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Archive for February, 2009

Depreciation can be your friend

February 16th, 2009 at 07:30 pm

I had some free time today so I went to Kelley Blue Book (/http://www.kbb.com) and updated the values of our 2 vehicles. I track these values in Quicken because it gives me a sense for how fast vehicles depreciate (hint: very).

Our 2003 Subaru is worth about $10 grand. The original MSRP was $25.5K. So in 5.5 years it has lost just over 50% of its value. A good chunk of that (about $3000) occurred in the last year. New car sales have been so pitiful that it is pushing down the used car market as well.

Our 2nd car is a 98 Subaru station wagon. It's pretty utilitarian but it gets us around when we need it (I work from home so I don't need a daily vehicle). It has around 90K miles on it and its value has dropped to $5100. We paid $6700 for it 2 years ago so that's not too bad. Depreciation slows a lot after the first 5 years, in general.

The good news is that we are getting close to the point where we could just go to liability coverage on the 98 Subaru. Our insurance is really cheap so we are keeping full coverage for now, but another couple of years of depreciation and we might drop it! If we dropped collision and comprehensive on the 98 Subaru, we would save $220 a year on our insurance. If the car was ever stolen or totaled and we were going to file a claim, we would get back the blue book value minus our $1K deductible. Right now, that would be $4100. That works out to an 18-year breakeven period. When it gets down to about 12-15 years we will drop the comprehensive/collision, but for now it makes sense to keep it.

New addition (edition?)

February 16th, 2009 at 05:19 pm

Well, it's official. We saw the sonogram last week, and we are having another baby! We had a hard time getting pregnant the first time, but this time it only took about 2 months, so we must be getting better at it! Obviously, this is a huge change for our lives in general, but it has specific effects on several areas of our finances:

Taxes
With an additional exemption and child tax credit, my estimate is that our federal tax bill will go down by $1900, and our state taxes by $250.

In 2008, we were just on the cusp of the 15% federal tax bracket, which is a good place to be. With the additional $3650 exemption, we can now reduce pre-tax 403b savings by $3650 and still be on the cusp of the 15% bracket. We will increase our Roth savings by $3650 to keep the same savings percentage. So some of the tax savings will be reduced by cutting back on the 403b contributions. The rest of the tax savings will go towards our increased expenses.

Day care
My wife works part time, so our daycare needs are reduced already. My mother will be watching the kids once a week. We have a nanny for the other 2 days. We will probably give her a significant raise due to the increased workload. This will increase our daycare costs from around $800 a month to about $1000.

Maternity leave
We were not expecting to get pregnant so quickly, so we will come up a bit short on leave. My wife earns 6.5 hrs every two weeks of general leave (sick, vacation & personal). Right now she has saved up about 84 hrs. If #2 is on time, she will have about 171 hrs by the time she has to take her leave. Her short term disability will cover 6 weeks at 60% pay. The rest comes out of paid leave, and then unpaid leave when she runs out. We are calculating that we will only need to take 2 weeks of unpaid leave, so this is a fairly minor hit to our budget.

Expenses
We will definitely see some increases in our weekly expenses (diapers, clothing, food). My wife plans to breastfeed again so we won't need formula. Except for the diapers, we are expecting these expenses to increase pretty gradually so we will adjust to them when we notice a big difference in our budget. Probably we will see some cost savings in other places since I think it will be harder to go out.

Overall, the effect on our budget will not be nearly as drastic as when we had our first child. However, I know my sleeping budget is going to see some serious cuts!

ESPlanner vs. Sherman Hanna's spreadsheet

February 4th, 2009 at 03:25 pm

A comment to my recent post reviewing the ESPlanner software guided me to a finance professor named Sherman Hanna, who created a consumption smoothing spreadsheet, called LCS. The commenter was curious how this (free) LCS spreadsheet compared to the fairly expensive ESPlanner software ($149 for the basic, $199 for the premium with Monte Carlo simulation).

I did a basic test using my family as a test case. My family consists of myself (33), my wife (32), and my daughter (2), with another child expected in the next year. I started with $70K in retirement savings and approximately $120K/$100K in pre/after tax earnings. I assumed we paid for both childrens' college in full, at a price of $20K per year per child (today's dollars). I tried to put the same inputs into both software, although it's not always possible (ESPlanner wants pretax income, and LCS after-tax; ESPlanner calculates Social Security for you based on your earnings, and LCS wants you to input expected SSI, for example). I assumed early retirement at age 60, and taking SSI at age 70, with 75% of the projected benefit. The results? A huge variation between the programs. Here are my observations.

Inputs into LCS were much simpler. The program only needed a few basic numbers to give you a initial estimate. I'd venture that the estimate is only as good as the numbers you put in though. Digging deeper you find that most of LCS assumptions can be changed manually, which allows as much or as little detail as one would want. ESPlanner requires a thorough breakdown of most aspects of your finances. ESPlanner, while somewhat rough around the edges, is several orders of magnitude more streamlined in its interface. With LCS, you pretty much need to know Excel inside and out.

Outputs from LCS are pretty rough as well. Printing a pre-defined print-area will give you some basic summary info in both table and graph form. ESPlanner's output is better, starting with a formatted PDF summary document, along with supporting spreadsheets (ESPlanner uses Excel as the engine to do its calculations).

However, the biggest difference between the two is the handling and definition of "consumption". ESPlanner defines household consumption as gross after tax spending minus housing expenditures (mortgage, tax, maintenance, insurance). Housing expenses are entered in detail fashion (including loan info and schedule). Then ESPlanner calculates a household factor which is based on the number of adults and children. It assumes some economies of shared living. So 2 adults can live together as cheaply as 1.6 singles (by default). Children are handled in a similar fashion. It divides the household consumption by the household factor to give the "consumption per adult". Then it attempts to smooth the consumption per adult over the family's lifetime. The whole approach seems reasonable to me, and the economies of shared living data is based on studies that have been done.

On the other hand, the LCS approach is somewhat different. The LCS formula uses a complicated ratio of household size, likelihood of death, and "thriftiness factor" to approximate the change in spending from one year to the next. All expenses are lumped together, including housing, and no allowance is made for paying off loans. This causes spending to change relatively slowly from year to year, even if the household changes size drastically. This approach does not seem as intuitive or reasonable to me as the ESPlanner method.

The two programs produce drastically different spending plans in our case. Here is a chart detailing the 2 different savings plans.
Here is a chart detailing the 2 different spending plans.

ESPlanner recommends saving only $9000 this year (including all retirement contributions), with savings generally growing up to about $20K just before college, whereupon savings basically stops, resuming gradually as each child graduates, and peaking at $55K just before retirement. This produces a living standard per adult of $35880 in today's dollars up to age 100. Remember that ESPlanner does not include housing costs in consumption. Including housing, total household spending is in the range of $90-95K pre-college, and around $65K afterward (the "Empty Nest" phase).

LCS recommends saving $20K this year, increasing to $32K in 2 years, and then gradually decreasing to around $20K by the time the kids reach college. Household spending (including housing) starts at $80K and basically rises continuously throughout life, reaching a peak of $105K at age 75, and then gradually declining to $66K at age 100.

Since these plans are very very different, they obviously cannot be both be right. For me, it comes down to whether you think spending follows the ESPlanner model (non-housing spending is strongly correlated with household size) or the LCS model (overall spending grows throughout life and changes very slowly with household changes). Also, ESPlanner's treatment of housing expenses as separate from consumption seem more logical to me. Your housing expenses would not change much if a child moved out, but your food and entertainment costs would likely see big drops. LCS seems to make only a small allowance for this. Also, the fact that ESPlanner allows for loans to be paid off is a big plus for me. In LCS, it is probably possible to enter housing costs manually as line item expenses which could be drastically reduced when a loan is paid off, but I have not tried this as of yet.

The big price tag for ESPlanner will likely discourage many but I believe the accuracy of its planning tools makes more sense for detail-oriented planners. On the other hand, LCS freeware nature, combined with a more conservative spending model, will probably suit many just fine.

LCS can be downloaded from http://hec.osu.edu/people/shanna/lcsprogram.htm, and an explanation is available at http://hec.osu.edu/people/shanna/lcs/overview.htm.

ESPlanner is available for purchase at http://www.esplanner.com.