for negotiation. And again, many of these are covered in more detail in the book and other resources, which we’ll link to in the show notes. I just want to hit on a few of these. Let’s talk about mirroring, accusation audits, and the importance of getting a “That’s right” while you’re in these conversations. And we’ll leave our listeners to dig deeper in some of the other areas. So talk to us about mirroring. What is it? And kind of give us the example and strategies of mirroring.

Tim Baker: Yeah, and I would actually — Tim, what I would do is I would actually back up because I think probably one of the most important tools that are there I think is the calibrated question. So that’s one of the first things that he talks — and the reason, so what is a calibrated question? So a calibrated question is a question with really no fixed answer that gives the illusion of control. So the answer, however, is kind of constrained by that question. And you, the person that’s asking the question, has control of the conversation. So I give the example, when we moved into our house after we renovated it — so brand new house. I walk into my daughter’s room, I think she was 4 at the time, and she’s coloring on the wall in red crayons. And I’m from Jersey, so I say “crown” not “crayon.” And I look at her, and I say, “Olivia, why are you doing that?” And she sees how upset I am and mad and she just starts crying. And there’s no negotiation from there.

Tim Ulbrich: Negotiation over.

Tim Baker: There’s no exchange of information. So in an alternate reality, in an alternate reality, what I should have done is said, “Olivia, what caused you to do that?” So you’re basically blasting — instead of why — why is very accusatory — you’re like, the how and the what questions are good. So and of course she would say, “Well, Daddy, I ran out of paper, so the wall is the next best thing.” So the use of — and having these calibrated questions in your back pocket, I think again buys you some time and really I think frames the conversation with your counterpart well. So using words like “how” and “what” and avoiding things like “why,” “when,” “who.” So, “What about this works, doesn’t work for you?” “How can we make this better for us?” “How do you want to proceed?” “How can we solve this problem?” “What’s the biggest challenge you face?” These are all — “How does this look to you?” — these are all calibrated questions that again, as you’re kind of going back and forth, you can kind of lean on. So have good how and what questions. To kind of answer the question about mirroring, as you’re asking these questions, you’re mirroring your counterpart. So what mirroring, the scientific term is called isopraxism. But he defines and says “the real-life Jedi mind trick.” This causes vomiting of information is what he says. So you know, these are not the droids you’re looking for. So what you essentially is you repeat back the last 1-3 words or the critical words of your counterpart’s sentence, your counterpart’s sentence. So this is me mirroring myself. Yeah, well you want to repeat back because you want them to reveal more information. And you want to build rapport and have that curiosity of kind of what is the other person thinking so you can, again, come to an agreement. Come to an agreement? Yeah. So at the end of the day, the purpose — so this is mirroring. So I’ll show you a funny story. I practice this on my wife sometimes, who does not have a problem speaking. But sometimes the counterpart is —

Tim Ulbrich: She’s listening, by the way.

Tim Baker: Yeah, exactly. So I’ll probably be in trouble. But so I basically just for our conversation, just mirror back exactly what she’s saying. And you can do this physically. You can cross your legs or your arms or whatever that looks like. But what he talks about more is with words. And you know, I’ll basically just mirror back my wife, and she — at the end of the conversation, she’ll say something like, “Man, I feel like you really listened to me.” And I laugh about that because I’m just really repeating back. But if you think about it, I did. Because for you to be able to do that, you really do have to listen. So mirroring, again, if you’re just repeating back, you really start to uncover more of what your counterpart is thinking because often, like what comes out of our mouth the first or even second time is just smoke. So really uncovering that. One of the things he talks about is labeling where this is kind of the — it’s described as the method of validating one’s emotion by acknowledging it. So, “It seems like you’re really concerned about patient care. It seems like you’re really concerned about the organization’s retention of talent. So what you’re doing is that you’re using neutral statements that don’t involve the use of “I” or “we.” So it’s not necessarily accusatory. And then you are — same with the mirror. You really want to not step on your mirror. You want to not stop on your label and really invite the other person to say, “Yeah, I’m just really frustrated by this or that.” So labeling is really important to basically defuse the power, the negative emotion, and really allow you to remain neutral and kind of find out more about that. So that’s super important.

Tim Ulbrich: Yeah, and I think with both of those, Tim, as you were talking, it connects well back to what we mentioned earlier of talk less, listen more.

Tim Baker: Yeah.

Tim Ulbrich: Like you’re really getting more information out, right, from a situation that can be guarded, you know, people are trying to be guarded. And I think more information could lead hopefully to a more fruitful negotiation. What about the accusation audit?

Tim Baker: Yeah, so the accusation audit, it’s one of my favorites, kind of similar with calibrated questions. I typically will tell clients, I’m like, “Hey, if you don’t learn anything from this, I would say have some calibrated questions in your back pocket and have a good accusation audit at the ready.” And we typically will use the accusation audit to kind of frame up a counteroffer. So it kind — so before I give you the example, the accusation audit is a technique that’s used to identify and label probably like the worst thing that your counterpart could say about it. So this is all the head trash that’s going on of why I don’t want to negotiate. It’s like, ah, they’re going to think that I’m overasking or I’m greedy, all those things that you’re thinking. So you’re really just pointing to the elephant in the room and you’re just trying to take this thing out and really let the air out of the room where a lot of people just get so nervous about this. So a good accusation audit is, “Hey, Tim, I really appreciate the offer of $100,000 to work with your organization. You’re probably going to think that I’m the greediest person on Planet Earth, but I was really looking for this to that.”

Tim Ulbrich: That’s a great line. Great line.

Tim Baker: Or, “You’re probably thinking that I’m asking way too much,” or, “You’re probably thinking that I’m way underqualified for this position, but here’s what I’m thinking.”

Tim Ulbrich: “No. No, no, no, Tim.”

Tim Baker: Right. So when someone says that to me, I’m like, “No. I don’t think that.” And what often happens — and again, clients have told me this — what often happens is that the person, the counterpart that they’re working with, like they’re recruited as — one person said, one client was like, “Oh, we’re going to find you more money. We’re going to figure it out.” So they like — so when someone says that to you, just think about how you would feel. “Oh, I don’t think that at all.” And then it just kind of lets the air out of the room. So you basically preface your counteroffer with like the worst thing they could say about you, and then they typically say, “That’s not true at all.”

Tim Ulbrich: Yeah.

Tim Baker: So I love the accusation audit. So simple, it’s kind of easy to remember. And I think it just lays I think the groundwork for just great conversation and hopefully a resolution.

Tim Ulbrich: That’s awesome. And then let’s wrap up with the goal of getting to a “That’s right.” I remember when I was listening to an interview with Chris Voss, this was a part that I heard and I thought, wow, that’s so powerful. If you can get — in the midst of this negotiation, if we can get to a “Yeah, that’s right,” the impact that could have on the impact.

Tim Baker: Yeah, so he kind of talks about it like kind of putting all of these different tools together. So it’s mirroring and labeling and kind of using I think what he calls minimal encouragement, “Uh huh,” “I see,” kind of paraphrasing what you hear from your counterpart. And then really wait for — it’s like, “Hey, did I get that right? Am I tracking?” And what you’re really looking for is a “That’s right.” He said that’s even better than a “Yes.” So one of the examples I give is when I speak with prospective clients, we’re talking about my student loans and my investment portfolio and I’m doing real budgeting, and I got a sold a life insurance policy that I think isn’t great for me. And so we go through all of these different parts of the financial plan. And I’m basically summarizing back what they’re saying. And I say, you know, at the end of it — so I’m summarizing 30 minutes of conversation. And I’m saying, “Did I get that right?” And they’re like, “Yeah, that’s right. You’re a great listener,” which I have to record for my wife sometimes because she doesn’t agree with me. So that’s what you’re looking for is “Yeah, that’s right.” This person has heard, message sent, heard, understand me. He says if you get a “You’re right,” so sometimes, again, I keep talking about my wife, I’m like, “Hey, we have to do a better job of saving for retirement,” and she’s like, “You’re right.” That’s really code for “Shut up and go away.” So it’s a “That’s right” really what we’re looking for.

Tim Ulbrich: Awesome.

Tim Baker: So that’s very powerful.

Tim Ulbrich: That’s great stuff. And really, just a great overall summary of some tips within the negotiation process, the steps of the negotiation process, how it fits into the financial plan. We hope folks walk away with that and just a good reminder of our comprehensive financial planning services that we do at YFP Planning. This is a great example of when we say “comprehensive,” we mean it. So it’s not just investments, it’s not just student loans. It’s really every part of the financial plan. Anything that has a dollar sign on it, we want our clients to be in conversation and working with our financial planners to make sure we’re optimizing that and looking at all parts of one’s financial plan. And here, negotiation is a good example of that. So we’ve referenced lots of resources, main one we talked about here today was “Never Split the Difference” by Chris Voss. We will link to that in our show notes. And as a reminder to access the show notes, you can go to YourFinancialPharmacist.com/podcast, find this week’s episode, click on that and you’ll be able to access a transcription of the episode as well as the show notes and the resources. And don’t forget to join our Facebook group, the Your Financial Pharmacist Facebook group, over 6,000 members strong, pharmacy professionals all across the country committed to helping one another on their own path and walk towards financial freedom. And last but not least, if you liked what you heard on this week’s episode of the podcast, please leave us a rating and review on Apple podcasts or wherever you listen to the show each and every week. Have a great rest of your day.

 

Current Student Loan Refinance Offers

Advertising Disclosure

[wptb id="15454" not found ]

Recent Posts

[pt_view id=”f651872qnv”]

10 Financial Benefits for Federal Pharmacists You Wish You Had

Posted on by yfpadmin

10 Financial Benefits for Federal Pharmacists You Wish You Had

The post is for educational purposes and does not constitute financial advice. The post may contain affiliate links through which YFP receives compensation.

The federal government is one of the largest employers of pharmacists and offers many unique practice opportunities beyond traditional roles.

Besides the Veterans Health Administration and the Indian Health Service, federal pharmacists also are employed at the Centers for Disease Control and Prevention, the Federal Drug Administration, the National Institutes of Health, the Department of Defense through one of the military branches, and the Department of Justice in the Federal Prison Bureau.

Pharmacists tend to find their work extremely satisfying with the hours and flexibility in schedule being among the top reasons which are something I can personally attest to after spending nearly a decade in a government position.

But beyond these factors that can positively contribute to one’s quality of life, there are also some huge financial perks of being a federal pharmacist.

While salaries are usually less than those in community pharmacy positions, the gap isn’t that wide. However, it’s really the employee benefits in combination with one’s salary that make the total compensation package so generous.

1. Federal Employment Retirement System (FERS) Annuity

As a federal pharmacist, your retirement plan has three components: a FERS basic benefit plan, Social Security, and the TSP (Thrift Savings Plan) which I’ll discuss later on. Contributing to your basic benefit plan each pay period is mandatory and the amount you contribute depends on when you were hired with those starting in 2013 and 2014 paying a higher percentage than those with an earlier start date.

The FERS basic benefit plan is essentially a pension paid out as a monthly annuity which is pretty amazing in a world where these are basically extinct. Remember, this is in addition to any social security income you are entitled to.

How much will I get?

Your benefit is calculated using a pretty straightforward formula:

1.1% x High-3 x Years of Service = Basic Annuity Annual Payment

If you retire before age 62 or at age 62 with less than 20 years of service the 1.1% multiple is reduced to 1.0%. Your “High-3” is your highest average salary for three consecutive years which is usually the last three years of your service. This number is based on your average rates of basic pay which does not include bonuses, overtime, allowances, or special pay for recruitment or retention purposes.

Length of service takes into consideration all periods of creditable civilian and military service and only years and months are used in this calculation, so odd days you worked beyond a month are dropped.

Here’s an example of this calculation: Let’s say you are 62 years old, have been a federal employee for 30 years and your “High-3” salary is $150,000. This would result in an annual annuity of $49,500.

If you don’t want to worry about all the rules check out the FERs Retirement calculator below.

FERS Retirement Calculator

 

When can I retire?

To be eligible to receive the basic retirement annuity you have to meet two conditions. First, there is a minimum number of service years. If you retire at 62, that number is 5, 20 years if you retire at 60, and 30 years if you want to retire at your minimum retirement age (MRA) and that happens to be prior to age 60.

You can also retire at your MRA with 10 years of service, but your benefit is reduced by 5% per year every year you are under 62 unless you have 20 years of service and your benefit starts when you reach age 60 or later.

The second condition to retire is to reach your MRA and this depends on when you were born. If you are a millennial or Gen Z, then your MRA is 57. Sorry FIRE folks!

Check out this table to find out what your FERS minimum retirement age (MRA) is:

fers retirement, fers retirement calculator

 

2. Access to the Thrift Savings Plan

The Thrift Savings Plan (TSP) is essentially the 401(k) equivalent for federal employees. It’s subject to the same contribution limits as other employer-sponsored plans at $19,500 with the option for $6,500 catch-up contributions if you’re 50 or older for 2020.

However, unlike many 401(k) plans there are some unique features and benefits.

First, regardless of how much you contribute, your employer will contribute an automatic 1% of your basic pay. In addition, your agency will match the first 3% you contribute dollar-for-dollar and 50 cents on the dollar for the next 2%. Essentially, you get a match up to 5%.

This is something to pay close attention to especially if you are a new employee as you are automatically enrolled in contributing 3% of your income. Therefore, unless you adjust this promptly when you start, you could be missing out on the additional matching contributions.

There is a 3 year vesting period but this does not include the 1% automatic contributions.

Similar to other employer-sponsored plans you have the option to make traditional contributions or after-tax contributions via the Roth TSP.

When it comes to fund selection, you have two basic choices: Lifecycle or target-date funds and individual funds. The lifecycle funds (L Funds) are a combination of the individual funds and every three months, the target allocations of all the L Funds except L Income are automatically adjusted, gradually shifting them from higher risk and reward to lower risk and reward as they get closer to their target dates.

There are five individual funds that range from government-backed securities to index funds with the objective to match the performance of the major stock and bond indices such as the S&P 500.

While one of the criticisms of the TSP is the lack of fund options especially for savvy investors, others tout the simplicity in the options and find it less challenging to navigate and make decisions.

But beyond the options that exist, the number one feature that sets the TSP apart from other employer-sponsored plans is fees!

The average plan fees for those with 401(k)s range from 0.37% to 1.42%. Compare that to the expense for the C fund in the TSP at 0.042%!

Here’s why that’s a big deal. If you were to invest $500/month over 40 years into two different funds with a similar performance of 7% rate of return, one with an expense of 1% and one with fees similar to the C fund, that fund with an expense of 1% will cost you about $700,000 over that period, significantly lowering your overall rate of return.

That’s the power of fees.

You can see the current expenses of the individual funds within the TSP. One of the major reasons why the fees are so low is that many employees leave money on the table when they separate from federal service prior to becoming vested and that helps offset the administrative costs.

[wptb id="17373" not found ]

3. Life Insurance

Working for the federal government means that you’re eligible for the Federal Employees’ Group Life Insurance (FEGLI) program. FEGLI was started in 1954 and is the largest group life insurance program in the world covering over 4 million federal employees and retirees. This program provides basic term life insurance coverage as well as three additional options that can be added on (Standard, Additional and Family).

To give you an idea of cost, for ~$250,000 policy at age 35 would be around $40/month. You can calculate your potential cost based on coverage here.

One of the huge benefits of this program is that it does not require any medical exam prior to being in force. In fact, you are automatically enrolled when you start.

While getting access to affordable life insurance regardless of pre-existing medical conditions is an amazing benefit, the biggest downside is that it’s not portable. This means that if you are terminated or leave federal service for another position, you no longer have coverage. That’s why it’s important to consider a private term life insurance policy as well.

life insurance for pharmacists, term life insurance

4. Long-term Disability Retirement Benefits

Beyond the life insurance benefit, you also have some protection in the event you became disabled while in federal service. This is known as disability retirement.

To be eligible, there are several requirements that have to be met including:

  • Completed 18 months of Federal civilian service which is creditable under the Federal Employees Retirement System (FERS);
  • The disability is expected to last at least one year;
  • Your agency must certify that it’s unable to accommodate your disabling medical condition in your present position and has considered you for a vacant position in the same agency at the same pay grade or level;
  • You, or your guardian, must apply before your separation from service or within one year thereafter;
  • You must apply for social security benefits. Application for disability retirement under FERS requires an application for social security benefits

The amount you’ll receive varies depending on your age and number of years of service. If you meet the requirements for traditional FERS retirement benefit based on age and years of service, then the calculation of benefits is the same.

However, if you are under 62 and not eligible for immediate retirement, the calculation gets a little more complex. For the first 12 months it is 60% of your high-3 minus 100% of your social security benefits you are entitled to and after that the calculation is based on 40% of your high-3.

Benefits are recalculated after 12 months and again at age 62 if the person is under age 62 at the time of disability retirement.

While this does guarantee at least some income beyond social security once you have at least 18 months of service, it’s not going to be similar to your take-home pay as a pharmacist.

Therefore, you should strongly consider an individual long term disability insurance policy as a supplement in order to move your potential replacement income closer to your current pay.

You will notice that when you are applying for policies, you will be asked if you are a federal employee. That’s because most states will not allow you to replace over 60% of your total income and this will essentially be a supplement.

5. HSA Eligibility

There are a variety of health plans that are offered for federal employees including fee-for-service plans (both PPO and non-PPO), health maintenance organizations (HMO), and high deductible health plans (HDHP) which offers a health reimbursement arrangement (HRA) or health savings account (HSA). This large variety of health plans allows federal employees to choose a plan that makes the most sense for themselves and their families.

I explained in a recent blog post Why I’m Not Using My Health Savings Account to Pay for Medical Expenses that choosing to use a PPO instead of the HDHP that was available to me was one of my biggest financial mistakes. This is because I was making high premium payments each month but wasn’t utilizing the majority of coverage that was available and I was missing out on the triple tax benefits that an HSA account boasts.

As mentioned, an HSA is unlocked through a high deductible health plan (HDHP) and can be used as an account to save for medical expenses. An HSA allows you to contribute money on a pre-tax basis to pay for qualified medical expenses, like costs for deductibles, copayments, coinsurance, and other expenses aside from premiums. If you’re using your HSA to pay for a qualified medical cost, you don’t have to pay any taxes on the money that’s withdrawn from the account.

In my opinion, the most powerful aspect of an HSA is that it can be used as a retirement vehicle, like an IRA. What makes an HSA so appealing are those triple tax benefits I mentioned. Triple tax benefits, you guessed it, all have to do with taxes; your HSA contributions lower your adjusted gross income (AGI), the contributions grow tax-free and the distributions are tax-free. If you’re under 65, the distributions are only tax-free if they are being used to pay for a qualified medical expense. If they aren’t, you’ll have to pay a 20% penalty. After age 65, your distributions don’t have to be for qualified medical expenses, but you will have to pay income taxes if they aren’t.

To learn about how I’m leveraging this benefit and how I’m allowing my money to stay in my HSA as long as possible, check out this post.

6. Paid Parental Leave

Paid parental leave varies so much from one employer to the next. Some companies like Netflix offer up to a year off of paid maternity or paternity leave while employees at other companies are “lucky” to get 4 or 6 weeks off, if any.

Due to recent changes, federal pharmacists will be able to receive up to 12 weeks paid parental leave for the birth, adoption or foster of a new child. This benefit is supposed to go into effect October 1, 2020.

7. Raises for additional credentials and board certifications

Federal employees are paid based on their grade and step and will have a GS or General Schedule status. The grade usually pertains to the position and the step is typically determined by initial qualifications at the time employment starts and also the years of service. Therefore, the most common way to get to the next level is often just to keep your job.

However, some federal employers may actually incentivize you to get these as well either in the form of a one-time bonus or even a permanent raise. In the VA they are referred to as Special Achievement Awards.

8. Opportunity to Pursue PSLF

When I graduated from pharmacy school, I made one of the biggest financial mistakes that ended up costing me hundreds of thousands of dollars! That was not pursuing the Public Service Loan Forgiveness (PSLF) program. As a government pharmacist, I was eligible for PSLF but because I wasn’t aware of all of my options and didn’t have a good handle on the program, I ended up paying way more money than I needed to.

Although PSLF has had a rocky past, it is one of the best payoff strategies available for pharmacists. The math doesn’t lie; PSLF is often the most beneficial to the borrower as far as the monthly payment is concerned (it’s the lowest) and the total amount paid over the course of the program (it’s the lowest).

Of course, determining your student loan payoff strategy takes a lot of thought and discussion. To learn more about all of your options, check out this post.

9. Tuition Reimbursement and Repayment Programs

Did you know that working as a federal pharmacist might qualify you for tuition reimbursement or to enroll in a tuition repayment program? These programs essentially provide “free” money typically from your employer or institution in exchange for working for a certain period of time.

Pretty awesome, right?

The programs that tend to provide the most generous reimbursement or repayment are those offered by the federal government through the military, Veterans Health Administration, and the Department of Health.

If you’re a pharmacist who works for or plans to work for one of these organizations, connect with your human resources department to see if you’re eligible. There is generally a set amount of funding for these programs, so even if you aren’t eligible initially, you may be able to reapply in a subsequent year.

Here’s a rundown of federal tuition reimbursement programs that are currently available:

Veterans Health Administration – Education Debt Reduction Program

Eligibility

Pharmacists at facilities that have available funding and critical staffing needs.

Benefit

Up to $120,000 over a 5 year period

Army Pharmacist Health Professions Loan Repayment Program

Eligibility

Pharmacists who commit to a period of service when funding is available

Benefit

Up to $120,000 ($40,000 per year over 3 years)

Navy Health Professions Loan Repayment Program

Eligibility

Must be qualified for, or hold an appointment as a commissioned officer, in one of the health professions and sign a written agreement to serve on active duty for a prescribed time period

Benefit

Offers have many variables

Indian Health Service Loan Repayment Program

Eligibility

Two-year service commitment to practice in health facilities serving American Indian and Alaska Native communities. Opportunities are based on Indian health program facilities with the greatest staffing needs

Benefit

$40,000 but can extend contract annually until student loans are paid off

National Institute of Health (NIH) Loan Repayment Program

Eligibility

Two year commitment to conduct biomedical or behavioral research funded by a nonprofit or government institution

Benefit

Up to $50,000 per year

NHSC Substance Use Disorder Workforce Loan Repayment Program

Eligibility

Three years commitment to provide substance use disorder treatment services at NHSC-approved sites

Benefit

$37,500 for part-time and $75,000 for full-time

10. Generous Leave Structure

One of the benefits that I have really appreciated while working for the federal government is the amount of paid time off. First, as a federal employee, you get all 10 federally recognized holidays off assuming you have a typical Monday-Friday schedule. But if you do have to work on one of those days, you get paid double time!

In addition to holidays, you start off accruing 4 hours of annual leave or vacation in addition to 4 hours of sick leave every pay period. This equates to a total of 7.2 weeks of leave as a brand new employee.

Once you hit 3 years of service, your annual leave increases to 6 hours and then to 8 hours per pay period once you reach 15 years of service.

When you become eligible for retirement, any accrued annual leave you have remaining is paid out to you in a lump sum whereas any remaining sick leave counts toward extending your time of service which can increase your overall FERS annuity benefit.

Conclusion

Working as a pharmacist in the federal government carries a lot of benefits that go way beyond your salary. Between possible student loan forgiveness with PSLF, access to TSP and HSA accounts, life and disability insurance, and raises for additional credentials and board certifications plus so many more, there are a lot of reasons to consider working for the government. If you’re currently unemployed, are a recent graduate or you’re looking to make a career change, I highly suggest checking out USA JOBs and sign up to get alerts as new positions become available.

Need Help With Your Financial Plan?

Trying to navigate your federal benefits can be overwhelming. If you need help analyzing how these benefits affect your overall plan or are looking to solidify your financial game plan, you can book a free call with one of our CERTIFIED FINANCIAL PLANNERSTM.

Current Student Loan Refinance Offers

Advertising Disclosure

[wptb id="15454" not found ]

Recent Posts

[pt_view id=”f651872qnv”]

 

 

YFP 165: The Power of a Health Savings Account

Posted on by yfpadmin


The Power of a Health Savings Account

On this week’s podcast episode sponsored by HPSO, Tim Church joins Tim Ulbrich to talk about the ins and outs of a Health Savings Account, how an HSA fits into a financial plan and why he is choosing not to use his HSA to pay for medical expenses.

Summary

A health savings account (HSA) is an account that allows someone to contribute to it on a pre-tax basis to pay for qualified medical expenses. Unlike a FSA, any amount you contribute to it is yours and you aren’t forced to spend it within a year. If you have a high deductible health plan (HDHP) that has a deductible of $1,400 for an individual and $2,800 for a family, you can qualify for an HSA.

Tim Church explains that an HSA is not a health plan per se, but instead is a benefit that unlocks if you have the option to have a high deductible health plan. For 2020, HSA contribution limits are $3,550 for an individual and $7,100 for a family. A catch-up contribution of $1,000 is available for those that are over age 55.

Tim shares that HSAs have triple tax benefits: your contributions will lower your AGI, any contributions grow tax free, and distributions are tax free. The caveat with the last benefit is that if you’re under 65, these distributions must be used for qualified medical expenses. Otherise, you’ll pay a 20% penalty and will be taxed according to the marginal rate. After age 65, any distributions don’t have to be for qualified medical expenses, however you’ll have to pay income tax if they aren’t.

Tim explains that the most power in an HSA comes from this loophole: you don’t have to reimburse yourself in the same year you incur medical costs. This means that you’re able to allow your money to grow in the HSA and reimburse yourself for the medical expenses later on in life as long as you have the receipts and are keeping good records. Tim is essentially using his HSA like a 401(k) or TSP account, meaning he’s aggressively investing it in stock index funds and is using it like a retirement account instead of a savings account for medical expenses.

Mentioned on the Show

Episode Transcript

Tim Ulbrich: Tim Church, two weeks in a row. Welcome back to the show.

Tim Church: Always good to be on. And you could also call this episode, “One of Tim Church’s Biggest Financial Mistakes Ever.”

Tim Ulbrich: I mean, how many episodes have we discussed the context of the topic as it relates to our mistakes? So here’s another one, which we will jump into in more detail. So today, we’re talking all about using an HSA as a savings vehicle. Now we talked a bit about HSAs on the podcast in the past, specifically Episode 019, How Does an HSA Fit Into a Financial Plan?, Episode 073, How to Determine the Priority of Investing, and most recently, on Episode 163, we briefly HSAs as it relates to Investing Beyond the 401k and 403b. But when I saw you wrote a blog post for the YFP blog on HSAs, I was reminded how powerful these accounts can be if you have access to them and knew we had to dig in more and dig in further on this topic. Now, for some of you listening, you may already saving in an HSA, some of you may have no idea what we’re talking about or this is the first time you’re hearing of it. And some of you may not have access to an HSA currently. And that’s OK as you may have this option available to you in the future. So Tim Church, let’s start with the basics: What the heck is an HSA?

Tim Church: So HSA stands for Health Savings Account. But the name itself is a little bit of a misnomer, as we’ll unpack, because you really can use it as more of an investing vehicle than necessarily just a simple savings account. But essentially, it allows you to contribute money on a pre-tax basis to pay for qualified medical expenses. These include costs for deductibles, copayments, coinsurance, and other expenses, generally not premiums, but a lot of different things that would fall under that as a qualified medical expense. And one of the biggest things — and I see this confusion come up a lot — is unlike an FSA or a Flexible Savings Account, any amount that you contribute into this is yours and you’re not forced to spend it every year. So it’s not a use-it-or-lose-it situation. Basically, those funds are there until you use them, even if you change jobs. It doesn’t matter. It’s going to follow with you, so it’s portable. So even if that’s the situation, it’s something that you’re going to continue to be able to utilize.

Tim Ulbrich: So key difference there, Tim: FSA/HSA. FSA you lose it if you don’t use, so you get some of the tax benefits, of course, that are associated with an FSA, but you’re always kind of worried about, OK, how much do I need? Am I going to need it? What if I don’t need it? HSA, totally different, right, in terms of if you decide to contribute or even max this out, you’re going to be able to continue to let those funds roll over, and we’ll talk about the growth opportunities that can come from those long term. So what is an HSA exactly? I mean, beyond what you just mentioned there, in terms of the setup of the accounts and how these worked and who ultimately has access to them.

Tim Church: So a Health Savings Account is not a health plan per se but rather a benefit that you unlock if you opt into a specific kind of health insurance plan called a high deductible health plan, or an HDHP. And these plans, as defined by the IRS, are those with deductibles of at least $1,400 for an individual and $2,800 for a family. Now that’s as per 2020. And these change over the years.

Tim Ulbrich: So we’ll link in the show notes to the IRS numbers if folks want to take a look at that further. But just to reiterate what you had said there, you essentially have to be enrolled in a high deductible health plan, so folks need to be thinking about not only can they contribute to the HSA if they’re eligible but also what’s their plan to be able to fund and bank the deductible monies in the event that they would need to use them throughout the year. So obviously coming into play here would be the emergency fund. So Tim, what from your experience — before we talk about contribution limits — from your experience, how widely available, in talking with many pharmacists, how widely available are these? And is this something that you’re seeing grow each and every year?

Tim Church: I think a lot of people have access to some form of a high deductible health plan. Not all of them are always that great. But I think that they are becoming more available. For me, I had this available for several years, even when I first started working, but just really didn’t understand what it was and how it worked and really was persuaded into a traditional PPO plan where everything was basically covered. If I had to go in for an appointment, covered medications, but the reality and the biggest thing that I didn’t understand is that with those traditional health plans, the premiums were much higher. And for somebody like myself who’s been fairly healthy, even though I’m not paying for things as they come up, they’re coming out of my paycheck, so I’m paying more for health-related expenses that I may not actually incur and didn’t incur for the first couple years when I was working. So that’s one of the biggest distinctions is that a high deductible plan is that you’re going to have to pay out of pocket for things that come up until you hit your deductible. But in general, your premiums are going to be lower.

Tim Ulbrich: Yeah, and I think that’s the mistake you had referenced earlier, which I think thankfully is not a catastrophic one, right? But is worth noting for folks that may be in a similar position. If you’re healthy and otherwise don’t have a lot of healthcare expenses, obviously you never know what the future is going to hold, but if you’ve got a good emergency fund and there’s a stark difference between the premiums in more of a traditional plan versus a high deductible health plan, you could fund the deductible if something were to happen, well then obviously being able to go into the high deductible health plan not only unlocks perhaps the HSA but also is going to free up monies each and every month that you could allocate towards another part of your financial plan. So Tim, as we talk about HSAs here, what are we referring to as contribution limits? Because I think this is important as folks are considering OK, I know how much I can put in a 401k or 403b, we’ve talked about that many times on the show. I know what I can do in a Roth IRA or a traditional IRA. And here, if we’re going to begin to think about an HSA perhaps not only for health care expenses but as a long term savings account, it’s important we have an understanding of how much we can allocate towards that. So what’s the dollar amounts we’re looking at in 2020 for contributions?

Tim Church: So similar to an IRA or a 401k, these contribution limits change every couple years. For 2020, for a self high deductible health plan, you can contribute up to $3,550. And for a self plus one or family, that number is $7,100. And then there’s also a catch-up contribution of an additional $1,000 for those who are 55 and older.

Tim Ulbrich: And Tim, I want to go back. One thing you had mentioned when I asked you how widely available these are, you said I think lots of people may have access to them or certainly they’re growing in the number that are available. But you had mentioned not all of them may be good. And what were you referring to there? Is it in terms of the construct, design of the plan? The investment options that are available? What are you referring to there when you talked about the quality of the plan?

Tim Church: So Tim, I think there’s a couple things to consider when you’re looking at those plans. And one is what the deductible is set at because if it’s something that’s very, very high, that means you’re going to be paying a lot of money out of pocket until you reach that level. I’ll give you an example for my high deductible health plan. For my wife and myself, our deductible is set at $3,000, meaning that health expense that comes up, we have to essentially pay for it out of pocket until we reach that $3,000 mark. And then from that point until about $6,800, that’s when our insurance would kick in and we would have a copayment. But the one thing that we like about our plan is that you’re out-of-pocket expenses cannot exceed a certain level. And so the IRS sets that. For individuals, that’s $6,900 and $13,800 for in-network services. And that’s something to take into consideration as well because that may also be a benefit if you look at you’re never going to pay in a given year over a certain amount, that can be very helpful and beneficial. But if the deductible is set very, very high, that means anything that comes up, you’re on the hook for paying those. I think the other thing to look at is what are your typical needs that you’re going to have in a year for whatever medical conditions you have for medications? So you always have to look at what those additional coverage options are going to be versus what you would get in a traditional plan. And then I think the other thing to consider is when you are going to go with one of these high deductible health plans is picking a trustee or somebody who’s going to administer the HSA that is going to offer good investment options if that’s the route that you’re going to go. And when I say good investment options, meaning you have a diverse number of options available but then also ones that have low fees associated with those funds.

Tim Ulbrich: Love it. Great summary. And I think that aligns so well with what we talk about in terms of investing philosophy with our comprehensive financial planning services. You want to have options, right, where you can have choice but also be able to keep those fees low because as we’ve talked about on the show, we know how those fees can eat into your long term savings. So if you’re putting the money in, we want to do everything we can to minimize what’s ultimately eating away at those funds. So let’s dig into the HSA more. And to be honest, this is where not only does it get good, but this is also where I start getting a little bit of FOMO because I don’t have access to an HSA so every time we’ve talked about it, I mentioned previous episodes, I’m always like, man, I wish I could do this as it relates to my financial plan. And our listeners have likely heard us talk or perhaps somebody else talk before about how an HSA has what’s referred to as the triple tax benefit. So Tim, break that down for us. What is the triple tax benefit? And spend a little bit of time on each one of those areas.

Tim Church: Sure. So the first one is that contributions that you make towards a Health Savings Account will lower your Adjusted Gross Income. So I think as pharmacists, one of the things that’s sort of annoying is that there’s a number of deductions that are available, but I often find myself, well, you make too much money to qualify for that. You can’t deduct student loan interest because you make too much. You can’t deduct traditional IRA contributions. Well, that’s one of the biggest benefits of an HSA is that it doesn’t matter how much money you make, that anything you contribute will lower your Adjusted Gross Income, which I think is huge. So that’s one of the things that I would often tell my colleagues is that look beyond the difference in cost in what you’re going to pay with your health insurance is that you have to look for other ways to lower your tax liability. And even though this may not be huge, depending on if you’re an individual versus a family, it still can be a pretty significant amount. So that’s No. 1. No. 2 is that any contributions you make to the HSA, whether they’re in investment accounts or some bond account or a high yield savings account within that is that those contributions are growing tax-free, which is also a really big deal.

Tim Ulbrich: Absolutely.

Tim Church: So like I said, whether you invest or you simply save them, they’re going to — if there’s growth on any of those accounts, you’re not on the hook for paying any taxes on those gains. And again, this is where it really comes down to how you want your HSA to function. So there’s a lot of people who are going to have medical expenses that they’re going to incur throughout the year, and they may want to use their HSA to pay for those expenses on a pre-tax basis, which is fine. I mean, there’s nothing wrong with that. You’re still getting the savings by paying for those expenses in that way or reimbursing yourself. But the power of the HSA is really where you can essentially pay out of pocket for health expenses that you may incur through the year and any of those contributions you make to an HSA, you can really look at it as almost an IRA. I know Dr. James Dowley at the White Coat Investor, he calls the HSA a “Stealth IRA” or an “IRA in disguise,” which really, that’s how it can function if that’s the way you want it to be. So that’s really powerful when you look at the ability to get growth and those investments in the HSA to grow over time and not have to worry about paying taxes on those gains.

Tim Ulbrich: And Tim, just real quick there, you’re essentially then looking at this, potentially, if you don’t have to use it for health care expenses, you’re looking at this as another long-term savings, another retirement account, correct?

Tim Church: Exactly. I mean, that’s exactly how ours is functioning right now. So I’ve had it set up now for three years since we changed our health insurance plan to a high deductible plan, and essentially everything we’ve been contributing in there I’ve just basically focused on that it’s an investment, it’s for retirement, and I’m not using any of the money in there.

Tim Ulbrich: Awesome. Awesome. So No. 1 was contributions lower your Adjusted Gross Income, your AGI. No. 2 was your contributions can grow tax-free. So these two both sound awesome. So give us the third, the good news to wrap it up.

Tim Church: So the icing — yeah, the icing on the cake is that the distributions are tax-free. And I’ll put a little asterisk there.

Tim Ulbrich: Ding ding!

Tim Church: Because there’s a couple things with that. But in general, there is a way you can take money out and not have to pay any taxes on it. So first off, if you’re under 65, the distributions you make have to be for a qualified medical expense. Otherwise you have to pay a 20% penalty, and you get taxed according to your marginal rate. So definitely not something that you want to do. But after age 65, any distributions, they don’t have to be for a qualified medical expense, but you have to pay income taxes if they’re not. So the question then becomes, OK, well, what if I wait until I’m at the age but I still don’t want to pay taxes. Is there a way to get around this? And that’s really one of the loopholes, and this is completely legal and something to really consider, but when you’re taking distributions out of your HSA, let’s say this is 20 years down the road, 30 years down the road, you don’t have to reimburse yourself for medical expenses in the same year that you incurred them. Meaning let’s say today in 2020, I paid for medical expenses out of pocket. Well, 20-30 years from now, I can essentially say that I’m reimbursing myself for those expenses that were made several years before as long as you can prove that those are expenses that you paid for at some point in time, even if you get audited from the IRS, you’re still legally reimbursing yourself for those medical expenses. You’re just not doing it at the same time or same year that they were incurred.

Tim Ulbrich: Yeah, that’s awesome. And that detail I think is really important, one that’s not talked enough about. And just to summarize, Tim, you did a great job succinctly, but the triple tax benefit, you know, folks think of — like we’ve talked before on the show — of the benefits of say like a traditional 401k or a 403b where you’re lowering Adjusted Gross Income today but ultimately you’re going to pay taxes in the future when you pull those monies out whereas the Roth IRA, what you’re putting in today you have already been taxed on and it’s growing tax-free, and then you pull it out tax-free. This really takes the best of both of those worlds. As you mentioned, ultimately what you are putting into your contributions lower your AGI, then your contributions grow tax-free, and then distributions are tax-free with the important stipulations that you mentioned. So talk to us about how you approach this, Tim, with your HSA. And again, this isn’t investment advice, of course. You know, we know every personal situation is different. But I think it would be helpful for our listeners to hear how do you approach your HSA in terms of aggressive, conservative, is this the place you’re really leaning in? Or are you looking at other places to do that and you’re a little bit more conservative here? How do you look at the investment strategy when it comes to your HSA?

Tim Church: Yeah, I mean, really it’s just similar to my 401k, which is through the government, it’s a TSP or a Thrift Savings Plan. That basically is very aggressive. So I don’t plan on using —

Tim Ulbrich: Full throttle, Tim Church-style, full throttle.

Tim Church: Take it to the limit. So it’s super aggressive into stock index funds because I’m not planning on using any of the money for several years down the road. And so it really is — the way I’m viewing this is I’m not touching it, I’m not going to use it for medical expenses today. Even if later down the road — you know, some people have said, let’s say you get to age 65 but you have so much money in your HSA that you haven’t even incurred that amount in medical expenses. Well, No. 1, that’s pretty awesome because that means I’ve been pretty healthy, my family’s been healthy during those years. But No. 2, the worst case scenario is you don’t pay a penalty but you pay income taxes on that. So it’s still a good option, even if that were the case. But yeah, it’s very aggressive. I’m viewing it as a retirement account, I’m not thinking about using it today or even in the next year. So it’s a very aggressive strategy. And like I said, that’s where it’s kind of a misnomer when you heard the word Health Savings Account because within my particular plan, there are several aggressive investments where you can put the majority of your money, all of your money if you want to, in a very aggressive portfolio in order to achieve greater gains several years down the road. And so for us, that’s the way we’re looking at that. And that’s why we’ve made that a huge priority after getting our matches at our work that that’s basically step No. 2 because of all of those tax benefits, this is very high in our priority with looking at those accounts.

Tim Ulbrich: Yeah, and again, just to reinforce a point you made earlier to our listeners that just like we say, not every 401k or 403b is created equal in terms of your investment choices and fees, the same thing is true with HSAs. So you know, we’re obviously talking about this at a high level and globally talking about the tax benefits, but ultimately the construct of the high deductible health plan and where that deductible is set as well as your savings options within the HSA and the fees associated with those is going to make this — I would say on the spectrum of attractive because I think regardless, it’s still attractive, but more or less on that higher end of attractive. So Tim, you just alluded to this, but I don’t want to have anybody overlook it. You mentioned where this fits in priority-wise, but I want to dig into that a little bit further because I think we spend so much time talking about some of the, you know, more popular I guess you would say, 401k, 403b’s, Roth IRAs, brokerage accounts, etc. And HSAs sometimes gets lost in the mix of looking at this as an investing vehicle because of its name, Health Savings, as well as how it’s often used. But to reiterate what you just said there, we’ve talked about this before when we talked about priority of investing on Episode 073, where do you see this fitting in to one’s investing plan? Again, generally speaking.
Tim Church: Yeah, so this is really Step 2 for us after the match through our employer. Through my wife’s, she has a 401k match and I do as well. And really, after that, the HSA was Step No. 2. Just because of all those benefits that we outlined. And you know, for us, even when we were paying off student loans, we were getting our matches at work and we were going all-in on the HSA. And for us, we just didn’t want to miss out on those benefits of the years being able to contribute to that. So that’s something that we did, even in tandem while paying off student loans. Now I’ll say one thing that’s really cool is that if you are a person doing PSLF, so the Public Service Loan Forgiveness program or even a forgiveness after 20-25 years, that’s something that’s really cool beyond putting money in a traditional 401k, as we talked about, your contributions to an HSA are lowering your AGI, which are ultimately going to lower your student loan payments that you have to make. So again, you’re growing investments while you’re lowering your student loan payment. So it’s a really cool benefit for those who are pursuing forgiveness.

Tim Ulbrich: Love it. And Tim, one of the questions I saw come up recently in the YFP Facebook group, you know, I think somebody was asking essentially, hey, I would love to be able to take advantage of my employer’s HSA. I’m not currently in a high deductible health plan, but I’d like to make that switch so I can unlock that option. What are you seeing out there — and I know this could differ from one employer to the next for folks that might be listening here in August, it’s not open enrollment yet, do they have to wait if this option is available? Are there triggering events that may open up that door for somebody? What advice would you have for folks that are hearing this and saying, “I want to jump on this.”

Tim Church: Yeah, usually you can’t until it’s open enrollment unless there’s a qualified life event. Usually that’s birth of a child, marriage, what are some of the others? What are some of the other ones I’m missing, Tim?

Tim Ulbrich: We actually just — you mentioned marriage, birth of a child are the big that I can think off the top of my head. Somebody in the group actually mentioned there after consulting with their HR, their employer had considered COVID-19 as an event that allowed them to make changes. So that may be some unique circumstance like that. But the two that you mentioned are the two biggest ones.

Tim Church: And the other thing I think that’s important to look at is a lot of people are very nervous about switching to a high deductible plan knowing that they’re going to have to shell out quite a bit of money in the event that they have medical expenses come up. So you briefly mentioned it, having that emergency fund is really important if you’re going to make that switch because you have to be ready to put out quite a bit of money until you reach that deductible. So I think that was really key. The other thing, what is a cool benefit is that a lot of health insurance plans is that when you enroll in a high deductible plan, they actually give you money every year that directly goes toward your contribution limit for your HSA. So for example, the plan that we have through the federal government, they actually give us $1,500 every year just for being in the plan towards the HSA, which is a huge benefit. So when you add that up to the savings in the premiums, as long as I’m fairly healthy, it tends to be a much better situation in terms of costs. Obviously the difference is going to vary between a traditional plan, depending on how much you utilize medical services in a given year. But again, the only way to even unlock the HSA is to be in a high deductible plan anyway.

Tim Ulbrich: Great stuff, Tim. And a really succinct but good overall summary of not only what is the HSA but how you have viewed it in your personal financial plan. And I would remind our listeners, as always, if you want to look at the show notes for this episode, you can go to YourFinancialPharmacist.com/podcast, pull up the episode, and you can get a link to not only a transcription of this episode but also other resources that we mentioned during this episode.

 

Current Student Loan Refinance Offers

Advertising Disclosure

[wptb id="15454" not found ]

Recent Posts

[pt_view id=”f651872qnv”]

YFP 164: The Pros and Cons of Paying Cash for a Car

Posted on by yfpadmin


The Pros and Cons of Paying Cash for a Car

Tim Ulbrich and Tim Church debate the pros and cons of paying cash versus financing a car purchase.

Summary

Tim Ulbrich and Tim Church talk through several pros and cons of paying cash for a car on this week’s podcast episode. Tim Church recently purchased a used Honda CRV with cash and Tim Ulbrich has purchased several cars this way, including his current Honda Odyssey.

The pros they talk through of purchasing a car with cash include: buying a car within your means; saving a lump sum of money forces you to slow down as a buyer; never have to worry about paying interest; don’t have to worry about negative equity on your car; no monthly car payments which will open up your cash flow; get through the buying process quicker and with less paperwork; could have cheaper car insurance; and a sense of accomplishment.

The cons discussed are the opportunity cost of putting all of that cash elsewhere with a potentially better return; you might pay more when buying a car with cash depending on the person you are buying it from; may take a long time to save money; may dip into your emergency fund which is generally not a good idea; and a missed opportunity to help your credit score by making on-time payments.

Tim and Tim then discuss which move they think is best and the value of having a coach in your corner to help you navigate financial decisions like this such as one of YFP’s CERTIFIED FINANCIAL PLANNERS™.

Mentioned on the Show

Episode Transcript

Tim Ulbrich: Tim Church, thank you for joining us. We’re going to talk all about car buying, pros and cons of paying cash for a vehicle versus finance a vehicle. And I thought it would be fun if we start by talking about the history of our vehicles, not only what are we currently driving, but have we been driving up to date as I know I’ve got some beaters in my history, and I’m guessing you’ve got some good stories as well. So Tim Church, give us some background. What’s been the vehicle story for Tim Church up until now?

Tim Church: You mean before the Lambo?

Tim Ulbrich: Yes, yes.

Tim Church: So I started out with a — what is it? — a 2001 Oldsmobile Alero. So this is a silver —

Tim Ulbrich: Hey, I had one of those!

Tim Church: You had one too?

Tim Ulbrich: Yeah. Yeah, I did.

Tim Church: Oh, nice. Obviously that Oldsmobile is no longer in business, is no longer there. But it was a pretty good car for the first couple years and then a lot of stuff just started to break down and there was some issues with it. But it was still, it was a good first car. And then really, I went on, personally went on to a Honda Accord, which I still have. Still have that, so when did we get that? 2011. So that’s, we’re going on almost 10 years with that car, but it’s been great. It’s been very reliable. And then I married into a 2009 Volkswagen Rabbit, which finally we got rid of.

Tim Ulbrich: Which is well documented in “Seven Figure,” right? We talked about that.

Tim Church: Right. We talked about how much cash we had to shell out to fix everything on it because it was so expensive. So that was one that I had married into, but finally — as I know we’ll jump into — it is no longer. It’s gone because we were able to upgrade.

Tim Ulbrich: And we’re going to come back to that upgrade and the decision that you made, why you made it, which will lead nicely into our discussion about pros and cons of buying cash, using cash to purchase a car versus financing a vehicle. So my history on vehicles starts in — passed down, actually, from my brother to me junior year of high school a Toyota Tercel. Do you remember the Toyota Tercels?

Tim Church: Yeah, isn’t there — there’s a song, there’s like a hip hop that well documents Tercels I think.

Tim Ulbrich: I got to look. So our vehicle, we named it, of course, because it had so many issues. Its name was Tercy the Tercel. And it did its job and then my upgrade was actually to an Oldsmobile Alero as I was in pharmacy school. And I am now a proud owner, of course, of the Swagger Wagon, a minivan, No. 2 minivan. You know, obviously we’ve got so many kids now we really don’t have many options but to have the minivan, about to need that rooftop carrier here pretty soon. And in between that, I’ll talk about the Lincoln MKX and Nissan Sentra, a couple other cars along the way and certainly some good stories that will come with those as well. Now, some of you may be thinking, wait a minute, paying cash for a car, why on earth would I ever do that instead of just getting a loan? And I know this may sound like a far-fetched idea, but hang with us for a minute and on the YFP blog, titled “My Top Ten Financial Mistakes,” really I should have called that “Things I’m Really Embarrassed About,” here’s the reality of all the decisions that we’ve made. And we’ll link to that in the show notes. I talked about how I bought a car I had no business buying back in 2014. And really, here’s the quick gist of it. Jess and I were nearing the end of paying off her student loans, almost at the finish line, I bought a used Lincoln MKX. And it was nice. It was really nice. Leather heated seats, moonroof, awesome sound system. I think it had one of those Bose systems. But the reality was I didn’t need the car. And I’m even getting a warm, fuzzy feeling just thinking back to riding in that car, to be honest. It was awesome. But I had a fully functioning, paid off!, paid off, Nissan Sentra with less than 50,000 miles on it. And so we ended up paying $12,000 for the Lincoln MKX and that was after turning in our Nissan Sentra, mind you. And while $12,000 may not seem like a lot of money, imagine what we could have used that money for: getting out of debt quicker — again, almost at the finish line — building up our emergency fund, saving for retirement, saving for real estate investment property, insert any other financial opportunity that outweighs the benefits of the car. But you get the point. So we ended up selling the Lincoln MKX six months after, talk about serious buyer’s remorse and purchased a Nissan Altima with 87,000 miles on it from my mother- and father-in-law. And the difference, which was significant, in that process, in that transaction, became our last student loan payment of the more than $200,000 in student loan debt that we paid off. So certainly good news, the outcome was good. But we paid for it, albeit not in a catastrophic way. We paid for it in the way of sales tax, delaying our debt payoff timeline, but the lesson learned was certainly priceless and one that hangs with me today. And I still have that Altima. It’s got a couple of quirks, I’m embarrassed to admit on the show, if anybody wants to know, shoot me now. But at 140,000 and no major issues, it No. 1 gets me from Point A to Point B and No. 2, it’s safe. And I think that second point is really important that we preface our conversation and before we get too far in this debate. Because I’m all about safety, and I’m not suggesting as we talk about what type of cars might provide the sweet spot in terms of the value and keeping that expense low, I’m not suggesting that you drive an unsafe vehicle to save money. And I really think that it’s fair to assume with few exceptions that here in 2020 whether we own a 2020 car or a 2008 car, we’re all driving what would be deemed safe vehicles. I think we’re often splitting hairs perhaps between the new safety features in 2020 and those of 2012. And that can be easy to convince ourselves is a part of justifying a purchase and we need a new vehicle. But not necessarily does, you know, an older vehicle necessarily mean it’s not safe. So the truth is most of us need a car for some reason or another, and maybe that’s not the case, maybe some people have been able to cut back their car situation. And while this isn’t an episode on best practices to buy a car, reference Episode 047 if you want to hear more about that, thinking through your strategy for purchasing a car is important to do. And buying a car, as with anything else that carries a dollar sign, is an important part of your financial plan. Edmond says that the average car payment for a new vehicle reached an all-time high in March 2020 of $569 per month. $569 per month. So doing a bit of research, thinking of some options outside of regular financing, is always a good idea. And I think this debate is really healthy. So Tim, talk to us about before we get into the weeds on the pros and cons — and we’ll go through each in detail — talk to us about what you and Andria just purchased and ultimately why you guys made that decision.

Tim Church: Yeah, I think before I jump right into that, I think you made such a great point is when you go through this whole process, I think you have to look at the perspective that you have. I think a lot of people, they think a car is a great asset potentially, but it doesn’t necessarily generate revenue unless it’s some collectable or something like that. So and our mentality is really something that’s safe, something that gets us from Point A to Point B. So I think you made a really good point there. And when you look at it, the opportunity to do so many other things, that has to be key in that type of decision. But I can understand, there’s a lot of people that are car enthusiasts, so they really enjoy that aspect of trying to get something that either looks good, that’s fast or has other intrinsic value. But for us in general, when we were looking, it was like OK, it’s a Point A to Point B. But one of the things that we really did is just figure out what were we going to actually buy and why? And for us, it was really just a midsize SUV. Talked to other friends and family who have vehicles kind of in that line. And we weren’t looking for anything luxury, just kind of middle-of-the-road, something that was safe, something that’s reliable. And so we essentially kind of landed on we wanted to go with a Honda CRV. So once we kind of made that decision, OK, what type of vehicle we wanted, then it was looking at the different models within that particular vehicle. So there’s actually, I think there’s like four different tiers of that, which is crazy. And what’s interesting is at one level, there’s actually the safety features that are present that aren’t on the lowest model. So that was really one of the key points that we looked for when we wanted to purchase and also from what I’ve heard, I didn’t know specifically, but it actually gets you a little bit cheaper insurance because of the safety features, so that was kind of one of the things. But I mean, what we did was once we kind of settled on what that model, what that vehicle was that we were going for, then we kind of looked at the Kelly Blue Books, the Truecar, the Edmonds, and just tried to get an idea of based upon that model — and what we were looking for was a certified pre-owned, so we wanted to get a little bit of a deal on that but still would be fairly new. So we got an idea of like what other people were paying for, what was a reasonable deal. So we kind of had a ballpark range. And then what we did was really look at the Honda certified pre-owned site and then from there, it kind of gives you all of the dealers that are in your particular area that have that make and model of the vehicle along with the features and the mileage on that. So that was kind of an easy way versus having to go on every single dealer website and trying to figure out who has what. So I think that kind of actually saved us quite a bit of time doing that. So from that point, once we had the vehicle inventory from the Honda site, then we were able to go to the individual dealers and not actually physically but I mean, call them, email them, and get an idea of what their quotes would be and in this particular case, we were trading in the Volkswagen Rabbit, which I was not anticipating we were going to get much for that thing. But eventually, we ended up getting $2,000 as a trade-in, which is really I thought quite generous to say. But one of the things is that the dealers obviously have a lot of — their main tactic is to get you on property, on site, get the emotions flying around, so that you’re not leaving without something. And what I did, what we did, was really try to get as close to an estimate on the quotes, really just via email. I tried not to even talk to anybody, didn’t want to give them my phone number, just because I didn’t want to get harassed. And I would say that if you have to give out a phone number, give out a Google Voice number, not your actual phone number, so that at least you can kind of screen those calls. But actually, I was pretty successful with getting quotes via email just saying with our trade-in and what we were looking for. And then once I got a couple of those estimates, then I was basically playing against each dealer and trying to figure out before I even stepped on the property, what was going to be the best option in terms of the deal so that when I even got there, at least I had some documentation, I knew an estimate of what we would pay. Obviously it would depend on the exact amount for the trade-in, but that was kind of our approach. And I think it actually worked out really well and because of the COVID situation, I think they were more willing to negotiate even via email before even going in there. And that really saved I think a lot of time and effort going that route.

Tim Ulbrich: Yeah, and I love what you said there, Tim, in terms of the emotion. Every sale is made from an emotional point of view or anything we buy, we buy from an emotional state of being. So I think, you know, what you just outlined there is that you really took advantage of doing a lot of your homework in advance and really trying to make it objective and analytical, you bought yourself a little bit of time, you don’t have that pressure in the moment, and all of those pieces add up to being your advantage as the buyer. So you know, if you’re going in uneducated, you’re going in — you know, it’s kind of like when you go to the bank and you just start a conversation about buying a home. Like, oh, let’s just talk about it, right? All of a sudden you’ve got like a preapproval letter for like, you guys can get a home for $700,000. You’re like, whoa, wait a minute, we just wanted to see what was going on. So you know, I think here, this is a good reminder too of the value of as a buyer, trying to put those advantages in your cord to give you the best shot. So let’s dig into some of the pros and cons of purchasing a car with cash. We’re going to go back and forth between you and I on these. We’ll talk pros, and then we’ll talk about cons. And I’ll kick us off from my experience. You know, I think perhaps the most overlooked, yet most important pro, in my opinion, is that paying cash gives you a better chance of buying within your means and stops you from putting your car buying priorities out of order with other priorities that you’re trying to work on. And I think it’s important we preface part of this conversation that we’re doing so under the assumption that other people listening to this are in a position like you and I, Tim, that they are also trying to balance other competing priorities and goals, whether that be paying down debt or buying a home, paying down a mortgage, saving for kids’ college, investing more for the future, whatever other goal, any money that’s put toward a car you could argue that yeah, there’s somewhere else I could potentially use that money. But if there’s folks listening that maybe don’t have other competing financial priorities and cars are their thing, are their jam, you know, Ramit Sethi from “I Will Teach You to Be Rich” would say, “Dial it up. Dial it up.” If that’s your thing and you certainly can control other parts if you don’t have those competing pressures. So buying within your means, what I mean by this is if Jess and I say, you know what, our next car we’re going to buy and we’re going to buy cash, and we determine, OK, we’re going to get another minivan and we’re going to look for — we’ve had good luck with Honda Odysseys and we want to look for one that has about 70,000-75,000 miles, we know that they hold their value, so anything we can do to find one at a lower price point but that will also live hopefully beyond 150,000-175,000 miles, let’s say we’re going to save up $13,000 cash to make that purchase. You know, taking the time to do that not only slows you down as a buyer and really makes you critically think about OK, where does this fit in with the rest of our plan? And that delayed timeline I think really helps you look at that purchase in an objective manner but just takes discipline, you know, to do that. So I think naturally, the conversation Jess and I will have is, alright, is there something else we can do? Can we downgrade to a different model? Can we look at a car that has a little bit more miles? We don’t want to wait that long to save up all that money. So I think it drives down the purchase price. Obviously you would compare that again, you walk into the dealership, you finance something new, you’re only worried about that next payment and even that next payment may not be due for three or six months if they give you some runway. Maybe you’ve got some money down, maybe you don’t. Obviously you don’t have to think about that lump sum purchase. So I think it really helps you or gives you the best chance of buying within your means and putting your car buying priorities in the right order as you look at the rest of your financial plan. So Tim, what are your thoughts on other pros?
Tim Church: Yeah, well I think too, like thinking about that, so many times people are buying things where they say, “I can afford that monthly payment. I can make that payment.” So I know Dave Ramsey talks about this a lot. He says, are you saying you can — if you’re saying you can make the payment, can you actually afford it? Meaning can you pay for it? And so I think that mentality is really important here when you think about that because as you mentioned, yeah, maybe you can afford a $500-600 payment for a car that’s $30,000+. But how long if you actually had to pay for it cash, how long would it take you to buy that? And I guess if the answer is it takes you years to save up enough to pay for it, then maybe you’re buying a little bit out of your budget range for where you want to be. But I think obviously the other big pro is that you never have to worry about paying interest.

Tim Ulbrich: Yeah. Yeah.

Tim Church: So even though a lot of times people will argue that car payments or car financing is pretty cheap and sometimes you can get close to 0%, maybe 1-2% interest rate on a car — and over the long term, even if it’s a standard term of five years or so, the interest may not be astronomical compared to what we would see with student loans or a mortgage or something like that. But obviously, that’s still money that you don’t have to pay for when you come to the table with cash.

Tim Ulbrich: Absolutely. And I think it reminds me of, similar to what we talk about on the mortgage of a 30 versus a 20 versus a 15, no mortgage, you’re obviously going to minimize the amount of interest that’s paid over the life of the loan, which can have an opportunity cost. And we’ll talk about that here in a little bit with the cons as I think that is worth considering. Tim, along that line, you know, obviously we know about financing, one of the things I also think about is you don’t have to worry about the negative equity position. And what I mean by negative equity is that you owe more on your car loan than the vehicle is worth. And this is also known as being upside down on your car loan, which is so common with new cars, right? Because especially if you fully finance it or have little down on that purchase, we all know that the second you drive a car off the lot, the value of that car goes down significantly in that moment but also quickly in those first few years. So many people, myself in previous vehicles, you’ll find yourself in a position where you likely owe more on the vehicle to pay it off than it is actually worth in terms of a market resale value from Kelly Blue Book or another source like that. So you know, I don’t really ever think of a car as an asset, although a paid off car is technically an asset. I think Robert Kiyosaki would fall over if he heard us talk about a car being an asset. But you know, I guess if we had to say it’s nice in the sense that even if my car is only worth $5,000 or $6,000 or $7,000, I’m not in a negative equity position. And if need be for whatever reason, perhaps I could sell that and free up some cash. So I think that’s certainly a pro as well.

Tim Church: Yeah, and I think obviously the next pro, so No. 4, means you don’t have any payments. So when you come and pay it off, you don’t have that monthly payment. So you’re really opening up your cash flow from that point forward. And I think for us, that was such a powerful thing to look at. So it ended up not taking us too many months to save up and pay cash because as we talked about not that long ago, we knocked out the student loans. So it was much easier and faster to kind of save up for it. But moving forward, really, when you think about those loan payments, you’re talking about $500+, like I don’t want that coming out of my budget. Like I’m trying to free up as much cash as possible moving forward to put towards things that are assets, so retirement accounts, other opportunities that may come about. So to me, that was like probably the No. 1 reason for wanting to pay cash for the car.

Tim Ulbrich: That’s good. And another pro, Tim, that I think of from previous experiences — the memory is coming alive as I’m even thinking about it — if anybody has financed a car before, you know what that feeling is like at the dealership. You know, you go to the back room, right? All the papers come out and you sit down with the finance guy and you’re signing a bunch of papers and the upsells start happening, one after one after one in terms of other things that might be tacked onto that. And so you know, obviously the pro here is that you can get through the overall buying process quicker with less paperwork if you’re paying cash. You write the check or if Joe Baker is listening, perhaps he’s showing up with the cash in envelope, and you move on and certainly you don’t have to deal with all that financing. And we’ll talk about some cons that could come from that as well. But certainly from a process standpoint, quicker and easier.

Tim Church: So the other potential pro — and I’ll say potential, I’ll preface it that — is you could have cheaper car insurance. Now if you look at just kind of on a one-to-one basis looking at what it costs to insure a car that has a loan on it versus not, usually that aspect alone is not going to make it cheaper. But when you have a lender and you have a loan on the vehicle, they may require certain coverage options that you may not necessarily want or need. So one of the things that a lender may require you to have is gap coverage, so that essentially covers the gap between the cost of a replacement for a new vehicle and the current value of the vehicle. So that’s something that you may not have to have on your policy along with maybe some other options that a lender is requiring you to have. So I would say that’s a potential.

Tim Ulbrich: And I want to wrap up the pros, Tim, by mentioning that you cannot overlook the sense of accomplishment and just the feeling and the behavioral aspect of this. And it’s hard to put a monetary value to that. We talk about that all the time on the show when we talk about the behavioral part of the financial plan. But feeling that sense of winning and not having a payment, whether it’s student loans, whether it’s a mortgage, whether here it’s a car, can be incredibly motivating towards achieving other goals. And so I think often, you’ll see folks that it’s not just the lack of payment but all of a sudden they have then been motivated to take those monies and put them to use for them in terms of investing, whether that be in the market or real estate or whatever it be to help get that growth side of it as well. So I think that sense of accomplishment is really important. Alright, let’s talk about the cons. What are your thoughts here in terms of the potential cons of paying cash for a car?

Tim Church: Yeah, so I think one of the biggest arguments is that there’s an opportunity cost versus throwing all that cash that you have at a car, especially if you can get a low interest rate. So one of the arguments could be let’s say you’re going to get a low interest rate, like 1-3% or something like that. Instead of putting that huge lump sum of money, could you get a better return in the stock market? Could you get a better return on putting a down payment for an investment property or some other investment where you may get a better return? So I think that’s usually one of the biggest arguments against paying cash for a car, especially in that situation.

Tim Ulbrich: I think, Tim, to that point, one of the common I guess debates is the right word that I have on this topic is that often, the point of comparison I hear is a new car that’s offering 0%, 0.9%, some low financing. But I don’t think that’s a comparison we’re talking about. I mean, I’m thinking of the mindset of a used car, 40,000, 50,000, 60,000, 70,000 miles on it, lot of the depreciation has already happened. So I think the financing on the new car, certainly. It’s great. The financing on a used car, not as competitive. Typically not anywhere near as competitive. So I think that point of comparison can even be off as folks are weighing those two options. Another con, Tim, that I think about and I’ve heard people talk about this is the thought that you can actually pay more when you’re paying cash for a car, especially if the sales associate gets commission on the financing. And I think that’s an important consideration. I mean, I think the traditional thought here is hey, if you’ve got a wad of cash and it’s the end of the month and they’re trying to meet quotas for the month, like you’re really in the best negotiation position. But that may not always be true. And I think this is certainly depends on the individual that you’re buying the car from. But I think it’s at least a consideration that paying cash may not necessarily mean a better deal and at some point may actually mean that you pay a little bit more.

Tim Church: Yeah, I think that one’s always interesting. I feel like I’ve always learned it as the opposite.

Tim Ulbrich: Correct.

Tim Church: That if you have cash, you have more negotiating power, but I feel like the more I’ve come across, especially depending on what kind of cut the sales associates are getting that it may be the opposite. The other thing I think as a con is that depending on what you’re looking at buying, I mean, it may take a long time to actually save up for that money. It really depends on obviously the type of car that you want but also your overall situation. So if you’re dead set on wanting to pay cash, whether that’s a new car or used car, it may take a lot of time. And maybe you’re not willing to wait that long, depending on the situation and how dire it is that you have to have a different vehicle, an upgraded vehicle. But that may be a big con if it’s going to take several months to maybe even a year or more.

Tim Ulbrich: Yeah, and I think building on that, Tim, I think saving up for a car, even if it’s used, I mean, I gave the example before of a used Honda Odyssey can easily $14,000, $15,000, $16,000, even with 70,000-80,000 miles on it. Saving that much, depending on your timeline, I’m trying to do that even within a year period, that’s going to be a big amount each and every month, and that could put other financial priorities on hold and that you might have to either pause other things or you are delaying other goals that you’re trying to achieve. So I think to this point, Tim, I’d love to hear from your perspective, you know, I know a little bit of the behind-the-curtain of the Churches, you know, in terms of other things that you guys are working on and other things, but regardless, any listener is usually working through multiple goals. So how did you guys reconcile this one in terms of paying cash despite having other goals that are on the horizon?

Tim Church: Yeah, that’s a great question. And I think for us, it was just being kind of crazy. It’s like we had the huge goal of knocking out the student loans. But then it was like, OK, these other life events and things just happened right after that. So the first thing was really bulking up and beefing up that emergency fund. So that was really the first thing that we did after paying off the student loans. So why I took a little bit longer than I anticipated to save up and pay cash is we wanted to beef that up first, really get that to a position — and then and only after that was done really kind of put most of our focus on saving for the car. And I mean, along the whole time, we were still putting money towards our HSA, maxing that out, getting our matches through our employer-sponsored plans. So we were doing multiple things but really just the main focus was beefing up that emergency fund and then really going right after saving up for the car.

Tim Ulbrich: And what I love, Tim, about what you guys did, which I think is easier said than done but I so value both for the listeners to hear, is if you have identified goals, not only just if you’re in the middle of student loans but if you know, OK, we want to plus up the emergency fund, we want to save this much for a down payment on a home, we want to do this much for retirement or whatever the goal would be, when you meet one of those goals, you instantly redirect those funds that were going towards whatever that goal was to the next goal that you’re working on or goals at the same time. Because with a pause or with time, that money can certainly evaporate quickly into different areas that are always surprising about where it goes. And being able to identify where you want that to go I think is so, so important and a cool part of the story in what you guys did. Tim, you mentioned emergency fund. What are your thoughts here in terms of a potential con that folks may end up dipping into an emergency fund? And is that a justifiable dip in that fund to be able to pay cash for a car?

Tim Church: Yeah, that’s a good one. I mean, I think it can be tempting when you — however you have your emergency fund set up, when you have a chunk of cash there, I think it can be so tempting to want to use that, break into it, to put towards a new or used vehicle but when you’re paying for cash. Even for us, just looking at it was tough because we knew the timeline was going to be stretched because of it. But I think some people may be tempted and may have even dipped into that emergency fund to want to pay cash. But you know, which may have worked out OK, but obviously the downside is that if something comes up in that interim period directly after the purchase or within that, you might be in a bad situation. And yeah, you may have a paid-for car, but you may not have enough savings and you may have to look at other means on how you’re going to get around that and make it work if you’re in a tough spot. So I think that is one thing that you really have to consider as you’re going through the process.

Tim Ulbrich: And the last con here — or at least the last one we’ll discuss, I think there’s probably more we’re not even touching on here — the last con in terms of paying cash for a car I think would be the missed opportunity to help the credit score in terms of making regular, on-time payments. Now, of course that assumes that somebody’s making on-time payments. So if you were to finance a car and you don’t or you’re overleveraging yourself, that can have the opposite impact. But for those that would be making on-time payments or perhaps even paying off some of that debt early, obviously paying cash for a car would remove that opportunity. But I think it’s safe to say most folks have multiple other areas in which they’re probably able to impact their credit score in a positive way that wouldn’t be dependent upon a car purchase. So there you have it, pros and cons of paying cash for a car versus financing a vehicle.

Tim Church: So Tim, what do you think the best thing to do is?

Tim Ulbrich: Gees, million dollar question, right? You know, obviously I’m biased. We’ve paid cash for most, not all, of our cars. And I honestly, I struggle with this one. I think that because we’re purchasing used vehicle and I’m not comparing new vehicles as even an option, if anybody’s looked at what a new Honda Odyssey costs, my gosh, crazy. So you know, we’re looking at used vehicles. For us, it’s kind of a get to Point A to Point B, doesn’t need to be fancy, needs to do the job, got to have the DVD for the kids so they keep quiet somewhat in the back of the car. So for us, I have that bias. But I think it really depends on the situation and other financial priorities. I do think there’s a real opportunity cost that people need to consider saving up a wad of cash. Now, if you can convince yourself that a $5,000 car is an option for you, which I would argue I think it is for many people that are listening, maybe not all, but for many people, then I think you’re obviously minimizing the negative impact of what that opportunity cost could be of the time that’s delayed and the monies that are needed to save for that. But I really believe, back to one of the pros we talked about, I really believe for most cases and most situation, never in all, most cases and most situation, saving up and paying cash for a used car, I think the benefit of forcing you to slow down, further evaluate the purchase, think about how it fits into the financial plan, and ultimately probably driving down the purchase price a little bit is really going to have a net positive effect on the rest of your financial plan. Certainly other benefits that are there as well. So I think if somebody is talking about buying a $30,000 car, could I justify saving cash and paying cash for it? Probably not. But I’m not looking at a $30,000 purchase. I think best case scenario in my mind is you think about other competing priorities and putting your money into assets that are going up, not going down, would be to try to minimize as much as you can the purchase price of a depreciable asset. And here we’re talking about one while we’re talking about cars. So Tim, other factors we need to keep in mind when talking about buying a used car. What have we not talked about that folks should consider?

Tim Church: I think we covered most of the common things to consider. I mean, I would just kind of reiterate the point, like I’m looking at our situation right now. You know, we have a paid-for Honda CRV, it’s not brand new, I think it’s almost about three years old now, which is much, much cheaper than a brand new one. And that feeling, No. 1, that it’s paid off, that there’s no payments, I mean, that feeling is just pretty awesome. And then moving forward from this point, there’s not going to be any car payments. And to me, I didn’t realize how powerful that was going to be because my first car was financed. And it was like a $400+ payment every month. And I mean, I remember the pain of that. And so I think that at this point, just moving forward and that feeling is more powerful than I anticipated. And for me, personally, I’m OK with that opportunity cost knowing that we had to save up and pay for it. I know a lot of other people, it really depends on what your risk tolerance situation is and how aggressive you want to be with investments. But I think for us, like I feel that it was a great decision.

Tim Ulbrich: That’s great stuff. And I think the question I would leave our listeners to reflect upon is, there’s not a right answer here. How important is a car to you? And how important is it relative to other parts of your financial plan? You know, I’ve determined, Jess and I have determined, that a car is pretty darn low on the totem pole as I’ve put it in the context of other areas that money could be going towards. But that does not mean that’s true for everyone. Nor does it mean there’s a right or a wrong here. So if a car means a lot to you, as I mentioned, awesome. Make sure you appropriately prioritize that and fund it accordingly. Ramit Sethi would say, “Figure that out.” Figure out how you can prioritize that and turn down, dial down anything else that doesn’t matter. But if not, my question is, why are you spending so much money on a car at the expense of other goals? And what adjustments might you be able to make to help get you towards those other goals if you determine that those matter a little bit more. I think that connects so well, Tim, to our financial planning services that we offer, comprehensive financial planning, over at Your Financial Pharmacist. You know, like anything else that carries a dollar sign in your life, we believe that here as we’re talking about car buying, this is one part of the financial plan. And I talk often about not looking at the financial plan — any part of the financial plan — in a silo. And I think here, it’s a great reminder. As you’re looking at your car, how does your car fit with your debt, with your savings goals, with every other part of your financial plan? And having a coach, having a planner, that can work with you to identify those goals, to prioritize those goals, to fund those goals, is critically important. And that really is what we believe is the value of comprehensive financial planning and what our planners do so well over at YFP Planning. So for those that are interested in working one-on-one with a financial planner, certified financial planner at YFP Planning, head on over to YFPPlanning.com, where you can book a free discovery call to learn more about our services. And as always, if you liked what you heard on this week’s episode of the Your Financial Pharmacist podcast, please leave us a rating and review on Apple podcasts or wherever you listen to your show each and every week. Have a great rest of your day.

 

Current Student Loan Refinance Offers

Advertising Disclosure

[wptb id="15454" not found ]

Recent Posts

[pt_view id=”f651872qnv”]

YFP 163: Investing Beyond the 401k/403b

Posted on by yfpadmin


Investing Beyond the 401k/403b

Tim Ulbrich and Tim Baker talk about investing beyond the 401k or 403b and break down the traditional IRA, Roth IRA, HSA, SEP IRA and taxable/brokerage accounts by discussing their contribution limits, how to appropriately use them and the advantages and disadvantages of each.

Summary

Tim Baker joins Tim Ulbrich on this week’s episode to break down investment vehicles beyond the 401k and 403b. To start, Tim Baker explains that investing is just one part of the financial plan and should not be looked at in a silo. However, when he works with financial planning clients he helps to get their nest egg on track so that they are financially prepared for their retirement some pharmacists feel overwhelmed that they will need $4 or $5 million at retirement. The certified financial planners at YFP Planning help to provide actionable steps to help you get you on track while keeping the rest of your financial plan in mind.

Tim runs through several investment vehicle options that are outside of the 401k or 403b employer-sponsored plans. He digs into the IRA, Roth IRA, HSA, SEP IRA and taxable/brokerage accounts and discusses their contribution limits, how to appropriately use them and the advantages and disadvantages of each. Tim also talks through YFP’s view of the priority of investing, common mistakes and assessing risk tolerance and risk capacity.

Mentioned on the Show

Episode Transcript

Tim Ulbrich: Tim Baker, welcome back to the show. Two weeks in a row!

Tim Baker: Yeah, crazy. Good to be back.

Tim Ulbrich: Fresh off vacation, right? You’re primed and ready to go, talk about investing?

Tim Baker: Yeah. We spent a week at the Jersey shore, kind of close to my old stomping grounds. And good family vacation away from Baltimore and the city and do some good social distancing on the beach. And yeah, just feeling happy to be back but glad I got to get some quality time with the fam.

Tim Ulbrich: Awesome. So we’re back at it here today, talking about how to invest your money beyond an employer-sponsored plan like a 401k or a 403b, which we’ve talked about many times before on the podcast. And before we jump into this discussion, Tim, I think it’s important that we highlight, as I know I hear you say often, that investing, albeit a very important part of the financial plan, it is just one part of the financial plan. So talk to us about why that is so important that look at it that way. And really, what are all of the different parts that you work with in terms of the financial plan with clients?

Tim Baker: Yeah, so I think one of the issues that I have in, you know, with other financial planners, financial advisors, is a lot of financial advisors will say, “Hey, I do financial planning and investment management.” And it kind of, it grinds my gears a little bit because I think those are like one and the same. Like the investment management is nested in financial planning in the majority of cases. But the reason it’s separated out I think is because a lot of advisors will say, “I do financial planning,” but it’s really just managing your investments. They’ll say, “Hey, Tim, you have half a million dollars, we’ll manage that for a fee or we’ll get commissions or things like that. And then maybe we’ll talk about some of these other things along the way like insurance, especially if I can sell you insurance or hey, the kids are going to college. You’re probably not going to get any help with your student loans or anything like that. So to me, you kind of follow the money. So with the way that most advisors are paid, it’s based on the investments and then if they can sell you kind of a crappy insurance product. So it has like this elevated designation of, you know, with regard to the financial plan. And it is important and it is a main driver. But I think, you know, getting your student loans right, having a savings plan, a plan for the debt, a plan to pay off your house, you’re properly protected from an insurance perspective so you’re managing your risk, estate plan, your taxes, which permeate everything, you’re doing some planning for that. Like to me, it’s just one piece of the puzzle. And I think we kind of put the investment up on a pedestal. And again, it’s important. It’s typically the thing that’s most confusing or most exciting to the average consumer because it’s kind of like this, oh, OK, I can buy shares of this and I can be investing in these companies. But I often argue that those are some times where the more exciting an investment is, typically the worse it is for the investor because they’re chasing returns or they’re tweaking too much. So you know, at YFP, we do all of the things and we fit the investment and retirement piece into that puzzle. But then we also kind of go beyond where we talk about things like credit, credit score, credit report, and you know, kind of the life events of hey, Tim, I’m buying a house, I’m buying a car. I’m getting married, so now I’m combining finances, we’re having a baby, we’re retiring in a couple years, we’re getting into real estate investing, we’re negotiating our salary, we’re downsizing. Whatever that is, to me, those are the main — kind of some of the main drivers. We have the structure that is the financial plan, but then we have these life events that happen that can throw a wrench and kind of force us to zig and zag. So again, the investment is super important, but at the end of the day, it’s going to be one piece of the overall financial journey.

Tim Ulbrich: Yeah, and we’re going to keep coming back to this over and over again, that the financial plan and how you think through your financial decisions should be comprehensive, comprehensive, comprehensive. And so I think especially because we do so many episodes or blog posts or whatever that are more topical in nature. So here, we’re talking about investing. It might be student loans, it might be home buying. And I think it’s just human behavior that you hear something and you’re like, ooh, I can optimize that. Maybe after today, somebody’s like, ooh, I should go max out my Roth IRA. But you know, you take a step back and that may or may not be the best decision once you have a chance to look at all of the different components of the financial plan and understand how one decision can have a ripple effect into the others. So let’s jump in. I want to start by talking about the end, and that really is the nest egg. As we talk about long-term savings, trying to determine what we ultimately need to have saved so that we can turn that into a meaningful plan of what we should be doing today. So as you work with clients, Tim, on this long-term savings strategy, talk us through why that nest egg calculation is so important, what it is, and then how you ultimately are able to back that into a plan of something that they can take action on today.

Tim Baker: Yeah, so you know, typically when I talk to some of our clients that are in maybe 20s, 30s or even 40s, you know, I’ll ask the question, I’m like, “Well, how are you feeling about your retirement?” And you know, sometimes the question is — sometimes, especially early on in the 20s and maybe even 30s, it’s kind of similar to the question that we would ask when we would ask students and residents, probably students at like the APhA conference, we would say like, “How are you feeling about your student loans?” And a lot of the answer was like, “Ah, I just don’t even really look at it. I’m not really worried about it. I’ll figure it out later.” And that kind of perpetuates into like the next, really one of the next big things is trying to establish retirements savings. So it’s like, ah, I don’t really know. So then if I ask the follow-up question — if I say something, if I get an answer like, “Well, I guess I feel good about it, I’m getting a match and maybe I’m putting a little money into like an IRA or something,” I’m like, “Well, do you feel like you’re on track?” And you know, I think that question then kind of goes into like, well, I don’t know. I’m not really sure. I think I want to retire at 65, but there’s some people that think they have to retire or that they’re going to work forever. So what the nest egg is is it’s an exercise that we do, it’s a calculation that we do, and I kind of walk it line-by-line through with the client that says, that shows them if they’re — basically, are they on track or off track? And it’s kind of a binary thing. So what I often say to a lot of clients is like I say, “Hey, you know, you probably need $4 or $5 million to retire.

Tim Ulbrich: What?

Tim Baker: And they typically — yeah — and then they typically look at me like I have 4 or 5 million heads, right?

Tim Ulbrich: Yeah.
Tim Baker: So I say, “Alright, once” — I’m processing that look — once we get beyond that and what we typically do is then is we start to break or deconstruct that number down to a monthly number that we can digest today. So big, big number, way in the future, Tim, that doesn’t mean anything to me. That’s just this noise. That doesn’t connect. That doesn’t connect with me today. So what we do is we then break it down to a number that they can sink their teeth in today. So I can say, “OK, if you need — if we had nothing saved for retirement and you’re getting the match and maybe you’re maxing out your Roth IRA, you’re still running a deficit of $100 per month. So we need to maybe put a little bit money into the 401k or something like that.” So what it does is it provides actionable steps, you know, for them to kind of get on track. And then as they kind of pursue, we kind of check in with that calculation as the years go by, and then as we get into the 40s and 50s and 60s and 70s, we do a little bit more robust planning and kind of decisions that are stuff like, OK, if we retire early or if we downsize our house or if we relocate to this state that’s maybe more tax-free, we can kind of show the effects of that and if your money’s going to run out or not and at what age. So longer story longer, the nest egg calculation is really meant to say, alright, we need some type of money in the future so you’re 30-, 20-, 20-, 30-, 35-year-older self can retire and really not have to work anymore or have the option not to work. So you know, to bring this full circle, the investment plan and the retirement plan that’s kind of executed per what the nest egg says is really, really, really important.

Tim Ulbrich: Yeah, and you know, we’ve mentioned before on the show that saving for the future, whether it’s traditional retirement or something else, it shouldn’t be I hope, I wish, I dream, maybe. I mean, it’s a set of assumptions based on mathematical calculations. And we may or may not like the outcome of that, but we can then begin to understand the variables that go into that calculation and make adjustments or changes, whether that be investments or changes in expectations or adjustments in changes on how we’re executing our savings plan. And so Tim, we talk a lot about wow, it’s really important to invest, invest, invest and do so at an early age and you’ve got to take advantage of compound interest and let it work its magic. But I think we often brush over, you know, what does that mean? And why is that so tangible? So give us the 20,000-foot view of exactly what is compound interest, why that’s so important, and then perhaps an example of how investing can really help someone grow their nest egg. So somebody who is and is not investing.

Tim Baker: Yeah, so you know, we use this quote by Albert Einstein, and it says, “Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.” So a lot of pharmacists, especially early on in their career, they’re feeling it from the paying it side, right? Oh man, I’ve got $200,000 in debt, I’m paying 6.5-7% in interest, you know, this is terrible. But you know, once we kind of have a plan for the loans — and I’m not saying it needs to be paid off — but once we have an intentional plan for the loans and our consumer debt is in check, we have an emergency fund in place, we can then really start dipping our toe very seriously into the investment waters. So you know, so that’s really the idea is that we want the compound interest is our money, we’re taking risks to earn it. But we’re putting it out, we’re putting it into companies and to maybe bonds and we’re saying, “Alright, here’s some money. Hopefully we can earn dividends and capital appreciation as we go. And I can get a much better return down in, basically in the future.” So to give you kind of a case study — and the reason this is really important is, you know, if we talk about Ally Bank, a big one for a high yield savings vehicle, but as many people with where interest rates are, you’re making like 1%. And one of the main things that you’re combating as you’re building wealth is tax, so Uncle Sam always needs his bite of the apple, and inflation. So — and I think, Tim, you might have created this graph, but I showed the graph of the $10 latte. So you know, if you have a latte that costs $4 in 2020, using historical rates of inflation of about 3%, in 30 years, that latte will cost $10. So this is why my dad, who’s in his 70s, would say, “Well, Tim, back in my day, the nickel would buy the whole candy store.” And now it doesn’t buy anything because prices, the prices of goods and services go up naturally over time.

Tim Ulbrich: So just a quick aside, Tim, on that. It made me laugh when you said that. I just — the other day with my boys I had a box of Cherry Heads with like a $.25 sign on the corner of the box, and I was like, “When I was a kid, we used to go out to the candy store. And those were not $.25.” So.

Tim Baker: Yeah. I mean, my wife sent me a picture of I think she filled up at like $1.25 because she had some points or whatever. And I was kind of reminiscing, like I think it was either when I started driving or when my brother started driving, gas was at like $.89 or $.99 a gallon.

Tim Ulbrich: I remember that.

Tim Baker: You know? And you see it in the movies. And those are — that’s a staple of American life. That’s pretty kind of inflation-focused because people really get upset when gas goes up because it’s right in our face, but if you think about all these other, I mean — gosh, we could talk about college tuition and drive our listeners off a cliff here. But yeah, I mean, prices just go up. So to combat the taxman and the inflation monster, we have to — we can’t just put our money into the mattress and not take risks. We can’t just put our money into a bank account and not take risks because naturally, maybe that $500,000 that you have in your bank account, maybe it’ll some interest, but in 30 years, it’s going to purchase about half of what you can purchase today.

Tim Ulbrich: Right.

Tim Baker: So if we take a case study here, so we’re going to talk about Conservative Jane. So Conservative Jane, she’s a pharmacist, she makes $120,000 in income, she gets her 3% cost of living raises, which might be generous. She gets that every year. She’s going to put 10% into her retirement plan, but she’s just going to put it into a Money Market, which is like a cash-like investment. And she’s going to work for 30 years. Over the course of that 30 years, she’s going to accumulate a nest egg of about $600,000. So you’re going to say, hey, that’s not too bad. But because hopefully a lot of our listeners are reading “Seven Figure Pharmacist,” we assert that — or at least you and Tim Church assert and I agree — that we need to be thinking like millionaires because it’s going to — that is what it will take for us to achieve that financial freedom, that financial independence that we’re looking for. So this Conservative Jane, she’s really afraid about what the market has done in the ‘08-’09 crisis, the subprime mortgage crisis if you remember that, the COVID crisis where the stock market did a nose dive here and now is recovering. And she’s saying, “You know what? I don’t want to look at my balance and see it go down. I just want to slow and steady.” So unfortunately, that amount of money is not really — if she retires at 65, it’s not going to last her until 95, 100, 105, which is typically what she’ll live to. So in an alternate reality, which again, another of maybe Einstein’s theories, we wave our wand and we say, OK, if we take a more aggressive stance with our investments and we take the exact same Conservative Jane with the same income, $120,000, the same cost of living raises, the same contribution amount, 10%, and the same timeline of career, 30-year, and the only thing that we do differently, the only variable that we change is we change the stance towards investment. So instead of being conservative, we’re being aggressive. And what the market bears consistently over 20+-year periods, it’s about a 10% return. And when we adjust that down for inflation, it’s about a 6.87% return. So this is where Aggressive Jane is now taking advantage of that compound interest, so those capital appreciation where you buy that stock at $100 and it sells for $500 in the future. Or the dividends that these companies will reward shareholders over time for being investors. So when we do that and we get that 7% return, it’s about a $1.2 million swing. So that nest egg is not going to be $600,000 now. With Aggressive Jane, it’s going to be $1.8 million. So and you’re not doing anything different except for your stance. So it’s going to be a rockier road, it’s going to be a bumpier road because you’re going to have ups and downs in the market, but if you believe that the market takes care of you over time like we do, it’s going to be OK. So to me, that is the power. And when we show that and we can demonstrate that in the nest egg calculation to say, hey, we’ll talk about risk here in a little bit. This is your risk tolerance, you’re showing this type of portfolio, but if we’re a little bit more aggressive, then they’re like, oh, well I don’t have to save as much right now or I’m actually set for where I’m at. I don’t have to work until I’m 85 years old. And I think demonstrating that, you kind of get that (sigh). And we’ve had clients that have looked at this and were like, alright, well, one spouse was maybe I don’t need to work anymore. We could have a single-income family because we want to stay home and raise the kids. That’s the power in it is to have some intentionality about what we’re doing and we’re not just like oh, I don’t really know how I’m tracking for retirement. And the sooner that you do it, you know, one of the big things that we say with working with a lot of young professionals is time is a great asset to have. We do believe that the income that pharmacists make is great. But time is a great asset to have, and it can kind of be a double-edged sword because some people are like, well, I have 20-30 years to figure that out. But the sooner that you figure it out, the better.

Tim Ulbrich: And I just love that example because as you had mentioned, one variable that was different, you know, where you put that money — so instead of a Money Market account, you’re investing that. We’ll talk about vehicles to do that here in a moment — the only variable that’s different. So you’ve already done the hard work. You’ve already said, “I’m going to save x% of my salary.” That example was 10%, perhaps those that are listening are aspiring for a higher number. But you’ve already made that hard decision. Now it’s a matter of where do I put that to be able to put myself in the best advantage and best position to achieve my long-term goals. So we’ve talked about the concept of what you need in the nest egg. We’ve talked about why investing and compound interest is so important. So the next natural question is, well, how do you get there? Where do I put my money? What are the options that I have available? And this episode is all about investing beyond the 401k and 403b. So we’re not going to talk about those two, and we’ll link to our investing series back from episodes 072-076 where we have more information on those. So let’s jump into those other investment vehicles beyond the 401k or 403b, Tim. And here we’re going to be talking about traditional IRAs, Roth IRAs, HSAs, SEP IRAs and taxable brokerage accounts. So we’re going to do this in a rapid-fire format. So Tim, we’ll tee up each one one-by-one, we’ll start with the IRA. And I’d love for you to talk about, you know, generally, characteristics and design, contribution limits and perhaps some advantages and disadvantages with each of these options. So let’s start off with the IRA.

Tim Baker: Yeah, so the traditional IRA or just sometimes called an IRA, this is an investment vehicle, I like to say investment bucket, that you can use as an investor often to supplement your 401k, 403b. So with this particular bucket, it is a bucket that you fill with pre-tax dollars. So anybody can contribute — anybody that has earned income can contribute to a traditional IRA. Now, once you start making more money than say like a resident makes, if you’re a normally salaried pharmacist, you don’t get that deduction but you can still put non-deductible contributions into your IRA, which you don’t get that tax benefit. And then any money — and this goes for any of these vehicles that we’re talking about — any money that’s inside of that bucket grows tax-free. So if you get investment income or if you get dividends paid, you’re not taxed on that. So outside of that, in the taxable account, you are taxed on that. And I’ll talk about that when we get there. So typically the contributions that you can make into these accounts are $6,000. So that’s in aggregate with the Roth IRA, which we’ll talk about here in a second, next. So if you put $4,000 into a traditional IRA, you can only put $2,000 into a Roth. So it’s in aggregate. But it’s completely separate from your 401k, 403, TSP. So these aren’t tied together in terms of contribution amount. Once you reach age 50 or older, you can put an extra $1,000. And like I said, this is subject to phase out for the deduction. So the IRS will look at your AGI and say, “Hey, Tim, you make too much money. You can put money in here, but you’re not getting that deduction.” So the appropriate use here is that you’re supplementing a 401k or you have no retirement savings, so again, we work with a lot of independent pharmacists that don’t provide a 401k to their employers. So call me if that’s the case, we can definitely help there. But in the meantime, you can use this as really your main retirement. And then in that case, you do get a full deduction, no matter what you make. You want to shelter your income from tax, so if you are trying to lower your AGI and you can, if you’re in the right tax bracket, so you’re a resident, that’s the way to do it, you’re deferring taxes on your investment portfolio. So it’s not taxed going in, but it is going to be taxed coming out when you distribute it in retirement. And then this is for long-term accumulation for retirement. So you’re not going to put money in here and then use it for a home purchase or something like that. So the biggest advantages here is, again, it’s a tax benefit, the investing selection is nice. So you can typically — I always talk about with the 401k, you kind of have to play with the toys in the sandbox, so you only get 20-30 selection. Here, you can basically invest in anything you want.

Tim Ulbrich: Right.

Tim Baker: And typically, less fees associated with it. Now the big drawback is if you do take money out, it’s a 10% penalty unless you’re 59.5. You can take loans against it, which I think is actually a benefit. And then the distributions when you’re retired are taxed as ordinary income, which is not great. So hopefully — I don’t know if that was quick enough, Tim, but those are the high level pieces.

Tim Ulbrich: No, that’s great. So there we were talking about traditional IRA. Let’s talk for a couple moments then about the Roth IRA.

Tim Baker: Yeah, so Roth IRA, a lot of the same things are true. The main difference here is that this is — you’re contributing it to a Roth IRA with after-tax monies, which means that you don’t get a deduction going in, so you pay the tax up front, it grows tax-free, and then when you distribute it in retirement, it comes out tax-free. So one of the things I’ll talk about is like I say, “OK, Tim Ulbrich, you have $1 million in your Roth IRA and $1 million in your traditional IRA. How much money do you have?” Unfortunately, your balance sheet says $2 million, but that’s not what you actually own because in the traditional IRA, Uncle Sam hasn’t taken his bite of the apple. So if you’re in a 25% tax bracket, in the traditional IRA, you own $750,000 of that and the government owns $250,000 of that as it’s distributed. So that’s kind of a high-level look at that. So you can convert a traditional IRA to a Roth IRA, and that’s kind of a separate ball of wax, but you can contribute up to $6,000, there’s a catch-up phase, again, this is typically to supplement the 401k. You’re looking for long-term retirement. You can use this money for like a first-time home purchase, you can distribute up to $10,000 without a 10% penalty. So there are some little nuances to — you don’t have loans or anything like that.

Tim Ulbrich: Yeah.

Tim Baker: And typically the investment selection is good. There’s less fees associated in most cases compared to like a 401k. And your distributions of basis, which is the money that you put in, are always tax- and penalty-free. Now the earnings that it makes could be taxed and could be penalized based on the situation, so that’s something to keep in mind. So high level between traditional pre-tax, not taxed going in, grows tax-free, tax comes out when you distribute it. For a Roth, it’s taxed going in, it grows tax-free, and then it’s not taxed coming out. So I usually take clients through some pretty cool graphics that show them that because it’s harder — oh, and the big thing I forgot to say — this is important — is that for a Roth, for a traditional IRA, anybody can contribute to a traditional IRA, maybe not get the deductions. For a Roth, once you start making a certain amount of money, the door starts to slam shut for you to actually make contributions. So as a single earner in 2020, once you start making more than $124,000, that Roth IRA door starts to shut. So then that’s typically where we do a nondeductible contribution to an IRA and then do a backdoor contribution to a Roth IRA.

Tim Ulbrich: Yeah, and since you mentioned that, Tim, and I’m glad you did, the backdoor, I would point our listeners to Episode 096. We talked about how to do a backdoor Roth IRA. And we also have a blog post on why every pharmacist should consider that as an option with their investing plan. We’ll link to both of those in the show notes. So that’s the IRA and the Roth IRA. Next up is the Health Savings Account, the HSA, also known as the Stealth IRA. Talk to us about that one.

Tim Baker: Yeah. So this is typically paired with a high deductible health plan. So a high deductible health plan is a health plan that you’re — for an individual, the minimum annual deductible is $1,400 a year or more. And the max out-of-pocket expense is $6,900 a year more. So if you have the option with your employer, you’re young, you’re healthy — I guess you can be older and healthy — but if you’re healthy, you don’t go to the doctor a lot, this might be a thing to look at. And you can couple the HSA with this. So this is — the HSA is different from an FSA. FSA is a use-or-lose fund. So every year, you’re going to say, “OK, if I put $1,000 into this and I don’t use it, then I lose it.” And it doesn’t accumulate over time, so at the end of the year, you’re buying a bunch of stuff for like contacts and things like that. I don’t like playing that game. Whereas the HSA, it does accumulate over time. So you don’t have to use it. So the money goes in cash and then for some HSAs, you can invest it dollar one or maybe you have to wait for you to have a balance of $1,000 and then you can invest above $1,000. It just depends on the HSA. But it allows you — it’s very similar to an IRA in a sense of how you invest it. Now, the main thing for this, it has a triple tax benefit. So what I mean by that is for the IRAs, we were talking about a double tax benefit. You either get a tax break going in or going out. And it grows tax-free. With the HSA, there’s a triple tax benefit, meaning that you get a deduction — and it doesn’t matter how much money you make. So you could make $10 million a year, and you’d still get this deduction. You get a deduction as it goes in, it grows tax-free, and then it comes out tax-free if it’s used for qualifying medical expenses or once you reach age 65, you can use it for really whatever you want. So for a lot of people, they use this is as almost like another IRA bucket, which is what my household uses it for to get that. So it never sees the IRS. It never sees the taxman, if you do it correctly. So you can put up to $3,550 as an individual, $7,100 as a family, and then there’s a catchup after age 55, I believe. So you know, the advantages, the advantages of this is obviously the tax treatment, it’s another bucket that if you’re a little bit higher income that you don’t get some of the tax breaks like the traditional IRA deduction, you can put money in there. So what we try to do as a family is we fund this first and then we try to cash flow our health expenses as best we can.

Tim Ulbrich: So that’s the traditional IRA, Roth IRA, HSA. Talk to us about us about the SEP IRA.

Tim Baker: Yeah, so the SEP IRA out there is typically for those self-employed pharmacists out there or maybe ones that are running a side business or could be they work for a small business owner that has a SEP IRA as their sole retirement plan. So they look and act very similar to a traditional IRA, but they’re kind of like a super IRA because the contribution limits are a lot higher. So this is an employer-sponsored IRA, so if you work for a company that has a SEP, you don’t put any money into it at all, and you can’t put any money into it at all. The employer basically has to put — and they’re not necessarily as popular once you start getting employees just because there’s flexibility on when, you know, so you don’t have to contribute to it every year. So if you have a down year because of COVID or whatever, the business owner could say, “Hey, I don’t want to contribute this year.” But next year when business starts to pick up, you have to contribute at the same rate as you contribute to yourself. So if I put 10% in for what I make, you have to do the same for your employees. So typically the rules here, eligible employees have to be at least 21, they have to work for the employer at least three out of the last five years, they have to earn at least $600. So if you’re the employee and the owner, so if you’re one and the same person, this is kind of what I used early on in my business, a SEP, to basically save for retirement above and beyond the traditional IRA. So you can typically put in like the lesser of 25% or up to $57,000 as of 2020. So the hard part about this — and one of the disadvantages — it’s really hard because you’re really looking at what the business profits are to kind of gauge what you can put in. So in my experience, I would put money aside and then like on tax day when I had all those numbers, then that’s when I would kind of check the SEP IRA. So long story short, the IRA is just typically used for those self-employed, if you’re running a side business, you might be able to shelter a little bit of the business income there to help from a tax perspective, from a Schedule C perspective. But there’s no Roth component or anything like that. So there are some disadvantages.

Tim Ulbrich: So we have lots of tax advantage savings vehicles. So obviously the 401k or the 403b, traditional IRA, Roth IRA, HSA, SEP IRA, so as we talk for a moment about taxable brokerage accounts, not only what are they but what would their role be, considering that we have all of these other options available?

Tim Baker: Yeah, so the taxable account — and we can kind of talk about this in kind of the mistakes that I see — but the taxable account is often — think of it as like a savings account but on steroids. So instead of in the savings account that money just sits in cash and maybe earns an interest rate, in a taxable account, you can actually convert that cash into shares of an investment, you know, Facebook stock or S&P 500 ETF or a mutual fund, and then that’s where you start earning the capital appreciation, the dividends, etc. So the contributions here, it’s really unlimited. So you know, you can put a couple bucks a year into it or millions of dollars a year. It’s really — the world’s your oyster. Same thing with the investments: You can basically invest in whatever you want. There’s restrictions like you see in some of the retirement plans. You typically use this when you’ve exhausted your retirement contributions to some of these other accounts that we’ve talked about or if you say, “Hey, Tim, I want to retire at age 55,” a lot of these accounts, the IRA, the 401k, they’re going to say, “Hey, you’re going to be penalized to take money out until you reach this kind of arbitrary age of 59.5 years old. So if I retire at 55, I can’t get that money out of the 401k without a penalty. So when you might use this account for like near — like kind of the beginning phases of retirement and then shift — when you get to age 60, shift over. The other use for this is my wife and I use this for a future car purchase is we see where rates are and how the saver is taking a beating now because interest rates are so low. So we say, alright, we can use this taxable account, we’ll put a car payment worth every month into a taxable account and hopefully over the next five years, the average investment return in the S&P 500 is about 6-7%. Hopefully we can get that versus the 1% that we’re getting in our high-yield savings account. So it’s more of a near- to medium-term goal, which could be a home purchase, a car purchase, maybe real estate investing, investment, with the caveat that you could lose that investment. So you know, there’s risk there that you’re taking. So big advantages in terms of flexibility, there’s no penalty to withdraw, you can recognize losses to offset gains. So this is where you’re paying capital gains, whether they’re short-term or long-term. So when you buy that share at $100 and sell it for $400 in a taxable account, you’re paying $300 in capital gains per share. And so that is one of the disadvantages to the taxable account.

Tim Ulbrich: So Tim, we started by talking about the nest egg, what you need, and then we talked about the importance of investing and taking advantage of compound interest to get there, and then we talked about the vehicles that are available to get there, lots of different ones. So then the next question is, OK, well how do I prioritize this? I’ve got some dollars that I want to save each and every month towards my long-term savings goals to get to that nest egg and take advantage of compound interest. But with all of these options available, where do I go and in what order? And so this takes me back to Episode 073, where we talked about the priority of investing and we talked about the order in which we think you should consider filling your long-term savings or retirement buckets. And it’s important to say, as with any other part of the financial plan, this has to be tailored to the individual. So of course, this is not investment advice. But walk us through again, Tim, at a high level what we think of as the priority of investing between these different vehicles that are available to someone.

Tim Baker: Yeah, so assuming that we have kind of the foundation in place, the consumer debt is kind of taken care of, emergency fund, we don’t owe any taxes, we have a plan for the student loans, we’re kind of accounting for more of the near-term goals like travel, wedding, home purchase, education planning for the kids, really as we kind of wade into the how you prioritize, it’s going to depend. Obviously that’s my statement answer, but in most cases what we would say is you want to start with the employer match. That is — we talk about that’s free money in 99% of cases. 95% of cases, you always want to get, at least get the match so you don’t forego that benefit. And then typically, the next step, the decision tree here is based on if my — how great or not so great my retirement plan is. So you know, in a lot of cases, retirement plans, 401k’s, 403b’s, they have a lot of fees associated that the investor doesn’t necessarily see. So what we typically say is that if you don’t know, it might be good to go out into the IRA/HSA world and max those out next. And then go back into the 401k, the 403b, the TSP and get the max, which is in 2020 $19,500. And then from there, from a traditional investment perspective, that’s when you would start loading up in the taxable account or if you’re more nontraditional, you might look at real estate investment, investing in businesses, or something like that. So that’s typically kind of steps 1, 2, 3 and then 4 with regard to how to kind of prioritize your approach to filling your retirement buckets.

Tim Ulbrich: And you talked about one of these already, but common mistakes that you see people make in the investment prioritization, but talk us through some others that you commonly see as well as people are trying to sort out these different options.

Tim Baker: Yeah, so you know, often when I come across — and I had a conversation with a pharmacist here recently. You know, they get into investing before the debt is paid or there’s a plan for the debt. So that could be a student loan, that could be a credit card or a personal loan. So you know, you have $10,000 in credit card debt, but you’re putting 10% in — you get a 5% and you get a 10%, and you have a 10% contribution into your — you know, that doesn’t really make any sense. Or sometimes there’s no purpose or goal with the investment. So most of these accounts that we’ve talked about are retirement accounts, so they’re for retirement. But if you have taxable accounts, I often ask clients that have like a Robinhood account or — what’s the other one? Robinhood and…

Tim Ulbrich: Acorn?

Tim Baker: Acorn. And I’m like, what’s this account for? And they’re like, I don’t know. And to me, I think that’s dangerous — not dangerous, but just to me, I’d like to say, “OK, my wife and I, we have a taxable account, which is like Robinhood in terms of the same tax treatment. But it’s for real estate, it’s for a trip to Australia.” And sometimes we do the taxable accounts before we even get the match, we have an emergency fund in place. And I know why that happens. It happens — and I think you, Tim, and I can appreciate this — is because you’re interested, you’re curious, you want to see how some of these apps or like the investment works. And it feels good to invest in Tesla or Disney or Ford or whatever. But it’s kind of putting the cart before the horse. So in a lot of cases, we kind of advise clients, like, hey, you need a $30,000 emergency fund. Right now, you have $10,000. You have $30,000 in the taxable account. Let’s do the math here and figure that out. Another mistake is just having no concept — I know we’re not talking about it today — but no concept of how good or bad their 401k and 403b is, which that’s tough because it is very opaque to the investor, unfortunately. And then probably the last thing is just kind of having that 401k inertia where they just stick it at the match and then they wake up and they’re 45 and they’re still just putting it at 3% or 5%. So some of that investment, some of the mistakes I see with kind of the prioritization is kind of outlined there.

Tim Ulbrich: And you mentioned, Tim, earlier I think an important part about risk tolerance and understanding how that fits into your investment selection, your long-term goals. So how do you work through this with clients in terms of understanding the risk tolerance and then ultimately developing a portfolio that aligns with that.

Tim Baker: I kind of look at risk tolerance as — so you really have two things going on here. You have the risk tolerance, and then you have what’s called risk capacity. So risk tolerance is the amount of risk that you want to take. So in the case study that we went through earlier in this episode, we talked about Conservative Jane. So Conservative Jane didn’t want to take any risk at all, didn’t want to. The risk capacity is the amount of risk that you need to take or the amount of risk that you can take. So for some people, you know, if they’re age 50, they want to retire at age 60-65 and they haven’t done the things that they need to do throughout the course of their career and they’re a little bit behind, you need to take a little bit more risk to kind of make up for lost time. The other example is if you’re 30 years old and you’re going to retire at 65, you have 35 years, so you can take more risk because you just have a longer time horizon. So we measure the risk tolerance but then we talk about the risk capacity. And what I kind of say is — and I would say it’s not very common, but kind of the rules of thumb out there where you say, alright, you take your age and you sub — so say I’m 30 years old and I subtract that from 100, that’s 70. So the rule of thumb is you put 70% in equities and 30% in bonds. And I think that is utterly terrible. That’s a terrible rule of thumb. And I love those rules of thumbs and making it easier. But it’s — I think it’s the wrong advice. So to me, what I argue is if you have decades worth of time, 20-30 years, you really shouldn’t have many bonds in your portfolio at all, if any. So as an example, I’m — how old am I? — I’m going to be 38 this year, Tim.

Tim Ulbrich: Old. Old.

Tim Baker: Yeah. I’m getting up there. But I’m not going to smell bonds in my portfolio for another 20 years probably because, you know, right? And it sounds weird, but like when COVID happened and the market went down, like I never looked at my balances. I don’t care. And the reason I don’t care is because I’m not going to spend that money for another 25 years, 30 years. So in 25 or 30 years, we’ll probably remember COVID, but we’re not going to remember what our balances were there. So now if you’re 60 and you’re going to retire next year or in a couple years, then you do care. And that’s where we start shifting from an equity portfolio to more of a bond portfolio where it’s more safety in principle and you’re protecting what you’ve built over the course of your career. So that’s important. And that’s, again, something that when we talk about, when we change that one variable between Conservative Jane and Aggressive Jane, if you’re willing to kind of join me on that ride — and it can be bumpy — but the market goes up, then you just have to save less hard, if that makes sense. Because your money’s just going to go a lot further, and a lot of people get that wrong.

Tim Ulbrich: Yeah, and I remember when Jess and I were working through this with you, Tim, I remember taking an assessment that we each did that helped us understand our own risk tolerance but then also stimulated a great discussion between the three of us about OK, let’s take that information and then let’s also look at that in the context of our nest egg and our goals and everything else that we want to do. And I think that’s exactly how this process should work. So I want to talk about taxes for a moment. And we talk often because we so firmly believe that tax strategy and planning is ideal when it’s paired up with the financial planning in the process. So we are fortunate to have Paul Eichenberg, our IRS-enrolled agent, on the YFP Planning team to help our clients that are also working with our Certified Financial Planners. But as we look at the tax piece here in the context of investing — and we’ve talked a little bit about it already — but paint that picture for us. Why is the tax consideration and having that input so valuable as we are looking at it through the lens of the investments?

Tim Baker: Yeah, you know, just coming from the beach, it’s like tax is like the sand. Like it gets into everything, right? So it’s everywhere.

Tim Ulbrich: That’s good.

Tim Baker: And you have to consider that. And I’ll give you — I’ll kind of give you a real-world example. I was having a meeting with a client we’ve been working with forever and we were talking about his Roth IRA and some of the other things. And we’re not doing his taxes right now. I think he has a family member that does it. And I said, “Hey, let’s at least upload your tax returns so we can kind of take a look and see how everything’s doing and see if I can give you some advice.” And we found out that his AGI, it was actually too high for him to be making Roth contributions. So we’re going to have to basically back those contributions out, you know, put them into as a nondeductible contribution in the traditional IRA and then figure out a way to convert them. So you know, it’s going to cost him. There’s going to be a penalty and things like that. And it’s just one of the — this was the year that he kind of went over that threshold. He was working a lot of overtime, etc. So you know, so those types of things happen. But what I say to clients is like, look, most financial planners, they don’t do taxes. So in my last firm, we would say, “Hey, client, we don’t do taxes. But you know, go work with a CPA,” and then there was really no cross-planning between the two of us. And I think you leave a lot on the table when you do that or you potentially can run into some of the cases like I was telling here today. So my big pitch to the client that I just mentioned was like, hey, let’s just roll it up in with us. Let’s do it. Fire your aunt or whoever that’s doing it and let us do it because it’s just — it’s that important. So I think whether it’s something like the Roth contribution or just when to convert things, it’s just for everything, every financial decision that is involved typically has some type of tax implications. And what I’ve found, at least in my experience, is that similar to like the student loans, most financial planners don’t really understand student loans, most financial planners are not going to basically file the taxes and do the associated planning that is kind of need through every walk of life with regard to the financial plan. So that’s why we’ve kind of rolled that up into our service. And I think it just makes it — it allows us to have more robust conversations and cover more bases with regard to the journey that we’re on.

Tim Ulbrich: Yeah, great stuff, Tim. And we preach and hopefully model with our clients the importance of both the filing aspects as well as the strategy and the planning. And so our clients have the opportunity to work closely not only with you and Robert and the rest of the team but also with Paul to be able to make sure that that tax piece is closely integrated with the rest of the financial plan. So as we wrap up here, Tim, with everything that we have talked through here as it relates to investing, and from my experience, there is huge value for having a financial coach. And we know that investing is a huge part of the financial plan, as we started with. It’s only one part. And like we talked about, it’s essential for helping folks, me and others, increase their nest egg and ultimately achieve their long-term financial goals. And I know firsthand from my experience for Jess and I having you on our side as our coach to guide us through our options and help us assess our risk tolerance and ultimately put together that savings plan has been so critical. So for those that are listening that say, “Hey, I want a coach in my corner. I want somebody to help me guide me through not only the investing part of the financial plan but the rest of the plan and the ins and outs of each part of the plan,” talk to us more about not only where do folks go to ultimately have a conversation with you but also the offering and the service of what we do at YFP Planning.

Tim Baker: Yeah, so the best way to — if someone’s listening to this and they’re like, hey, that sounds really something that I need in my life, they can go to YourFinancialPharmacist.com and at the top right, there’s a “Book Free Financial Planning Call.” And you’ll see an appointment calendar where you’ll see my ugly mug and then also you, Tim Ulbrich, that we can have conversations about potentially working together. Or I think if you go to YFPPlanning.com is our other website, you can book a meeting that way. And those are free of charge. It’s really hey, this is us, who are you, let’s learn more about it and see if we would be potentially a good fit. You know, I think when — the way that I look at financial planning is I don’t really even look at it as like financial planning. I really look at our service as a life plan that is supported by a financial plan. So I often say, you know, we were talking about that nest egg as like, hey, you need $4 or $5 million in your nest egg, you know, let’s suppose that we work together for the next 20 or 30 years and we have $10 million in the nest egg. $10 million is better than $4 or $5 million. However, if you’re miserable because you haven’t done the things that you wanted to do in life, you feel like you don’t get fulfillment from your career, you haven’t traveled, whatever those goals are, whatever — we talk about the why — whatever that why is, who cares? Like what’s the point? What’s the point of making a six-figure income, what’s the point of becoming a Seven Figure Pharmacist, what’s the point of paying — like what’s the point if you’re not happy, if you’re not fulfilled? So to me, the hard part — so we’ve kind of gotten into some of the technical pieces today with regard to investing outside of the 401k, but to me the hard part about this is the human element.

Tim Ulbrich: Yes.

Tim Baker: It’s the how do we thread the needle between taking care of you, the listener that’s listening out there today, but then you the listener who’s 10, 20, 30 years older that things are completely different. So it’s threading the needle between taking care of yourself today and your future self. And that is hard, especially if you’re doing it with a partner, working with you and Jess, my wife, I mean, you just have different opinions about money and there’s compromise and things like that. So to me, we go into lots of different pieces of the financial plan and we kind of rattle off a bunch of them, but at the end of the day what we want to see — our mantra really is are we helping the client grow and protect income, which is the lifeblood of the financial plan? Without the income, nothing moves. So sometimes we kind of like poo-poo the six-figure income, that’s going to solve all your problems. It is good to have, but we want to be intentional. So how can we help you grow and protect the income, and then more importantly, grow and protect the net worth, which means increasing the assets efficiently, which includes the investments, but then also decreasing the liabilities efficiently, which includes things like student loans, paying off the house, etc. So assets minus your liabilities equal your net worth. So income and net worth quantitatively are the two most important numbers. And we track the net worth over time to show progress. But then it goes back to the who cares unless we’re keeping the goals in mind. And those are the qualitative aspect that we really have to pair. So you know, it’s not uncommon for me to say, hey client, we talked about this trip to Australia. We’ve been working together for 12, 18, 2 years, whatever that 12-18 months, maybe two years — and again, keep COVID in mind — but I’ll say, “Where’s the money? We haven’t done that yet, but where’s the money for that?” Either it’s important and we want to be intentionally saving towards that goal and check that off because when I asked you the questions of like hey, what are we trying to do? You said hey, that’s something that came to mind. So it must be important. Or maybe it’s not anymore. And then we’ll adjust the plan accordingly. So how can we help you grow and protect income, the net worth, while keeping your goals in mind? That’s our jam.

Tim Ulbrich: I love it. And again, YFPPlanning.com, you can book a free discovery call to see if it’s a good fit for you, good fit for us. And if we’re not already yet a part of the Your Financial Pharmacist Facebook group and our community of more than 6,000 pharmacy professionals that are answering questions, encouraging one another, challenging one another, I hope you will join us in that community. And as always, if you liked what you heard on this week’s episode of the Your Financial Pharmacist podcast, please leave us a rating and review on Apple podcasts or wherever you listen to your show each and every week. Have a great rest of your day.

 

Current Student Loan Refinance Offers

Advertising Disclosure

[wptb id="15454" not found ]

Recent Posts

[pt_view id=”f651872qnv”]

YFP 162: Credit 101

Posted on by yfpadmin


Credit 101

Tim Ulbrich and Tim Baker, CFP® dig into credit, a not so exciting but incredibly important part of the financial plan. They talk about what makes up a credit score, the impact of good (or poor) credit, how to find and interpret your credit score, the difference between hard vs soft credit checks and how to protect your credit.

Summary

Assessing your credit report and credit score are integral pieces of the financial planning services offered at YFP, but why? The CFP® board focuses on several different topics like budget, taxes, insurance, retirement and estate planning, but YFP Planning expands that list to support clients with essentially any aspect of their life that carries a dollar sign. On this podcast episode, Tim Baker breaks down credit, its misperceptions and what factors go into your credit score.

Tim explains that credit starts with you and your behavior and that agencies create credit reports based on what they get from creditors, like loan servicers or credit card companies. A credit score is created from this record of payments and essentially shows a snapshot of your reliability or likelihood of paying debts on time. You’re then able to use your credit score to apply for more credit. Your credit score matters because it affects if you can get more credit and how much you pay for that credit (i.e. interest).

Tim also shares the 6 factors that go into a credit score. The high impact factors are credit card utilization, payment history and derogatory marks. Medium impact factors include age of credit and your total number of accounts. Finally, a hard inquiry (think applying for a credit card or mortgage) has a low impact on your credit.

Mentioned on the Show

Episode Transcript

Tim Ulbrich: Hey, what’s up, everybody? Welcome to this week’s episode of the Your Financial Pharmacist podcast. And today, Tim Baker and I are going to be talking all about credit. So Tim Baker, welcome back to the show.

Tim Baker: Yeah, I think it’s been awhile since I’ve been on a full like episode, so it’s good to be back.

Tim Ulbrich: It is. I feel like every time we do this, we say that and then we say we’re going to do more of it, and then, you know, it ends up being awhile. But we are going to do more of it in the future, and we have been doing more of it with the Ask a YFP CFP segment of the podcast. So Tim, credit as it relates to the financial plan. And with YFP Financial Planning clients, credit is a presentation, it’s a module that you walk through. And I think many people may not think about this as a core part of the financial plan and perhaps not even covered by many financial planners. So talk to us about why is credit such a big part of our financial planning services that we offer? And what’s really the goal of talking to clients about this topic?

Tim Baker: Yeah, so I think there is — you know, I kind of look at the financial plan. I mean, you have the core pieces that the CFP board teaches and there’s curriculum for that. And that’s the things that we talk about, which are kind of budgeting, cash flow, your balance sheet, tax, insurance, investment, retirement planning, estate planning. Those are the things that are — you know, debt management, not necessarily student debt but overall debt management — so those are the things that we kind of talk about as core to the financial plan. And we kind of — we do those things, you know, at YFP Planning, but we also have kind of adapted our service to talk about more things that are kind of top of mind for a lot of our clients and kind of what they’re experiencing. So those are things like hey Tim, I’m buying a home. What do I do? And you know, very much related to that is credit, you know, is making sure that the credit is pristine and looking good. It could be planning for a kid’s education, salary negotiation, things like that. So we kind of — real estate investing, most financial planners are not going to get into real estate investing because they’re not necessarily paid on the assets that are in real estate portfolios. So we kind of drift a little bit to kind adapt our service. And I would say credit is one that a lot of people don’t think about. But we often do it in tandem with the home purchase, so say, “Hey, if you’re going to make the biggest purchase of your life,” — and I’ll put it in and edit on that because I have clients that are like, “Well, the biggest purchase of my life is my pharmacy, my PharmD.” And I’m like, “OK, if you’re going to make the biggest purchase of your life at one time, you want to make sure that you get the — you have the best, you know, your credit is as best it can be and you get the best terms.” So a lot of people — and I can say, you know, we talk about mistakes that we’ve made in the past. I know, like in past life, I was afraid that my credit score — and I never really checked my credit, so I remember renting an apartment way back when, this was kind of when I was getting out of the Army and I’m like, I wasn’t always as great a saver and I would carry credit card debt and all that kind of stuff. And I would be scared because they were like, “Hey, we’re going to run a credit report.” I’m like, oh my goodness, like my credit’s probably looking — and I had no idea what it was. And I’m like, I was almost apologizing for my credit score, not knowing what it was. And I think it came back, it was like in the 800s. So in a lot of ways, credit is a good measure of your dependability and reliability and kind of your overall financial health. But also like not really because you can have a fantastic credit score but also be not necessarily positive on the balance sheet, you know, and things like that or at least moving in a positive direction. So we definitely look at this as a key piece of the financial plan and make sure that — and I really break it down into two pieces. You have your credit — you know, when we talk about credit, we have your credit score. And you have your credit report. And those are the things that we kind of break down and then we go into things like identity theft. But those are the two main pieces that we kind of work through.

Tim Ulbrich: Yeah, and I’m glad you said that, Tim, you know, that we shouldn’t confuse a good credit score with necessarily meaning that that’s — that you have a sound financial position or situation. Maybe that’s true.

Tim Baker: Yeah.

Tim Ulbrich: We hope that’s true. But you know, as we’ll talk about how credit scores are determined, you know, that may or may not connect with your net worth, that may or may not connect with your debt position, your asset position.

Tim Baker: Sure.

Tim Ulbrich: And I think I would encourage folks too, I’ve made plenty of financial mistakes. But one of the mistakes that I made related to credit is I underestimated the importance of credit based on my situation in the moment. So you know, I can think of several years ago right after we paid off our student loan debt where I really wasn’t worried about, you know, having a sound credit history. We did, but being able to continue to maintain that because I had really thought, hey, we’ve got no more debt, what’s really the need for credit going forward? We already purchased our home. But I think that speaks to a common situation that people may fall into similar to ours where you look at your financial situation for the future through the lens of what you’re doing today, right?

Tim Baker: Right.

Tim Ulbrich: And not think about what about a future home purchase? What about a real estate investment purchase? What about starting a business in the future? What about x, y, or z that may be important to be able to have that credit down the line? So thinking about where the future may go as well. So you mentioned, Tim, two important pieces here: credit report, credit score. So let’s jump into those both in more detail. And let’s talk about the credit report first. So where do you pull a credit report? What does it show? And why is it important to check it?

Tim Baker: Yeah, so I would say even before we get into that, I kind of want to back up and kind of just talk about like how really how the credit system works. So it really kind of starts with you and your behaviors. So where — how you’re getting credit, where you’re — so if we kind of walk through a scenario, let’s pretend, Tim, that you’re saying OK, hey, I want to buy a car. You’re going to go to the Honda dealership, the Toyota dealership, the Ford dealership or whatever, and say you don’t have the cash to pay. As most don’t. You’re going to basically put a note on the car. So the creditor, they’re going to say, “Hey, we’re going to lend you this $20,000. And every month, you’re going to pay this back with an interest rate.” So basically, your behavior of what you’re doing with Toyota or Honda or Visa or your student loans, your creditors are going to be reporting that back, you know, your payments, every month to these different reporting agencies. So the reporting agencies are Equifax, Transunion, Experian. And then these agencies are going to be taking all of that information that are sourced by the creditors and essentially they create these credit reports, which is just kind of a record of your — of kind of your payments based on what the creditors are telling them. And then from there, they create this credit score, which is basically a snapshot of your reliability or your likelihood that you’re going to pay your debts back on time. And then if we kind of bring this back full-circle, you then use your credit score to then apply for more credit. So it’s like this cyclical thing that happens with regard to the how credit works. Now, if we talked about the credit report first, the credit report, again, is a record sourced by the creditors of an individual’s different credit, you know, loan payments, etc. One of the misconceptions, it doesn’t show your credit score. So a lot of people — when I’ll ask clients, “Hey, have you run your credit report?” they assume that their credit score is there, and it’s not. So back in 2003, Congress passed the FACT Act, the Fair and Accurate Credit Transaction Act that gives free access to credit reports but not necessarily free access to your credit score. So every year, every 12 months, you can run a credit report from each of the three major credit reporting companies. Right now with the CARES Act, you can actually run this report weekly.

Tim Ulbrich: Yeah.

Tim Baker: Which is interesting. And sometimes needed, given what’s going on with some of the student loan services. We talked about that in the past. So to quickly break down the credit report, when you run your credit report — and you can do that at freeannualcreditreport.com I believe it is. Sorry, it’s annualcreditreport.com. So you can go there and you can see all the different credit reporting agencies and you can pick the one that you like. I like Transunion’s. It’s colorful, so they’re all essentially the same. But Transunion is kind of a prettier version. So you can pick Transunion. And I would say don’t run them all at the same time. Just run one. If you have a big discrepancy when we talk about credit score, then maybe run another one. So when you run your credit report, basically the things that you’re going to be looking at is kind of your pertinent information, so your name, maybe aliases, your birth date, your addresses. I joke that if I ever — so I’ve lived all over the country. If I ever forget like, OK, what was the address that I had in like southern California when I lived there, I look at Amazon and I look at my credit report because those are typically the best places for that. And then it might show like your occupation and things like that, but the bulk, the meat of the credit report is going to be your account information. So it’s going to show first any adverse accounts, so these are things that have like negative, like a negative report associated with that, so like a missed payment or something of that sort. And then all of your satisfactory accounts, so these are accounts in good standings with no blemishes at all. So that’s really kind of the — and you’ll see, like when you look at it, you’ll be like, oh yeah, I forgot about that account or this account’s been closed for five years but it’s still going to show on your credit report for a total of 10. So it’s kind of a little bit of a trip down memory lane, but it’s a good exercise to pull their credit report, to look at it. We do that on behalf of clients. But I even tell clients, like I’m not going to know if something looks kind of fishy or out of whack because, again, I wasn’t there. But I can kind of still look and provide feedback and overall advice on how to better improve the credit report.

Tim Ulbrich: Yeah, so again, annualcreditreport.com. You can do that once per year for free through each of the three agencies. Although as you mentioned here, in the CARES Act time period, you can do that more often. And we’d certainly challenge and encourage our listeners that have not done, I think it’s a great exercise, for the reasons that you mentioned, but also just another way that you can be engaged and involved in your financial plan as we talk about credit being an important part of the financial plan. So Tim, you talked about one misconception around credit, which is that your report does not include your score. Those are two different things. What are some other common misperceptions that you hear about credit that we can debunk right now before we go into talking about credit scores?

Tim Baker: Yeah, so some people think that like, oh, if I check my credit, it’s going to drop. And that’s not true at all. Like you know, the government actually wants you — like before, you had to pay for your credit report. Now, they’re giving you free access. Another big thing is closing — and some of this sounds like counterintuitive — but like closing an old account improves your credit score. And in fact, I actually just had this happen in one of mine. I had a very old credit card that I think I used when I was at West Point that eventually, it eventually like closed because I just stopped using it. And my age — so we’ll talk about different factors that affect your credit score — age of credit is going to be one of those. So that longstanding account that was open basically cut my age of credit in half, which lowered my credit score. So that’s another big one. You know, another thing is like, hey, if I have a missing payment on a credit card and I have a derogatory mark, if I basically get that back to where it’s good to go, then that comes off my credit. And that’s not true. Like I had a — I think it was back in 20 — and I actually show it on my credit report when I go through this with clients. Back in May of 2010, I went 30 days over — like I didn’t pay my credit card and it went 30 — once it hits 31 days, then it basically is a derogatory mark. That stayed on my credit report until May of 2017. So it can be — some of those things can be very long in terms of them coming off.

Tim Ulbrich: This was the old Tim Baker, right?

Tim Baker: Yeah, this was the old Tim Baker. I actually want to go back to my calendar and see what was going on. I’m pretty — and I kind of joke, you know, the two things that — and I wouldn’t say it’s just two things, but the two main things that my parents taught me about money growing up was don’t have credit card debt, like pay those off, and then like buy a house, that’s a good investment. And I obviously didn’t listen to that first one 100% of the time. So but that derogatory mark stayed on my credit report, you know, for seven years. So you know, this is where we talk about like autopayment and things like that. Like don’t — make sure that you’re — and for some people, some people, they’re like, ah, 30 days, they just throw up their hands. And then the next 30 days, that’s another derogatory mark. And then there goes the 90 day, that’s another. So you don’t want to let those cascade. And then probably another one is like being a cosigner doesn’t make you responsible for the account. That’s exactly what it does. So lenders like cosigners because it’s two different people that they could potentially revert back to if the credit goes — if the loan goes into default. So that’s exactly what that does. So that, you know, you’ve got to look at that from a some people are like, oh, yeah, well I’ll cosign for my brother’s car note or my kid’s or things like that. You’ve got to be wary of that because at the end of the day, you want to protect yourself — you want to help loved ones, but you also want to protect yourself in terms of your credit. And probably the last one that, you know, you hear is like, well, if I pay off this debt, my credit is going to be boost by 50, 100 points. And it’s not — there’s just so many different — it’s not a linear relationship. There’s so many different factors that go into your credit score that it’s going to depend on a variety of things of how your credit score is going to move.

Tim Ulbrich: Yeah, and I think that last point’s a good segway into what is a credit score and what makes that up so you can have an understanding how any one decision may or may not move the needle very much based on the components and the percentage that they make up of that overall score. So give us the broad definition of a credit score.

Tim Baker: Yeah, so the credit score is really a number that summarizes your credit risk based on a snapshot of your credit report at a particular point in time. It’s really the picture of your ability to pay back a loan over really the next two or three years. So the higher your credit score, the more likely you’ll be able to pay back the loan and on time. And really, the credit score matters because it affects whether you can get credit and what you pay for credit, meaning if you have a higher credit score, then you can potentially get better rates. A higher score, you know, will more than likely be more chance of approval for that credit. It can affect your ability to rent an apartment. Sometimes it affects your ability for your deposit on a telephone, a utility, that type of thing. And a lot of employers will run credit scores just as kind of a measure of your dependability. So it can have far-reaching effects. So you know, if we look at kind of the different bands on credit — so like some people will say, oh, like my credit score is only 760. Like that’s a really good — in essence, that’s an excellent credit score. So anything about 750 is excellent. Good is kind of the 700-749. Fair is 650 to basically 699. And it goes all the way down to poor then bad credit. So this is a really, really important score. And if you look at it from the — I try to look at it from both sides of it. So you look at it from the lender’s perspective, you know, when, you know — and we talk about this like, we kind of talk about this with like interviewing like candidates and things like that, you’re trying to really get a good snapshot of this person and by answering a series of questions or something like that. And from a credit granting decision, the lender is really trying to get a good snapshot of how hey, if we, you know, if we’re going to take risks to lend you this $300,000 for a home, we want a good feel that you’re going to be able to pay this back and on time. And from their perspective, they’re using that as a way to, you know, sum up your dependability.

Tim Ulbrich: Yeah, and I don’t want to brush over — you mentioned it — but not only impacting your ability to get credit but what you pay for that credit. I think that’s so incredibly important when you talk about big purchases like a home. And we talked about this in Episode 159 with the refi and, you know, what is the difference of a point or point and a half? And that can be due to credit and how attractive you are as a lendee. But obviously that has significant impacts on your monthly budget as well as over the life of the loan, student loan refi, car buying, the list really goes on and on, real estate investing and so forth.

Tim Baker: Yep.

Tim Ulbrich: So you mentioned the number and the ranges that we see in a credit score. We talked a little bit about why it matters, what it can impact, the various parts of your plan. Talk to us about the new FICO credit score effective January 2020.

Tim Baker: Yeah, so they’re trying to like tweak the system a bit to kind of make it more of a reflection of like a borrower’s behavior. So one of the things that they changed at the beginning of the year — and FICO is the biggest credit score out there. I think Vantage is the next one. But FICO’s the big one on the block. They’re trying to tweak their algorithms, so they’re going to judge more harshly those who fall behind on payments. And what they’re trying to do is give more weight to people that are basically improving their credit situation. So they’re looking at more like trended data. So the example I’ll give is let’s pretend that you have $40,000 in credit card debt, and we work with clients that have $40,000 in credit card debt. And let’s pretend that over the year, the first year that we’re working with them, that $40,000 moves to $20,000 as an example. And then we basically compare that to another client that we’re working with that just basically has we’ll say $5,000 in credit but at the end of the first year, they still have $5,000 in credit balances that they’re carrying. The first client would actually be, you know, graded out a little bit better because they’ve gone from $40,000 and their trended data says they’re moving in the right direction in terms of paying off their credit whereas the other client, which we’re kind of just saying they’re treading water, their balances are the same, would be graded more harshly. So today, that second client, that $5,000 is — before we made the changes would have a better credit rating whereas the one that’s trending in the right direction now is they’re giving more consideration to that, which is good. I think the other thing that they were looking at changing is to kind of — you can play a little bit of a smoke-and-mirrors game with credit. So if I had $40,000 in credit card debt and I moved that to an unsecured personal loan, that actually helped my credit score out quite a bit. So now, for those types of loans where you’re kind of just shifting it from a credit card debt to a personal loan, it’s still graded similar to how like a credit card would be. So they’re recognizing that there’s a lot of people that will consolidate credit card debt into other types of debt. And they don’t — they want to make sure that they’re capturing that data accordingly.

Tim Ulbrich: Sure.

Tim Baker: So they’re going to continue to — it’s not a perfect system at all. But you know, they’re trying different ways to make sure that they’re capturing overall behavior and where a particular borrower is trending with regard to their credit decisions.

Tim Ulbrich: Yeah, and I think that makes sense in terms of the trends and, you know — I think about this in terms of like when we admit student into the PharmD program, you’re looking at the whole picture, but often the best indicator of their success going forward is the most recent behavior. So you know, if you see somebody really struggled academically in their first or second year of undergrad but they’ve significantly improved in their third and fourth year, obviously that’s an indicator of where they’re going to go, even though overall, they may not be as competitive as some students who did average throughout. So let’s talk about a credit score and how it’s calculated. So how is a credit score calculated? What factors are considered in this calculation? And what’s considered high impact versus lower impact?

Tim Baker: Yeah, so there’s really six different factors that kind of go into your credit score. So we’ll start with the high impact ones. So really, there’s high impact ones. The first one is credit card utilization. So the credit card utilization is — it’s basically the amount of credit that you’re carrying month-to-month. So if we say that — and really, this is a high-impact factor. The lower the utilization, the better. So lenders like to see that you’re not using too much of your available credit. So the more you use, the harder it is to pay off. So the idea is to keep the balances low. So the example I give is let’s pretend that you have a line of credit on your credit cards of $10,000. So if you’re carrying $3,000 worth of credit card balances every month, then your utilization is basically 30%. And that, you’d be right in the middle of the pack. That’s kind of a fair credit utilization rate. So the idea here is that to be excellent, you want to have basically under 10%. So in that case, the borrower, if they want to have an excellent credit card utilization, it would be carrying $1,000 or less. Now obviously we’re big believers in just paying off the credit card every month. But that’s a big one is that lenders like to see that you have a little bit of rope but you’re not using all of it. The second one is kind of the payment history. So lenders look at this factor to determine how likely you’ll make future payments on time. So that’s like not being like me and making sure that 100% of the time you’re paying your debts back and on time. So you want to be aware of lateness, you want to set up things like automatic bill pay, those types of things and not let those latenesses cascade. And for you to be excellent, you really want to be 100% effective. Good is 99%, fair is 98%. And you’re going to say, “Wow, Tim, that’s like, that’s really tough.” But if you think about it, you know, think about like if you were to pay off a student debt, like let’s pretend you refinanced your loans a couple years ago and you made your last payment in July of 2020. Those payments and that account is going to stay on your credit report for 10 years. So it’s not going to come off until July of 2030. So if you add up all of these different accounts and all of these monthly transactions, like the denominator is very large. So you know, even if you do make — miss a payment, you’re still going to be in that high 90s. Probably the last high-impact factor is derogatory marks. These are basically the result of things like a late payment or if you go to collections or have a bankruptcy. The derogatory marks are going to be anything that’s adverse that a creditor is going to want to know. So this is high impact. The lower, the better. And again, these are where you want to make sure that you’re keeping all of your accounts in good standing and they’re not basically moving from an account in good standing to an adverse account. The other ones are going to be — so the age of credit is more of a medium impact. So the higher or the longer, the better. So they’re looking at really 9+ years. So this is where some people, some younger clients get penalized. I actually had a client that was — I think she was 28. And her age of credit was like 38 years old, or 38 years. And I was like, what’s going? And I think her parents put her on like a Conoco gas card as like a user or whatever. And that like really helped her credit history. So lenders like to see that really it’s not your first rodeo, you have experience using credit. So you can improve your age of credit by keeping accounts open and in good standing. The next one is total accounts. So I thought this was — like when I was learning about credit way back in the day, I thought this was a little bit of counterintuitive. Actually, the total accounts, higher is better. So lenders like to see that you’re using various accounts. So it could be installment accounts, so loans paid in fixed increments over a period of time. So take like a car loan, a student loan, a mortgage. It could be revolving credit, so credit lines that have variable payments. So think of like a credit card, an open credit line, which could be things that are balances that need to be paid every month. So think of like a utility or a cell phone bill. So it suggests that — it’s kind of a little bit of the herd mentality. It suggests that other lenders have trusted you before, so we can trust you as well. So they like to see, you know, lots of different — and for you to be in the upper echelon here, excellent is like 21 accounts or more. And you’re thinking like, wow, that’s a lot. For pharmacists, this is typically a piece of cake because everytime your loans are disbursed, so think like per semester, that’s an account. So pharmacists usually have a really easy time of getting this, even if they don’t have credit cards or things like that, they typically have a lot of accounts listed on their credit report.

Tim Ulbrich: Unfortunately.

Tim Baker: Yeah, unfortunately. And then finally, the last one. And this is a lower utilization as like a hard inquiry. So this is lower is better. This results in applying for credit. So the idea here is that they don’t want people that necessarily don’t have great credit to kind of be fishing for credit like all over town, essentially. So you’re applying for credit and you’re just trying to find somebody to lend you money. So instead of — and that’s kind of like a shotgun blast. You take a sniper approach. So like if you’re going to buy a car, you’re going to narrow it down to the dealership or two that you’re looking at and apply for credit there instead of like just going everywhere. So these hard inquiries stay on your report for two years. I feel like I have a bunch of these from refinancing my house. I switched from Sprint or Verizon, they check your credit there. So ways to kind of get around this is you can take advantage of like preapproved credit cards where they’ve already kind of pulled your credit. If you use that car buying example, you know, if you say, hey, you apply for credit at Ford, Toyota, Chevy, etc., if they’re within a relatively short period of time, like I think it’s like a week or two, they group all of — it might be like three or four inquiries they’ll group together as one. But excellent is that 0-1. I think for right now on one of my credit reports, I have like three or four. And again, my credit is in the 800s, so it’s not a big, big thing. But it is something that they want to kind of keep tabs on because they don’t want people just fishing for credit. So those are really the different factors that kind of go into your credit score.

Tim Ulbrich: So before we talk about hard v. soft pull — because I think that’s an important distinction that many of our listeners would be interested in — I want to go back to that first one: credit card utilization because I think this is one where people might be surprised by that number of less than 10% or even try to get below 30%. So I imagine there is many people out there that might have, you know, one major credit card that they use, all their monthly expenses go on there, so they’re putting $4,000, $5,000, $6,000 and they’re obviously above that threshold. So what’s the play here? Is it trying to get that limit increased? Is it having multiple cards to diversify those expenses? What do you typically advise or work with clients here?

Tim Baker: Yeah. So you know, it’s something that I think you have to kind of tread carefully. And I kind of — depending on the client that I’m working with and the situation that we’re in, I’ll advise them accordingly. So you know, one of the ways to kind of game the system is if you say, hey, I have $2,000 worth of purchases of balances that I’m carrying, and I’m in a $10,000 limit. You’re in the 20%, which is not necessarily excellent. So one of the things that you could potentially do is ask for a credit increase, a credit line increase. So again, you’re increasing that denominator that kind of gets you — if you go from $10,000 to $20,000, that gets you kind of in that excellent band. I’ve done that in the past — or I’ve suggested that to clients in the past, and it’s worked, especially clients that are trying to get into like from like a 740, 745 credit score to a 750 and they’re like on the verge of buying a house. But if I also know that that client struggles with credit card debt, like I wouldn’t necessarily suggest that because now we’re just giving them a bigger chasm to kind of tumble into. So there are ways to kind of game the system. I think again, FICO and Vantage, they’re trying to kind of figure out ways to kind of, you know, get around that. But the utilization is still very, very important. If you’re maxing out your cards all the time, lenders want to know that. So yeah, I mean, I think it depends so much — like everything, it kind of depends on the situation and the person that we’re working with. But there are ways to kind of, I kind of say game the system because, again, you’re not really changing anything about your own behavior. You’re just kind of changing the numbers and the calculation and getting a little bit of a better score. So it’s going to depend on the situation. But I would imagine that they’re going to — you know, and I’ve also had clients that I’ve suggested that to that come back and they’re like, and actually the creditors push back on that. So it’s not — it used to be that — and in some cases, it still is — it’s like, yeah, no problem. If you want to spend more money, we’ll definitely collect the interest. But I think they’re trying to find ways to kind of make that a little bit harder so that they know that it’s not just for kind of gaming the system.

Tim Ulbrich: Yeah. So hard and soft pull on your credits. What’s the difference? And give us an example.

Tim Baker: Yeah, so typically I think for all three of the credit reports, at the end you’ll see kind of your soft pulls. So you’ll see like, hey, I’ve never done any type of business with like Discover card, but you’ll see them on your credit report.

Tim Ulbrich: Yeah.

Tim Baker: And what they’re doing — kind of think of it as like marketing. So they’re paying the reporting agencies to basically say, OK, show me the people that have a score from 700-750 or whatever. And they’re basically looking at your credit and devising a marketing strategy or deals for you to potentially — so that’s why you might get a mailer from Discover because they prequalified you for a deal. A hard inquiry is performed when you actually apply for a loan like a credit card, a mortgage, and the lender checks your credit history before granting or denying the loan. So these are the ones that basically stay on your report for two years whereas the soft ones, they don’t really have — they’re recorded, but they don’t really have any sway on your credit history at all. And it’s kind of something that’s good to review, but they’re not really, they’re not really going to move the needle in terms of — so like when you go to refinance your loans, to get a quote, they might do a soft pull on your credit. And it’s not going to affect anything, but then actually when you go to apply, they’ll do a hard pull. And that results in a hard inquiry, which will then be on your credit report for two years and it could potentially tick your credit down for, you know, a little bit. Like I said, it’s not going to move the needle much. But those are the big differences between the soft is kind of like where you’re just checking things out. The hard is where you’re basically signing papers for a particular loan.

Tim Ulbrich: Yeah, and student loan refi is a good example. I think for our audience, that may hit home where they’re initially trying to gather rates across multiple companies in terms of soft pull, but then they ultimately move forward with one in terms of that full application, signing papers, and that’s where that hard inquiry would come from.

Tim Baker: Yep.

Tim Ulbrich: So let’s wrap up by talking about identity theft. What should somebody do if they find out that their information has been compromised or that someone has stolen their identity, is making charges out of their accounts or perhaps some listening want to be proactive and try to protect their identity and information? What advice would you have there?

Tim Baker: Yeah. So I don’t — I think this is kind of, I think in kind of the world that we live in, it’s not necessarily a question of if, you know, your identity is going to be stolen. It’s really a question of when, unfortunately. So I want to say, I don’t know, every other month, once a quarter, a client will say, my identity’s been stolen, what should I do? And you know, we typically kind of go through, like we obviously contact that creditor and we shut it down. You want to run a credit report, you want to dispute. And a lot of banks, like I’ll get alerts and things like that. They’re like, ‘Hey, is this yours?’ and I’m like no. So a lot of the banks have mechanisms in place to kind of protect you. But it also kind of gives you a little bit of a false sense of security too. So you want to make sure that you’re checking your reports regularly. And I tell clients, I try to do mine personally like when the clocks change. So when they fall back and they spring forward, like when you change the batteries in your smoke alarms. So I think it’s a good practice. And one of the times I checked mine — I want to say this was maybe five years ago — I checked my credit report, and it wasn’t necessarily identity theft, but there was a credit card that I shared with an ex long ago that just popped up on my report. And it affected my credit a lot, so I went in and I disputed it. You can go on to whatever, Experian, Equifax, Transunion and dispute those online. And then that basically puts the onus back on the creditor to basically say that this is a legit thing. And it was cleared from my credit report pretty quickly. So probably the biggest thing, though, outside of kind of being aware of your report and your score is looking at either like a credit freeze or credit lock. And they’re going to be very, very similar. But there’s slight differences. So both are ways to protect your credit reports from being used by scammers to open up new accounts or file your taxes with your social security number. They’re often — these are often used interchangeably. They are similar, but there’s slight differences. So the freeze, you can freeze your credit at each of the three credit reporting bureaus. It essentially restricts access to your credit report. And lenders can’t see your information until you unfreeze it. So it’s really a good protection against fraud. And unfreezing could require your name, social, a password, maybe even a pin. And this is going to be free by federal law. Federal law requires free credit freezes and unfreezes. The lock is where you restrict most lenders’ access, and you can lock your credit report immediately at any time. And sometimes there’s — I don’t think right now because of COVID, but some of these — this is like a charge, so there’s a monthly fee that you pay to a credit bureau. Again, it’s a preventative measure to prevent scammers. But this is not governed by federal law. So under the freeze, you’re kind of protected; under the lock, not necessarily. So I would always kind of revert to the freeze. You know, freezing your credit when I’ve done it — and if you’re not making any credit granting decisions, you’re not buying a house, a car, refinancing anything, it probably makes sense to go through and freeze your credit. It probably takes about 3-5 minutes each for each of the — and then to freeze it and then call it a day. So you’re going to need things like your identifying information, your name, address, birthdate, social. You might be able to — you might be required to basically set up a pin for that. So that’s going to be very, very important to protect. But this is going to prevent people from basically opening up fraudulent accounts in your name. And then when you go to make a credit granting decision, you just unfreeze it. So it’s kind of just a good defense rather than just keeping it unfrozen and open all the time. And believe it or not, this happens — I’m sure many people listening are like, yeah, that’s definitely happened to me. I’ve had this situation. And it’s typically not until you kind of talk to me about this or you have a big loss that you’re like, yeah, I’m keeping it frozen because it’s just not worth the time and the hassle to kind of go through mitigating losses or just the hassle of an identity theft event.

Tim Ulbrich: Great stuff, Tim Baker, as well. A topic that has been long overdue for us to talk about on the show. Three years in, we finally got to it. But I think this episode is a great reminder of the comprehensive nature of the financial plan. And we talk about this over and over again because it’s so, so important that when you’re working one-on-one with a financial planner, it’s not just about debt, it’s not just about investments, it’s not about any one given part of the financial plan. You have to look at really the whole spectrum. We say comprehensive means anything that has a dollar sign on it, we want to be involved with. And I think this is a great example where credit can transcend so many parts of the financial plan. It really speaks to the power of having a financial planner in your corner. So for those that are interested in working with YFP for comprehensive financial planning, make sure you head on over to YFPPlanning.com, where you can book a free discovery call. And as a reminder, show notes for this episode and every other show that we do, you can get access by going to YourFinancialPharmacist.com/podcast and finding the episode and getting the resources and information that we covered on that show. And please don’t forget to join our Facebook group. Over 6,000 members strong, pharmacy professionals committed to helping one another. And last but not least, if you liked what you heard on this week’s episode of the Your Financial Pharmacist podcast, please leave us a rating and review on Apple podcasts or wherever you listen to your podcasts each and every week. Have a great rest of your day.

 

Current Student Loan Refinance Offers

Advertising Disclosure

[wptb id="15454" not found ]

Recent Posts

[pt_view id=”f651872qnv”]

YFP 161: 5 Key Financial Lessons to Teach Your Kids

Posted on by yfpadmin


5 Key Financial Lessons to Teach Your Kids

Cameron Huddleston, award winning journalist and author of Mom and Dad, We Need to Talk: How to Have Essential Conversations with Your Parents About Their Finances joins Tim Ulbrich to talk about five key financial lessons to teach your kids.

About Today’s Guest

Cameron Huddleston is the author of Mom and Dad, We Need to Talk: How to Have Essential Conversations With Your Parents About Their Finances. She also is an award-winning journalist who has written about personal finance for more than 17 years. Her work has appeared in Kiplinger’s Personal Finance magazine, MSN, Yahoo, USA Today, Chicago Tribune and many more print and online publications.

Summary

Cameron Huddleston, personal finance journalist and author of Mom and Dad, We Need to Talk: How to Have Essential Conversations with Your Parents About Their Finances joins Tim Ulbrich back on the podcast to dig into 5 key financial lessons to teach your kids. Cameron and her husband have tried to instill these lessons in their own children who range between the ages of 8 to 15. Cameron shares that she wasn’t given much financial education growing up which caused her to make some mistakes with money. She wants to openly communicate to her children about money so that they can form a healthy relationship with it. These lessons include: money is not a taboo topic, money must be earned, make saving a priority, it’s ok to spend but don’t waste your money on junk and be grateful for what you have.

During this episode, Cameron shares several tips that help to bring these lessons into your daily lives. For example, she suggests talking to children about money from a very young age so that they can form a healthy relationship with it and learn how to use it wisely. When they are younger, you can explain to them that money is used to buy things, like food or toys. As they get older, this can turn into talking about how to spend money and following a budget. Cameron also shares that her children have financial chores, in addition to chores that they don’t receive money for. She gives her older two daughters money monthly and her son, the youngest child, an allowance weekly. They are encouraged to put this money in three different jars to either save, spend or give. This helps them think about what they want to use their money for and shows them what happens when they use their money to purchase something.

Cameron discusses speaking to your children about money in the last chapter of her book Mom and Dad, We Need to Talk: How to Have Essential Conversations with Your Parents About Their Finances.

Mentioned on the Show

 

Episode Transcript

Tim Ulbrich: Hey, what’s up, everybody? Welcome to this week’s episode of the Your Financial Pharmacist podcast. And I’m excited to welcome Cameron Huddleston back onto the show. Cameron is the author of “Mom and Dad, We Need to Talk: How to have essential conversations with your parents about their finances.” She’s also an award-winning journalist who has written about personal finance for more than 17 years. Her work has appeared in Kipplinger’s Personal Finance magazine, MSN, Yahoo, USA Today, Chicago Tribune and many more print and online publications. Cameron, thank you so much for your willingness to come back onto the show.

Cameron Huddleston: Thank you so much for having me.

Tim Ulbrich: So we had you on the podcast way back in Episode 108 to talk all about your book, “Mom and Dad, We Need to Talk,” and that was a great conversation and you provided many valuable tips and thoughts around having this sometimes difficult conversation or conversations with our parents. And while today we’re not going to talk about having these conversations with our parents, we’re going to flip the script and talk about having these conversations, these important money conversations, with our kids. And the final chapter of that book, Chapter 17 in “Mom and Dad, We Need to Talk,” was “Pay it Forward. Start Talking to Your Kids.” We’re going to use that chapter as well as an article that you recently wrote that’s on your website and we’ll link to in the show notes titled “What I Teach My Kids About Money” to use that article as a framework for our discussion today. So before we jump into the five key things about money that you’ve tried to share with your children, tell us a little bit more about your family as I think that context will be important to our discussion here today.

Cameron Huddleston: Sure. So I have three kids. They range in age from 8 to 15. Actually, my 15-year-old is turning 16 in August.

Tim Ulbrich: Oh gees.

Cameron Huddleston: I know. My 13-year-old turns 14 in July. And so two girls, one boy, all very different in the way they think about and handle money, which makes it interesting and a bit of a challenge when it comes to teaching them about money. And this should be my key warning to parents of children who are still young and just kind of starting to figure things out that no two kids are alike, which I’m sure every parent has figured out. But no two kids are alike when it comes to their approach to money. I mean, even if you’re in the same household and you’re talking about the same things, it just, it becomes very apparent from the time children are young how they view money differently.

Tim Ulbrich: Yeah, and I think that’s fascinating, Cameron. You know, something my wife and I talk about with our four boys — and I would say we’re, ours are a little bit younger, so 9 down to just over 1. So obviously we’re not talking with our 1-year-old yet about money. But what we’ve realized is, you know, with our three older ones just how different — I mean, to your point — just how different they can be in so many different areas but even when it comes to things like questions they’re asking about saving and spending and how we are spending our money. And I like to think that we’ve been relatively consistent in our household. But nonetheless, you know, you take their different personalities and I think that can lead you to a different outcome with money for each and every child but also how you approach this topic. And so we’re going to talk about five key things about money that you’ve tried to share with your own family. And we hope that that will provide a framework for those that are listening to be able to apply some of these principles in their own households. So before we jump in to these five things, I’m curious, you know, we talk a lot on the show about when it comes to two individuals, two spouses working together on a financial plan, how important that communication is and how important it is to be on the same page and to have good conversations about money. So were you and your husband both on board with these five points? Was it something that you were leading more? That he was leading more? Talk to us a little bit more about the dynamic and the vision for teaching your kids about money as it relates to you and your husband.

Cameron Huddleston: Sure. I don’t think we ever sat down and started making a list of things that we wanted to teach our kids. It just happened naturally. I do think that my husband and I are pretty much on the same page when it comes to money. I feel fortunate that we don’t fight about money, which is something that’s so many couples do. We’re similar in our spending patterns. We’re similar in our beliefs about money. We did come from very different money/financial backgrounds, but I don’t think that’s really created a lot of an issue for us. It’s just I think being on the same page has helped us convey a consistent message to our kids. There was one area where we had a bit of a disagreement, and we can kind of get into that because that’s one of the points I make — and I know you’re referring in particular to a post I had on my blog about what I teach my kids. And so — and that comes, that point where we have a little bit of a difference of opinion is when it comes to allowance, which is what we — and we can discuss that.

Tim Ulbrich: Sure.

Cameron Huddleston: But yeah, I feel like we do take a similar approach that’s made it easy when it comes to teaching our kids about money and instilling a set of values about money.

Tim Ulbrich: Yeah, and as you mentioned, the article in reference here is “What I Teach My Kids About Money.” We’ll link to it in the show notes and that will be the framework for our five points about money and teaching kids about money. So let’s jump in. No. 1, money is not a taboo topic. And you mention in your blog that your middle child asked you why people think it’s bad to talk about money. So tell us about that conversation, how you responded, and what your family dynamic is in terms of how you approach and how you speak about money as a family.
Cameron Huddleston: So a few years ago, my middle daughter, who might have been around 11 or so at the time, out of the blue, she comes up to me — and I remember I was sitting in my office — and she says, “Why do people think it’s bad to talk about money?” And I was a little bit taken aback by the question because I was wondering what prompted her to ask that.

Tim Ulbrich: Yeah.

Cameron Huddleston: And I know why she did because we talk about money all the time, so in her mind, there’s nothing wrong about talking about money. Someone must have said something at school or maybe she saw something on TV, I don’t know. But when she asked me that, I wanted to explain to her in an age-appropriate way why people think talking about money can be a bad thing. I actually used something I had heard from a financial psychologist I know. And what he had explained to me and what I told my daughter was that the reason people often are reluctant to talk about money or they think it’s a taboo topic is because there’s a lot of shame around money. And I explained to her that some people are embarrassed if they’re having a conversation with someone else about money that maybe they make more money than the other person or they’re embarrassed because they make less. And that’s what can create the awkwardness, having more or less than someone else and you don’t want to feel like you’re bragging about how much you have or you don’t want to feel like you’re not doing as well as another person. So that’s what I explained to her. And I guess she kind of processed it in her little head and went on about her way, but like I said, we talk about money all the time. We’ve been talking to our kids about money matters since the time they could talk. Of course, when they were 2 years old, we weren’t talking about mortgages and debt and interest rates and that sort of thing. You know, just explaining the basics: This is money, this is a coin. They would go with us as we run errands and using that as an opportunity to explain things cost money. We have to earn that money to pay for those things. We have to make choices about what we’re buying. These were not conversations I had in my family when I was growing up. We didn’t talk about money at all. My dad was one of those people who said, we don’t talk about money. It’s not polite. And so I wasn’t raised with a good personal finance education from my parents. I had to figure out a lot on my own. When I got out into the real world, I made a lot of mistakes. And thank goodness I became a personal finance journalist because it’s taught me everything I know and needed to know about money. And I don’t want my children to become adults without a strong financial foundation. That’s why my husband and I have been talking to them since the time they were little about money so they can learn to use it wisely and they can have a healthy relationship with it.

Tim Ulbrich: So a couple things I want to unpack there that you said. You know, the shame piece really stands out to me because it’s almost like the baseline that, you know, we often feel shame around money and talking about money, typically, as you mentioned, because either the feeling that we may have more or less than somebody else, so there’s this natural point of comparison. My question that I’m thinking through is like, where does that come from? Is that innate human behavior? Is that because of the society that we live in? Is that because of the money scripts and the conversations that we were a part of or not a part of as a child that we may or may not even remember those? Like what are your thoughts on why even young children may begin to pick up on some of that in terms of this concept of shame around money and conversations of money?

Cameron Huddleston: I think it’s more the latter two reasons that you mentioned: society and those money scripts. I think we tend to view our self-worth in terms of how much money we have or don’t have, unfortunately. And so we think people who are wealthy are somehow better and those who are poor aren’t as good. And I wouldn’t say this is universal, but I would say that this, this idea is engrained into a lot of our heads. And then like you mentioned, the money scripts. If you grew up in perhaps a lower income family where, you know, people were always talking about how they wanted more money but then perhaps disparaging people who were making a lot, referring to them as, oh, the rich or greedy, it does affect the way you think about money when you get older. Maybe you want to do well and improve your lot in life, but there’s that idea in your head that if you become rich, you’re greedy and you’re somehow bad. And those things we don’t often realize are there deep down and can help us or not. I shouldn’t say help us — can lead to bad relationships with money and these negative thoughts about money that lead to this idea that we shouldn’t be talking about it.

Tim Ulbrich: And I struggle as a parent, Cameron. I struggle in conversations with my boys trying to strike the balance — and I don’t know if I’m doing it well or not, but I feel like I tend to have a frugal mentality and mindset. And what I worry is if that’s what they hear me talking about all the time, I don’t want them to have that restrictive mindset around money. But I also want them to be conscientious in terms of how they spend and alternatively, if they hear about the wealth-building and the growth side of it, I don’t want them to lose sight of there’s hard work and effort that goes into earning money and to have that association between work and money. So I feel like probably, you know, myself and many others that are listening may not have some of these conversations either because they don’t know how to have them or out of fear of what they’re saying may be developing a mindset that they already have or they don’t want their children to have or baggage that’s being passed on from one generation to another. So when I hear you say that “we as a family” talk about money all the time, like give us some tips or strategies. Like how is that conversation just a regular conversation in the household? Is it specific moments? Is it around the dinner table? Is it when you’re out and about at the stores? Like what does this practically look like that we as parents can better engage our children in this conversation?

Cameron Huddleston: So obviously it’s going to depend on the age of the child. When your kids are young, the least you want to do is introduce them to the concept of money. This is a coin. And you want to wait until your kids are at least old enough not to stick those coins into their mouths and swallow them.

Tim Ulbrich: I did that as a child, so yes.

Cameron Huddleston: Right. All kids do it. They all do. They want to pick things up and stick it in their mouths. So you know, when they’re maybe 2 or I would say perhaps even 3, probably 3-4 years old, they’re less likely to stick those things in their mouths. This is a coin, this is money. We use it to buy things. This is paper money, a dollar bill. And here we are, we’re at the store, we’re at the grocery store, we’re buying things. And so often, we will use a debit card or a credit card. So explaining to your kids, you know, I just put this debit card in. I put this credit card in. But it’s still money. The money is coming out of my bank account. That’s something that would come up more when they’re 5 years old or so. 3-4, this is money, we have to earn the money, we use it to buy things. You know, and letting them see what it is. Let them touch it. Maybe even, you know, giving them your spare change and letting them start collecting that money in a coin jar or a piggy bank, something along those lines. You know, and then as they get older, the conversations can be more advanced, talking about spending decisions. You go to the grocery store, they’re begging for — or you go to Target. Let’s use Target as a good example because they sell everything.

Tim Ulbrich: Everything.

Cameron Huddleston: And so they want a toy — everything. We all know that we spend too much at Target. You go to Target, and the kids want a toy. And that’s an opportunity for a conversation, “while it’s great that you want a toy, but we are here to buy this. We don’t have money in our budget,” or, “This is not something that we need to be buying right now. You get gifts on your birthday, you get gifts on holidays.” Making those things clear. You know, I would tell my kids before we went to the store so there wouldn’t be a meltdown. “We’re going to the store to buy this. We are not going to buy you a toy.” Now that my kids earn their own money through allowance, I tell them, if this is something you want, you use your money to buy it. And it’s funny how quickly —

Tim Ulbrich: That changes.

Cameron Huddleston: They don’t want that thing so much anymore.

Tim Ulbrich: That’s right.

Cameron Huddleston: No, I want you to get it for me.

Tim Ulbrich: Yeah.

Cameron Huddleston: So it just — really, our conversations are part of our daily living and them — you know, they become, like I said, they do become more advanced as your kids get older and you have to talk about more serious things like buying a car and whether that’s something you expect them to pitch in and help you do. Do they have to pay for gas? Do they have to pay for insurance? Do they have to use their allowance to pay for things they want? Do they have to use it to pay for things they need? It just — you know, a friend of mine who is a financial coach said she had a client who told her that she didn’t talk about money at all with her kids because she didn’t want it to stress them out. She wanted them to be kids. And I thought, this is so unfortunate. You’re missing a really good opportunity to help your kids develop a healthy relationship with money. If you don’t talk about it at all, you create that idea that it’s taboo. And then as they get older and they haven’t had that experience with money, they struggle to make smart decisions.

Tim Ulbrich: Yeah, and I think going back to your Target example, I think it’s really important — in my opinion — to teach kids at a young age and all throughout the concept of opportunity cost. Obviously I’m not going to use the word “opportunity cost” with my 5-year-old, but getting them to understand like if we’re at Target, you know, I try not to use language like, “We can’t buy this,” or, “We can’t afford this,” but rather because, as you mentioned, because of the budget or “We’re here to do this,” or, “We’re choosing to do this and we’re not buying this because we want to be able to do this.” So really, I think that tradeoff concept is so important. And as you mentioned, I think when it’s our own money and our own allowance, that becomes a little bit more clear and obvious. But when it’s not their own money, that may not be as obvious. So No. 1, money is not a taboo topic. Really great introduction and conversation there. No. 2, money must be earned. So you alluded to this in terms of the discussions you and your husband have had, but talk to us about, you know, the options of either chores or allowance and how you made that decision and how that ultimately has played out in your own home to be able to connect this concept of money and work and earning that money.

Cameron Huddleston: So because I have been writing about personal finance so long, I have written about the topic of allowance on several occasions. I’ve interviewed a variety of experts. And there are a variety of approaches to allowance. One of them in particular is to give your kids financial chores. So you give them a certain amount, and then they are expected to use that money to pay for certain things. So the allowance is not tied to the chores you do, but you have to use it to pay for certain things. Initially, I really liked this idea and discussed it with my husband. And he felt very strongly that our children’s allowance should be tied to their chores because in the real world, you have to work to earn money. And he wanted them to learn that from a young age. Money is not just handed to you; you have to work. Now I know some people will say, “Well, if you tie the chores to money then you’re going to end up having more fights and the kids aren’t going to want to do the chores, they’ll just say, ‘Well, fine, I’m not going to do it. I don’t care if I don’t get any money.’” I do think it’s important that kids have to do some chores without getting paid for them, just because they’re part of the family.

Tim Ulbrich: Yeah.

Cameron Huddleston: And you have to pitch in when you’re part of the family. So there are some things my kids are expected to do, and they don’t get paid for it. But we have a spreadsheet that we have printed out, and it hangs up on the refrigerator, and it details what the kids are supposed to do and what — the way we do it is they get penalized if they don’t do those things. So they get a certain amount each month for my daughters, each week for my son because he’s younger. And if they don’t — so for example, if he doesn’t make up his bed every day — and he doesn’t have to do a great job, he just essentially kind of has to get the covers up and not leave it looking sloppy — he loses $.25.

Tim Ulbrich: OK.

Cameron Huddleston: And I will tell you, it has worked incredibly well. Once we instituted that system, things got done around the house. Shoes were not left out because with my son in particular, who was always leaving his shoes by the sofa, his room was always a mess, and when I would ask him on the weekend, it’s time to clean up, oh no, I can’t do it. You have to help me. Once he was in charge of doing all these things and he knew that he was going to lose money because he’s very motivated by money, he was on top of it. Just the other day, he said to me, “Oh, Mom, I forgot to make up my bed two days in a row. I’ve lost $.50.” And I was like, “Well, you need to make yourself a to-do list that says, Start the day by making up my bed, so that you know that you do it.” It has not, fortunately, caused fights in our household. The kids are willing to do their chores. They know if they don’t do them, they’re going to lose money. So my son, he gets his payment every week in cash. He has a choice of putting it into a Save, Spend, or Give jar. And I let him make the choice because when you’re older, you have to make those choices. Now I will tell you he has raided some of his Save and Give jars so that he could spend some money. And he looks back and he says, “Oh my gosh, I don’t have any money left.” And that’s a lesson that he has learned. My daughters, they get it monthly just because they’re getting a larger amount of money. But it works for us. That’s not to say it’s going to work for everyone. And I think it’s important to figure out a system that works for you. So if you feel strongly that money should be earned, then you can have an allowance that’s tied to chores. If you don’t like that idea, you can use, I don’t know, the financial chores system. The key is to give your kids their own money so that they have experience using it and making decisions with it.

Tim Ulbrich: And there’s something you said there that really stands out that I want to make sure we dig in for a moment here is that your son being younger, you had more frequent moneys that were given and it was given in cash, right? I think that’s really important at a younger age that there’s not a long time period, that they can see that immediate connection between the work that is or is not and the money that is or is not earned. But I also think it’s important as they get a little bit older that you give them a little bit more leeway and by increasing some of that flexibility, it also puts some of that responsibility on them to manage over a longer period of time. So for example, you get paid on the first of the month or however you do it and somebody wants to buy a really nice new pair of shoes. And now they’ve got 30 days left of the month where they have no money left. Like that’s something that we have to reconcile — we have to reconcile with every month, right, in terms of how we balance that per month and then obviously eventually even over longer periods of time. So I’m assuming, was that intentional, both the time period as well as the mode of like cash or non-cash? Talk to us a little bit more about that.

Cameron Huddleston: Yes. Yes. And so with — well, my oldest has a bank account. We set it up last year. She actually got paid for a job. She worked for a week at a local camp here helping out, and they gave her a check. And so we opened up a checking account for her so she could deposit that check and put money in there. My middle child, who was — let’s see, she was 12 at the time. My oldest was 14 when we opened up that checking account. And so I was still paying — well, still am paying my middle child — in cash. We wanted to switch her to a checking account, but with the pandemic, we haven’t been able to go to the bank and I couldn’t open an account for her online because of her age. She, at least with the bank we use, she needed to be 16.

Tim Ulbrich: Right.

Cameron Huddleston: And to be honest, I haven’t checked to see if the banks have actually opened their doors. But when I was checking before to see if I could set up an account for her, they were closed at the time. She very much wants to have a bank with her money being deposited directly into the checking account I think most likely because she wants to have that debit card so that she can do online shopping, which her sister has done some of. And what I will tell you too, this is really interesting and I had read about this and I’m sure you probably have too. You know, studies show that when you pay with plastic, you don’t feel the pain of parting with your money as much as you do when you hand over that cash. And I’ve watched it firsthand with my oldest daughter, who is a natural saver. She’s such a tightwad, which is probably a good thing. But sometimes, she’s so stingy to the extent that just it pains her to make decisions about spending her money when it was cash. Since she’s had this debit card, I have found that she’s a little bit more willing to spend. And she will admit that too. So my middle child, who is a bit more of a spender naturally, I know that when she does get that debit card, she’s going to want to use it to spend more and will not hang onto her money as well as she has been doing. So it’ll be interesting to see what happens once we finally get a bank account open what she does with that debit card.

Tim Ulbrich: I’m so glad you brought that up because I’ve experienced something similar with my oldest where when we opened up an account for him, it went from, you know, I got this $50 cash bill for my birthday to now you put it in this online virtual world that I — like he almost viewed it as he like lost it. Like it doesn’t exist anymore, it’s not physical anymore. And so there’s a great conversation to be had there. But I think this nuance between the emotional and the behavioral side of the cash in hand versus just the credit or the debit card and having those conversations — I’ll never forget one day, I was in the grocery store. And he was I think 5 or 6 and one time we were at the checkout line, I swiped my card and he made a comment, something along the lines of, ‘Oh, so if you need something, you just swipe your card and you get it.’ And I was like, oh wow, we’ve got some work to do, you know? But I think thinking of it through the view and the lens of a child and how they observe — and obviously I’m not suggesting that you have to go out and buy cash for everything, but using some of those moments as a conversation starter to teach some of those important differences and principles. So that was No. 2, money must be earned, different ways certainly to do that. No. 3, make saving a priority. So how do you explain the importance of saving money to children? You know, I think it’s such a difficult concept because there’s a natural tendency to, you know, yes, if I can connect that work to money, now I want to spend that money on something I want. So how do you explain the importance of saving money to children? And is there a certain age at which you think that conversation begins to be fruitful?

Cameron Huddleston: So if you’re paying your kids an allowance or they’re earning an allowance if you want to put it that way, I think it’s a good idea to start at that point of encouraging them to save by having those Spend jars, the Save jars, the Give jars if that’s something important in your family too so that they’re making those decisions from an early age. You know, how much of my money do I want to set aside for the future? How much do I want to give to help others? So as soon as you start that allowance system, saving should be a component. Now with small children, the idea of saving, say for a car when they’re 16 or saving for their college tuition, that’s too abstract for them. And it’s too far out in the future. I feel like with younger kids, one of the easiest ways to get them to understand the concept of delayed gratification is to — and this might sound contrary to what you’re trying to achieve — but to encourage them to if they want to buy something, to save up for it. So because that’s more tangible to them. And it’s something that’s a little bit more exciting than thinking about saving for a car when they’re 16 years old. So like I said, with my oldest, she’s a natural saver. And it’s just, it’s very easy for her to hang onto money. We would give her change, our spare change when she was little. She would get cash from her grandparents for birthdays, and she hung onto it and hung onto it. And when she was — oh gosh, she was in elementary school, early elementary school. She had enough saved to pay for about half of an iPad. And we pitched in the other half as a gift for her. My middle child, as soon as she got money, she wanted to spend it. And so we had to work really hard with her to tell her, “Look, what do you want more? Do you want these little trinkets? Or would you rather save your money to get something that you really want, this toy that you’ve had your eye on?” So we used that initially to motivate her. And so once she got in the habit of saving up to get something she really wanted, saving just became a more natural habit for her. She doesn’t want to spend her money all the time now as soon as she gets it. She has amassed a decent amount of savings that she’s kind of hanging onto. And once she sees that money accumulating, she doesn’t want to part with it as easily anymore. Because then that means she’s going to have less money. Both of my daughters, when I told them, “Look, you’ve got the money. You can pay for it.” They’re like, “But no, then I won’t have as much.” My son has been more of a challenge. He is 100% a spender. And he very much — and we can get into this because this is one of the things I mentioned too in that article — he very much wants what his friends have. And so when he gets money, he wants to spend it. And we’ve had to work harder, and fortunately I’ve had my two daughters who’ve been trying to pound this message into his head too — “Hey, why are you spending your money on these toys? They fall apart so quickly.”

Tim Ulbrich: Yeah.

Cameron Huddleston: And he’s had to learn that lesson a few times. He spends it on something, it falls apart, and then he’s upset, he regrets it. So we are making progress, slowly but surely.

Tim Ulbrich: Yeah, and just a great example there with the three children, back to our conversation at the very beginning of how different this one principle can be applied and should be applied and customized in three different ways. And I really like what you said, Cameron, about this concept of saving, having them save up to buy something that they want but in the shorter term and how different that is than having them save and put money in a long-term savings account or thinking about college or cars or things that are far off, abstract and may lose that motivation. So you want to have some of that yes, we’re teaching them to save but also want them to see the rewards that happen through that saving process as well. So you mentioned this a little bit, but No. 4, it’s OK to spend but don’t waste money on junk. So going back to the example you just gave with your son and your daughters, helping guide him a little bit, how do you as a parent, how do I as a parent, you know, strike this balance between you need to learn this lesson, it’s important to spend but just don’t waste money on junk and let them make some of those mistakes versus, you know, I’m going to give you a sandbox in which you can play because I know that these aren’t junk but I want you to have some choice in the process as well. Any advice you would have in this area?

Cameron Huddleston: Sure. So this is something that we’ve done with my son. So when he wants to get something, we have a discussion about it. And this happens all the time because in school, they have book fairs. And they always have, in addition to books, they have all sorts of trinkets they can buy. They have fundraisers, you know, where you can get contributions and if you do, you get toys. And he’s all about winning the prize. And so when he wants to use his money to buy something, I ask him, “Well, do you think this is the best way to spend your money? Is this something you really want?” And if he’s dead set on getting it, oh yeah, yeah, yeah, OK I have to have this. I have to have this. OK, well how about we do this? Let’s wait a week and see if this is something you still want. We did this, actually — I can think of a specific example. Last year, they had a fundraiser to school. And if he got a certain donation amount, then he would have won this prize. And I said, “Well let’s” — and he was ready to raid his piggy bank and use all of his money so that he could donate enough to win this prize, which is great that he wanted to make a donation, but it really wasn’t the best reasons. He just wanted to get this particular prize. I said, “Well let’s go online and see how much this toy actually costs.” So we found that he could get two of those things for $9. And so well, let’s wait until the end of the week, see if you still want it. And the next day he came back and he’s like, I still want it. I said, “OK, well it’s not the end of the week.” By the end of the week, he had forgotten about it. And so that cooling off period I have found helps. And of course, asking your kids to use their own money, you know, even reminding them of times when they’ve bought something and then they regretted it. Hey, remember when you bought that pen at the book fair and it broke the next day? “Oh yeah, yeah, yeah, that was a bad idea. I don’t want to do that again.” But it’s OK to let them make mistakes because if they don’t, they’re never going to learn. So — but just having those conversations and when they want to buy something, getting them to at least reflect for a few minutes on whether that’s the best way to use their money or if there’s something that would be a better use of their money I think is a good idea.

Tim Ulbrich: Yeah, and such great advice with the cooling off period and something that I think we need to ask ourselves. Are we role modeling that, you know, for our children? You know, I can think of several examples in the last couple months where probably conversations my wife and I have had about buying something and are we even articulating, you know, let’s wait a day or two and think about how this impacts other areas or do we really need this, do we really not need this? And are we role modeling this but also applying it in our own situation because I know I have found that to be true over and over again how something — how your feelings toward buying something can change significantly with just one night’s rest, let alone a whole week to be able to think about that. And one tangible example I can think of is in the last week, we’ve been waiting to watch Hamilton, you know, recently released on Disney+. And I thought, oh, it would be really nice if we like upgraded our TV game and our sound system game. This is a good reason to do it. And I’m glad we didn’t because it came, it went, we watched it, it was great. But it would have been as good, you know, nothing really changed. And so I think just taking the time to think about it, to cool off. Doesn’t mean you can’t spend money, you shouldn’t spend money, but just really evaluating how that impacts other parts and taking the time to think through that. So No. 5, which is something I have such a great desire for my kids to have and I struggle with how to instill this is to be grateful for what you have. So how do you instill in your children that, you know, they don’t have to have everything someone else has and that there are a lot of people that may have much less and to instill this mindset of gratitude and even taking a step further, a mindset of giving?

Cameron Huddleston: One of the conversations that we have with our kids about money is about how we choose to spend our money and what our values are. So we have let our kids know that one of the things that we really value are experiences: travel. We love to travel. We have a goal of getting our kids to all 50 states before they graduate from high school. This summer has put a damper on that. We had plans to knock out several states in the middle of the U.S., but that did not happen. But when the kids are asking for something, something perhaps that’s expensive, we tell them, “Well, you know, remember how we’ve talked about how we choose to spend our money on travel? We could afford to buy this, but if we did, we would have less money to travel. What do you enjoy more? What do you think you would like more? Do you like getting to go places and seeing new things? Or do you really want, I don’t know, a new iPhone?”

Tim Ulbrich: Yeah.

Cameron Huddleston: You know, so getting them to think about what they value, what we value, is important and pointing out when — and this is in particular with my son, who as I said, really wants what his friends have. I don’t have that issue so much with my daughters. But when he constantly says, “So-and-so has this. So-and-so has that,” I tell him, “Well, you have a lot. There will always be people who have more. There will always be people who have less.” We choose — and going back to this conversation about what we value — we choose to spend our money on these sort of things, on experiences, on travel. Yes, I know you want to have all of these toys and it seems really wonderful, but you have a lot of toys already. And if we bought you every toy that you wanted, then we wouldn’t have as much money to do some other really fun things. And you know, in the moment that conversation usually works. You know, it gets them to realize. The problem is getting that idea to stick in his head because as I said, he just, he wants to keep up with the Joneses. My daughters don’t ask for nearly as much. They don’t seem to be as concerned about what their friends have. And I feel so fortunate that they don’t. You know, even with him, I hear things like, “Oh, my friends’ homes are better than ours. They have a pool. We don’t have a pool. Why can’t we have a pool? Can’t we buy a pool?” And I tell him, “Well, we probably could a pool if we really wanted to. We could put a pool in if we really wanted to. But your dad and I have to save for things in the future too. We can’t spend all of our money on what we want now. We have to have money for when we’re older and we don’t want to work anymore, money for our retirement. We have to pay for things like if someone has to go to the hospital or if we have to get a new car. So if we spend all of our money right now, we won’t have enough money in the future when we need money too.” So I have a lot of conversations with him about it. I feel like maybe I’m making some progress slowly. You know, but I have to spend a lot of time pointing out to him, you have a lot. You’re not going to have everything. But you do have a lot already, and you need to be thankful for what you have. It is certainly a challenge. And as I said, you know, some of my kids are much more receptive and I believe much more grateful for what they have than the other — just singular other — with my son. But it is something I am trying to instill in them because I feel like if you are always longing for more, you’re never going to be satisfied with what you have.

Tim Ulbrich: Yeah, and as a father of four boys, I have a soft spot for your son. So I hope he doesn’t feel like we’re singling him out.

Cameron Huddleston: Sorry.

Tim Ulbrich: What you said about him reminds me, I feel like this topic, when you’re talking about values and vision for your financial plan — and I love that you’re doing that because we talk a lot about with our financial planning clients about having a vision and a purpose for your plan. And under that becomes the framework of why we’re paying off debt or why we’re saving or why we’re investing in life experiences and how we balance and prioritize all of those. And this is the beginnings of that conversation, right? What’s the values in which how we spend our money? What’s the vision for how we spend our money? And I think it’s a conversation that reminds me of the book, “Compound Effect” by Darren Hardy where it’s the every day, every week conversations. Any one of those may not seem significant or that it’s moving the needle, but over the course of time, you know, we hope that that will bear the fruit in which we desire that it will. Thank you, Cameron, for a great discussion and taking the time to come back on the Your Financial Pharmacist podcast. And we’re going to link to your book, “Mom and Dad, We Need to Talk: How to have essential conversations with your parents about their finances” in our show notes for this episode as well as your article from your website, “What I Teach My Kids About Money.” So we will link to both of those in our show notes so our listeners can go and learn more or pick up a copy of your book, available at Amazon, Barnes and Noble. But in addition to those two resources, where can our listeners go to connect with you and to follow your work?

Cameron Huddleston: You can learn more about me at CameronHuddleston.com. You can — there’s a link to email me if you want to get in touch with me. I have a newsletter, I have some free resources on the site. You can follow me on Instagram @cameronkhuddleston. And you can follow me on Twitter @CHLebedinsky. I know it’s a little confusing. I’ve got my maiden name that I use for my byline, and I’ve got my married name, which just happened to end up being my Twitter name. And so I know it’s a little confusing, but that’s where you can find me.

Tim Ulbrich: Awesome. And no worry, we’ll connect to all of those in our show notes. So go to YourFinancialPharmacist.com/podcast. You can find this episode and within there, you can find not only reference to the article and Cameron’s book but also the ways to connect with her. So Cameron, again, thank you for your time and for coming onto the Your Financial Pharmacist podcast.

Cameron Huddleston: Thank you so much for having me.

 

Current Student Loan Refinance Offers

Advertising Disclosure

[wptb id="15454" not found ]

Recent Posts

[pt_view id=”f651872qnv”]

Facebook Linkedin Envelope

Compliance/Legal

Disclaimer/Privacy Policy

Firm Brochure (ADV Part 2)

Brochure Supplement (ADV Part 2B)

YFP Planning CRS

Subscribe to YFP Money Matters and get financial tips, money resources, and the latest podcast episode sent straight to your inbox every Friday morning!

© Your Financial Pharmacist Planning LLC, 2024 All Rights Reserved

Careers
Privacy Policy
Disclaimer / Advertising Disclosure