Potential Trap in Bond Funds

Right now with the state of the stock market investing in bonds is looking more and more attractive. If you can get a more dependable get 4-8% return off bonds then that is more attractive to many people than investing in stocks and hoping for a 10% long term annual gain but risking a -20 or -40% short term loss.

An ETF that invests in high yield corporate bonds like the iShares iBoxx $ High Yield Corporate Bd (HYG) can yield about 10% right now. While these are low credit quality rating bonds so the default rate is higher the wide diversification of an ETF and the high yield should make up for the higher defaults. Or you could go with a lower risk and lower yield ETF like the Vanguard Long-Term Bond ETF (BLV) which invests in high quality bonds and yields about 5%.

Say you own 100 shares of BLV today and it trades at $77.79. The yield is 5%. Lets say just for example sake that 12 months from now the average interest rates go up. Lets say at that point that a typical AAA bond will sell with a yield of 6%. If someone can easily buy a bond for 6% then thats what bonds are going to sell at. This means the price of the existing bonds being traded will be less. If you could take $100 and buy a new bond at 6% or you could buy an existing bond at 5% then you wouldn't want to pay the full $100 face value for the 5% bond. That older 5% bond would only be worth about $83 since the return of $5/$83 would equate to a yield of 6%. So if interest rates go up from 5% to 6% then your current bond investment would drop to 83% of what you paid for it. That would mean your BLV could easily drop down to a price of 83% of $77.79 or $64.56.

If the interest rates go up then the price of bond funds will go down.

Given the current situation the interest rates are near or at historic lows. Its very likely that interest rates will go up in the upcoming years. For this reason investment in a bond fund right now could have a built in loss looming in the future.

This is one of the major down sides of investing in bond funds. The price of the bond will go up and down based on changes in prevailing interest rates.

Best of Blog posts for the week January 16th

Everybody Loves Your Money alerts us to Free Coffee and Donuts on Inauguration Day The free donut is from Krispy Kreme and the free coffee from Starbucks

Lazy Man and Money looks at a few ways to Save Money on Your Landline Phone

Early this week I got a mention in The Digerati Life blog roundup: Dividend Paying Stocks from The S & P, Volatile Stock Market: The Roundup

Wise Bread covers the fact that Old calendars never really go out of date. which means you can recycle old calendars for current years.

The WSJ recommends you file for college financial aid early: Seeking Financial Aid for College? Better Get FAFSA Forms in Early

Early Retirement Extreme presents the first 2 weeks of a step by step 30 day Extreme retirement plan : Day 15: The first two weeks of the make over

Figuring our Baby Budget in Advance

My wife and I are planning on having kids "soon". So in preparation for that I want to determine the rough budget for our first baby.

Using a Baby Cost Calculator

If you want a quick, ballpark figure then using a premade calculator is the simplest way to go. Thankfully folks have already made calculators that let you estimate the cost of a baby. The BabyCenter website has a Baby Cost Calculator. The calculator is easy to use and customize the expenses you expect for your situation and choices. I plugged in our choices in and the calculator estimated our baby first year expenses would be $3,800.


Adding everything up

To get a better estimate of your own costs it makes sense to estimate add up all the costs that you expect to have for your own situation. Everyones expenses for categories like medical, childcare, babysitting, diapers, etc. will vary greatly from one couple to another. Below I'm going to look at each category of spending and estimate our expected costs for my wife and myself.

Cost of Childbirth

Childbirth total costs would probably run $5,000 to $10,000 ballpark. Since we have insurance this will be covered by our medical insurance plan. We have a high deductible with a Health Savings Account. So much of the cost will be paid out of our HSA. However we fully fund our HSA up to the maximum so we will have more than enough money in the account. Our maximum cost for the year is $4,200 which is pre-tax so this equates to about $2,800 out of pocket. This is money we've already got dedicated in our current budget so there will be no net budget change.

Medical visits and expenses

There will be required visits to the doctor for the baby and other medical expenses such as immunizations. Like childbirth these medical costs will be covered by our insurance. I'm pretty sure we'll cap our deductible with childbirth so any other expenses for the year after that will be covered 100% by our insurance. No net changes.

Furniture, Clothes and Stuff

Here is a page with a list of baby gear. Its a lengthy list of various furniture and accessory items deemed necessary for a baby. The prices vary a lot and they give wide ranges for each item. I figured the totals for the gear ranges from $1,781 to $7,895.

Diapers and Food

Disposable diapers run roughly 13¢ to 20¢ each for the first year. If I assume that we'd change diapers 5-10 times a day then thats about 1,800 to 3,600 diapers a year. This comes out to something around $450 a year on average for disposable diapers. We might also with cloth diapers and cloth diapers could cost us anywhere from $500 to $1,000 a year depending on how we do it. We plan on breast feeding so that should mean very little cost for formula. However for whatever reason we may need to buy formula instead. So its a potential we could spend another $100 to $150 a month or a possible $600 to $900 for formula for the first 6 months. In the second 6 months we'd start to introduce baby food into the diet. I figure that cost would be another $600 to $900 for baby food for the second six months. Overall our costs for diapers and food will run us somewhere between $1,050 to $2,800 total for the year.

Extra Travel

We'll probably want to take a trip to visit relatives and show off our new baby. This kind of travel will be in replacement or combined with our normal annual vacations. So there should be no substantial additional out of pocket costs related to travel.

Daycare

My wife works from home and plans to be a stay at home mother. We will not need daycare in general therefore there should be no additional costs.

Babysitting

I figure we'll want to go out for a nice dinner on occasion and not have to deal with a possibly noisy baby in a nice restaurant. A night out would likely last 2-5 hours and end up costing $20-50 roughly for babysitting. If we do this weekly or monthly then the cost for babysitting would range from $250 to $2,500 a year. This might also be paid for in part with our entertainment budget.

College Savings

We plan to start 529 savings accounts for our kids and putting $2,000 a year away per child. So this will run is $2,000 per year.

Other, Miscellaneous

I'm probably missing some expenses. I think you could add another $0 to $1,000 to cover other things I haven't considered.

Add it up

Total costs would range from $5,081 to $16,195.

Thats a pretty wide range and mostly due to the possibility of spending higher amounts on the one time expenses. I expect our spending will be closer to the lower end since we're fairly frugal. However I should budget for more than minimum.


Potential Savings

While its true that a baby will cost us a lot there are savings in some areas.

Gifts

We'll probably get some gifts from family and friends. I would have no idea how much or what we might get. I'd guesstimate we could get gifts in cash or items worth anywhere in the $100 to $1,000 range.

Reduced spending Due to changes in our Habits

With a baby we'll be less likely to eat out and spend money on entertainment. But its hard to say how much this will change. We might spend less on eating out but then spend more by paying for a babysitter or more expensive meals at home. Honestly I don't know enough at this point to know how much we'd save if anything in this area. Since I don't have enough data I'm going to leave this category out of my figures for now.

Tax Savings

I should be under the limit to qualify for the child tax credit. That will take $1,000 off our tax bill. With another mouth to feed we'll have another dependent to claim so this will give us an additional $3,400 deduction. Our marginal IRS bracket is 25% so that $3,400 deduction will net us another $850 savings. Our federal tax savings will be $1,850. We'll also get approximately $350 in savings on our state taxes. Net tax savings would be $2,200 per year.


Bottom line Cost - Savings

Overall we're looking at a cost somewhere around $3,800 to $16,200. This will be partially offset by tax savings of about $2,200. Potential gifts could cut another $100 to $1,000 of our costs. So our total out of pocket expense for a new baby in the first year will be anywhere from $1,500 to $14,000. Its most likely this figure will fall somewhere around $3,000 to $5,000.


Keep in mind that this is just a rough budget and I'm sure the final amount we spend will vary some. However I wanted to do this in order to get at least a ballpark estimate of what it will cost for our first baby's first year. If you go and have a child without taking a look at all the potential costs then you could deplete your savings rather quickly. Its important to consider and plan ahead for the costs involved with raising a child.

My Financial Story : Part 4 - Gainfully Employed

This is the fourth part of a series on my own personal financial story. First I discussed my childhood years, then I talked about my first four years in college and then I talked about my second college trip. Today I'll talk about my years in the work force leading to the present.

I started work in 1997 and was making about $42,000 a year. I had a few thousand in student loan debt at the time and no other debts. For the first couple years I rented an apartment. After a couple months at work I bought myself a late model used car. It was an inexpensive compact car model with good mileage and I got a loan via the credit union for about $7,000 for the purchase.

In the first couple years at work I paid off my student loans and my car loan. Then in 1999 I started looking for and bought my first home. I bought a home for $142,000 at the time and paid only 3% down and got the seller to pay the closing costs. By that time I'd gotten a promotion and a couple years worth of raises and I was making around $50,000 a year base income. I had also stopped smoking cigarettes.

Around 1998 to 2000 I enrolled and contributed to my companies 401k and I dabbled in some individual stock investments. When the dot-com bubble burst in 2000 I lost about 50% of my 401k money and my stock investments did poorly too. I walked away from the dot-com bust with a negative attitude towards stock and 401k investments. I discontinued my 401k contributions after that and stopped investing in stocks too.

My employer has a stock purchase plan where I can buy company stock at a 15% discount two times a year. I invested the maximum 10% of my pay into this program since its a guaranteed 15% return. For the first 7-8 years I bought the stock and then held onto the shares. Over those years I accumulated quite a large stake in my company stock. To make matters worse my employers stock did has not increased in value over the past 10 years. It peaked in late 2000 and then lost most of its value and hasn't come close to its 2000 high yet. I wasn't diversifying this money. I was overly invested in my own employer stock and the investment was not performing well. Eventually I stopped holding the shares and would instantly sell the new shares as I got them to cash in the 15%. Since then I've sold off most of the stock I bought and was lucky to liquidate most of it early in 2008 before the bottom fell out of the market in late '08. I sold my shares for about 2 times what the stock is currently trading at. Overall I am at a loss on the stock I bought through employee purchase plan.

I continued to do well at work and get raises and promotions over the years. My salary grew from about $42,000 in 1997 to over $100,000 today. By doing a good job at work I've seen my income grow. More importantly I've avoided 3-4 separate rounds of layoffs within my department and I've remained employed at a high income the entire time.

I've kept my expenses low and lived well within my means. I've lived in the same home the entire time. I drove my first car for about 10 years and then bought a second late model used car with cash. As I made more money and got raises I would not just spend more money but would instead save more and more. For a time, I would say to myself that for my next raise I would dedicate half the additional income to savings and then allow myself to spend the other half. So as my income grew my savings as a percentage of the income grew at a higher rate.

A few years ago I started investing in rental real estate. I had seen the success my parents had with their rental properties and I gained some knowledge of how to invest in rentals successfully. I bought my first property around 2003 as a 50% partner with my Dad. I found the unit for a very low cost and it was a fixer upper. My father did the work and is the property manager. We bought a second unit in another 50% / 50% split a couple years later. My initial investment in those two properties was about $75,000 total and they are my half is now worth around $120,000 and they generated a cash flow of about $8,000 for me in 2008.

In 2008 I got married for the first time. My wife and I are a good match in many many ways. One of the ways we are a good pair is our attitudes towards money. We both share similar philosophy towards finances. Once we got married my wife and I combined our finances. My wife had owned two houses of her own. One was her original home that she was renting out and the second was the home she lived in at the time we met. We decided that she would move in with me and we'd rent out her current house. So now between the two of us we own our home, we have two other homes we rent out and we own half of two other rental properties with my father.

After we got married it took us a while to get all her possessions moved out of her house and either move them to our house, sell them or give them to charity. We also took a while to fix up her house to get it in the state to rent it. We took our time moving things out and sorting things. We tried to do most of the work on the home ourselves with the idea of saving money. All together the house was vacant and in transition for nearly six months. That was six months that we paid mortgage and didn't have rental income to offset it. So by doing everything ourselves at our own pace we took 6 months and spent a few hundred dollars total in materials. What we should have done is hire professionals to do the work quickly so that we could rent the home faster. It should have been easy to hire movers to move all our items out and then hire contractors to do a bit of work and get everything done within 1 month. Even if we had to pay people a few thousand dollars we'd have still come out ahead with the additional rental income we never saw.

Since I've started my working career I've made very good progress financially. I went from making about $42,000 to over $100,000 annually. I went from having a negative net worth to being married with a net worth over $500,000. Two keys to my success were 1) having a good paying job and progressively getting promotions and 2) spending less than I earn. I've made some mistakes along the way especially in the area of stock investments and retirement savings but I've learned from and since corrected those mistakes.