Jess is a single mom of two young daughters living in northern California along with their opinionated four-year-old Siamese cat. Jess works for herself as a freelance writer/public relations consultant, which is a job she loves. After getting divorced in 2020, Jess went on to buy her own home and chart her new life as a single parent. Although Jess has done a great job setting herself up with a fulfilling career in a place she loves living, she’s concerned about her long-term financial future. She’s asked for our help in analyzing whether she should take a higher-paying job or if there are other ways she can stretch her income.
What’s a Reader Case Study?
Case Studies address financial and life dilemmas that readers of Frugalwoods send in requesting advice. Then, we (that’d be me and YOU, dear reader) read through their situation and provide advice, encouragement, insight and feedback in the comments section.
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The Goal Of Reader Case Studies
Reader Case Studies highlight a diverse range of financial situations, ages, ethnicities, locations, goals, careers, incomes, family compositions and more!
The Case Study series began in 2016 and, to date, there’ve been 94 Case Studies. I’ve featured folks with annual incomes ranging from $17k to $200k+ and net worths ranging from -$300k to $2.9M+.
I’ve featured single, married, partnered, divorced, child-filled and child-free households. I’ve featured gay, straight, queer, bisexual and polyamorous people. I’ve featured women, non-binary folks and men. I’ve featured transgender and cisgender people. I’ve had cat people and dog people. I’ve featured folks from the US, Australia, Canada, England, South Africa, Spain, Finland, the Netherlands, Germany and France. I’ve featured people with PhDs and people with high school diplomas. I’ve featured people in their early 20’s and people in their late 60’s. I’ve featured folks who live on farms and folks who live in New York City.
Reader Case Study Guidelines
I probably don’t need to say the following because you all are the kindest, most polite commenters on the internet, but please note that Frugalwoods is a judgement-free zone where we endeavor to help one another, not condemn.
There’s no room for rudeness here. The goal is to create a supportive environment where we all acknowledge we’re human, we’re flawed, but we choose to be here together, workshopping our money and our lives with positive, proactive suggestions and ideas.
And a disclaimer that I am not a trained financial professional and I encourage people not to make serious financial decisions based solely on what one person on the internet advises.
I encourage everyone to do their own research to determine the best course of action for their finances. I am not a financial advisor and I am not your financial advisor.
With that I’ll let Jess, today’s Case Study subject, take it from here!
Hello Liz and Frugalwoods readers! My name is Jess and I’m a 37-year-old single mom of two daughters, ages 6 and 9, living in beautiful Northern California. I have lived in this region most of my life and we have family nearby. My daughters live with me a little over half the time and we have an opinionated four-year-old Siamese cat. I have been a freelance writer/public relations consultant for about 6 years, and I absolutely love the work and the freedom that freelancing offers me. I’m also very involved in my kids’ school and activities, thanks to the flexibility of my work. Life with elementary-aged kids is full of sports, birthday parties, dance class and lots of fun!
Jess’s Hobbies and Lifestyle
When it comes to fun and hobbies for myself, I love hitting the gym and yoga classes, snow skiing, playing tennis, cooking and enjoying the great food and wine in my region. I also like to hike and travel with my boyfriend and spend time with friends and family.
I got divorced in the middle of 2020, because why not throw everything into the air during a pandemic? In all seriousness, it has been a healthy growth experience – fortunately at this point we are all living happy, healthy lives and the kids’ dad and I are good co-parents. It’s not perfect, but we are doing well. Financially, we split everything down the middle so it was a pretty clean break.
I’ve been in a serious relationship for awhile now, and at some point we see a future of combined households, which could change this whole picture – but for now my household is just me and my girls.
What feels most pressing right now? What brings you to submit a Case Study?
I hit a wall recently with work and my income has dropped a bit. At the same time, I bought a house on my own in April (I rented for almost two years post-divorce) and with the market the way it was, let’s just say I paid top dollar. While I qualified for the payment and technically can afford it, it’s tight each month, especially with the slowing of my client work and income. I am working to boost my income and identify new clients/projects, and am also trying to adjust my expenses so there’s more to work with. While the house is the obvious financial liability, it’s also not one I’m willing to sacrifice. We love this home and I am going to do whatever it takes to make it work.
With the big mortgage plus kid costs (activities! Sports! Field trips! Fundraising!) and the cost of living in California, I feel like I am just hemorrhaging money sometimes with not a lot left for fun (can’t a girl get a pedicure!?). I do split kid-related costs with my kids’ dad, which helps, but it can be tight.
The biggest challenge because of these factors is that I feel like I’m not saving enough, especially for retirement, now that I’m on my own. When I got divorced, we split our retirement down the middle and so now I feel like I’m playing catch up. Last year I was really proud to save a little over 10% of my income – I know that’s not quite as high as some experts recommend, but for a single mom, it felt good. I was also putting a lot into my house fund at the same time. This year I haven’t saved nearly that much. I also wish I had more to put away to boost my emergency fund and set aside cash for travel and mid-term expenses so I don’t have to cash flow them.
What’s the best part of your current lifestyle/routine?
I absolutely love the area where we live. It’s a wonderful small town near a bigger suburb, and I wouldn’t change the location for anything. It’s a kind and caring community, we have a great school district, and everything is really easy to get to – we never spend excessive amounts of time driving around to activities or errands, etc. We also have tons of access to the outdoors – lakes, hiking and biking trails, and just an hour or two from world-class skiing in Tahoe.
I would also say the work schedule I’ve built for myself is ideal. I do work hard and on a regular schedule, but I rarely have to work more than 30 hours per week. I’m able to handle personal or household needs between calls or writing projects, for example, and I don’t have to answer to anyone but myself. It also allows me to get in a midday workout or run errands during the day so I have more time later to spend with my girls. The freedom/flexibility is unmatchable.
What’s the worst part of your current lifestyle/routine?
My mortgage feels so expensive! I knew what I was getting into when I bought the house in April, but projection vs. reality feels different, especially as I noted with a dip in my income. And with an expensive mortgage, everything else starts feeling too high. (I did buy this home with the intent to either stay here forever if I’m single, or to turn it into a rental property if my marital status changes in the future and we eventually want to move.)
The mortgage combined with a lack of retirement and health benefits also makes being my own boss stressful. Sometimes I feel like I should just work full-time for an organization for the stability and 401k match + health insurance – but then I realize it’s hard to find a salary to match what I’ve built for myself, especially working the hours I do.
There’s one more component I struggle with, too, which is a bit less tangible. Since becoming a sole income earner, I find I am very fearful financially of going broke, running out of money, having financial disaster strike, etc. It’s more of a psychological issue than a financial one. It’s driven me at times to not put money into retirement because I feel like a cash cushion provides me more stability given our circumstances.
Where Jess Wants to be in Ten Years:
I want to remain debt-free other than my mortgage.
- I want a solid six-figure income with room to save at least 15% into retirement.
- I’d also like to have my mortgage be more in line with recommended ratios and have it look more like a 15-year mortgage than a 30-year.
- I would like to have some type of rental/income property in 10 years.
- I envision being happily remarried, preparing to send my girls off to college, and looking forward to the next “empty nest” chapter with some financial freedom on my side.
- I expect I’ll still be enjoying many of the same hobbies and activities!
- I could see myself still working independently as long as I keep hustling to stay where I need to keep maintaining (and ideally growing) financially.
- On the other hand, I’m open to moving into a full-time, in-house role with a good company if I find the right fit.
|Item||Number of paychecks per year||Gross Income Per Pay Period
(total BEFORE all deductions)
|Deductions Per Pay Period (with amounts)||Net Income Per Pay Period
(total AFTER all deductions are taken out)
|Jess’ income (self-employed)||12||$10,000||Estimated taxes: $2,500 (note, I typically get back a large chunk in tax refund — anywhere from $5k to $9k, but my accountant prefers I pay plenty upfront)||$7,500|
|Annual gross total:||$120,000.00||Annual net total:||$90,000.00|
|Item||Outstanding loan balance||Interest Rate||Loan Period and Terms||Equity||Purchase price and year|
|Mortgage on primary residence||$533,000||4.30%||30-year fixed-rate mortgage||$52,000||$585k; purchased in April 2022|
|Item||Amount||Notes||Interest/type of securities held/stock ticker||Name of bank/brokerage||Expense Ratio||Account Type|
|Roth IRA||$62,540||My Roth IRA. I try to max this out annually. No match.||ETFs and Mutual Funds||Schwab||Retirement|
|Traditional IRA||$53,935||Money earned through previous employer retirement plans and rolled over.||ETFs and Mutual Funds||Schwab||Retirement|
|529 College Fund: Kid 1 (age 9)||$16,930||We started these when the kids were babies. We have very generous grandparents who have helped fund them!||ETFs and Mutual Funds||Merrill||College fund|
|Savings account||$14,600||This is my emergency fund. Slightly lower recently because of unexpected medical bills and moving costs.||Earns .02% interest||Bank of America||N/A||Cash|
|529 College Fund: Kid 2 (age 6)||$11,935||We started these when the kids were babies. We have very generous grandparents who have helped fund them!||ETFs and Mutual Funds||Merrill||College fund|
|SEP IRA||$1,511||This is an additional retirement account I opened for the years where I’m able to go beyond the max in my Roth IRA.||ETFs and Mutual Funds||Schwab||Retirement|
|Vehicle make, model, year||Valued at||Mileage||Paid off?|
|Toyota Highlander, 2015||$24,000||100,000||Yes|
|Mortgage||$3,396||This includes $89 in PMI, which I would like to get rid of sooner than later!|
|Groceries||$650||Includes household supplies (such as toilet paper) as well as cat food.|
|Health insurance||$395||I pay for insurance out of pocket through Covered California|
|Retirement savings||$350||Listing this as an expense because it’s an item I pay for out of pocket after I pay myself. My goal is always 10% of my income, but this year I haven’t been able to swing it. In my tighter months I don’t save at all.|
|Utilities||$277||Gas/Electric: Avg. $165/month, Sewer: $400 a year: Trash: $400 a year, Water: $45/month|
|Gas||$275||Fortunately I don’t have high mileage so I can keep gas bills relatively low|
|Kids activities||$275||Includes birthdays, sports, dance classes, school field trips, after-school care, summer camps, etc.
This is my half — their dad pays for the other half of all these expenses.
|HOA||$257||Covers my gutter cleaning, roof replacement and front yard maintenance|
|Medical expenses||$245||This is not a typical line item but I’m including it anyway; I had a bit of a health issue this year that cost me nearly $3k out of pocket|
|Restaurants/coffee||$225||Pizza nights with the kids, occasional date night, etc.|
|Vacation/travel||$200||I usually save for travel in three-month stretches, but this is probably the average monthly breakdown|
|Emergency Fund savings||$200||Trying to boost this fund back up as it’s not quite enough for my comfort after buying my house. In my tighter months I don’t save at all.|
|Gym membership||$150||It’s expensive but I value fitness and love this option to get me out of my house since I’m ALWAYS here|
|Charitable donations||$125||Not something I want to cut|
|Christmas||$125||Averaged over the year|
|Car insurance||$104||Triple A, bundled with my homeowners insurance|
|Household supplies||$100||This includes essentials plus the occasional home décor splurge or things like towels, sheets, etc.|
|Housekeeper||$90||This could be considered a “luxury” but it’s a monthly sanity saver for a single working mom!|
|Car maintenance||$75||Estimate of the average breakdown including regular and major mileage maintenance, tires, etc.|
|Personal care||$75||Hair cuts, occasional pedicures, beauty/hygiene products|
|Subscriptions||$54||Netflix, Disney+ bundle, Discovery+, Spotify, Audible|
|Gifts||$50||Includes family/friend birthdays, kids’ birthdays, etc.|
|Entertainment||$50||Averaged over the year|
|College savings||$40||I only contribute a little bit to the kids’ funds at the moment. We are fortunate to have generous grandparents who are putting a lot in for our kids! When I have more funds freed up and am meeting my retirement goals, I’d like to increase this.|
|Mobile phone||$20||Switched to Mint Mobile in October!|
|Dental insurance||$16||I pay for insurance out of pocket through Covered California|
|Annual total:||$94,560||NOTE: I realize this technically puts me in the red…yikes!!|
Credit Card Strategy
|Card Name||Rewards Type?||Bank/card company|
|Bank of America Rewards Card||Cash back||Bank of America|
|Item||Annual Amount||Year and age you’ll begin taking SS|
|Jess’ anticipated social security||$47,388||2055, age 70|
Jess’s Questions for You:
1) Is there a better or more creative way to set aside money for retirement that I’m just not seeing?
2) Since I can’t change my mortgage, what other expenses could I cut?
3) Should I be pursuing a full-time job with benefits instead of trying to make freelancing work in my situation?
4) How can I release my financial fears and stop looking to dollar signs for security?
Liz Frugalwoods’ Recommendations
Jess has just come through several very stressful, tumultuous life events–pandemic, divorce, moving and buying a house–with her finances intact! Jess, you should feel tremendously proud of what you’ve been able to accomplish in a few short years. I’m so impressed with your determination to provide a wonderful home for your girls, sustain a job and work/life balance that fulfills you and continue saving and investing for retirement. Many congrats on getting to this point and I hope that today we can help you see even further down the financial road. Let’s dive into Jess’s questions!
Jess’s Question #1: Is there a better or more creative way to set aside money for retirement that I’m just not seeing?
In general, there are three ways to save/invest more money:
- Earn more
- Spend less
- Do a combination of both
Jess currently has $62,540 in a Roth IRA, $53,935 in a traditional IRA and $1,511 in a SEP IRA for a total of $117,986. Let’s take a look at where Jess stands according to Fidelity’s Retirement Rule of Thumb:
Aim to save at least 1x your salary by 30, 3x by 40, 6x by 50, 8x by 60, and 10x by 67.
Since Jess is 37, let’s go with 2x her salary, which would be $240,000 (2 x $120,000). What we’re looking at here is how much Jess should have, at this point, if she intends to work until a traditional retirement age and then draw down a sustainable percentage of her retirement investments to live on each year.
In light of that, Jess is correct in her assessment that she should beef up her retirement savings. Let’s first take a moment to talk about the types of accounts she has available to contribute to and why it’s important to invest for retirement in the first place–and not just save up a bunch of cash.
Also, remember that this total doesn’t include her Social Security, which is inflation-adjusted, and which she projects will be $47,388 a year starting at age 70.
What you want to be able to do in retirement is draw down a sustainable percentage of your overall investment portfolio to live on each year. You want to have enough invested to allow you to do this for the duration of your retirement.
Many experts consider 4% to be a sustainable rate of withdrawal. If, for example, you know you want to spend an inflation-adjusted $50,000 per year in your retirement (and not run out of money before you die), you’d need to have $1.25M in retirement investments at the time of your retirement (because 4% of $1.25M = $50,000 per year).
The reason to invest for retirement—as opposed to just saving cash for it—is threefold:
- There are tax advantages to utilizing retirement accounts
- There are grave disadvantages to cash (opportunity cost and it doesn’t keep up with inflation)
- There are advantages to investments (namely, anticipated rate of return)
Here are the Retirement Accounts Available to Jess:
1) Roth IRA
Jess already has one of these, which is fabulous. IRA stands for “Individual Retirement Account” and there are two different primary types of IRAs: Roth and Traditional. The difference between the two is in how they’re taxed.
- A Roth IRA is a retirement account that’s post-tax:
- That means you pay taxes on the money you put into a Roth IRA, but you don’t pay taxes when you withdraw the money in retirement.
- A Traditional IRA is a retirement account that’s pre-tax:
- That means you don’t pay taxes on money you put into an IRA, but you do pay taxes when you withdraw the money in retirement.
- A person can have both a Roth and a traditional IRA, but their combined annual contribution to both can’t exceed this $6,500 ($7,500 for ages 50+) limit.
A Roth typically makes the most sense if your income is on the low end because in that case, your tax rate is low and so it doesn’t matter that you’re paying taxes on your contributions.
Based on this chart from the IRS, Jess is indeed eligible to contribute to a Roth IRA because her MAGI (modified adjusted gross income) is less than $138k/year (assuming she correctly reported her income above).
2) Traditional IRA
Jess has one of these too. However, from a tax perspective it will likely make the most sense for her to concentrate her contributions to her Roth IRA. Again, you can only contribute $6,500 total to both a Roth and a traditional IRA, which means she should focus on getting her Roth contribution up to $6,500 per year. She can just let her traditional IRA sit in the stock market and grow.
3) SEP IRA
Jess has the triple crown of IRAs with her SEP IRA, often referred to as an IRA for self-employed people because they’re available to businesses of any size (which includes business of one, like Jess’s). SEP contribution limits are a bit more confusing, but the IRS helpfully explains as follows:
Contributions an employer can make to an employee’s SEP-IRA cannot exceed the lesser of:
- 25% of the employee’s compensation, or
- $66,000 for 2023
Since Jess’s gross annual income is $120k, she’s eligible to put $30k into her SEP IRA each year. Even though this plan has the name “IRA” in it, per our buddies at the IRS, you are still allowed to contribute to it as well as the full $6,500 to your Roth IRA.
Grand total, between her Roth and SEP IRAs, Jess could sock away $36,500 in 2023 ($30,000 into her SEP + $6,500 into her Roth), which breaks down to $3,041.66 per month.
Now that we’ve established what Jess is legally allowed to contribute to her two retirement accounts, we need to determine where she’ll find this money. And so, let’s go to…
Jess’s Question #2: Since I can’t change my mortgage, what other expenses could I cut?
Anytime someone is interested in saving more money, I start by categorizing all of their spending as Fixed, Reduceable or Discretionary. These three categories allow us to see where reductions are possible:
- Fixed expenses are things you cannot change. Examples: your mortgage and debt payments.
- Reduceable expenses are necessary for human survival, but you control how much you spend on them. Examples: groceries and gas for the cars.
- Discretionary expenses are things that can be eliminated entirely. Examples: travel, haircuts, eating out.
Now that we know which items have leeway, I went through and assigned a “Proposed New Amount” to each line item. Only Jess knows which items are priorities and which items she can reduce, but the below spreadsheet gets this exercise started for her:
|Item||Amount||Notes||Category||Proposed New Amount||Liz’s Notes|
|Mortgage||$3,396||This includes $89 in PMI, which I would like to get rid of sooner than later!||Fixed||$3,396||Jess is correct that this is really high, but, she articulated that this is her highest priority and she doesn’t want to sell her house.
In light of that, we’ll work to determine other areas where reductions are possible.
|Groceries||$650||Includes household supplies (such as toilet paper) as well as cat food.||Reduceable||$500||This is already pretty low, but, it is an area where reductions could be made.|
|Health insurance||$395||I pay for insurance out of pocket through Covered California||Reduceable||$395||Jess, have you looked into subsidies through the state of CA? I assume you have, but double checking just in case.|
|Retirement savings||$350||Listing this as an expense because it’s an item I pay for out of pocket after I pay myself. My goal is always 10% of my income, but this year I haven’t been able to swing it. In my tighter months I don’t save at all.||Reduceable||$0||In order to not confuse ourselves, I’m removing this retirement amount so that we’re only looking at true expenses on this sheet.|
|Utilities||$277||Gas/Electric: Avg. $165/month, Sewer: $400 a year: Trash: $400 a year, Water: $45/month||Reduceable||$277||Any opportunities for reductions here? Have you done an energy audit or used an energy kilowatt monitor to determine areas where you could cut back on electricity usage?|
|Gas||$275||Fortunately I don’t have high mileage so I can keep gas bills relatively low||Reduceable||$175||This is already pretty low, but, it is an area where reductions could be made.|
|Kids activities||$275||Includes birthdays, sports, dance classes, school field trips, after-school care, summer camps, etc.
This is my half — their dad pays for the other half of all these expenses.
|Reduceable||$175||Any opportunities for reductions here?
Would it be possible to eliminate some of the extra-curricular/discretionary activities?
Would it be possible to ask grandparents to gift things like dance lessons for birthdays or Christmas?
|HOA||$257||Covers my gutter cleaning, roof replacement and front yard maintenance||Fixed||$257||Yikes! On top of the mortgage, this brings Jess’s monthly carrying costs for the house to $3,653!|
|Medical expenses||$245||This is not a typical line item but I’m including it anyway; I had a bit of a health issue this year that cost me nearly $3k out of pocket||Fixed||$245|
|Restaurants/coffee||$225||Pizza nights with the kids, occasional date night, etc.||Discretionary||$0||Much as I hate to eliminate this, it is a discretionary line item that could be deleted.|
|Vacation/travel||$200||I usually save for travel in three-month stretches, but this is probably the average monthly breakdown||Discretionary||$0||Much as I hate to eliminate this, it is a discretionary line item that could be deleted.|
|Emergency Fund savings||$200||Trying to boost this fund back up as it’s not quite enough for my comfort after buying my house. In my tighter months I don’t save at all.||Reduceable||$0||Similar to the above retirement contribution, I’m going to eliminate this here so that we’re only looking at true expenses on this sheet.|
|Gym membership||$150||It’s expensive but I value fitness and love this option to get me out of my house since I’m ALWAYS here||Discretionary||$0||I hate to eliminate a priority for Jess, but this is something that is technically Discretionary.|
|Charitable donations||$125||Not something I want to cut||Discretionary||$0||I hate to eliminate a priority for Jess, but this is something that is technically Discretionary.|
|Christmas||$125||Averaged over the year||Reduceable||$50||Any opportunities for reductions here? This totals $1,500 for Christmas.
Would it be possible to purchase second-hand gifts for the kids? Do a Secret Santa with family to reduce the number of gifts to give? Reconsider your gift giving list?
I will note that $50/month would still be a total of $600 for Christmas.
|Car insurance||$104||Triple A, bundled with my homeowners insurance||Reduceable||$104||Worth shopping this around if you haven’t done so recently.|
|Household supplies||$100||This includes essentials plus the occasional home décor splurge or things like towels, sheets etc.||Reduceable||$50|
|Housekeeper||$90||This could be considered a “luxury” but it’s a monthly sanity saver for a single working mom!||Discretionary||$0||Again, I hate to eliminate it, but it is one of our few Discretionary line items to work with.|
|Car maintenance||$75||Estimate of the average breakdown including regular and major mileage maintenance, tires, etc.||Fixed||$75|
|Personal care||$75||Hair cuts, occasional pedicures, beauty/hygiene products||Reduceable||$25|
|Subscriptions||$54||Netflix, Disney+ bundle, Discovery+, Spotify, Audible||Discretionary||$0||Could you pick just one or two of those subscriptions and eliminate the rest?|
|Gifts||$50||Includes family/friend birthdays, kids’ birthdays etc.||Discretionary||$10|
|Entertainment||$50||Averaged over the year||Discretionary||$0|
|College savings||$40||I only contribute a little bit to the kids’ funds at the moment. We are fortunate to have generous grandparents who are putting a lot in for our kids! When I have more funds freed up and am meeting my retirement goals, I’d like to increase this.||Discretionary||$0||My suggestion is to stop these contributions while getting yourself on track for retirement. See more notes on this below.|
|Mobile phone||$20||Switched to Mint Mobile in October!||Fixed||$20||Well done on switching to an MVNO!|
|Dental insurance||$16||I pay for insurance out of pocket through Covered California||Fixed||$16|
|Monthly subtotal:||$7,880||Minus retirement & emergency fund savings = $7,330||Proposed New Monthly subtotal:||$5,830|
|Annual total:||$94,560||Proposed New Annual total:||$69,960|
To be clear, I am not an advocate for cutting every last expense. And, if Jess were already on track for retirement, I wouldn’t suggest so many eliminations. One of the challenges with Jess’s budget is that her house-related expenses–mortgage + HOA fees–total $3,653 a month. In light of that, she knows she’ll be spending $43,836 per year just on housing. While I understand that this is her highest priority, it does mean she will need to reconsider some of her other stated priorities.
→If the house stays, a lot of other Discretionary items will need to go.
If Jess were to implement the above proposed new budget, she’d be on track to save $20,040 a year ($90,000 net income – $69,960 expenses).
A Note On Saving For the Kids’ College
529s are tax-advantaged college savings accounts and Jess wisely opened one up for each of her children. However, while 529s are great, you need to ensure you’re not prioritizing contributions to a 529 ahead of your own retirement. This is why I suggest Jess stop contributing to her kids’ 529 accounts.
This is a “put your own oxygen mask on first” scenario.
While you want to provide for your children, you must provide for your own retirement. Kids can take out loans for school, you cannot take out loans for retirement. I always advise parents to first ensure they’re on track for their own retirement, then contribute to a 529 account. The scenario you want to avoid is that you pay for your kids’ college and then have to move in with them in your old age because you didn’t save enough for retirement. I’m not saying that’s going to happen to Jess, but that’s my standard cautionary tale around 529s (and other college savings accounts).
What To Do With This $20k Per Year?
If Jess is able to save per the above guidelines, there are two priorities clamoring for her money:
- Her emergency fund
- Her retirement investments
Jess’s Emergency Fund: $14,600
Jess mentioned that her emergency fund is too small and I agree. Your cash equals your emergency fund and your emergency fund is your buffer from debt. Ideally, you want to target an emergency fund of somewhere between three to six months’ worth of your spending. At Jess’s current rate of spending $7,330 per month, she should save up $21,990 (three months’ worth) to $43,980 (six months’ worth).
→However, it’s also true that the less you spend, the smaller your emergency fund needs to be.
If Jess were to instead start spending at the proposed new amount of $5,830 per month, she’d want to have an emergency fund of $17,490 (three months’ worth) to $34,980 (six months’ worth).
Why Have An Emergency Fund?
Your emergency fund is there for you if:
- You unexpectedly lose your job
- Something horrible goes wrong with your house that needs to be fixed ASAP
- Your car breaks down and must be repaired
- You’re hit with an unexpected medical bill
- Your dog gets quilled by a porcupine and has to go to the emergency vet
As you can see, an emergency fund is not for EXPECTED expenses, such as:
- Routine maintenance on a car, such as oil changes and brake pads
- Anticipated home repairs, such as boiler servicing/chimney sweeping
- Planned medical expenses
An emergency fund’s reason for existence is to prevent you from sliding into debt should the unforeseen happen. It’s your own personal safety net.
This is also why it’s so critical to track your spending every month. If you don’t know what you spend, you won’t know how much you need to save. I use and recommend the free expense tracking service from Empower, which used to be called Personal Capital (affiliate link).
While everyone needs an emergency fund, some folks have circumstances that make an emergency fund even more critical.
Here are a few examples:
- With only one stream of income, you’re in a more tenuous position because if that person loses their job, you don’t have another income to fall back on.
- Households with children:
- Need I elaborate? My children continue to astound me with their creative methods for spending my money…
- Home owners:
- The roof, the boiler, the oven, the toilet… it’s all going to break at some point. If you’re lucky, it won’t all break in the same month.
- People who must own cars:
- If you must have a car in order to get around, it’s an added liability.
- If you live in a place with ample mass transit and have a car for occasional convenience, you’re not reliant upon that vehicle and so it takes lower priority.
In all of these instances, you have expensive liabilities that could require money to fix. Lucky for Jess, she fits all of these categories, which is why I strongly encourage her to both reduce her spending and increase her emergency fund.
For folks who rent and don’t have pets, children or cars: your liabilities are typically less. If you don’t have other people dependent upon our income and you’re not responsible for home or car repairs, you have fewer potential emergencies to contend with. That’s not to say you shouldn’t have an emergency fund–you absolutely should!–but you can probably calibrate to more like a three-month fund. Knowing your risk level and potential exposure is key when identifying how much you need in your emergency fund.
How To Allocate Between Retirement and Emergency Fund
Since Jess has competing goals here–beefing up retirement and her emergency fund–I put together the below chart demonstrating how she might allocate her savings every year for the next 28 years:
|Year||Jess’s Age||Annual Net Income||Annual Expenses||Difference Between Income and Expenses||Emergency Fund Total||Total $ to Put into Emergency Fund||Total Available $ to Put into Retirement||Annual Roth IRA Contribution||Annual SEP IRA Contribution|
As you can see, I kept her income and expenses static for the sake of this model. Obviously that’s very unlikely, but, the great thing about this chart is that Jess can change those variables and view the resulting calculations. Same deal for the Roth and SEP contributions–those are also very unlikely to remain static since the IRS changes them nearly every year. Again, Jess can go in and adjust those amounts as needed. I do have her maxing out her Roth, but not maxing out the SEP (at $30k/year) because she doesn’t have enough room in her budget. However, if she earns more (or spends less), she can work on reaching that max if desired.
How Much Would Jess Have At Age 65?
To answer that question, we have to use a compounding interest calculator and account for her current retirement savings as well:
|Roth IRA||SEP IRA||IRA||Total in all Retirement Accounts at end of 2051|
|Total contributions made 2023-2035||$188,500||$372,430||None as all money should go into the other two accounts|
|Existing Account Balances
(as of 3/29/23)
While $624k sounds great, it doesn’t account for stock market returns! Let’s do that projection next:
|Amount Invested Per Month On Average (28 years = 336 months total)||$1,860.06|
|Projected Portfolio Total in 2051:||$2,585,642.30*|
*assuming a 7% market return on 28 years of investing $1,850.06 per month
If Jess were to contribute $1,860.06 per month to her retirement accounts for the next 28 years, she’d be on track to retire at age 65 with $2,585,642.30 in her investments. This assumes a historically average 7% annual market return (which doesn’t mean 7% every year, but rather an average of 7% annually over the course of 28 years). With that amount, if Jess were to withdraw a sustainable 4% annually starting at age 65, she’d have $103,425.692 to live on every year (plus Social Security), which is pretty sweet!
I did this calculation with this compounding interest calculator and here’s a chart demonstrating the growth she could see in her investments:
The caveats with this projection are, of course, that it is a projection since we can’t know:
- What the stock market will actually do.
- What the contribution limits will be for Roth IRAs and SEP IRAs in the future.
- What Jess’s salary and expenses will be over time.
- What inflation will do.
The point of this exercise is to demonstrate the power of compounding interest and the fact that Jess has time on her side. She’s relatively young in her working life if she’s aiming for a traditional retirement age of ~65. In light of that, she can capitalize on several decades worth of potential investment returns. It is much easier to start contributing early to retirement investments than it is to play catch-up later. If you start late, you won’t be able to reap the rewards of investment returns and compounding interest.
The Importance of Expense Ratios
Something missing from Jess’s list of retirement investments are their expense ratios. This is not a minor detail you can ignore because:
Expense ratios are the percentage you pay to a brokerage for investing your money and, as they are fees, you want them to be as low as possible.
As Forbes explains: “An expense ratio is an annual fee charged to investors who own mutual funds and exchange-traded funds (ETFs). High expense ratios can drastically reduce your potential returns over the long term, making it imperative for long-term investors to select mutual funds and ETFs with reasonable expense ratios.”
In light of their importance to one’s overall long-term financial health, I encourage Jess to locate the expense ratios for all of her retirement investments. I’m going to use VTSAX as an example of how to find an expense ratio.
You’re going to like this because it’s a three-step process:
1. Google the stock ticker (in this case I typed in “VTSAX”)
2. Go to the fund overview page
3. Look at the expense ratio.
Screenshot below for reference:
And done! Woohoo! To give you a sense of whether or not your investments have reasonable expense ratios, the following three funds are considered to have low expense ratios:
- Fidelity’s Total Market Index Fund (FSKAX) has an expense ratio of 0.015%
- Charles Schwab’s Total Market Index Fund (SWTSX) has an expense ratio of 0.03%
- Vanguard’s Total Market Index Fund (VTSAX) has an expense ratio of 0.04%
You can also use this calculator from Bank Rate to determine what you will pay in fees over the lifetime of your investments, based on their expense ratios. If you find that your investments have high expense ratios, it is well worth your time to investigate whether or not you can move them to lower-fee funds. This is not always possible with employer-sponsored plans (such as 401ks) as you’re beholden to whatever funds your employer offers. But, it’s still worth looking through all available funds to select the ones with the lowest expense ratios.
The Importance of a High-Yield Savings Account
The other thing that jumped out at me about Jess’s accounts is that her savings account isn’t earning anything in interest. Unacceptable ;)!
Jess needs to find a high-yield savings account ASAP because this is free money! For example, as of this writing, the American Express Personal Savings account earns a whopping 3.75% in interest (affiliate link). If Jess were to put her emergency fund in this account, in one year her $14,600 would earn $548 in interest!!!
Jess’s Question #3: Should I be pursuing a full-time job with benefits instead of trying to make freelancing work in my situation?
This is something only Jess can answer. As I’ve just modeled out, Jess earns enough and has the potential to save enough to have both a fully funded emergency fund and a fully funded retirement. It’s now a question of what’s most important to her.
- Does she want to reduce her spending as outlined above?
- Or would she rather increase her income?
If Jess wants to focus on income increases, then she should go for it with her freelance work and see what’s possible for her. If she’d rather lose the flexibility/hours of freelancing but gain the stability of a paycheck from an employer, she can go that route. The beautiful thing here is that Jess has options. She can control both variables–income and expenses–and she’ll just need to decide which levers to push.
Jess’s Question #4: How can I release my financial fears and stop looking to dollar signs for security?
To a certain extent, you can’t. Money does provide security. It’s a fact. I think it’s naive to assume otherwise. On the other hand, I also think it’s possible to put too much emphasis on financial stability. Financial stability doesn’t necessarily reduce anxiety, make people happier or deliver fulfilling lifestyles. It’s all about your perception of money and the emotional response you have to it.
There are plenty of millionaires who feel financially insecure and terrified. Conversely, there are plenty of folks with far less who experience far greater contentment and stability in their lives. There’s a great deal of privilege in having financial security and the confidence that your basic needs will be met. And so the challenge is to not lose sight of that while also allowing yourself to feel confident about the financial position you’re in.
- Move your cash into a high-yield savings account ASAP
- Review the Proposed New Expenses spreadsheet to determine which expenses you’re willing to reduce or eliminate
- Know that if you choose to stay in the house, many other discretionary items will need to be eliminated
- Review the expense ratios for all of your retirement investments and change funds if needed
- Stop contributing to the kids’ 529s while you catch up on retirement
- Implement the above plan for beefing up your emergency fund and retirement investments
- Determine if you’d rather increase income or decrease expenses (or do both) in order to do this
- Keep an eye on the long-term retirement investment targets over the decades
- Know that time is on your side right now in terms of compounding interest and that it’s MUCH better to start investing for retirement sooner rather than later
Ok Frugalwoods nation, what advice do you have for Jess? We’ll both reply to comments, so please feel free to ask questions!
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