The Doctor's Bill: Hell's Kitchen? (Verdict) ⋆ XRAYVSN

Johanna’s Take:

Bob Flay and his wife, Dr. Rachel have very busy careers, but love to spend their down time at home with their three children.

As with many families, they all tend to congregate in the kitchen and enjoy building memories there.

Can they afford to pay $50k for their dream remodel?

(Yes, they’re thinking it would cost $30k – $40k, but we all know how that goes…)

The positives:

· High income professional couple

· Planning to work 20 more years (until 65)

· Reasonable savings rate and good start on savings

· They drive cheap cars

The negatives:

· What’s up with the token student loan?

· I’m struggling to come up with anything else (but managed to at the end)

Assumptions (I will use conservative estimates wherever there is an uncertainty.)

· 6% average long-term returns on savings (Assuming no emotional mistakes in upcoming bear markets and corrections)

o By my calculations, you will have close to $6M at retirement (future dollars)

· Average inflation

· No more children

· You have plenty of appropriate life and LTDI in place.

· No divorce(s)

· You invest in an appropriately-diversified portfolio and do not make any behavioral mistakes

· No significant financial assistance for other family members

· Reasonably good health

· TCJA 2017 does not sunset in 2025 and current tax rates remain in effect

I don’t include future inheritances when making plans for the future unless the LW&T [Last Will & Testament] has been read (in other words, they should be ignored).

Too many things can go wrong, especially if a surviving spouse remarries.

Even without the mortgage-free rental property, the Flay/Rays appear to be ok at retirement.

So, I think the other focus in this scenario should be whether they can afford to pay cash for the remodel.

My calculations for a couple with $470k/yr income break down as follows:

· Savings $ 94,000

· Spending 220,000

· Taxes 134,000

· Outflow 448,000

· Inflow 470,000

· Available $ 22,000

It appears the Flay/Rays can fund a $50k remodel as a 2-yr savings project by tightening their belts just a little more (less eating out?)

If they can manage to stay with a 10% override on a $40k budget, however, things should work out quite well.

On a side note, my at retirement portfolio projection assumes both spouses are continuing full time at a similar income level until retirement.

However, they indicated they are hoping to work less when retirement is “more funded”.

What does that mean and how much do they want to cut back at work?

I ran a second projection – full time for the next 10 years then .75 FTE for the last 10.

Under this scenario, I kept savings at 20%, which produces expected savings of $5.5M in 20 years.

At 3% inflation, they will need $180,611/yr in 2040.

This appears to work just fine as, under the 4% rule, they can draw down up to $220k/yr.

Once again, however, I think we should examine cash flow.

With an annual income of $352,500, here’s the breakdown:

· Savings $ 70,500

· Spending 220,000

· Taxes 90,000

· Outflow 380,500

· Inflow 352,500

· Shortfall ($ 32,000)

Does that mean mom and dad can’t realize their goals of cutting back before they’re 65?

No, but they do need to plan carefully, budget realistically, and prioritize their goals in order of importance.

Budgeting realistically includes assigning dollar amounts to the cost of their goals.

For example, in 10 years, they won’t have to pay for a nanny and daycare.

But will the twins attend private high school and erase those savings?

Will they spend less/more on clothes?

Or do they dream of traveling more in semi-retirement?

I included this final illustration to emphasize the importance of being flexible and planning beyond the next year or two.

It can be difficult to envision life beyond the monthly changes in your bank balance.

Cutting back work certainly seems possible for this couple but will also require a leaner budget.

They need to think ahead – what will it be like to earn less?

Little changes today are a lot easier than big changes in 10 years.

For example, I think it might make sense to put the mortgage on a 10-year payoff plan while maintaining their current savings rate.

Paying off a 3.5% mortgage early may not seem like the best choice mathematically but will force them to explore their current spending and find ways to cut back.

It will be much easier to cut back work and not be stressed about finances if they’re debt free.

Xrayvsn’s Take:

The kitchen is the heart of a home and typically a place for congregation when entertaining guests.

I can therefore sympathize with this doctor if she feels her current kitchen setup is outdated or not up to snuff.

A home remodel can end up being the best financial option if it allows you to live in your current home longer and thus obviate the need to buy a new home (with all the expenses associated with it).

However I do think it is a fallacy to believe that the cost of a remodel can be justified if the driving reason behind the remodel is just to sell the home for a higher value.

[Side note: Some real estate agents encourage sellers to remodel major items such as kitchens and bathrooms prior to listing, however this typically is not a good return on investment (can be around 54% ROI for a kitchen remodel, for example).]

As far as kitchen remodel projects go, this request is actually quite reasonable as an average mid-scale remodel clocks in at around $66k and an upscale remodel can tip the scales at $131k.

Of course whenever dealing with the unknowns of construction/remodeling, a budget can be destroyed quickly.

Given the range of cost in this request, I am assuming that the higher number is a concession towards potential surprises found during the remodel.

What I like:

Great savings rate of 20% on a high household income of $470k ($94k).

Negligible student loan balance ($10k @0% interest).

Emergency fund equivalent to a little over 4 months of expenses.

Plan to work for another 2 decades.

What I don’t like:

Mortgage balance of $973k.

The mortgage balance currently is still 2.07x household income which likely meant the original mortgage amount was likely even higher.
Obtaining a mortgage >2.0 your household income can cause you to become house poor.

A $40k kitchen remodel paid out of the emergency fund would bring it down to $40k = 2.2 months of living expenses.

Will this purchase alter their retirement trajectory?

If indeed this physician and her husband can put in 20 years of work and get reimbursed at a similar rate, a $40k expenditure this year will be a small blip in the review mirror for their retirement nest egg as Johanna demonstrated above.

There is obviously less wiggle room if there is a planned slowdown at the tail end of the careers but even the above scenario showed that the net effect would be around a $500k reduction in the nest egg value

[Using the 4% rule as a guideline, this would lower their safe withdrawal rate by $20k/year.]

The great thing however is that nothing is set in stone and there is the ability to adapt.

If the markets are booming, a quicker descent from full time work is possible.

If the markets stagnate or decline, then the original plan of working full time for 20 years is still in play.

How to minimize my concerns.

Given that this family saves $94k/year ($7.8k/mo), I would much rather them create a sinking fund for this endeavor and cash flow it rather than raid the emergency fund.

This sinking fund could be fully funded in a little over 5 months if time was a pressing factor.

Ideally, if the project can be put on hold, an even better compromise would be to take a 12-24 month approach for funding so that all disposable income does not automatically get siphoned into it.

The Decision:

Johanna: Thumbs up.

Xrayvsn: Thumbs up.