The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: Jpete32 on September 17, 2014, 06:18:05 AM
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Hey everyone,
I've been going back and forth on whether to start investing in index funds now, or wait a few years until my situation is a little bit more stable. What is really getting me is we have a good chunk of change in the bank that's doing nothing but earning 0.747% interest, while I'm thinking I could be getting much more through an index fund.
Currently I have an online work from home job and am making roughly $75K a year with some stock option benefits. My wife is in her first year of her professional graduate degree and we will have to pay another $72K in tuition before she is finished in the summer 2017. After she graduates she will likely start somewhere between $65K - $90K (depending on where we live).
I've been using my work's 401K program up to my company's match, and have recently upped my percentage a little bit to 10% to try and stay under the $73,800 25% tax bracket for 2014.
Income: $75K / year
Current Assets: $50K cash, $6K 401K
Current Liabilities: $8K of an interest free loan
Anticipated New Liabilities until my wife graduates: $72K
Current Expenses: $17.3K for the two of us.
So, do I continue to save up cash at a low interest rate until I have enough in the bank to fully pay our anticipated liabilities of $72K and avoid costly graduate student loans around 7.5%?
Or, do I start investing more of our assets now to not miss out on potentially much higher returns from a total market index fun?
Or, other options other Mustachians might think up?
Thanks for the help!
-Jpete32
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If I were you, I'd set aside 12 months of living expenses at the highest interest rate I could find and begin investing the rest both now and later. I choose index funds, but many here like to buy property and rent it out.
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If you are fairly stable in your job, i would do whatever you can to cash-flow your wife's degree before I would think about starting to invest more after-tax money. The best investment you can make right now is making sure your wife gets through school, and preferably debt free, because of her large future earning power. Long term the stock market will return 10-12% but that is by no means guaranteed, and can be highly variable on a yearly basis. The 7.5% you would avoid paying on the debt is a guaranteed return and more worthwhile on a risk-adjusted basis.
You expenses are really low compared to your income so you're in a great situation with over 50k/year of excess cash flow. I would:
1. Save up the full tuition (this shouldn't take you much longer given your excess cash flow and starting at 50k cash).
2. Save up a good emergency fund (if something was to happen to your job or your ability to work (illness/become disabled) it would be nice if your wife didn't have to stop school to work to support you guys...her large future earning power should not be compromised).
3. Contribute enough to your 401k to get yourself to at least 11k below the break for the 15% marginal tax bracket. As you make 75k which is right around the break over, and assuming standard deductions/exepmtions for a married couple are about 20k, you probably don't have to contribute anything to do this. Always contribute for the full match, it's free money.
4. Max out a ROTH IRA for both you and your wife (11k/year). If your marginal tax bracket is 15% now that's a good rate to lock in taxes on considering in a few years when your wife is done you will likely be in the 28% bracket and will probably want to focus more on maxing tax-defered accounts. Max the Roth's for a few years and get a nice pot of money in there and growing.
5. Whatever is left can go to after-tax investments.
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Thanks Terrestrial. Great idea about getting into a ROTH IRA while we're still in the 15% tax bracket. I think you've answered all my questions.
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I don't get why people worry so much about tax brackets. You do know that only your 73,801st dollar would be taxed at 25%? The rest is still at 15%. I would still increase the 401k as much as you can though, even before funding a roth.
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You have to worry about tax rates because when considering investments you always have to assume it's your 'last dollar' that is being invested, and will be begin taxed at that marginal rate. While investing in ANY kind of tax advantaged account is better than not I think you can be smart about how you do it.
Paying taxes at 15% to never pay them again (Roth) is better than deferring taxes at 15% and owing them on that money in the future. While we can never know what rates will be 30 years from now it is unlikely that anybody making a reasonable income will pay less than that. As I noted, when his income goes up to 180k and their marginal rate is 28%, then the opposite is probably true, defer all those taxes and hope your rate is lower in retirement and the Roth makes a lot less sense.
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Yes I do know that. But with roth conversion I still think funding a 401k is a no-brainer in almost all circumstances. With any kind of mustachian retirement you'll pay 0-10% tax on most of your income. (I guess the only catch could be that they might eliminate this option in the future.)
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Yes I do know that. But with roth conversion I still think funding a 401k is a no-brainer in almost all circumstances. With any kind of mustachian retirement you'll pay 0-10% tax on most of your income. (I guess the only catch could be that they might eliminate this option in the future.)
Not everyone will RE quite as soon as they really can. So when OMY lasts 10-15 years combined with the savings rates normal among the participants of this board, you can end up in the 25%+ tax bracket from age 70 on as the IRS's mandated RMD withdrawals force people to finally take out money. Sure carefully planned Roth conversions earlier on could lock in 15% and below taxes instead of 25% or 28%, but the years available to do those Roth conversions in might have been the same ones being spent working that extra decade "just to be safe." It is an interlocking problem. And it is a nice problem to have, but it is still a thing.
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And another thing. Say you retire in your 30s and your RE thing is buying foreclosures, remodeling them, and renting them out. What if you do really well and before you know it your FIRE amusement is actually a highly lucrative RE thing? It could happen.
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Invest now. I've never heard of anyone being sorry they saved money in past years. Well, I guess I'm sorry I just saved it instead of investing it. I just put 80K of savings into the market this year, and I really wish I'd invested it sooner. It was supposed to be a house down payment, but it just kept getting bigger, and we never bought a house. We were already maxing out other retirement options that were available to us (401K & Roths).
One reason you might want to stay out of the 25% tax bracket (even if it's only the dollars over x amount that are taxed at 25%) is to take advantage of 0% capital gains tax rates. I transferred some non-retirement investments from American Funds to Vanguard this year, resulting in about 10K of capital gains. I am very cognizant of which tax bracket I end up in, because at the 15% tax bracket, the capital gains tax is 0%. If I'm in the 25% tax bracket, it goes for 0% to 15%. If I'm understanding all of this correctly. So I could pay $0 on that 10K gain, or $1,500. It's not just the last dollar at 10% more.
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Index funds may be better for long term savings, but since you will want to access funds for the student loans in a few years, I would be inclined to invest at least half your money in something really secure for two or three years. You may not earn as much as index funds but you can likely find a rate better than you're currently getting.