Author Topic: Reader Case Study - Master's Grad & New Job - Loans/Emergency/401k  (Read 2585 times)

erikdhoward

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Beginning Jan 1, I will start a new job and I would love everyone's advice so that I get a solid start. I have done quite a bit of my own research, but I can't decide the best path forward (even after running the numbers). I live with my significant other, and while I've tried to show her the ways of MMM, I haven't been too successful, so keep that in mind with the expenses. Thanks ahead of time!

Income: $60k - bi-weekly

Expenses (my portion):
Rent - $755/month (high for MMM, but relatively low for the city I live in; also provides me the ability to use public trans. and walk/bike to work)
Groceries - $150/month
Out - $150/month (I know this is high - still working on it)
MISC - variable (and I'm open to what this amount should be)

Assets:
Emergency fund - $1k
Old 401k rolled to IRA (before grad-school): $1100
Car - paid off 03' Jetta (probably worth $4k)

Liabilities:
Student Loan - $18600 @ 6.8% (minimum=$238)

Specific Questions:
Conventional wisdom suggests that I approach my situation in the following order:
(1) Match 401k (match is 25% of first 6%, so $3600)
(2) Create Emergency Fund (I'm comfortable with $5-7k)
(3) Eliminate debt.

That being said, I have run the numbers various ways, and if I'm shooting for the highest net-worth in, say, 5 years, MAXING my 401k provides the best route. That route elongates the life of my loan to 5yrs from 18 months if I were to attack it with very large additional monthly payments, but the amount of interest saved by attacking (~$1k) seems miniscule compared to the impact of NOT maxing my 401k from the get-go (potentially $10k). As always, the power of compound interest is incredible.

So, in short, do I:
(1) Max 401k and split the rest between loan and emergency OR
(2) Match 401k, aggressively fund emergency, then aggressively attack loan, and finally Max 401k?

I am wide open to your advice, experience, thoughts, etc. I have probably forgotten something that would make the decision as clear as day, so let's hear it! Thanks ahead of time!
« Last Edit: December 05, 2013, 03:26:01 PM by erikdhoward »

desrever

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Re: Reader Case Study - Master's Grad & New Job - Loans/Emergency/401k
« Reply #1 on: December 05, 2013, 03:39:54 PM »
I don't think the math of ($1K versus $10K) works out at all like you've computed. You're doing saving either way, at comparable expected interest rates, the only difference is which vehicle you're using to do the saving.

The match is free money, so of course you should max that out.

The fact of the matter is, on the margin, paying down the loan is a better investment than anything you'll be able to find in the 401k. It's a guaranteed return. The gains you get (in the form of interest you don't pay) are not subject to taxation. You will feel absolutely great when you pay it off.

Also, after your debt it paid off, your medium-term plans ought to include ramping up savings in some non-retirement investment account.

erikdhoward

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Re: Reader Case Study - Master's Grad & New Job - Loans/Emergency/401k
« Reply #2 on: December 05, 2013, 05:34:02 PM »
What exactly do you mean by on the margin? 'After-tax' rate?

What do you recommend with regards to non-retirement investment accounts? I have thought about that in the past (where does an 'early retirement account' fall on the list of priorities and how does one go about structuring it?).

desrever

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Re: Reader Case Study - Master's Grad & New Job - Loans/Emergency/401k
« Reply #3 on: December 09, 2013, 11:06:51 AM »
By "on the margin" I meant: suppose you have one additional dollar of gross income to save, you have a choice of (a) paying say $.25 taxes on the dollar, paying down the debt with what's left and having that yielding a guaranteed 6.8% return, or (b), deferring the taxes, investing the money in a 401k that may yield an average but unpredictable 7% return (minus maybe 0.5% in fund fees?), with the gains and original contribution subject to income tax when you withdraw.

For me, the risk free nature of the debt payoff makes it much more attractive.

If, as life progresses, you keep on with saving such a large slice of your income, having savings in non retirement accounts is going to give you the flexibility to avoid debt and pursue investments on the side. Especially the purchase of a home, a rental investment property, or such other non securitized investments. For example, I just invested 25k with a friend who is starting a small business. I could not have done that if my net worth were stuck in retirement accounts that couldn't be touched for decades.

As for how to invest, I really like wealthfront, but I might be alone on this forum in being willing to give up 25 basis points for the convenience of not having to pick stocks, execute share purchases, or remember to reinvest dividends.

desrever

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Re: Reader Case Study - Master's Grad & New Job - Loans/Emergency/401k
« Reply #4 on: December 09, 2013, 11:15:30 AM »
One last point in response to your original post: you'll see "the power of compound interest" work the same in debt payoff versus investment. And you'll see it work the same in pre tax and post tax accounts. Remember that your debt is somebody else's investment! The retirement accounts do have tax advantages, but these tax advantages are finite, and so you need to actually run the numbers to see what gives you a better outcome between options a and b above.

Note also: consider Roth type options as part of your mix, especially if you expect significant salary growth as your career progresses or live in an area with low income taxes relative to the taxes you may be paying in retirement.