Where to put extra money

[smalliswell]

Hi there,
I'm a long time reader but still do not have the investing thing quite down. Here is my situation.
We are in our mid 40's with a paid off house and 6 month emergency fund. We also owe 106K on a rental that makes 400 a month.

I'm not sure what to do with our extra cash. Currently my husband and I contribute up to the match in our employers 401K. Me 6%, him 5%. We are setting aside additional cash 9% myself, and 10% him for a ROTH IRA. We do plan to retire earlier, in 6-10 years.
I've been reading up on Vanguard. Should we put our additional cash there, after the ROTH or instead of the ROTH?

Also, this house either will need updating or selling at some point. Either way we will need additional funds. Where is the best place to put the cash when we need it later?

[neo von retorch]

You have two questions with a third, implied question:

1) In what order should we contribute funds to various investment vehicles (pre-tax retirement, post-tax retirement, taxable investment)?
2) Where should we keep the investments (Vanguard, etc)?
  a) What should our allocation be (stocks/index funds, bonds, REIT, etc)?

The first question is basically a question of math. Given your income and tax situation, how can you get the most bang for your buck? Make sure you start by maxing out any employer match - you will not beat a 100% return. Next up, you will likely want to maximize all other pre-tax retirement contributions, but this varies with tax situation. Many in the FIRE community likely have intentions of minimizing expenses, and living off less once they retire. So money that is in pre-tax retirement vehicles can be migrated into post-tax with very little tax impact. (You'll want to look into a Roth conversion pipeline if you retire before 60; otherwise 401k pre-tax can be withdrawn after 60, and as long as you keep the withdrawals low enough, your income tax will be minimal.)

The "conventional" wisdom for those that spend a lot AFTER they retire is that you might actually pay more tax then, so you might want to contribute more to Roth (post-tax) now and be done paying taxes already. But this is usually not a great fit for us.

Given that you 1) Max out employer match, 2) take advantage of pre-tax contributions, then you can 3) make use of Roth contributions and finally 4) put any leftover post-tax money in your own investment accounts. (The last two steps are important because you'll need some post-tax money available when you retire, particularly if it's before you've turned 60 and can't get to the pre-tax stuff yet.)

Now, with all this money in those various vehicles, you also want to know "where" to keep it. The easy answer is Vanguard, though you will have to do some research to decide on asset allocation that meets your goals, your risk tolerance, and how much time between now and retirement. From there, you can use Vanguard index funds with a split between Index funds, Bond funds and even REIT funds if that suits you. This takes a small learning curve to set up, but then you just check in every 3-12 months, see if the allocation is still where you want it for where you are on your journey, and if not, make some small changes (sell some stock index funds that are up to buy bond funds that are down and vice versa) and you're set.

Hopefully I kept that simple enough to give you a primer, and when the simple stuff sinks you, you can dive in and ask more specific questions about exactly where, exactly what funds, exactly what allocation, and how often you should rebalance.

[neo von retorch]

The reason you want to take advantage of the ROTH IRA compared to individual investment accounts is again because of taxes. Money that you place in a ROTH IRA can grow with stock market value increases and dividend gains tax free. Money that you put in your own accounts will grow, but that growth will eventually be taxed when you sell those investments as capital gains.

[smalliswell]

Thank you for answering Neo-Godless. When we need to take money out to do a home update, will Vanguard allow for that, or should we put that money somewhere else? I thought that I read here that I can take out the principal, just not the growth from the Vanguard funds. Is that correct? To give you some background, the saving we are doing for these home updates will take place within the next couple of years or less.

[neo von retorch]

Vanguard is just one example of a place to create your accounts. But whether you can make withdrawals is determined by the type of account.

From your question, it's clear you're talking about a ROTH IRA example. In that case, it's true. Any contributions you make to a ROTH can be withdrawn, but the gains cannot be withdrawn tax free until retirement age.

If you have an individual investment account, any time you sell the investments, you'll pay capital gains tax. If those investments were held for less than a year, it's a much higher tax rate for short-term capital gains.

401k funds cannot be withdrawn before retirement age unless you convert them to a ROTH IRA. When you do this, they are treated as taxable income, so you don't want to do this while you have a regular income.