Monday, September 17, 2018

If You Follow This Advice You Won't Be Able to Buy a House

If you follow this advice from Ramit Sethi, you won't have any money to buy a house or start a business, unless you have a lot left over after doing all these things. The image that accompanies the article is very apt:

If you follow this advice you will be locking all your time away in the piggy bank until you are 59 1/2 (or 60 in Australia). I think I should start writing my own financial advice:

The first step is the same - if your employer requires you to match to their retirement contributions in order to receive it, do it. In Australia that isn't normal, but in some jobs in the public sector there can be additional tax advantaged employee contributions on top of the employer contributions. I would suggest skipping those until you do my step two unless it really reduces the retirement benefits you will get.

Step two is also paying down debt, but only on high interest loans like credit cards. If you have debt where the after tax interest rate is lower than the after tax expected return on investment, pay those off as slowly as you can. So yes, get rid of credit card debt ASAP, but student loans and home mortgages are usually debt you don't want to get rid of in a hurry. Taking on a moderate about of extra debt if the rate is good (as in leveraged managed funds or even margin loans) can be good, but don't overdo it.

Step three is the "emergency fund" or equivalent. Get some cash together to cover emergencies and opportunities. Having the ability to borrow more is good too of course, but don't just rely on that. I had about $20k in cash before I started to invest. As that is 20 years ago, you probably should double that number now.

Step four is probably investing outside of retirement accounts. This means your money isn't locked up till you retire. The supposedly lower tax of retirement accounts comes at a heavy price. With low long-term capital gains tax and reduced rates on dividends (especially in Australia) the tax on non-retirement accounts may be not much higher than on retirement accounts in Aus (and you can make bigger contributions later in Aus as I am now contemplating when you have plenty of money). US 401ks are taxed heavily on withdrawal in retirement though they have no tax during accumulation. The US Roth IRA though is an attractive investment as it leaves options more open.

Step five - if house prices are reasonable relative to rents in your area and you aren't planning on moving a lot, once you have more than enough for a downpayment, buying a house is probably a good move. But do a proper cost benefit analysis of this.

Step six - once you have done these and if you aren't thinking of getting into business, now you can look at maxing out retirement accounts.

I didn't mention trading - unless you have a proven model and want to pursue this as a real business you can do this as a hobby alongside Step 6. Most traders lose money though, so it is definitely an expensive hobby for them.

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