Author Topic: Investment Order  (Read 10471 times)

arebelspy

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Investment Order
« on: December 08, 2016, 12:53:59 AM »
This thread has the recommended order in which you should invest your money.

1. USA

2. Australia


Anyone from another country (Canada, UK, etc.), willing to step up and create one for your own country, please do so and PM me to get it added!
« Last Edit: December 08, 2016, 04:06:07 PM by arebelspy »
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with a kid.
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MDM

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Re: Investment Order
« Reply #1 on: December 08, 2016, 10:51:59 AM »
This ordering is appropriate for investors in the US.

It is up to you whether to consider "saving for a house down payment" as a "day to day expense", vs. lumping the down payment savings in with "taxable investments" at the end.

If you are renting, you may not be throwing away as much on rent as you might think.  See            
   http://jlcollinsnh.com/2012/02/23/rent-v-owning-your-home-opportunity-cost-and-running-some-numbers/         
for some thoughts.            
            
In the lists below, thinking "first your 457 (if you have one), then your 401k and/or 403b" wherever "401k" appears is likely correct -            
   unless your 457 fund options are significantly worse than those in the 401k/403b -         
   due to penalty-free access to 457 funds at retirement, even if younger than 59 1/2.
   "Max _____" means "contribute up to the maximum allowed for _____, subject to your ability to pay day-to-day expenses."            

The benefits of employee stock purchase plans (ESPPs) relative to other opportunities is highly dependent on tax rates, because ESPP benefits all occur in taxable accounts. 
 - For someone paying 15% tax on ordinary income, and 0% on dividends and capital gains, ESPPs can be very favorable, perhaps competing with high interest rate loans in step 2. 
 - For someone paying 25% tax on ordinary income, and 15% on dividends and capital gains, ESPPs are not as favorable, perhaps coming between steps 6 and 7.
         
Differences of a few tenths of a percent are not important when applicable for only a few years (in other words, these are guidelines not rules).            
            
Current 10-year Treasury note yield is ~2%.  See            
   http://quotes.wsj.com/bond/BX/TMUBMUSD10Y         
            
WHAT            
0. Establish an emergency fund to your satisfaction            
1. Contribute to your 401k up to any company match            
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.            
3. Max HSA             
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level            
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)            
6. Fund mega backdoor Roth if applicable            
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.            
8. Invest in a taxable account with any extra.            
            
WHY            
0. Give yourself at least enough buffer to avoid worries about bouncing checks            
1. Company match rates are likely the highest percent return you can get on your money            
2. When the guaranteed return is this high, take it.*
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs.            
4. Rule of thumb: traditional if current marginal rate is 25% or higher; Roth if 10% or lower; flip a coin in between. See also Traditional versus Roth.
   See Credits can make Traditional better than Roth for lower incomes and other posts in that thread about some exceptions to the rule.
   The 'Calculations' tab in the Case Study Spreadsheet can show marginal rates for savings or withdrawals.
5. See #4 for choice of traditional or Roth for 401k            
6. Applicability depends on the rules for the specific 401k            
7. Again, take the risk-free return if high enough            
8. Because earnings, even if taxed, are beneficial            

Similar to "put on your own oxygen mask before assisting others," you should fund your own retirement before funding 529 or similar plans for children's college costs.

The emergency fund is your "no risk" money.  You might consider one of these online banks:            
   http://www.magnifymoney.com/blog/earning-interest/best-online-savings-accounts275921001         
               
If your 401k options are poor (i.e., high fund fees) you can check            
   http://forum.mrmoneymustache.com/investor-alley/to-401k-or-not-to-401k-that-is-the-question-43459/         
for some thoughts on "how high is too high?"            
            
Priorities above apply when income is primarily through W-2 earnings.  For those running their own businesses (e.g., rental property owner, small business owner, etc.),            
   putting money into that business might come somewhere before, in parallel with, or after step 5.         
            
Why it is likely better not to pay a low interest rate mortgage early:            
   http://allfinancialmatters.com/wp-content/uploads/2013/08/SandP500_5-Year_Rolling_Returns_with-CPI_calendar_year.pdf         
            
See http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html for some data on historical returns.   
« Last Edit: March 14, 2017, 10:41:41 PM by MDM »

deborah

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Re: Investment Order
« Reply #2 on: December 08, 2016, 03:37:19 PM »
AUSTRALIA

WHAT           
0. Pay the minimum required on all debts.
1. Establish an emergency fund to your satisfaction.  See https://www.bogleheads.org/wiki/Emergency_fund.  Use your mortgage offset account OR use springy debt http://www.mrmoneymustache.com/2011/04/22/springy-debt-instead-of-a-cash-cushion/  .       
2. Pay off any debts with interest rates above your mortgage rate (if you have one)
3. Put money into your PPOR mortgage offset account (if you have one).           
4. If your taxable income is less than $51,021 (before salary sacrifice) consider contributing $1000 per year to superannuation to get the Government co-contribution.
5. Pay off any debts above the return you can get on your investments.
6. If you taxable income is more than $37,000 optimise Salary Sacrifice into Superannuation - you need to work this out individually, because how much depends on at what age you will ER, how much is already inside/outside superannuation, and your marginal tax rate.
7. Invest any extra into low cost index funds (long term investments - 10 years) or high interest accounts (short term - 2 or 3 years).           
           
WHY           
0. Don't get yourself into trouble.           
1. Give yourself at least enough buffer to avoid worries about paying bills.
2.& 3. Because it's untaxed, the effective return on a mortgage offset account is likely to be the highest percent return you can get on your money           
4. When the government is giving you money - take it.
5. It's better to pay off expensive debt than to invest.
6. Salary sacrifice is taxed at 15% as it goes into superannuation and people on low incomes have a lower tax rate. You will need other money to last you between when you retire and when you are eligible for superannuation. However superannuation tax rates are low.           
7. Because earnings, even if taxed, are beneficial. If you are saving for the short term (eg. a house deposit whether PPOR or IP), you want to be absolutely sure that you will get back what you saved, but longer term savings are better off in an index fund.

Note: This assumes that you are employed. If you are a business, make sure that you put the 9.5% superannuation guarantee for yourself because if the business fails, you will at least have that money in old age.
« Last Edit: December 08, 2016, 03:51:47 PM by deborah »

erp

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Re: Investment Order
« Reply #3 on: December 24, 2016, 07:45:19 AM »
CANADA

What:
0: Pay off any high interest debts and establish emergency fund based on your risk tolerance
1: Max out your contributions to your TFSA
2: Contribute to your RRSP (remember that $25,000 can be used for a down payment through the first time home buyer's plan if you have not owned a house in the last 4 or 5 years)
3: Pay off your mortgage and low interest debt
4: Invest in non-registered funds

Why:
0: High interest debt is a huge drag on your money, and you'll be much happier without it. An emergency fund is a fairly personal decision, if you are risk averse or work in a boom/bust industry then a substantial emergency fund can help you sleep at night. If you have a very stable career and are comfortable with 'springy debt' as described in the Australia section you probably don't need much.
1: The TFSA is a pretty amazing investment vehicle, particularly if you're young. You contribute after tax dollars and never pay tax again on the money, regardless of how much it grows. You have the option of withdrawing money and preserving the contribution room in the following year, but withdrawals should be avoided unless there's a really good reason for it (people often invest their mortgage downpayment in their TFSA, which may be appropriate if you're planning on buying 'in a few years').
2: RRSP are a reasonable tax deferred investment vehicle, you don't pay tax (or are refunded taxes if you contribute after tax dollars) on the contributions, but do pay tax when the money is withdrawn. You will pay taxes on the withdrawn money as income, rather than potentially more favourable capital gains and dividend tax rates. In general, the fact that your RRSP can grow for years tax free should balance the potential tax consequences. If you are discovering MMM after working for a few years, you will probably find that you have fairly vast contribution room in your RRSP (it grows at 18% of your salary/yr).
3: Low interest in this context means 'close to or less than the expected return on your investments'. Less debt is pretty great. You may decide to invest in non-registered (taxable) accounts rather than paying off your mortgage at this phase, either way is fine and it will depend primarily on your risk tolerance and what your best guesses are on what your interest rate will be.
4: Shovel money into your taxable accounts. Remember that eligible Canadian dividends are taxed at a preferential rate (as are dividends from VCN or similar index funds), but that this is not true of international dividends.

Possible Variations:
- If your income in retirement is likely to be higher than your working income, you should avoid investing in your RRSP. This is possible if you have a lot of money in your RRSP, a relatively low income and are approaching 71, when you you will be required to start withdrawing a percentage of your RRSP. You can probably avoid this by retiring earlier and drawing down your RRSP in a controlled manner prior to control your taxes.
- If your income is very high, and you expect it to be lower in retirement (eg. you started saving late in life but have a high salary) then it might be optimal to be contributing to your RRSP before your TFSA.
- RRSP income is considered as 'income' for tax purposes, as is your Canadian Pension Plan (CPP).  In a perfect world you'll be able to keep your income below ~ $71,000/yr after you reach 65 years so that you can receive the Old Age Supplement. It's hard to know whether this program will change if you're currently relatively young, but if you're in your 50s then it's worth looking at your taxes pretty carefully to try and make sure you're not inadvertently limiting your wealth by having a suboptimal withdrawal strategy.
- Mortgage choices are pretty personal, and depend a great deal on where you live. Between the TFSA and First Time Home Buyer Plan you should be well on your way to a downpayment if you don't own a house. If a purchase is imminent (6 months or a year?) then you should be invested in something very safe (eg. GICs) or in cash.

jooniperberries

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Re: Investment Order
« Reply #4 on: January 03, 2017, 04:29:06 PM »
re: Canada, and probably other regions, too, I would make the following Step 2.

Find out which accounts offer matching grants from your employer or government, and optimize those. e.g., If you are eligible for the RDisabilitySP, shovel money in there to get $10,500/yr in cash gifts. If you or a child might ever do any version of formal learning after high-school, shovel $5k/yr in there to get $1k (or more) free. Etc.

Eucalyptus

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Re: Investment Order
« Reply #5 on: January 28, 2017, 06:44:44 AM »
re: Canada, and probably other regions, too, I would make the following Step 2.

Find out which accounts offer matching grants from your employer or government, and optimize those.

Agree, this should be clear for most countries.

For Australia, Deborah's list is awesome. Perhaps one thing to highlight along these lines is what to do about any HECS-HELP debt if you have one. Lots of people are often unclear on this. As of 2017, there are no longer bonus % contributions from the federal government for upfront payments. Its also still only indexed to inflation. Also, depending on when you completed your degree, and which field, if you are then employed in that field, for several years you may be eligible for extra free repayments from the gov...you just have to fill out a form each year. Its not insignificant, I think for me in Science I worked out it will save me a few years of repayments. Rates vary depending on field (includes education and nursing also I think). Because of this, it would work out a super dumb move if you are in a qualifying degree+ field to make upfront payments on your HECS-HELP debt....effectively the debt is far below inflation, probably even "backwards" depending on your debt level.

EDIT: It now seems that the HECS-HELP Benefit disappears after this current financial year! Sad :-(

Excellent idea for a thread, by the way!
« Last Edit: March 06, 2017, 05:55:38 PM by Eucalyptus »

Prairie Stash

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Re: Investment Order
« Reply #6 on: March 03, 2017, 01:02:50 PM »
Canada - invest in non registered accounts under certain circumstances first. The correct order depends on income, its not universal.

For example if you earn under $42,000/year in Ontario dividends are taxed at -6.83% (that's a negative tax rate). In Alberta its -0.03%, basically zero. That's a case where non-registered come first (low income spouse scenario).

Low income earners should tackle TFSA/nonregistered while high income earners benefit from RRSP. Eligible dividends are held outside and non-eligible held inside TFSA. That's the basic rule.

Hooray for tax laws ;) Not every Canadian should be following the same order, don't forget to tailor to your own province. It gets more complicated when you add in the clawbacks for children (depends on number and age of kids). there's a $65,000 tax bracket, because of the clawback percentage change, that most people are unaware of. I've used RRSP contributions to increase benefits, in later years I won't get benefits (as kids age), then the allocation shifts again to be optimal.

Well Respected Man

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Re: Investment Order
« Reply #7 on: March 16, 2017, 09:54:07 AM »
This ordering is appropriate for investors in the US.

<snip/>

- For someone paying 25% tax on ordinary income, and 15% on dividends and capital gains, ESPPs are not as favorable, perhaps coming between steps 6 and 7.
         
Differences of a few tenths of a percent are not important when applicable for only a few years (in other words, these are guidelines not rules).            
            
Current 10-year Treasury note yield is ~2%.  See            
   http://quotes.wsj.com/bond/BX/TMUBMUSD10Y         
            
WHAT            
0. Establish an emergency fund to your satisfaction            
1. Contribute to your 401k up to any company match            
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.            
3. Max HSA             
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level            
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)            
6. Fund mega backdoor Roth if applicable            
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.            
8. Invest in a taxable account with any extra.            
            
<snip/>

I believe the ESPP belongs between 1 and 2, whatever your tax rate. For a typical plan, there is a 15% discount on the purchase price, which over a 6-month offering period with equal contributions each month, is equivalent to 6% per month, or 100% annualized return. That assumes no increase in the stock price. With a look-back period and/or a stock price increase, it can be even more profitable. Even with a decline in stock price, there is usually a 15% discount off the lower price, with some limits on how much you can buy. So, take the free taxable money, sell the stock immediately, and consider it as a pay raise. Then use that money to pay down the debt, max HSA, etc.

Buying and holding ESPP stock for 2+ years is OK, with a lot of downside risk (bad quarter = 25% drop + lose job), and so probably belongs where you suggested, between 6 and 7, or maybe even between 7 and 8.

MDM

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Re: Investment Order
« Reply #8 on: March 16, 2017, 12:32:56 PM »
I believe the ESPP belongs between 1 and 2, whatever your tax rate.
You are correct that if one can swing the cash flow, getting in and out of an ESPP is ~"free money".  But if one has to make a choice between deferring income in a 401k vs. taking the income and using it for an ESPP, it isn't the same.

Assumptions:
- 30% current tax (e.g., 25% federal, 5% state)
- 20% 401k withdrawal tax (e.g., 15% federal, 5% state)
- 5% taxable withdrawal tax (e.g., 0% federal, 5% state)
- 20% tax on dividends in taxable (e.g., 15% federal, 5% state); all dividends reinvested
- total return  of 7%, 5% from growth and 2% from dividends
- 15% "bonus" from ESPP
- 20 years growth

Starting with a $5000 initial pre-tax amount available, one gets the results below, indicating the tax-advantaged account would be better.
ESPP401k
Initial cash50005000
Tax bite-15000
Start35005000
Bonus5250
Bonus tax-157.50
Investment3867.55000
After 20 yrs1388619348
Withdrawal tax3803870
Net spendable1350615479

Growth in the taxable account:
cgt = capital gain tax rate, %5.0%
d = annual dividend rate, %2.0%
g = annual growth excluding dividends, %5.0%
n = years invested, yr20
P = principal invested, $$3,868
t = tax rate on dividends, %20.0%
e = tax-adjusted annual growth, %6.60%
ecgt = tax-adjusted cap. gain tax rate, %3.788%
F = Future, after tax, value $13,506

One could even make the case that if the ESPP can be paid in a single lump sum, and the paperwork takes a few weeks to process, using emergency funds to get a guaranteed 15% for the cost of having a lower e-fund for those few weeks is worthwhile.  But if it's a choice between tax-advantaged vs. ESPP, see the tables above.

Well Respected Man

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Re: Investment Order
« Reply #9 on: March 17, 2017, 04:07:17 PM »
Yes, I guess the ESPP should be considered a cash management tactic to make more money become available for investing, and not an investment strategy in itself.

Heckler

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Re: Investment Order
« Reply #10 on: March 19, 2017, 11:01:28 AM »
Wow, this thread will get confusing with multiple countries posting in random order. 

Arebelspy, can I recommend your first post gets locked and stickied with links to a new thread for each country who is interested before it gets out of hand?  The thread for each country don't need a sticky, as they'd be referred to here with a link.




MustacheAndaHalf

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Re: Investment Order
« Reply #11 on: March 22, 2017, 05:49:16 AM »
I believe the ESPP belongs between 1 and 2, whatever your tax rate. For a typical plan, there is a 15% discount on the purchase price, which over a 6-month offering period with equal contributions each month, is equivalent to 6% per month, or 100% annualized return.
You don't double your money from a 15% discount on ESPP stock purchases.  You save 15%, and your $85 purchase of $100 worth of stock is like a +17.6% gain.  You do not roll over this purchase or multiply it: you have a limit on how much you can buy, and you can't buy more.  Each ESPP purchase is a separate decision, not something that multiplies each month.