Author Topic: Case Study: How should I allocate a pay raise?  (Read 2069 times)

sweetolive

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Case Study: How should I allocate a pay raise?
« on: March 13, 2016, 08:17:14 PM »
Hello fellow Mustachians,

Next week I start a new job that will bring in an extra $400pcm on top of my current earnings. I'm wondering how best to allocate this money, and more generally if anyone has advice about how my finances are currently structured.

Income: $60,000 pa (new job)

Vanguard index fund: $18,000

Savings: $2,000

Mortgage: $58,000 at 3.86%

I currently pay off my credit card in full every month. I don't have a car. I pay $100 pcm month each into my Vanguard and savings accounts.

I am wondering whether I should allocate this extra money toward my mortgage or my index fund? Also, if perhaps I should direct all my funds toward my mortgage and open an index fund only once my mortgage is paid off?

Thank you!


ShoulderThingThatGoesUp

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Re: Case Study: How should I allocate a pay raise?
« Reply #1 on: March 13, 2016, 08:22:16 PM »
Your interest rate is low, and so is your debt. Just invest the money.

turketron

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Re: Case Study: How should I allocate a pay raise?
« Reply #2 on: March 13, 2016, 08:24:09 PM »
Is your Vanguard index fund a taxable account? I'd put the additional money into a tax-deferred account like a 401k or tIRA if you can.

GrowingTheGreen

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Re: Case Study: How should I allocate a pay raise?
« Reply #3 on: March 13, 2016, 08:40:34 PM »
Index fund, homie.  Especially if you can do it in a 401k or other tax-advantaged account.

MDM

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Re: Case Study: How should I allocate a pay raise?
« Reply #4 on: March 13, 2016, 09:42:43 PM »
Here is the "usual advice", current as of the posting date.  See the 'Investment Order' tab in the case study spreadsheet for the latest version.
"Max..." means "contribute up to the maximum allowed for..., subject to your ability to pay day-to-day expenses."   
   
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.
   
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 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 (or see   
   http://forum.mrmoneymustache.com/investor-alley/deciding-between-roth-and-traditional-ira-based-on-marginal-tax-rate/
   if you want even more details on that topic).  See also
   https://www.bogleheads.org/forum/viewtopic.php?f=2&t=182081,
   http://forum.mrmoneymustache.com/ask-a-mustachian/case-study-overwhelming-student-loan-debt-how-would-you-get-started/msg868845/#msg868845
   and other posts in that thread about exceptions to the rule.
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   
   
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?"