Personal Finance in USA

Feel that many of us during our initial years in US have some of these ingrained financial instincts like directing all savings to fixed & recurring deposits, buying a home, using insurance policies as investments and being risk averse to market investments. Based on my experience, just wanted to share some quantifiable inputs. Priorities, necessities and understanding differ and below is just a personal perspective.

Some mistakes, which I made.

Transferring Dollars to India to fund fixed deposits for better returns.

Returns offered by banks are proportional to inflation. If the return offered in India is 7%, inflation would be around 5%. Similarly, if the return offered in US is 3%, inflation would be around 1%. The real return is 2% in either case. Rupee depreciates as the inflation rises and offsets the imaginary returns in India. If India makes progress from emerging economy to developed economy, inflation slows and the returns would also be downsized proportionately by banks. If the transferred dollars are to be repatriated (converting rupees back to dollars), remittance costs would further dent the capital. Review below use case. Assume dollar conversion rate is 51. Remitting companies outward transaction rate would be around 50. Transferring $1,000 equates to ₹50,000. Banks dollar selling rate would be around 52, which would be applied for incoming remittances. Repatriating ₹50,000 (50,000 divided by 52) would amount to $960. With neither inflation nor depreciation in picture, loss would be around 4%.

The only situation where above would not be applicable is when inflation in India is lower than that of US and rupee appreciates. This is not impossible but unlikely in near future.

Buying an apartment.

I bought an apartment (which was under construction) in 2009. Based on relevant foreign exchange rates over a period of 6 years, transferred around $112,000 (₹65 L). While the basic cost was ₹42 L rest ₹23 L amounted to interest on availed loan, amenities (car park & clubhouse), taxes (value-added tax & service tax), utilities set up (water & electricity), registration costs and interiors. Apart from car park and clubhouse to an extent, none of these would add to selling price. As of 2020 March, apartment price appreciated from ₹3,000 to ₹6,000 per sq ft which translates to ₹84 L. The rental income earned till date is around ₹11 L. Assuming a sale materializes and the whole of ₹95 L (including real estate gain and rental income) could be repatriated, current valuation stands at $122,000. Post taxes, this is just 1% annualized return with a rental yield (income generated on investment) of 2.5%. When adjusted for inflation, this is zero gain in spite of best-case scenario where the apartment sq ft price doubled and there was no gap in rental income. Marginal investment returns and low rental yields do not make monetary sense to invest in housing as an investment. It is very tedious as well, to move real estate sale proceeds back to US. To give some perspective, US Stock market rose by 15% during the same time period. Historical US market return is around 8% taking into account all major recessions.

If you could get a commercial space with high rental yield, do the math if the returns would at least beat the inflation and then decide.

Buying Life Insurance Policies as investments.

Endowment and Unit linked Insurance plans which are very popular in India are expensive products with stringent liquidity options. Popular LIC Endowment plan returns are comparable to fixed deposits. Unit linked plans (from Bajaj Allianz etc.,) invest in mutual funds and returns realized are much lower when compared to direct Mutual Fund investments. This is due to policy costs associated with life coverage. The assured coverage amount is very nominal relative to policy premiums, which defeats the purpose of life insurance.

Investing in Indian Mutual Funds.

In US with regards to Indian Mutual Funds, un-realized gains are subject to income tax while un-realized losses are not eligible for tax deduction. This coupled with rupee inflation could significantly diminish the investment growth.

What to do with US savings?

It is only natural due to emotional bonding and current immigration uncertainties to get fixated on the idea of moving back and base every decision on that. If planning to invest in US, below is a rough plan.

Invest 10% in Retirement accounts.

Invest in 401(K) as early as possible. If the employer is not offering 401(K), invest in IRA (via a Robo Advisor like Betterment). Allocate to Roth and Traditional in equal proportion. In Roth, gains are not taxed and contributions are accessible after 5 years. To illustrate, assume you invested $100 in Roth and $100 in Traditional. For Roth, you pay $30 in taxes upfront while tax is exempted for Traditional. If $100 investment in both accounts grow to $1000 at the time of retirement – $1000 in Roth would be fully tax exempted, while in Traditional your take home would be $700. (assuming tax rate remains in similar range)

This $30 vs $300 difference is not a straight conclusion but is contingent on various variables like your tax bracket at the time of retirement (which is likely to be lower) and opportunity cost of the $30 accessible upfront for Traditional contributions. Roth is no brainer for young and high-income earners. Since nothing is certain with taxes and future income, diversification helps.

Save 5% in online only Bank.

Online only banks like Barclays US or Credit Unions provide returns in line with current inflation. This is for capital preservation with zero risk. This could be used as investment capital if needed during market down times.

Invest 5% in Brokerage Account.

This is to provide flexibility with respect to investment options and liquidation as retirement 401(K) accounts have limited investment options and are locked in until retirement age. (A Robo Advisor like Betterment which invests in low cost exchange traded funds could facilitate this)

Invest 5 % in 529 Plan, if you have kids.

Certain states like New York provide 10% exemption on contributions and the gains are always tax free (similar to Roth) when used for education. Penalty is 10% if not used for education. Tax is exempted on both contributions (not all states) and withdrawals. Over a period of 15 to 20 years, this tax advantage could yield significant gain.

Over a period of time ensure you have 6 to 9 months of your net income saved in a Certificate Deposit.

Life happens. This helps to insure against any unexpected expenses and prevent liquidating long-term investments.

Enroll in Employer Benefits.

All of these reduce the taxable income

Health Savings Account: Eligible if enrolled in a high deductible health plan. Contributions, Gains and Withdrawals are tax exempted. Investments roll over automatically each year. Covers eligible medical expenses. Doubles up as an investment to cover medical expenses post retirement.

Flexible Spending Account: Covers health care related deductibles, copays, medication and other out-of-pocket costs. There is no eligibility restriction to enroll in a high deductible plan (as in Health Savings Account) but contributions cannot be rolled over into next year beyond $500.

Dependent Care Flexible Spending Account: Covers dependent care expenses like Child Day Care costs.

Commuter Benefits: Covers commute costs like parking, train & bus tickets.

Apply for a Term Life insurance and Create an Online Will.

Death and Taxes are inevitable and uncertain. You could at least plan for taxes. Life Coverage could be 10 times annual net pay. Time period could be number of remaining working years left. For Will, I liked Willing.com. It takes less than 10 minutes and is under $150.

Do not buy a car which is more than 25% of your annual net income

Do not buy a car on lease.

“You should buy a home” is a naive advice.

Below article advocates neutrally, advising to review the numbers methodically before making a decision. To ensure optimal cash flow for essentials it is recommended to not exceed 33% of take home pay for monthly payments.

Renting is Throwing Money Away … Right?

Quick home buying index (referenced from above): If Home price (including closing costs and initial set up cost) divided by Annual Rent is

Less than 20: Could buy as Primary Residence.

Between 20 and 25: Think before buying and review your numbers again.

Greater than 25: Do not buy.

Less than 8.33: Could buy as a rental property.

If a house costs $400,000, closing costs amount to 7% of house cost, initial set up costs $10,000 and applicable rent is $2,000 per month – Buying index is 18.25. ((400,000+ 28,000+10,000) / (2,000*12))

Stating the obvious 😊, none of this would matter unless you are physically and emotionally in a good space.