Money Obedience

Let me give you a little background about my thinking before I get to the meat of this post. I used to be a trader on Wall Street where I traded the firm’s money. My buy and sell decisions determined my success or failure. In the more than two decades of doing this, I was always guided by one question. What is the worst thing that can happen? Or rather, what is the worst thing that I will allow to happen? In trader terminology we used to ask, “when do you cut your losses?” Every trader knows that life as a trader is much easier when you can keep your losses small. But believe me, for most traders this is easy to say but difficult to execute all the time.

So, naturally I think like that in my personal life. There are some differences between my trading decisions and my personal finance decisions but the concept is very similar. One difference that stands out is the emotional impact of my personal decisions. My my wife and I have got to make sure that our financial decisions allow us to have a happy life. Heck, the purpose of this blog is to share our thinking about the connection between our happiness and our financial decisions. (Just in case you were wondering, in trading nobody cares about happiness – the bottom line is everything.)

Our life-style is based on our two incomes. We live below our means, which allows us to sock away a little savings here and there. We own a home that both of us really like. We have never looked at this home as a real estate investment. It has always been the place where we want to raise our children and where we want to live until the steep and creaky staircases are too much for us to climb. (That rule is suspended for the two days after I run a marathon when I don’t like walking up and down any stairs, not just the ones in my house.) In short, we conscientiously have developed an emotional connection to our home. We like it that way. It makes us feel good.

As most of you know, I no longer draw an income. Since our lifestyle is based on two incomes and since we know neither when I will get another income nor how big that income will be, we have to be prepared for the worst case, i.e. no income for a while. (But I’m still trying to convince my my wife that we turn my unemployment into retirement. What do you say, honey?) No matter what we decide, my wife’s income alone cannot support our current running expenses.

We have two choices now. One, we can rearrange our assets quite a bit. We could liquidate most of our savings - including our retirement savings - and pay off almost the entire mortgage so that we can afford the payments on just my wife’s income. Since our investments and savings have declined in value over the last year we cannot pay off the mortgage completely, but we can get it low enough to make the monthly payments affordable enough to be able to stay in our home indefinitely.

The other option is that we just stay put with things as they are. What would be the worst case then? It will be a while before I can create an income stream that will provide us with a sufficiently large income that our current belt tightening will be enough. What would we have to do to make a “stay put” scenario work out? Well, at some point we would have to liquidate our savings - again, including our retirement savings - but using this method of crossing financial crisis bridges when we come to them means it would take a good many years before we completely run out of money. This is mainly because in previous years, we worked very hard to put most of our savings into a retirement fund. Even though our 401Ks suffered a lot in recent months, as a rough estimate I even think that we could live like that until I can draw social security benefits under the current law.

So, what do we decide to do after all? The choice between these two options is pretty clear once you think about the tax implications of liquidating a retirement account. If you liquidate a retirement account all at once, you right away put yourself into a much higher tax bracket, and this costs you an awful lot in extra taxes. On the other hand, if you dip into your retirement savings over time, you will not have to pay the high taxes but you will probably stay pretty close to your current tax bracket. In either case, you can’t avoid paying the penalty for early withdrawal under the current law, unless you are withdrawing the money for a legitimate “hardship”. But the fact is that early withdrawal does not cost you as much in taxes if you withdraw money over time rather than all at once. (Plus, I hear that Congress is thinking about ways to lower the penalties for people like me who try to stay afloat by dipping into these savings, so now, it might make even more sense to go slowly with that kind of scheme.)

No matter what we decide in the worst case scenario, our retirement may not be as rosy as we thought only a few months ago, but a retirement plan needs to be adapted all the time anyway. We will figure something out. But right now we achieve our most important objectives. We know that we can continue living in our home for a very long time no matter what. This knowledge about our financial situation should give us comfort and allow us to relax a little about our future.