Not Rich Yet | Managing higher incomes

Personal income tax rates in the US are at relative lows.

Over the past 50 years, income tax rates have been much higher. See the following chart from Wikipedia:

Based on recent government spending as part of the bailout and other programs to stimulate the economy – regardless of your political opinion on whether this was right or wrong – taxes have nowhere to go but up. The government needs income to balance the budget, and like it or not, higher taxes are will come.  And guess who they will hit? Not the poor, not the “middle class”, not the ultra-rich, but the folks with higher incomes (doctors, lawyers, professionals, etc.) that earn enough to labeled rich by politicians, but not rich enough to really defend themselves.

So let’s just assume for a second that my assertion above is correct. What should you do differently if you anticipate (much) higher tax rates within the next few years?

Here are my ideas:

  • Accelerate taxable events
    • If you own a house or some other asset with a lot of appreciation, you may want to sell earlier rather than later to avoid a higher capital gains tax
    • If you want to pass on your wealth to the next generation, you may want to give extra thought to estate planning and vehicles that allow you to maximize the impact of your inheritance for your heirs
  • Reduce your reliance on tax breaks
    • One popular way for the government to increase taxes is by doing away with tax breaks or lowering the bar at which the tax breaks phase out. If you heavily use tax breaks, you should think of ways to reduce your reliance on them
    • This includes relying on tax-deferred accounts such as 401ks and IRAs.  Just because those are tax protected now, doesn’t mean they will be in the future. One day all of us who invested diligently in 401ks will be the new bad rich people that politicians will strive to tax.  So don’t put all your chickens in one basket and diversify amongst different tax-deferment strategies and keep a healthy chunk in good old-fashioned taxable accounts.

What would you do? What would recommend?



Under contract!

So we just signed the contract to buy the rental property I mentioned in my post The math behind buying a rental property!

This means we are under contract, but still need to arrange for financing, survive the due diligence by lawyers, underwriters and inspectors and then close on the property.

Mortgage rates are at historical lows currently so it was a good time to strike.

There are several pros and cons of investing in rental real estate that we have been weighing before embarking on this journey.


  • Good hedge against inflation – when inflation kicks in it will raise rents and property values but my mortgage will stay constant. This way I will have hopefully some protection against inflation of my cash and other inflation sensitive investments
  • My rental income is relatively independent from the volatility of the stock market and allows me to diversify away some more risk
  • It provides a decent return of 8-15% (decent because it is not risk-free compared to cash sitting in a savings account)


  • Requires active involvement (hey landlord, my toilet is clogged)
  • Not risk free (real estate prices, tenant damages, ability to rent out property 100%)
  • Emotionally taxing (aggravation over tenants)

Next we need to figure out our financing – how much to put down? buy down the mortgage rate with points or not? escrow or not?

I will keep you posted…

Image by NobMouse


We were featured on on the Carnival of Personal Finance today.

Check out the whole list: MoneyRelationship

Our featured article: The math behind buying a rental property

One big question that many people wrestle with is how much tuition and school loans they can afford to take on.

So I did a quick analysis to understand what a maximum reasonable amount of school loan a student could take on and still make ends meet.


My analysis calculates the maximum affordable tuition or total school costs given a post-graduation income and makes the following assumptions:

  • That all tuition and school costs are financed via loans
  • That schools loans run for 10 years at a 6% interest rate
  • That the student will be single and pay taxes in NY
  • That post-graduation the student will spend a minimum of either $1500 or 40% of his or her gross income on living expenses including food, mortgage, rent or car payments etc
  • That of the excess income – that what is left after taxes and living expenses – up to 75% can be used to pay-off school loans, the remainder is a safety buffer and for retirement savings


Given those assumptions, the total affordable tuition or school loans amount roughly equals the post-graduate income.

That means if you think you will make an annual gross income of $60k after graduating from college, you can afford to take out school loans of up to $64k.  Similarly, a salary of $100k would support school loans of about $106k, and an income of $150k loans worth $160k.

If your income would be below $35k per annum, your affordable school loans drop quickly, e.g.  for an income of $30k you could only afford loans worth $11k.

This same math roughly holds true for both undergrad and grad programs.

What do you think? Share this with someone who is thinking about going to college or grad school!

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Going to school – under-grad or grad – is tough these days. Many graduates are hurting to find jobs while tuition rates are going through the roof. But as someone for whom education payed off, I often get asked for advice by the younger generation among friends and family.

Here are my three pieces of advice:

  • Make sure you will enjoy it
  • Make sure you are talented and will excel
  • Make sure it will put you on a path you will be happy with both financially and as a person

Enjoy it

In order for pursuing a specific program or degree to lead to success, you typically need to do well in the program. One huge prerequisite for doing well at something is that you need to enjoy doing it. If you can’t stand the sight of blood, becoming a doctor is not such a hot choice. If you don’t like doing math, then studying accounting is not the route to success for you either.


Next, you should make sure you are actually good at what you want to do. You could enjoying singing tremendously, but if you can’t hold a tune to save your life – see me or most American Idol contestants – you will not do well as an opera singer. You should be better at  your chosen path than most or all of your friends. You should have an undeniable knack for it.

Right path

Finally, and most importantly you need to make sure that the degree you are pursuing will lead you on a path that you will be happy with.

Financial happiness

There are many degrees and programs that put you on track for a career that will return your investment and will give you a decent income.

There are many other degrees that will not pay off and may very well lead to an income under what you expect to earn. For example, law school tuition plus living expenses will cost up to $150k in total while many young lawyers make only $45-60k – try to make that math work.

So do some serious research on what careers you could pursue with a given degree, and what the expected income with that degree would be. Compare that to the life style would would want to live to be financially happy. And please be realistic. Some young lawyers earn $180k per year – do you think you are good enough to be one of the lucky few? If not, where does that leave you?

Also keep in mind the quality of program you can get into. An MBA from Harvard has a very different earning potential than an MBA from a no-name community college. Often the lower tier schools are not worth the money – you need to compare tuition and living expense rates with typical graduate salaries.

I was convinced in high school that I wanted to be an archaeologist. That was until I figured out what they earn :) . Then I chose something else I was good at and that led to an income that could support a family.

Happiness as a person

Financial happiness is not everything however. You should be happy living the career implied by your degree day in and out. If you have a serious social bent and want to do good to everyone you know, becoming a tax collector is probably not the right path. If you love the outdoors and hate being stuck in an office, studying to be an accountant doesn’t make sense.

These are not reasons to go to school

Finally some things that do NOT qualify as reasons to study for a particular program

  • My friends are doing this
  • But it sounds cool
  • I don’t know what else to do

Final words

In the end, you just need to think through what you really want to do and imagine yourself as a graduate. Is that the life you want to live? Don’t make a seat of the pants decision that you will regret for the rest of your life.

And please don’t study psychology if you don’t intend to enter that field.  Psychology is interpreted by most employers as “I had no idea what to study so I choose psych”.

Image by Ed Yourdon

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Today I am kicking-off a multi-post series on Angel Investing. This is an interesting avenue for high income individuals with tolerance for risk.

The topics I intend to cover in this series are:

  • What is angel investing?
  • How angel investing works
  • What the requirements for angel investing are
  • What to look out for as an angel investor
  • How to become an angel investor

Angel investing – what is it?

In 1998, Andy Bechtolsheim, a successful entrepreneur and co-founder of Sun Microsystems, was approached by the founders of Google. Larry Page and Serge Brin pitched their idea to Andy, and he consequently wrote them a $100,000 check as a seed investment for their brand new idea. Fast forward a decade, and Andy’s investment in Google is worth more than $1.5B.

Angel investing is a high-stakes, high-risk form of investing by one or a few investors into promising ventures. Typically these investors are expected to contribute more than just money, but also facilitate contacts, provide expert knowledge and generally be helpful. In return, they are allowed to invest at “basement” level, and can achieve amazing returns – if unlikely as spectacular as those of Andy Bechtlolsheim – if the venture does well.

Typically, such investments are equity purchases (stock or stock options) or convertible debt (loans that convert to stocks). Pure debt deals are rare as they don’t allow the investor to profit greatly if the company does well.

Typical investments

Most importantly, angel investors typically invest in companies that will have some sort of “exit” or liquidity event. Internet start-ups or biotech companies will typically have an IPO or be acquired by another company if they succeed. Such an event allows the investor to convert his or her initial stake into cash or tradeable shares. Before the event, the investors shares were illiquid since the company was not publicly listed and tradeable.  An angel investment in a company that never intends to have a liquidity event is a moot point – why sink money in a deal that you can never sell?

Companies most attractive to investors since they will likely follow the route above typically follow the profile

  • Technology or biotech focus
  • Own strong intellectual property such as patents that will afford them a defensible advantage
  • Are not “life-style” businesses but instead highly scaleable businesses that can drive tremendous revenue and profit with a small base of employees
  • Organized as C-Corp or more rarely as LLC
  • Are for-profit

What this means is that businesses that do not meet the criteria above are unlikely to be attractive to angel investors. Restaurants, bars, ice cream shops, consulting companies, advertising agencies and other businesses that rely on people instead intellectual property are unlikely to attract angel investors.

The risk

Angel investing is risky. One angel investor I know mentioned that only a handful of the over 50 investments he made were doing well. In fact the risk is at multiple levels

  • First, the company has to do well overall and turn an idea into a roaring business
  • Next, most companies need to change their business model a couple of times in their life. During such changes, esp. if they involve near-death experiences for the company, new investors may force unfavorable terms onto the company, often “cramming down” older investors. What this means as an angel investor is that while the company may be doing well overall, your personal investment could be doing horribly
  • Finally, you need to have a liquidity event that is successful. Many a dot-com start-up was bought up in the hey day giving their angel investors huge returns on paper – e.g. through stock swaps – only to find after the 12 month waiting period that the buyer negotiated that the stock market tanked and their shares are worthless

For this reason, the US government actually requires angel investors to meet certain requirements. The government wants to avoid that innocent and inexperienced investors get suckered into such deals, so they require investors to have a minimum networth or income (to be discussed in detail later).

Given the risk discussed above, most investors I know only invest a small percentage of their portfolio in angel deals, often 5% or less.

My experience

As a disclaimer, I am not an active angel investor myself but have received angel investments from others as an entrepreneur. I have negotiated over 15 such investments and have assisted investors in their due diligence in other transactions.


In my next post in this series I will explain how the nuts and bolts of angel investing work.

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We are currently considering buying a rental property as an investment. It turns out, there are many different ways to “skin that cat”.

But how do they all compare?

So I ran some IRR (internal rate of return) calculations for them. The IRR essentially tells me what the expected return on my investment will be. Investing in a rental is no different than investing in a CD or a stock – you expect to earn a positive return on your investment.

Here are the facts

We would pay roughly $200k for the property, and get a gross rental income of about $1700 per month. The gross “cap rate” of the property would be about 10%, the net cap rate of the property would be about 5.5%. This means that we would have an annual gross income on the property that equals 10% of the purchase price and after accounting for all expenses except for mortgage costs, an annual income of 5.5% of the purchase price.

Further then property would be cash flow positive on a monthly basis – the rental income would (slightly) exceed my mortgage payments, taxes, insurance and expected maintenance costs.  Sounds great, right? I buy a property and the tenants pay my monthly bills while my equity grows.

But there is a catch. I still need to make a down payment (no more zero down payments in today’s market).

So what is the return or IRR I earn on the down payment investment?

Base case

Lets assume I buy the property with a 20% down payment, and I own the property for 10 years after which I sell it. I assume that the property value increases every year by 2% (roughly with inflation), and rent increase each year 1% (slightly slower than inflation).

Under that base case, I would earn an IRR of 9.6%.

Not bad, right? Better than what I would get if invested in a CD. But hold on, isn’t this riskier than a CD? Shouldn’t I be getting a higher return to make a riskier investment worthwhile?

Value evolution

So what happens if the value of the property doesn’t evolve the way I assumed and doesn’t grow with 2% as assumed in the base case? Lets keep everything else equal and change that assumption.

  • 2% p.a. value growth (base case): IRR = 9.6%
  • 5% (market peaks): IRR = 15.8%
  • 1% (slower growth): IRR = 7.2%
  • 0% (flat market): IRR = 4.4%
  • -2% (market declines slowly): IRR = -3.1%
  • -3% (market takes a beating): IRR = -9.1%

Ouch! So if the real estate market grows or does well I get a nice or even very nice return. But if the market stays flat or starts declining I very quickly have less attractive and even negative returns.  I better be sure the market doesn’t tank!

Rent evolution

So what happens if rents don’t evolve the way I assumed and don’t grow with 1% as assumed in the base case? Lets keep everything else equal and change that assumption.

  • 1% p.a. rent growth (base case): IRR = 9.6%
  • 3% (rents grow quickly): IRR = 10.3%
  • 0% (rents flat): IRR = 9.1%
  • -2% (rents decline): IRR = 8.1%

Okay, so rent growth has some influence on my return but all in all it doesn’t move the needle much. My IRR is still reasonable even if rents start to decline  a bit.

Down payment

So what happens if I plunk down more or less of a down payment compared to the 20% in the base case? Lets keep everything else equal and change that assumption.

  • 20% down (base case): IRR = 9.6%
  • 0% down (no money down – not realistic): IRR = 17.0%
  • 10% down (hard to get for investment deals): IRR = 11.7%
  • 25% down (being required more and more for investment deals): 9.0%

Wow, this really illustrates why 0% down was so lucrative back in the old days.  You could nearly double your IRR by not putting anything down. In essence your renters would pay everything for you and you wouldn’t have to invest a thing but reap a big return when you sell.

Buying it out right

So many people like to pay-off their rental properties quickly, and then think they have a wonderful investment. That is a lot like putting 100% down or just paying cash. What is the IRR then?

  • 100% down (pay cash): IRR = 6.0%

So all else being equal, if you pay for cash for the property, your return on investment is a low 6%, nearly half of what you what have gotten with 20% down and a third of what you would have gotten with 0% down.


Frankly, from my perspective, the risk posed by fluctuations in property value are quite substantial.  So I would want to see an investment return of at least 9%. That means I should pay no more than 25% down, and not pay off my mortgage early. In addition, I should try to make sure I am able to increase rents over time.

I am still mulling this one over and will keep you updated as it evolves.

Image by TheTruthAbout

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How much money do you spend on food?

When I browse other PF blogs, I get the sense that being extremely frugal about food is a Very Good Thing. In fact, many people seem to brag about how little they spend on food.

But is minimizing your spending on food a good thing?

At the lower price end, you very often truly get what you pay for.

That rock-bottom priced chicken most certainly wasn’t the healthiest bird on the planet before it ended on the butcher’s block.

Those cucumbers on manager’s special most certainly do not have the lowest pesticide and contaminant load.

To understand this further, I recommend watching Food, Inc.

What we do

My wife and I shop at Whole Foods a lot, esp. for fresh meat, veggies and grains. We mostly avoid processed foods, but buy some processed food staples like soda and ketchup at the regular grocery store.

It ends up costing us more money, probably $500 more a month than if we bought everything at Costco, but after some recalled food scares (“Please discard the meat you bought from us, it is contaminated”), we a happy to invest that extra money.

It doesn’t ruin our savings rate and makes us feel better.

What do you do?

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Evolution of income

A while ago I decided to understand how our income evolved over time. The graph below summarizes a quick retrospective of how our pre-tax income evolved over the past decade. This captures life before and after grad school for both my wife and I.

How to read this chart

Blue and red show his and her histories. I am not quite ready to open the kimono fully, so I decided to index our income. So in 2000 we earned an income of x. Every subsequent year is shown as a multiple of x. For example, in 2010 we expect to earn more than 7 times what we earned in 2000.


Funny enough, before I went to grad school, I was –  in my eyes –  making a ton of money, esp. compared to my peers who went to undergrad with me.  But as you can see, grad school and then finding the right job, had a tremendous impact on our income.

You can see a dip in income while I went to grad school, but while the Mrs. went to grad school, my income was growing so fast, her old income was hardly missed. But when she graduated, we really hit the accelerator pedal.

My second job was very fulfilling and paid decent, but income plateaued. My third job however has a nice growth curve to it, and I have experienced steady pay jumps annually.

The right kind of education pays

Neither my wife or I could have gotten our current jobs without going to grad school. I will show the math in a later post, but we both have earned our tuition investment back with ease.

That said, we both went to good schools, picked degrees that meshed with our interest, abilities AND that had a clear path to a career, and excelled in our careers.

Not every investment in education pays – I will outline they why and how in a later post.

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There is an article on the New York Times online, telling stories of people who have posted their net worth on blogs and in particular on NetworthIQ.

Here are some interesting excerpts from the article:

The net-worth number, as Kincer found, is more appealing when you have someone else’s to compare it with. We tend to have an intense curiosity about our neighbors and friends, especially those who seem to earn about what we do but spend a lot more. Do they skimp on retirement savings or their children’s college funds? Are they not burdened by student loans? Do they have a trust fund? Have they simply maxed out every credit card they can get their hands on? There’s no way to answer these questions without seeing a breakdown of net worth.

So it should come as no great surprise that the curious are turning up at NetworthIQ to see what other people’s money really looks like. “This was our way of making money a little more social,” said Todd Kalhar, one of the founding executive partners at NetworthIQ, which is now part of Strands, an online-media company whosemoneyStrands site competes with Mint. “People had been talking about stocks forever. We wanted to add a bit more context. The guy talking about stocks might have been bankrupt 10 times.”

And …

Grant often wonders about the people who are far ahead of her in the NetworthIQ standings. Did they get lucky? Are they lottery winners? Or did they get smart about money before she did? She tries not to beat herself up over it. “For people with the same income as me but higher net worth, it tells me that I can get there, too. It just takes discipline,” she says. “I know it has only been a couple of months now, but I kind of feel like I’ve made a life change.”

She admits that some of her pleasure is fueled as much by competition as self-satisfaction. “I’m not that far off from the person right above me” on the NetworthIQ list, she says. “I can probably catch them this month. And maybe next month I can get to the next one.”

That attitude is familiar to Michael McBride, an economics professor at the University of California, Irvine. “We crave information, not just to outdo others but to know how we ourselves are doing,” says McBride, who has studied how people’s well-being is affected when they compare their incomes against those of others. “When I pass out tests, the first thing students want to know is what the mean was. They don’t know how to interpret their score unless they know how well others did.”

That attitude is familiar to Michael McBride, an economics professor at the University of California, Irvine. “We crave information, not just to outdo others but to know how we ourselves are doing,” says McBride, who has studied how people’s well-being is affected when they compare their incomes against those of others. “When I pass out tests, the first thing students want to know is what the mean was. They don’t know how to interpret their score unless they know how well others did.”

I have been a NetworthIQ user for 3-4 years now, but keep a private profile. That means I track my networth but no-one else can see it. I do however enjoy reading other peoples profiles and following their net worth evolution for the very reasons described in the article.

How do you feel about going open kimono and revealing your finances – either anonymously or with your real name?

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