How to optimize my stash?

[Goatee Joe]

Hey guys, been reading this blog and forum for the past few months and it's truly a gold mine of great info and discussion.  It's already inspired us to make some changes and continue with the mustachian stuff we were already doing (yet didn't realize someone else appreciated frugality like we do!).  Now that 2013 is almost upon us, I'm looking for some advice on how to make some changes to our investments, and thought I'd put this out there for your expert consideration.  Here's our situation:

I'm a federal worker living in the DC area.  Married, one kid.  After reading this blog, it occurs to us that we could probably do a better job making our money work for us.  Here are the figures:

Savings account (with ING):  about $90K
Thrift Savings Plan (the federal 401K):  about $90K

Mortgage:  still owe about $300K, at a 4.5% interest
Student loans:  combined, wife and I owe about $20K, at 3% interest

We stand to make around $150K pre-tax in 2013 and are considering how best to allocate the money.  Any thoughts/recommendations for investments?  The obvious thing to me is we have too much cash in savings, only making about .85%.  We've historically been pretty cautious investors, but in reality that cash is just losing money vs inflation.  Should we just pay extra on the mortgage instead?  Should we just max out the TSP and stick with the ING savings?  Should we look into stocks or an index account like Vanguard?  For any fellow feds out there, is the TSP Roth option an attractive alternative?

Thanks in advance for any tips you've got.  We're novices when it comes to investing and appreciate any good common-sense advice folks here are willing to share.

Happy Holidays!  --Goatee

[Ozstache]

I'd make your money work harder and pay the mortgage down with your savings.

[twinge]

1. Can you refinance your mortgage?  You should be able to get lower than 4.5% if you have some equity in the home. If you can't refinance, then I can see being tempted to pay that down a bit if you're a conservative investor. Not my personal choice, but might be yours.
2. At your income level I don't know if the TSP Roth would work out better--I guess it has to do with your stance on how high taxes are going to be in your retirement than now.  But you're at a pretty high tax rate right now. I have the option of a Roth 401k and I haven't chosen it because the tax deduction now seems more valuable at our tax rate.  But I would consider investing 10K in Roth IRAs each year (5K for both you and your wife) to diversify taxes in retirement and because you can take contributions out without penalty in an emergency--you can do 10K for 2012 until April 15, and then another 10K in 2013. 
3. I would look into other ways to reduce your tax burden--maxing out your TSP if there are any options, supplementing with a traditional IRA if you can, look into a 529 plan for your child if you're planning on assisting with college expenses (which only relieves state taxes sometimes, but is a good deal for its tax-free growth).
4. I'm not opposed to decent sized emergency funds when you have kids, house,etc.  but 90K seems a bit much for me.  It sounds like we likely have roughly similar income/expenses and I keep about 30K cash (savings account, I-Bonds), and then have about a decade worth of Roth IRA contributions for both my husband and I that we could tap if needed.  Anything beyond that that I invest in a taxable account at Vanguard.

[James]

Instead of thinking about it from the standpoint of "where should I invest and how much", start with "how much emergency fund do I need".  Once you have chosen your emergency fund options you can decide what to do with the rest of the cash.  I would search here, there are lots of threads about emergency fund numbers, and MMM has posted on that as well.  There is no simply answer or one rule to follow, you need to consider what options you have personally and balance them with your personal comfort. 


I think picking a good mortgage number is important, keeping enough equity to ensure you don't get underwater, and I would keep enough equity to give you a nice emergency buffer to borrow against as well.  So how much is your house worth and how big is your mortgage?  If you have a mortgage greater than 60-80% (depending on comfort level) of the value of the home, then I'd consider paying it down to your comfort level.  I would then try and lock in the mortgage rate at these historic lows unless you are able to pay off the mortgage in the next couple years.


Once you have done that, I wouldn't pay off the mortgage faster than necessary because you should be able to easily beat that return on your money.  Regarding where to invest, I think it's best to go find that information rather than ask for it.  When you ask, we try to read into your question and determine your priorities, goals, risk tolerance, etc.  That makes any advice anyone gives hard to judge, because you don't know how much of your personal information has already been factored into the advice, and how much more risk tolerance or other thoughts need to be factored in.  But if you read a book or two, read MMM posts on the topic, read some threads in this forum on the topic, you will start to find your plan, and can think of more specific questions to ask.  And if you ask specific questions (which I encourage), try to focus on the goals rather than the process.  There are many different options that can be "right" for you depending on the goal, so start to look at your goals as your driver rather than just figuring out rules someone else invented based on their own goals.

[DoubleDown]

I'll second what the others have said with a couple of minor additions. I'd do these things, in order:

1. Refinance your mortgage NOW to get your rate down considerably

2. While you are refinancing, apply for a HELOC that you can use as your primary source of emergency funds (MMM has an article about this)

3. You didn't state how much you're contributing to your TSP, but max that out if you are not already (i.e., contribute up to the federal maximum allowable amount each year to maximize tax savings)

4. Maximize traditional and/or Roth IRA's.

5. Take about 80k of that 90k in ING savings and apply it to some combination of paying down the mortgage, new (free) Vanguard ETFs, and possibly paying down the student loans. Just don't sink it all into the mortgage; the old adage of not being "house rich and cash poor" is good advice. To keep it simple, you might put $20k to pay off the student loans, $30k into the house, and $30k into Vanguard funds.

6. Also start automatic contributions into the Vanguard funds so you are continuing to purchase more shares each month. Do whatever mix of assets you are comfortable with, but making sure to have a healthy amount of stocks in addition to safer bonds/securities/etc. I don't know your ages, but if you're in your 20's, put at least 80% in an indexed stock fund. If you're in your 30's, put at least 60% in stocks. In your 40's, put at least 40% in stocks. If you're in your 50's or higher and just starting to have kids, I pity you :-)

Good luck, you are already doing great!

[Goatee Joe]

Thanks DoubleDOwn, twinge, James, and Ozstache for the input!  A couple answers to your questions, for clarification:

Home equity:  The house is worth about $400K and we just paid down the mortgage to just under 300K, so we're about a quarter of the way there.  We refinanced two years ago from 5.5% down to 4.5%.  One thing we found in shopping it around for refi was that, in the DC area, most of those wild claims of absurdly low mortgage rates don't apply.  Maybe it's that the banks know folks here have steady income (feds) and that drives the market up?  I don't know, but we didn't really find any better offers from anyone we considered a reputable lender, and ended up just refinancing with our original lender, Wells Fargo.  We've thought about refinancing yet again, or even getting into a 15-year mortgage with an even lower rate, but I wonder if just working on paying extra principal on our current loan is just about as good as messing with paperwork to improve the rate.  In any case, at a minimum, I think paying at least some extra toward the mortgage is a GREAT idea at this point.

TSP:  I'm currently kicking in about 10% of my gross income (around 10K/year) into the standard Thrift Savings Plan account.  Got 100% of it allocated to the L2030 account (one of TSP's Lifetime funds that provides a mix of stocks, bonds, etc with an investment allocation that grows steadily more conservative as the horizon of the year 2030 approaches).  Definitely going to increase that in the near future, as it's dawning on me that I need to take better advantage of that account, not to mention its usefulness as a tax shelter.  TSP just started offering its Roth option this year (it's equivalent to a Roth 401K, not a Roth IRA) but, as one of you alluded to above, I'm still not convinced it's a great deal since I suspect we'll be in a lower tax bracket in retirement.  In that case, wouldn't it NEVER make sense to use the Roth option?  Maybe I've figured it wrong, but it seems the standard tax-deferred TSP plan is the better way to go, though I'm still researching/considering it.  As an alternative, a mix is not out of the question:  the annual contribution limit for 2013 is $17,500, which can be allocated between either the standard or Roth options, but you can't exceed $17.5K in the calendar year.

Student loans:  my wife actually corrected me.... our students loans are about 1% on average, so we're paying almost no interest.  I've almost pulled the trigger on just paying them off a couple times, but that low interest rate stops me.  I know MMM preaches killing all debt, but isn't this almost a "good" debt to carry at this absurdly low rate?

More on us:  I'm 37 and my wife is 32, so we can afford to take some investment risks that older folks cannot (or should not!).  We bought both our cars cash so we have no car loans to deal with.  We each have a bike and we've drastically increased the amount we're biking (DC is loaded with great bike trails all over the place, thankfully!).  We even bought an old Radio Flyer wagon we found at a junk store and now walk to the grocery store (about a mile away) with Junior in tow, then plop him on the groceries on the way back.  He seems to love it, though we get weird stares from folks roaring by in their 9 mpg German SUVs... they think we're crazy, we think they're crazy.  Guess they're all independently wealthy already :-)  So anyway, we're trying to emulate the frugality of our Depression-era grandparents to the extent possible.

On the 529 plan, thanks for the tip.  Our little guy is just 1 year old, so we have some time till college, but we haven't set up any special accounts for him yet.  Any money we've gotten, we've basically just socked it away in the ING savings account.  How does the 529 plan (for Virginia, if anyone knows) work to reduce our Virginia state tax liability?

Anyway, thanks again for taking the time to share your thoughts.  We really appreciate it!

[twinge]

1. We  refinanced in the DC area last spring to get 3.875 where they supplemented all the costs.  Rates have gone down slightly since then.  We used "Amerisave" which doesn't sound reputable, but  I researched it carefully--if you have excellent credit and know for sure you have at least 20% equity in your home they are fine to use (if either of those are in question, don't bother)  They immediately sold my mortgage to Citibank (Citi-mortgage). We had no problems.

2. The 529 plan in Virginia is called Virginia inVEST and is operated by Vanguard (which is a good thing).  There's also a "prepaid" option but I would steer clear of that.  On state taxes, if you and your spouse each create a separate account for your one child you can each deduct up to $4000 year in state taxes.  http://www.virginia529.com/

[c]

I have a similar issue with a refi. On paper I'm great, but I'm really battling to find someone who will take on a co-op mortgage.  I've now started every conversation with "it's for a co-op".  This has made me wary about putting too much in to the mortgage as its so hard to access the money.

[trammatic]

1) I wouldn't care about the reputation of a loan company, unless it has horrible customer service.  A mortgage is a very detailed contract that's easy to enforce in court.  Also, you're getting your benefit up front, and as long as you keep detailed payment records, it should be easy to see how you're complying.

2) Be careful about payroll deduction amounts for TSP.  I work for DHHS, and was saved from getting burned by helpful advice from a mustaschian coworker.  Basically, once you hit your personal contribution limit, all contributions will be stopped.  And matching only applies to the first 5% of each contribution, so if you hit the limit early in the year, you won't get all of the matching dollars. There's a calculator here: https://www.tsp.gov/planningtools/electivecontributions/electiveContributions.shtml You should contribute no more than 674 per pay period to get the maximum matching.

3) Aside from the tax projection differences, any Roth account effectively lets you contribute more than the same traditional account.  This is simply because with a traditional contribution, you are contributing both spendable money and taxes, whereas in a Roth, you are only contributing spendable money and paying for the taxes out of other sources.  If you contribute the same $ amount to both accounts, invested in the same funds, they'll have the same dollar balances at any given time, but the Roth will have more purchasing power.  Also, there are different rules for Roth vs Traditional when it comes to required distrubitons, inheritence issues,  etc.