Advice on Saving/Investing/Car Loan Priority

[landstander]

Hello all,

Im a young engineer who finally paid off his student loans last month. Now I have a relatively large amount of extra cash each month to put towards a few different goals I have. Id like you to think back to your early financial growth phase, that is where I am. I rent an apartment, I have a car loan (I know, car loans bad...but there wasnt any other option when my car broke down a month into my first job after graduation), work 40 to 50 hours a week and I already max my 401k. I am trying to prioritize where to put this extra money I have every month. I have the following financial goals:

• Open Roth IRA (need $3k to start a vanguard IRA)
• 3 Months emergency fund
• Max IRA contributions
• Pay off car
• Save for down payment on home
• invest in index fund

Major expenses:
Rent - $1084 (just signed new lease so stuck here until August 2016)
Car Payment - $400 (about $8000 left on loan, 1.9% interest)
Other - ~$1200 (im looking for ways to save in my bills/spending but thats not why I'm here. Food/going out is in here and a huge expense I am actively cutting back)

Income - I essentially have about $1500 (after taxes, 401k, bills and any other expenses) a month to save/invest/pay off car, sometimes more, sometimes less. I get a quarterly bonus which until this point has gone towards student loans, this will now go entirely towards saving (maybe $3k to $4k a year after tax)

So with that in mind how should I put that $1500 towards these financial goals? Currently the order I have them listed above is how I have them prioritized. After maxing the IRA is where my priorities start to get fuzzy. Paying off the car gives me an extra $400 a month that can earn money rather than cost money, so might even prioritize it higher. I also hate that I am spending over a grand a month for housing when that could be building equity in my own home. I am slowly learning about home buying and looking in to housing in my area, including multi family, but I am in this lease until August 2016. I dont think I can save enough for a down payment without PMI before then. Dont even know enough about local market to pull a number out of the air but I am in a pretty low cost of living area. So a house is probably more on the 2 year horizon, I will look for cheaper housing next year though. So if a house is two years away, perhaps I should stick the money I am saving towards a house into an index fund to grow? I realize that should be long term investing, but I feel having tens of thousands of dollars sitting in a savings account for 2 years might be a bit of a waste. Like I said, still learning alot about real estate and investing in general.

Thoughts? Anything I have over looked? Advice on ways to make saving for house more productive than sitting in a savings account? Should I be investing money into index funds sooner?

Thanks in advance for any advice, gotta get to work now.

[by_1008]

Congrats on paying off your student loans. Though you don't state your income, I imagine that you are at least in the 25% bracket as an individual, which means IRA > Roth IRA. At 1.9% interest on the car loan, no real need to pay it off early, but I understand the desire. My suggestion would be 1) build up whatever emergency fund you are comfortable with (3 months - 6 months), 2) hit that 5.5k IRA max with an index fund, 3) then stick what's left into a taxable account.

With regards to housing, think carefully about your desire to own a home or multi-family rental. There are plenty of good reasons to do so, but don't fall into the trap of purchasing a home just because you should. If you are still young, owning real estate can tie you down to one location which could be problematic if your job changes, you get into a relationship, etc. You build very little equity in the first 5 years of ownership.

Dont even know enough about local market to pull a number out of the air

You have plenty of time to learn. If you decide to purchase real estate, you can always take money out of your taxable investments to do so. But if you don't at least your money will have been working for you in the meantime.

[landstander]

I imagine that you are at least in the 25% bracket as an individual, which means IRA > Roth IRA

Correct, but could you explain the reasoning. I don't know a ton about income tax, especially in retirement but I should go for Roth if I expect to be in a hire tax bracket later right? Since I am already in the second lowest tax bracket I'm not likely to be in a lower bracket when I retire, though being in the same tax bracket seems likely. And I will probably move to a higher tax bracket before retirement, meaning the taxes would be lower in retirememt. So maybe a normal would be better. I will do some more research/thinking.

As for housing I simply want my housing expense to be doing something better than going in another person's pocket. Yes interest on a mortgage is going into someone else's pocket but at least some of it goes towards the principle. I might not be building much equity in the first 5 years but at least I get a head start on that 5 years. I won't just jump in to it, 2 years is probably the best case scenario. Renting just feels wasteful to me. I could drop 12 grand on rent next year or 12 grand into the interest/principle of my own house that I could possibly get back when I sell. I'm looking for an investment more than a home. Regardless sounds like investing the deposit money until I find something might be an option.

Thanks.

[by_1008]

but I should go for Roth if I expect to be in a hire tax bracket later right?

Yes this is the conventional wisdom. The general rule is that if you are in the 15% bracket or lower, then a Roth is a good bet. If you are higher than 15%, than it's better to take the tax savings (~25% or greater) today using an IRA. But if you are willing to dig a little deeper there are plenty of resources and plenty of folks on the forum who would argue that regular is almost always better than a Roth. For instance see: http://www.madfientist.com/traditional-ira-vs-roth-ira/.

For every $$ you put into an IRA, you'll get $0.25 back in taxes at your tax rate. This is not the case for the Roth. However, when you pull the money out of the IRA eventually, you'll have to pay whatever tax rate based on your income at the time. For many folks, this rate will be lower. For you especially it will likely be lower since you are already in the 25% bracket. Therefore, traditional IRA makes more sense than Roth.

There are a few caveats here, such as accessing your money in the traditional IRA before age 59.5 is a little more difficult (though possible), whereas contributions (though not earnings on those contributions) can be withdrawn from a Roth IRA at any time, for any reason. Whichever you choose, your combined max contributions each year are $5.5k.

With regards to housing, you are exchanging money for a great place to live. I wouldn't call that wasteful! Remember all of the transaction costs that go into buying and selling real estate. Dropping 12 grand into interest/principle on a house may sound better than spending 12 grand on rent, but you have to pay lots for that privilege (property taxes, realtor fees, title, and all that maintenance that your landlord pays). So if you keep the house long enough, because you use it as investment as you say, then these costs can be spread out over many years. Are you willing to do that? Are you pretty confident you will remain in the same area for 5-10 years? As you learn more, consider exploring the real estate section on this forum, as they can help you make sure your investment decision makes sense.
Also see: http://www.gocurrycracker.com/how-i-made-102k-in-real-estate/ and http://jlcollinsnh.com/2013/05/29/why-your-house-is-a-terrible-investment/