First comes love, then comes marriage, then comes a baby in the baby carriage.
Ooops, I mean:
First comes love, then maybe comes marriage? Baby? Probably. But definitely then comes home ownership and oh yes, we’d like to completely remodel this home, please.
Remodels are expensive. On the other hand, your income is high, or you already have a large investment portfolio. So…maybe you can afford to spend $500k (to use a not-uncommon cost for my clients) on a remodel? How do you figure that out? You really want this remodel!
Let’s walk through whether doing a remodel is a reasonable choice for you, depending on the current state of your finances.
You don’t already have the money for it.
If you don’t already have $500k, you have two choices:
- Start saving the money, and then wait until you have the full cost saved up.
- Borrow the money.
I’m pretty traditional (unsatisfying, conservative) when it comes to this sort of thing. I think there are only a few reasons in life you should intentionally go into debt, notably:
- To buy a home (i.e., get a mortgage)
- To buy your first car (because you usually need a car early enough in life that you haven’t had the opportunity to build up any savings)
Outside of this, if you want to buy something (that isn’t absolutely necessary), I believe you should save up the money first. This applies to remodels, too. There could be exceptions, but you’d have to really convince me!
Why am I so conservative in this way? There are just too many ways to regret spending money you don’t have.
For example, you take out a big loan that is totally reasonable for your current income…and then you get laid off. Or, you take out a loan and then five years later you really wish you had the freedom to switch careers/start a business/take a sabbatical but you’re still paying off a giant HELOC and can’t afford to take zero or lower income for a while.
So that’s the first rule: If you don’t already the money to pay for it, you can’t afford the remodel.
But I work with lots of people who have meaningful wealth at an early age and already have $500k saved up in cash (it happens!) or (more likely) invested in a taxable account or in the form of company RSUs that vested and the person never sold them so now they have a bajillion shares of Apple or Google or Nvidia.
If you have meaningful wealth early in your life, how do you decide whether it’s prudent to take money out of that existing wealth to pay for a remodel? You don’t want to be foolhardy, but at the same time, the point of money isn’t to have the most of it. It’s to have enough money to spend—now and in the future—on the things that make you happy and give your life meaning.
Let’s look at a few scenarios, in decreasing order of wealth:
- You are already financially independent. You have so much money that you likely won’t need to work again for the rest of your life.
- You are already “Coast FIRE” (to be explained below) and would still be Coast FIRE after spending the money.
- You still have to save money for retirement, but assuming you continue to do that, your retirement projections look healthy.
You are already financially independent.
The OG “financial independence” is just plain ol’ Retirement, when you turn 65, quit your job, take up fishing or pickleball, and now live on your investments, Social Security, and this thing they call ‘“pensions,” whatever that is.
Financial independence in the tech industry can look very different. If you’ve had a windfall (through an IPO, tender offer, or persistently generous RSUs, say), then it’s possible you have so much money at the age of 37 (or 45 or or or) that you possibly never have to work again.
In any case, you’re living off of your investment portfolio, and you have to make sure you are taking a “sustainable” amount of money out of your investments each year to live on. You don’t want to take so much out that your portfolio will be too small in the future to support your spending.
I think the approach here is actually kind of stupidly simple.
Let’s say you have a $5M investment portfolio and you’re living off of your portfolio. There are a variety of ways to determine how much money you can sustainably take out of a $10M portfolio each year. The best known is the “4% rule.” (You can get more nuanced than that using additional calculations and different spending philosophies. That doesn’t matter for our purposes here. I just need to use a calculation to illustrate the “affordability” analysis.)
If you have a $10M portfolio, the 4% “rule” tells us that a sustainable withdrawal from your portfolio is $400k (4% of $10M) that first year. In each subsequent year, you will adjust that number up by the reate of inflation, and you can feel pretty darn confident that your portfolio will last you the rest of your life.
If you want to see if you can afford a $500k remodel, reduce that $10M by the $500k. Now you have $9.5M. 4% of $9.5M is $380k.
Can you fit your life within $380k/year (increased by inflation each year)? Yes? Well, then, it’s reasonable to do the remodel.
You are already Coast FIRE. And you would still be after the remodel.
Being Coast FIRE in your 30s or 40s is rare in general, but quite common in the tech industry, at least among my clients. (A bit of self-selection bias going on here, for sure.)
What is Coast FIRE? It is the state of your finances where you don’t need to add to your retirement savings anymore, as long as you don’t withdraw from it. Your existing pile of wealth, if you simply leave it invested, will grow into a big enough pile of money to retire on by the age you want to retire. In the meantime, you need a job that pays you enough to cover all your bills. It’s a wonderful financial position to be in. It gives you so much flexibility in your life and career. (Read more about all the nuances of Coast FIRE here.)
There are a bunch of Coast FIRE retirement calculators out there that you can use to determine whether you’re Coast FIRE. I have my own internal calculator.
One thing my calculator shows me is how much “extra” money the client has on top of their Coast FIRE number.
For example, let’s say you plan to retire (i.e., stop earning money and start taking money out of your investment portfolio) at age 60. We calculate that if you have $1M in retirement savings now and never add more money to it, you should have enough to retire at age 60.
And hey! Would you look at that! Your retirement portfolio is already worth $1.6M. Congratulations! You’re Coast FIRE.
(N.B.: Your Coast FIRE status can change on a dime as your portfolio balance changes and as your retirement plans—age and spending needs and habits—change. Coast FIRE status is a more a trend than a single calculation, in my opinion.)
Not only are you already Coast FIRE, but you also have $600k more than what you need to be Coast FIRE.
We could use that $500k of that “extra” to remodel your home and you’d still be Coast FIRE. How about that?
(I feel compelled to remind you that a “$500k remodel” never ever costs $500k. They cost more, often much more. I work with several clients whose remodels have gone $100ks over budget. And this is the rule, not the exception. The analyses I discuss in this blog post require using a realistic number for the remodel cost, not just what the contractor tells you initially.)
After the remodel, you still have to save, but you’re on the path to a good retirement.
The essence of Coast FIRE is that you don’t have to add any more savings to your retirement portfolio.
But what if you plan to/are willing to continue saving to your retirement for many more years? You know, the way Normal People do? Just plugging away, year after year, putting money into their 401(k)s and taxable investment accounts?
That could also work.
Let’s say you need $1.5M to be Coast FIRE. You currently have $1M. You are not Coast FIRE. Paying for the $500k remodel would make you even more not Coast FIRE.
Is that okay? Are you being irresponsible?
Now is the time on Sprockets—but alas, not this blog post—when we run some numbers!
You should work with a financial planner or use online software (that you can competently use…these things get complicated!) to determine whether your annual savings habits—to your 401(k), HSA, IRA, taxable account—on top of what you already have saved (now $500k smaller) will be enough to help you retire when and how you want to.
I mean, it’s not like we have to pretend that by the age of 37, if you haven’t already fully funded your retirement, it’s hopeless! That’s ridiculous. Most people work and save consistently for retirement year after year, decade after decade.
So, if you reduce your retirement portfolio from $1M to $500k to fund this remodel, but then plan to save, steadily each year until you retire, for example:
- $24,500 to your pre-tax 401(k)
- $30,000 to your after-tax 401(k)
- $8750 to your HSA
- $40,000 to your taxable account
Will you still be on track for a good retirement?
If so, then we can say it’s reasonable to fund the remodel.
Why am I being so delicate in my word choice and phrasing? Because sh*t happens. And a lot of choices based on high tech-industry compensation don’t look so smart anymore when you get laid off and can’t get consistent employment for a few years and kick yourself for having spent so much money in the past when the fish were jumpin’ and the livin’ was easy.
You have to choose for yourself whether the lifestyle improvement of having the remodel done is worth the increased risk it inevitably creates for you because now you have less money.
Other Thoughts about Remodels
Your remodel is not an investment. It’s an expense. And that’s okay!
Please don’t think of this remodel as an “investment” that you’ll get a good ROI from when you eventually sell your home. You might increase the value of your home, sure. But historically the ROI on home remodels are way less than what you’d get by keeping your money invested in the stock market. And also, getting that ROI usually requires that you sell your home! “But I like my home! It’s where I live!”
I think it is behaviorally/psychologically very useful to think of a remodel as a voluntary expense. Spending money on voluntary expenses is perfectly fine! Often good! These are things that bring joy to your life: a night out with your sweetheart, a vacation you’ll always remember, etc.
Do you think you’ll get enough enjoyment out of this remodel to justify not having the money to spend later? Or having to retire later (because keeping that $500k could have allowed you to retire a few years earlier)? It’s okay to say yes! I just want you to seriously consider the question.
You could use a loan even if you already have the money.
Let’s say you have plenty of money in a taxable investment account to pay for this remodel. It still might make sense to pay for it with a loan.
We have a client in this exact situation. Instead of selling their investments (which they can afford to do and still have a nice retirement), we’re using a securities-back loan so we don’t have to sell the investments (and pay capital gains taxes).
For such young clients, I’m not generally a fan of taking on unnecessary loans that last for years and years (The interest payments! The additional complexity!). In this client’s case, however, they anticipate earning enough income over the next couple years to pay back the loan fully. You might instead anticipate getting an inheritance or proceeds from selling a property in the near future.
The interest they’ll pay in the meantime will be far less than the capital gains taxes would have been, had we sold their existing investments to pay for the remodel. And if push comes to shove and they don’t get that income, we can choose at that point to keep the loan or sell the investments to pay it off.
So, you can optimize using a loan. But I still think you should use a loan only if you already actually have the money.
While I have focused on remodels in this blog post, the framework can be used to evaluate any major expense (remember, expense, not investment).
You don’t want to jeopardize your current financial security or your eventual retirement or other non-negotiable goals by spending the money. But if you can spend the money and still be currently secure and also remain on a reasonable track to retirement goodness, then you can likely afford it (whatever “it” is).
Happy (responsible) remodeling!
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