When I get emails from readers, I try to answer all the question I receive. Usually I keep the contents of those emails confidential, but occasionally the individuals allow me to share their “case” as long as I keep their identity secret.
Today’s post is going to be one of those case studies from my mail bag…we shall call this gentleman “Mr. Cricket”.
Mr. Cricket writes to me with the following situation (edited for brevity and clarity):
I’d like to be where you are in a few years as a stay at home dad, but I’m having a hard time determining if I’m close to having enough or not.
I’m a 48 yr old male, recently married(2nd time). My wife is 35 and just finished getting her PHD in Child Development. She got through school without any student loans, but has no 401k, IRA or brokerage account.
We are about to have our first child and I’d love to do what you’re doing, staying home with your children. Since my wife has just gotten her PHD, she’s actually looking forward to getting a job perhaps in a few years after staying home for a few years. I don’t want to be a pessimist, but she is likely to end up in academia, research or a school system, which means she won’t have a high salary.
401k(maxed every year) – $196k
Roth IRA(maxed every year) – $152k
Rollover(Traditional) IRA – $169k
Brokerage Account – $106
Checking – $10k
HSA – (just started this year)-$1.2k
House estimate – $600k (160k owed)
Total assets: $1,074,000
Debt – None (Other than house).
Monthly expenses – $4000
It looks like Mr. Cricket is doing great financially! He’s got roughly 1 million in assets and no debt other than the mortgage!
He’s killing it! Right? What could he possibly be worried about? Let’s dig-in!
Mr. Cricket has been saving lots, and piling up money in his retirement accounts like a madman. Nice job Mr. Cricket! Now that he’s got a nice bit of money saved up, he’s wondering if he should really have it all stashed there…
Should I switch over from maxing out my 401k and only contributing to get my employer match at 4% of salary? Then start piling up money in normal after tax brokerage account?”
I’m going to assume Mr. Cricket wants to avoid paying early withdrawal penalties while living off his portfolio income. That’s usually the case.
Frankly, if he needs to start drawing down his pre-tax accounts immediately, there’s no great way to do this.
There is the Roth IRA Conversion Ladder, but it will take 5 years to get a proper ladder setup and going. Mr. Cricket does not want to start the conversions when he’s still working…the taxes would be a killer!
So what’s going to bridge the gap for those 5 years? He currently has $275k in brokerage and Roth IRA accounts. Using the standard 4% rule (which I think is too high anyway), that’s only $11k per year to live off. That’s a low annual income. Probably lower than I would be comfortable with.
Now, we if we consider that Mrs. Cricket will start working soon, won’t that make up the difference?
Her salary could help bridge the 5 year gap, but it would also limit how much he can convert into his Roth IRA Conversion ladder (assuming he wants very low tax rates for the pre -> post tax conversion). I don’t think he wants to do this while she’s still working.
My suggestion? Keep saving into the post-tax account, but definitely take the 401k match.
Save up enough so they can live off either his wife’s salary or his post-tax investment accounts. While Mr. Cricket’s wife is working, he can keep banking his investment returns and grow the portfolio. If she loses her job, nobody is going to go hungry or sleep in a box, because they’ll have his post-tax investment income to live off.
When Mrs. Cricket does officially quit working, that’s a good time to start the conversion ladder to free-up those 401k dollars at low tax rates.
Mr. Cricket further inquires…
Would you be comfortable with the numbers I presented? I know a lot of people don’t agree due to the low interest rates on mortgages, but I feel if I can somehow get the house paid off, I’d be comfortable with the numbers.
In this situation, over half of his net worth is in his house. Many in the early retirement community want to pay off their mortgages, but I think this is a poor idea. You can’t eat a house. It doesn’t put food on the table. Unless he turns his home into a rental it’s going to consume cash, not generate it.
An early retiree needs income, and the ability to grow his cash flow over time to beat inflation. He needs to choose to allocate capital to the best return available, not a big wood box.
Mr. Cricket is no fool. He’s also worried about generating income after he quits working. He asks if he should change his investment strategy…
I don’t have enough dividends to sustain our expenses. I always concentrated on capital appreciation stocks, but have been converting over to dividend yielding assets for stability and income. In your opinion, if I decide to quit my job in a couple years, would you continue converting over capital appreciation to dividend yielding?
This is actually a very interesting question about investment strategy!
At his age, I wouldn’t focus on just generating dividend income. He’s got lots of life left ahead of him. He’s going to want portfolio growth over the coming decades of his life.
If Mr. Cricket switches out to a portfolio of high-dividend payers, he’ll be sacrificing growth for a larger current income.
Quite simply, if a company pays out a large percentage of net income as a dividends that means less cash for investing in growth. Remember that post about Return On Capital? Less capital around = less compounding!
If you want your money to grow AND you want dividends, stick with companies that have a high ROIC. They should also grow faster than inflation, have a dividend payout ratio under 50%, and a yield near the target withdrawal rate (2% to 4%).
Investing in this “balanced” way will ensure compounding growth of assets over time, AND derive optimal current dividend income without the fees associated with selling shares for a capital-appreciation strategy.
The Mental Factor
As a stay at home parent, I have to remind Mr. Cricket it’s no cake-walk.
Before you take the leap, make sure you’re mentally and physically ready for it. I actually think I work harder now as a stay-at-home parent.
Can you handle your kids all-day every-day, and still stay sane? I seriously doubt my sanity some days!
There’s also social factors to consider – Certain individuals in society still think a man has to be The Provider, and a woman should be The Homemaker. It’s sad, but true.
When people ask me what I do, I usually say “I’m a stay-at-home dad”. Unsurprisingly, I get a lot of funny looks, and not a lot of encouragement.
People think I should be working, not “hanging out” with the kids. This kind of thinking is sexist, outdated, and backwards. Many people are just not comfortable with non-traditional family roles.
Mr. Cricket needs to be certain he can deal with these outdated modes of thinking before taking the leap to stay home with the kids!
That wraps-up our first reader case study. Thanks to Mr. Cricket for allowing me to post his questions and financial details. Good luck to you Mr. Cricket!
Until next time…
[Image Credit: Flickr]