The Ultimate Formula for Determining Your Financial Priorities

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In this week’s Rich Girl Roundup, we answer the age-old question: Should I prioritize putting money towards X or Y? Rich Girl Natalie shares the choice she’s grappling with: Pay off a mortgage faster or focus on saving for retirement? We walk through the calculations and considerations to ask yourself to make your money work hardest.

Reminder: This is not financial advice; we are not licensed financial professionals. Please do your own due diligence.

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Katie:

Welcome back Rich People to the Rich Girl Roundup weekly discussion of The Money with Katie Show. As always, I’m your host, Katie Gatti Tassin, and every Monday morning Henah and I use Rich Girl Roundup to talk about listener questions, interesting money stories, thought exercises, casual financial topics, you name it. Right after a quick break.

So before we get into it, this week’s upcoming main full episode is about the growing movement of people who are buying homes with their friends. When housing is unaffordable and people are lonely, I suppose this outcome is unsurprising. Maybe we should have seen this coming, but we’re going to dig in. Okay.

Onto the roundup. Henah, how are we today? What are we talking about?

Henah:

We are good. This week’s question is going to sound very specific, but the reason that I love it is that it is also replicable for anybody who has this question and we get this type of question all of the time. It’s the classic, should I put extra money towards this or that? What is going to be more impactful?

So this one came from Natalie and she wrote, “I’ve been thinking a lot about the idea of front-loading life finances in an effort to eventually be comfortable with dialing back and enjoying some of the money later. Specific examples could be maxing out 401(k) contributions, taking on riskier investments, holding onto that sucky job that pays you well, being frugal, et cetera, et cetera, all while you’re young. And this would be relatively short term because it’s so high demand. In my instance, I’m 28 years old, I make about $110,000 a year as an engineer, and I’ve been living by this front-loading mantra for a while.

Last year, I significantly invested in a vacant family house to renovate for rental, and now I’m collecting rent from that investment. I took out a HELOC on my personal home to shoulder most of the cost, although I drained my savings too, which I know is scary. The ROI on the property is about four years, which is great, but I hate debt and I’ve been throwing everything I possibly can at it to cut the debt down. I’ve been considering temporarily dropping my 401(k) contributions from 12% of my salary down to 5% to get the employer match so that I could have even more leverage—my favorite word—over the debt and get rid of it faster. But I’m nervous because I understand that time and market is huge. So I’ve got a pretty decent nest egg in my retirement now. But do you think that six to nine months of minimal contributions could wreck that momentum? And for reference, my HELOC rate is about 9% and I started with $37,000 and I’m down to $25,000 in six months.”

So I know it’s a lot of details, a lot of context, and you might be like, why do I care? But again, this is a question we get so often, and Katie, I feel like you’ve really mastered the thought process of comparing doing the cost benefit analysis of both.

But before we do that, I just want to clarify that I do think if you are in this position, neither choice is probably a bad one. And if you are able to be in this position, you’re probably better off than 90% of people. With that, Katie, where would you start with this question?

Katie:

Well, so there are two things that I want to accomplish today. One is I do want to walk through the numbers and think through this type of trade off and how you weigh these things. To your point, I think it’ll be perhaps illustrative such that people can take that same thought process and apply it more universally. But I also want to talk about her broader question of front loading sacrifice and effort. So where do you want to start?

Henah:

Let’s start with the math. I feel like people have this specific question a lot.

Katie:

Okay, so here’s what I’m thinking. My brain is going, alright, if I’m understanding the numbers and her situation correctly, she has a HELOC that has a 9% interest rate and she is trying to pay that off more quickly. The comment about have even more leverage initially threw me for a loop because she was saying it with respect to paying down debt faster. And typically when you say more leverage, you’re associating that with taking out more debt rather than less such that your skin in the game, your cash involved gets a higher return and the rest of the money that’s being used is OPM, other people’s money. So if you are putting more of your own money on it. So I think that was just a semantics thing, but I did kind of clock that.

Henah:

So the leverage in her case is having more principle, having more ownership or equity in the home is how she’s referencing this.

Katie:

Right? She’s referencing like, ooh, I want to not pay as much interest, but that the wording initially kind of threw me. So I think if anyone heard that and was like, wait, you want more leverage but you’re paying down the debt faster.

I could be missing something, but that was just something that I wanted to call out. But it sounds like she’s only saying that because her rate is on the higher end, it’s 9%. So she’s considering, hey, should I contribute less to my 401(k) for a little while to pay this back faster? Now ordinarily the only thing that we would have to do is go, well, let’s compare our interest rate on the debt to the average real return of the stock market, which we know is around 7% per year on average compounding every year. To her point about time in the market, baby, you got to let that compounding engine run, but 9% is higher than 7%, which might indicate, okay, yeah, prioritizing this debt might be the better decision.

However, there is an interesting consideration here that actually I feel badly because when I initially wrote her back over email, it had not occurred to me yet. But as I was thinking through this episode, I realized we’re not just talking about the difference between paying off debt and investing. We are talking about the difference between paying off debt and investing in a pre-tax account, which means that every dollar we’re contributing is lowering our tax bill in a way that debt payoff.

Henah:

Phew. I just saw all of your notes, it’s like a full page going in on this and it truly is. I feel like the math meme lady.

Katie:

I guess I want to reiterate before we get into this two things. One is, I agree, I think she could go either way here and end up happy and it’s probably going to come out in the wash. And I think if you were going to really flesh this out full bore spreadsheet style, you would have to look at the full extent of both paths more than just over the next two years. But I want you to let me know if this makes sense. Tell me if you think this makes sense.

Henah:

It hit me, let’s go.

Katie:

So we know she’s got $25K left on the loan, right? She owes $25 grand. We know she’s paying 9% interest each year on it. We don’t know what her payment is. She didn’t tell us, but this is where I had to get creative. We know she is considering throwing an extra amount at it each month and we know that that amount equates to roughly 7% of her annual salary because she’d be dropping her contributions from 12% down to 5%.

Henah:

The way your brain gets to these conclusions blows my mind.

Katie:

Thank you for that gas. Thank you. For the hype.

Henah:

I wrote in my own notes and I was like, but we don’t know how much she’s doing. So this is just a shot in the dark. And you’re like, so by power of deduction, wow, okay, continue.

Katie:

A geometry proof. We know she earns $110,000 per year, right? So we are talking about the difference.

Henah:

How quickly will the train get to the station?

Katie:

Yes. Exactly. Okay, so we’re talking about the difference in 401(k) contributions between $13,200 per year plus a tax benefit worth around $3,000 per year. Assuming the 401(k) is traditional, if it’s not, all this goes to shit, you can stop listening now and just go back to the interest rate.

Henah:

And you’re assuming 22-24% tax bracket because she’s $110k?

Katie:

I actually went into SmartAsset income taxes and pulled the exact difference. It is $3,000 and 100 something, but I’m rounding down. So $3,000 bucks is the difference in tax bill. So it’d be either $13,200, that’s what she’s doing now. She’d be dropping it down to $5,500 a year, which drops to

Henah:

That’s the 5%.

Katie:

Yes, 5% of $110k is $5,500. So that drops her tax benefit to about a thousand. So the takeaway, right, the big flashing neon light is if she drops from 12% to 5% contributions in that pre-tax 401(k), her tax bill is going to go up by about $2,000.

Henah:

Which we didn’t account for when we originally wrote her back…

Katie:

Which we did not—put me on blast. No, I did not. I said, eh, compare the interest rates, you’re good. Make a decision either way is great. You’re doing amazing.

Henah:

Our bad, Natalie, our bad.

Katie:

All that to say, Natalie, the drop in contributions, say she moves forward with that plan, she drops her contributions, it’s going to give her $641 more per month to throw toward the debt.

Henah:

That’s the 7% that you’re referring to.

Katie:

That is the 7% difference. Correct. We have to make some assumptions about the original payment. We don’t know what her original payment was, but I assumed for the sake of my math that the original payment was around 500 bucks. And so now her higher payment with that 401(k) money she’s using is $1,100 a month.

So we know it’s $600 extra a month give or take. So that means that if she were to move from a $500 a month payment to an $1,100 a month payment, she’s going to pay it off over 26 months. So just over two years and she’s going to pay about $2,600 in interest over those two years. But she’s also giving up about $4,000 in tax benefits over that time.

Henah:

Right. Spread out over the years.

Katie:

Spread out over the two years. If she continues to pay only the $500 per month payment, that I’m assuming, again, we don’t know what it is, but for the sake of comparison we’re using $500 and she just keeps those 401(k) contributions the same. It’s going to take 63 months to pay it off over five years versus just over two and she’s going to pay about $6,400 in interest.

So the difference in interest between the two paths, taking time out of it, assuming you’re okay with the time difference, that’s around $3,800. An additional interest paid over five years though remember we still are keeping that tax break of about $2,000 per year and we’re getting money in the market. So that’s great.

I think, again, assuming I’m not missing anything here, I think the additional tax break element, which basically functions in this example like an investment subsidy kind of tilts the scales in favor continuing to do the pre-tax 401(k) contributions at the rate she is and making the minimum payments.

But I want to add the caveat that when I said, oh, you’d have to really flush this out entirely. If she were to drop the contributions, if she were to forego the additional $2k per year in tax benefits, pay off the debt really, really fast. You could argue that starting in year three now she can contribute even more to the 401k because she can add back the original that she stopped and now she has that $500 bucks—bingo. So she could actually contribute even more and get more of a tax break in the future. But I think that’s where someone smarter than me who can do net present value calculations would have to come in and go, what is the benefit and the value of having that tax break and that extra money now, not two, three years in the future?

Henah:

If they’re smarter than you, then I must be dumb as rocks because…

Katie:

You have been so nice to me, so shockingly nice to me today. Wow.

Henah:

Who knew? Okay, that makes a lot of sense.

Katie:

People are going to be writing in being like, what’s going on? Henah is being so complimentary.

Henah:

I always say this stuff to you, you just don’t ever share it.

So the only thing that I would also add here is that because she’s only 28, she does also have this really long time where we’ve said these early years are the most crucial for wealth building. And so I think ultimately if someone were to replicate this for their own life, they’d want to ask, what is the ROI on their property or investments or whatever they’re looking at across both options. What is the remaining balance and interest rate, but also what’s your risk level and timeline, so that you can really flush this out over the long run.

And I think that you can really run this with any set of parameters and not to give away your secret sauce, but I do think this is kind of the Money with KatieTM trademark approach to these things.

Katie:

Oh, thank you. Well, I feel like it’s just trying to think about all opportunity costs. And like I said, as I was doing this, I was like, this feels really obvious. I feel like I’m missing something. And that’s where I got into like, oh, but yeah, you’d have to go into year three and go, well, what would it look like to recoup that tax break? And then some in year three.

But I do think that having more money upfront, the extra $2000 a year to offset the interest you’re paying and to keep the money in the market is it is a subsidy. So hopefully that’s a useful comparison. But generally speaking, if you’re not getting any sort of tax break, you really are just looking at what is the interest that I’d be paying on the debt, which I know to your point about risk, I know what the interest rate is, I know what I’m going to have to pay. I don’t know what my return is going to be. I can look at history and take a guess and hope for the best, but investment returns are not guaranteed.

Henah:

I can hear Nick putting in the past returns are not indicative of future returns or whatever the—

Katie:

Drop it baby.

[Choir]:

Past performance is not indicative of future returns.

Henah:

Her broader question to me is more interesting as well, which is do I front-load all of this now in my twenties? And to your point, because you’ve also done this too, kind of do things a little bit unsustainably, putting your foot on full pedal mode and then wait or what do you recommend? And so I know we’re doing an episode on Coast FI, but I’m curious what you think about this topic at large.

Katie:

Yeah, so I love this question because an existential life question, it’s not even really a money question, it just shows up in money. How much do you sacrifice now to ensure a better life later? How much do you recognize that tomorrow isn’t guaranteed? So sometimes sacrifices are in vain, right? And there just so happens to be an additional wrench in the financial realm because it’s not just a comparison of do you want to do the work now or do you want to do it later? It’s more complex because of compounding. It’s like, do you want to do a little extra work now so you can have a lot of benefit later? Or do you want to have a ton of fun now and hope that it works out such that you can handle the heavy lifting when it’s time?

So I don’t know. I think in general, we are doing a roundup episode soon about this Coast FI topic, so might be useful for the dilemma more broadly. But to your point about my approach in my mid-twenties kind of saw that as the moment to put in a lot of the work. I think a lot of that was kind of the luck and timing of when I found the information. I do feel now that the three or so years of being, I would say, unreasonably dedicated and focused did, so far as I can tell, change the trajectory of things for me for good, God willing. Obviously anything could change, but I am in a vastly different position now than I was, and I credit a lot of that to those 36 months of just very intense focus. And now I feel like, okay, I have now unlocked a level of security. That means the sacrifices that I make now are very reasonable by comparison. So from this vantage point, I’m like, yeah, I’m glad I leaned into that very ascetic discipline when it felt good and it felt right to do so.

But it’s really hard to say for sure whether it was the right choice, no alternative version of my life that I can look at to compare what would’ve happened if I hadn’t. And I think that someone could make a case that there’s a chance you could have achieved the same outcome with a lot less effort and striving and stress and it would not have needed to be so hardcore for you to end up in the same position. But this is the dimension of reality that I live in. So it’s the only one that I can really speak from.

Henah:

Someone watched Dark Matter recently, I can tell; that book is great also, by the way. But first I mostly agree with you in the sense that I have seen just in the last two years of being pretty financially disciplined, how much I set myself up for success. And we could talk about that in the Coast FI episode, but I’m curious from your perspective where you said a lot less stress. What if it ends up shortening your life?

Katie:

Oh, good question. Alright, now we’re talking. Now we’re getting really existential. I don’t know.

Henah:

What’s the point if it kills you?

Katie:

I don’t know. I think that that’s a really good, I think that’s also why it had to be short-lived because I think the fact that it was unsustainable was very obvious to me at the time. And I am now in a position in a place where I kind of don’t think that that type of striving is worth it anymore. But it’s very easy for me to be in the position that I’m in now and say, yeah, it’s not worth it to go that crazy. I don’t know. I think that that’s something that remains to be seen.

Henah:

Or I guess the alternate question I would also offer is let’s say that you spent the last three years heads down really focused on work and then something happens with your family member. Would you be like I wish I hadn’t spent all that time. You know what I’m saying? It’s this unquantifiable thing that you’ll never really know. But to your point about, I don’t know if there’s another alternate version of my life, I guess for myself, I would think of if I had just continued on the path I was on, would I be where I am now? And I don’t think that’s the case and I feel like I made the right move, but to your point, yeah, there’s really no way of knowing. And oh, now I just very existential. I feel like we got to bring it to a…

Katie:

I know I’m like, we’ll save the meat for the Coast FI, but I’m glad that she brought that up. I think that that posture, that approach to life, I think does people naturally gravitate to one side or the other of it? I think some people have that tendency to associate, oh, if I can just get ahead on it. I even remember, I’ve always been this way even in school. I wanted to be the first one done on the assignment. I’m like, if I can get ahead on this, then I can be ahead on this assignment. It’s like I’ve always been in a hurry. I don’t know where I’ve been trying to go, but I’ve always been in a hurry to get there.

And I think that some people naturally have more of the YOLO mindset, which in some ways is very beneficial and very healthy and then in other ways can get you into a jam. So whether you fall on one end of the spectrum or the other, usually you spend a lot of your time, effort, and energy trying to modulate back to something a little bit more balanced in the center.

Henah:

Well, I think that’s a good note for us to end on before we move to a money story.

So kind of inspired by the fact that Natalie is running all the numbers for herself. Someone who wrote in after our financial advisor episode and their name is Erich, and they said it captured my interest because a financial advisor from a very popular company, like a household name company, ripped off my parents.

Katie:

Name and shame.

Henah:

They asked me not to name them, but I’ll tell you off the record.

Katie:

We should have a name and shame list. We should follow Ramit’s footsteps and just have a list of banks and companies that were like, no, hard, no.

Henah:

So they said, so my dad managed all of my parents’ financial matters, although not well, I would soon learn after his passing. My mom handed me her statement from the bank asking, what’s this? And I immediately saw that they were being swindled. A 2.5% management fee plus the guy was turning over a hundred percent of their portfolio every quarter, no doubt, to snag more fees and commissions.

Katie:

Oh, I want to name and shame so bad. Fuck this bank.

Henah:

Their advisor was a busy little beaver buying and selling like a madman. And ironically, amazingly, in the 30 years he managed their money, he never once beat the S&P 500. So I question your advice about sending your financial advisor a nice templated letter saying, thanks, we decided to go in a different direction. Doesn’t a heads up before you hit transfer just give these shady characters one last chance for a big buying and fee binge or just outright taking your money. I don’t understand why these characters deserve a nice letter. Thanks, love your show, et cetera. And then they said, you and I are very talented and charismatic and funny and we should consider the comedy club circuit as a side hustle.

Katie:

Thank you for knowing that. Kidding.

Henah:

Thank you. But I was like, that sounds horrifying. I’m so sorry that happened to you. But I would say in this case, it feels like a case by case basis is based on how sleazy or not your financial advisor was.

Katie:

Yeah. If you are getting fucked over that dramatically, do not be expecting a letter from me. I absolutely would not recommend the courteous goodbye. I would be yeeting my stuff out of there and never speaking to them again. But I do think that part of the reason we wanted to include that template was because a lot of people that we’ve heard from will take pains to mention in their email that this is a family friend or this person has been really great, or there are a lot of shady characters. There are also a lot of really nice genuine people that work in this industry that charge AUM fees that just aren’t what’s best for you. So I am a hundred percent on board: Yeet and don’t apologize in this case, that’s horrible.

Henah:

GTFO. The 100% turning every quarter was just wow. So I am so sorry that happened to you, but appreciate you sharing this with us so that other people can also look out for this on their own statements and see if this is happening to you.

Katie:

Yeah. Thank you Erich. Alright, well I think that’s it for this week’s Rich Girl Roundup, and we’ll see you on Wednesday to talk about whether or not you should buy homes with your homies.