The Frugal Professor: Let’s Get Deep in the Weeds

Alrighty, folks. This week I’m pleased to bring you a low-down-and-dirty financial deep dive with climber, writer, father of five, and lover of personal finance: The Frugal Professor. In this interview, we hold our breath and plunge into complex issues surrounding actually spending all this money we save for periods of no traditional income, meanwhile navigating the treacherous, shark-infested waters of the US healthcare system.

I’ve always said that saving and generating wealth is shockingly simple once some key concepts are understood, implemented, and doggedly followed, through thick and thin. And I’m sticking to my story.

What is not so straight-forward, however, is threading a very fine needle on living off the money we’ve saved. In a period of no traditional income⏤call it “retirement” if you want⏤we shouldn’t be just selling shares and calling it a day. We have to optimize healthcare spending, minimize taxes, and avoid early withdrawal fees and penalties meant for a much more traditional retirement.

But with a little planning, it ain’t no thang.

Let’s roll up our sleeves with the Frugal Professor and get a little dirty, shall we?

Frugal Professor the Climber: Origin Story

CC: Can you give me some background on you as a climber? How do you manage staying psyched climbing mostly in the gym? What was a favorite trip?

FP: I grew up near San Francisco, CA and was active in boy scouts growing up. My first exposure to rock climbing was at a climbing gym (Planet Granite, Sunnyvale, CA) and I instantly fell in love with it. Despite falling in love with it, I was only able to visit the gym a couple times a year during my youth.

I did my undergrad (five-year mechanical engineering degree) + MBA (1.5 years) within a half mile from some of the best climbing in the United States. You’d think that this would have prompted me to get serious about climbing, but for some reason it never materialized.

Fast forward a few more years to my phd, in the middle of corn fields (a common theme in my adult life). My phd was pretty grueling, but I got exercise by biking ~10 miles round trip every day. When biking to school, I passed the campus climbing gym daily. Inspired by my horrible posture and depleting health, I got back into gym climbing. I even dragged my wife and young kids with me, though they surely didn’t enjoy it as much as I did.

It beats the heck out of not climbing.

The Frugal Professor, on Midwest climbing

Making It Happen in the Midwest: Climbers of the Corn

FP: When I got my current job as a professor (also in the middle of cornfields), I was elated to learn they had a great climbing gym. Because I’m a cheap idiot, I was too stingy to pay the $40 gym fee every month and didn’t climb the first year here. Eventually, common sense prevailed and I joined the gym and have been climbing three times per week since.

At first, I struggled to get up 5.9’s. But with continued diligence, I’m happy to say that I’ve gotten considerably stronger. I’m getting up 5.12’s pretty regularly in the gym now and V8 boulder problems (I’m mindful, of course, of grade inflation at the gym).

Getting Outside

My success with gym climbing (in my mid/late 30’s) prompted me to reach out to a former phd buddy to gauge his interest in outdoor climbing. He lives near Cincinnati, so we’ve done a couple of trips to the Red River Gorge. Our success at RRG sparked an interest in trad climbing for both of us. We dropped some money on some shiny new racks and hired an AMGA certified guide (Pete Lardy) in Colorado Springs to teach us.

With that course behind us, we took our first trad climbing trip to Red Rocks in December of 2019 before the world shut down due to Covid. The Red Rocks trip, though short, was pretty epic. There is something special (and terrifying) about trad climbing. This same buddy and I are planning a Salt Lake City climbing trip in a post-covid world some day.

Keeping Motivated in the Gym

How do I stay psyched gym climbing? When you live in the middle of cornfields and the closest outdoor climbing is literally seven hours away, you learn to take what you can get. It beats the heck out of not climbing.

What reinforced my skepticism for my job was that I was surrounded by grumpy old men who hated their jobs.

The Frugal Professor

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The Frugal Professor on the Journey to Financial Independence (with a Family of Seven)

CC: Tell me about your journey toward financial independence. In particular, how have you managed this goal with a wife and five children?

FP: My journey to financial independence is a circuitous one involving 12 years of college. After graduating with my degree in mechanical engineering, I worked for Boeing for four years. While I was initially excited about my job⏤after all I would be engineering planes, right?⏤ the excitement quickly died as I realized that I had worked my ass off in undergrad to become a glorified paper pusher.

I wasn’t designing much of anything. Rather, most of what I did involved writing specifications for parts that subcontractors would design and manufacture (“the widget shall withstand forces of XXXX, temperatures of YYYY, and fit within ZZZZ size constraints). I did some safety auditing as well (not on the disaster of the 737MAX, I can assure you).

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They say the definition of insanity is doing the same thing and expecting a different outcome. I figured that it’d be insane to put in 45 years of my life at Boeing and expect an outcome different from the miserable existence of my colleagues.

The Frugal Professor

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Skepticism of a Long Corporate Career

What reinforced my skepticism for my job was that I was surrounded by grumpy old men who hated their jobs. Almost everyone hated coming in to work on Mondays. Most lived far away and had to battle Seattle traffic (the median commute was probably > 60 minutes one-way). One of my office-mates dropped dead of a heart attack over the weekend. It was a sobering reminder to the finite nature of my life and a desire to not die in my cube in my 60s/70s.

They say the definition of insanity is doing the same thing and expecting a different outcome. I figured that it’d be insane to put in 45 years of my life at Boeing and expect an outcome different from the miserable existence of my colleagues.

Cliff notes version of the rest:

• I loathe waste (especially money), so saving half of our salary was easy during the entirety of my career (we currently save 70% of our net income).
• I wanted two kids. My wife wanted five. We “compromised” at five. She has pretty much always stayed at home with the kids, though she recently got a job as a substitute teacher, which she enjoys.
• Three years after undergrad, we were worth $100k. I then quit work to start my MBA.
• I started my phd with a net worth of $120k or so. We ended it with a net worth of $250k.
• We have over $1M in investments now. But, given my loathing of waste, I still use rabbit ear antenna + freeish cell phones + brown bag it to work + ride my bike year-round (~12 miles/day). My wife is mostly on board.

These “little” things we do to save money really do add up. Particularly when compounded with a 14% return of the US equities market over the past decade.

The Frugal Professor

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The Frugal Professor on the Power of “the little things”

FP: These “little” things we do to save money really do add up. Particularly when compounded with a 14% return of the US equities market over the past decade.

With the tailwind of a 14% return for a decade (or 10%/year return since 1927), it’s pretty easy to accumulate wealth for a person who is well compensated and manages to keep their spending in check. An MBA colleague of mine just hit $2M in investments by the age of 40 by keeping it simple and investing in index funds (a nice post-MBA salary certainly didn’t hurt him either).

Saving ~$1k/month for the past 20 years with a 12% annual return would get you to $1M today (=PMT(0.12/12,20*12,,1000000)). $1k/month sounds spicy, but if you save $100/month on TV by having rabbit ears, save $100/month on cell phones, $500/month by not eating out, (etc), you can see how this is more attainable. I write about the power of staying the course here.

(Related Post: Five Essentials That Are Destroying Your Savings)

(Related Post: On Deprivation: Food)

Obligatory disclaimer on the anomalously high recent market returns

FP: Unfortunately, 10%+ returns are likely to be unattainable for the foreseeable future. Why? Interest rates are zero and asset prices are inflated. So, we have to learn to cope with subdued returns. What does this mean in practice? We need to save more. Harvard economist Greg Mankiw suggests that the current low-interest environment will require us to save 20% more (source):

[The low interest rate environment] also means that individuals will need to rethink retirement saving…To support any given level of spending for a 20-year retirement, a person’s nest egg entering retirement needs to be 19 percent larger.

N. Gregory Mankiw for the New York Times

To get to a 20% larger portfolio in a zero-interest rate environment is indeed going to be considerably challenging. Which is why strategically thinking about this stuff (like how to optimize your taxes) matters even more now. Frugality will be increasingly important going forward given the less-than-ideal investing environment we’re in.

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The Frugal Professor on Why a Background in Finance Doesn’t Solve the Personal Finance Dilemma

CC: Would you say your background in finance prepared you for your own personal finance journey?

FP: Not really. I was well on track before the MBA + phd in finance thanks to reading books from Jack Bogle and others immediately after I finished by undergrad. Some of these books include:

• A Random Walk Down Wall Street
• The Four Pillars of Investing
• The Richest Man in Babylon

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What matters most, by far, is spending less than you earn; preferably much less and preferably over a multi-decade horizon. They don’t teach that very well in school.

Here’s what else I think matters:

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(Related Post: I Have Cash! Is Now a Bad Time to Invest?!)

I did take an intro to finance course during my MBA which was helpful in teaching me about the time value of money. I also took an investments course that reinforced what I already knew about index funds. But 99.9% of my coursework was orthogonal to anything useful in the personal finance space.

*Related Post: Financial Advisor: Who Needs One?

What matters most, by far, is spending less than you earn; preferably much less and preferably over a multi-decade horizon. They don’t teach that very well in school.

The Frugal Professor

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The Importance of Tax-Advantaged Accounts and How to Pay Yourself in an “Early Retirement”

In this next section the Frugal Professor elaborates on the importance of contributing to (or ideally maxing out) tax-advantaged accounts like the 401(k). From there, we see how someone without traditional income (using ourselves as an example) can move, shuffle, and spend that money, minimizing taxes and paying no early withdrawal penalties.

A CC Family Case Study: How To Use Retirement Funds and Minimize Taxes/Fees/Penalties

CC: Let’s do a case study on our situation (the CC’s):

a. We have an approximately 45/55% split between tax-advantaged retirement accounts and taxable brokerage investments. We also have a two-to-three-year cash buffer (I know, that’s hefty).

b. We are on an ACA Healthcare Silver Plan* with an anticipated yearly income of $40,000. For this plan, we pay $256 per month, or $3,072 per year, so long as our income (that we pay ourselves with investment income) does not exceed $40,000. We should have gone with a Bronze Plan, but no matter. Calculate your healthcare costs here.

c. Can you break down your recommended process on how to both minimize taxes (bonus points for $0) and pay yourself in an early retirement or period of no traditional income?

*For more on how ACA healthcare is subsidized, check out this post: Is Healthcare Insurance About to Get a Lot More Expensive?

FP: To get to $0 income taxes, you need to leave Utah and move to a state with 0% income taxes. But Utah isn’t too bad with its 4.95% top marginal rate. Here’s a good resource for comparing state tax regimes, total tax burden (income, sales, property, etc): Tax Guide: Smart Asset.

To make the example easier to understand, let’s assume you have rolled over all Traditional 401(k) balances to a Traditional IRA (CC edit: We have). This has the advantage of achieving lower investing fees (and avoiding record-keeping fees) that plague many 401(k) plans. Plus, it makes additional downstream steps easier.

Paying $0 in Federal Income Taxes:

The Roth Conversion Ladder: Using Retirement Funds Early

FP: You can “convert”* the full “standard deduction” from a Traditional IRA to a Roth IRA each year. That’s $25,100 each year (2021, married filing jointly). Half that if single.

*CC Edit: FP is referring to what’s known as the Roth Conversion Ladder, where funds are transferred from a Traditional IRA (where they were previously untaxed) to a Roth IRA (where they won’t be taxed upon withdrawal).

A Roth conversion is considered a taxable event, but someone without a traditional paycheck is very likely living in or near the very lowest tax bracket. By converting up to the standard deduction, we are taunting the IRS to tax us, but they won’t (any income up to the standard deduction isn’t taxed). It’s a tax-free conversion. The money went into a 401(k) tax-free, is converted at low or minimal taxes, and then can be withdrawn tax-free after it “seasons” five years. It makes sense to somebody, right?

Capital Gains and Dividends Are Tax-Free in a Low-Income Environment

FP: You can realize $81,050/year in dividends and long-term capital gains each year without paying a penny in taxes.

Let’s say you invested $200k in an index fund many years ago, and it is now worth $500k. In other words, there is a $300k “unrealized” (because you haven’t sold it yet) capital gain. Put another way, $200k of your $500k balance (e.g. 40%) is “principal” (i.e., what you initially paid for it), and $300k of your $500k balance (e.g., 60%) is the “unrealized” capital gain.

If you were to sell $100k of your stock, you’d only generate $60k of capital gains. If you’ve held this investment for over a year, you qualify for the favorable “long-term capital gains” rate.

Because you can “realize” $81,050/year in long term capital gains (LTCG) for free if you have no other income (above the standard deduction), this implies that we could sell $135,083/year of your taxable brokerage account to arrive at the $81,050/year LTCG (=$135,083 * 60% unrealized capital gain ratio).

Of the $135,083/year that you just sold, I’d “eat” the $40k/year to live.

I’d then reinvest the remaining $95,083 back into the market IMMEDIATELY.

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Capital Gains Harvesting

Why would we go through the hassle of selling an extra $95,083 of stock only to rebuy it immediately? Because it cost us nothing in taxes to do so but increased our “cost basis”* by $95,083. Looking at the $95,083 we just re-invested, we’ll only have to pay taxes on any increase above $95,083.

I’m sure that was confusing, but the moral of the story is that there is a huge region of 0% LTCG taxation based on current law so I would fully exploit that each year while it’s available⏤even if you don’t need the money immediately. Worst case scenario, you’re simply increasing your cost basis as you do so.

*CC Edit: Resetting our cost basis has two primary advantages:

(1) We can reset the clock on new capital gains growth. By selling and re-purchasing old shares, we can now start the growth again, instead of incurring additional capital gains on old shares (which would be taxed).

(2) We can potentially set ourselves up for a tax-loss harvesting situation. I’m not going to go much into this right now, but check out that link above.

CC Addendum: *Important* Healthcare Considerations

CC: I’m going to add some important qualifiers here on healthcare. As mentioned above, we are insured under an ACA healthcare insurance (Silver) plan. One very important needle for us to thread is keeping our modified adjusted gross income (MAGI*) under 400% of the Federal Poverty Level ($68,960 for a 2-person household in 2021).

Why?

Because below that level the price of healthcare is highly subsidized, and without those subsidizes, it’s stupid and prohibitively costly. This is known as the Federal ACA Subsidy Cliff. If our income exceeds 400% FPL by even a penny, we fall off the cliff and pay thousands more for healthcare. Ouch. We don’t want to be anywhere near that cliff.

The Slope Before the Cliff

In Utah and many other states, the 400% Federal Poverty isn’t the only “cliff” to be concerned with. Here in the beehive state (who knew?), there is an upward slope before the cliff, and the subsidized rate of healthcare is tiered based on income.

The more income you make, the less you get of that sweet, sticky subsidy.

For example, we used an income of $40,000 to be given our monthly healthcare rate of $256 (try your healthcare costs here). If we exceed that income and actually make $50,000, that corresponds to a monthly rate of $397. In early 2022, Big Uncle Sam will come knocking and say…

“[REDACTED] WHERE MY MONEY?!”

Uncle Sam

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We’ll owe him $1,692 in subsidy back-payments for making more money than we promised when enrolling.

*For more on healthcare costs and how to calculate your MAGI, check out this post: Is Healthcare Insurance About to Get a Lot More Expensive?

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One could very realistically pay $0 in taxes in retirement…When you realize that you can viably withdraw this money at 0% taxes on the back end, you quickly realize that this is financial alchemy.

The Frugal Professor

Other Tax Optimizations Everyone Should Know

FP: In light of the arbitrage described above, here’s what I’d recommend to everyone: The Hierarchy of Savings.

Doing the above will minimize one’s lifetime tax burden, particularly when also paired with tax-conscious withdrawals on the back end.

As we saw with your case study, one could very realistically pay $0 in taxes in retirement. If your marginal federal tax rate is 24% and your marginal state tax rate is 7%⏤as is the case for me on both fronts⏤then one saves $0.31 in taxes today for every dollar contributed to a “Traditional” 401(k)/401(a)/457/403(b)/IRA.

When you realize that you can viably withdraw this money at 0% taxes on the back end, you quickly realize that this is financial alchemy. By being smarter about your taxes, you are able to grow your wealth by 44% (=$1/(1-31%)) through tax arbitrage.

When combined with added benefits of saving in tax-deferred vehicles (no dividend tax drag, etc), the arguments in favor of investing in tax-deferred vehicles are astounding. This message is what I try to drill into my undergraduate students every chance I get. The unfortunate thing is that 19-year-olds are oftentimes not particularly receptive to this messaging.

The Frugal Professor on Life after Financial Indepedence

CC: What is your ideal life in a post-FI world?

FP: When I eventually hang up my suspenders and pocket protector for greener pastures (when I’m old and crusty), I envision the following to be a pretty good post-FI existence:

• Spend a few hours putzing around outside daily (hiking, biking, climbing, etc).
• Spend some time helping people with personal finance.
• Spending a few hours reading/learning/creating.
• Spend several hours of quality time with family (or just Mrs FP once we’re empty nesters).

Rinse and repeat the above until I’m 6 feet under and that sounds like a pretty fulfilling existence to me. Maybe add a bit of traveling to the mix.

I think it’s asinine that we put students through four years of an undergraduate education without giving them any advice on how to navigate the complexities of the [personal finance and healthcare] challenge.

The Frugal Professor

The Frugal Professor on Education: Is Personal Finance Represented?

CC: As an educator, what do you wish was being taught in schools now?

FP: All of us are pension fund managers that are solely responsible for:

• Determining how much to save
• Deciding how to best invest
• Determining how to navigate the tax code
• Understanding how to deal with risks
• Understanding the corrosive effects of inflation, investing costs (including advising fees), etc

I think it’s asinine that we put students through four years of an undergraduate education (or five in my case) without giving them any advice on how to navigate the complexities of the above “savings” challenge.

Healthcare is another huge area where people are completely unprepared. It’s pretty daunting choosing between healthcare options at work. At the end of the day it’s a math/finance problem, but people are completely on their own here, left to decipher deductibles, coinsurance, max-out-of-pocket, in-network vs out-of-network. It’s asinine that such consequential decisions are not discussed in a single (mandatory) class in college.

In summary, I’d make a rigorous Personal Finance + Excel course mandatory for any student hoping to graduate college with any major. This stuff is too important to ignore and “hope it’ll work out somehow.”

Staying in Touch with the Frugal Professor

CC: Where can people reach you (social media, blogs, etc)?

FP: I’ve found that social media makes me dumber, so I’ve resolved to only post on my blog: https://frugalprofessor.com/. (Though I admit that I’m an occasional consumer of Reddit/Instagram….).

Hi, this is Mr. CC and I am open to interviewing more folks like you. Don’t be shy. Are you or is someone you know great/terrible with money, or living a great/could-use-improvement life? We all could relate. Hit me with your story.

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