Reader Case Study - Killing loans vs. saving and investing

[treefingers]

In short:  Hey guys, I'm a 25-year-old software developer.  I have manageable student loan debt, a car that I will be selling very soon (still paying off the loan until then), and some money put away in a 401k.  I would like to retire *EARLY* while making $21,000 a year and possibly selling art on the side.  I'm neither married nor in a relationship, so I don't have a partner to share expenses or savings with.
Questions:  I really don't want to own any houses.  Should I start investing money in the Total Stock Market Index Fund?  What's the point of maxing out my 401k contribution when I want to retire EARLY?  How much money should I put into a savings account?  Should I just try to pay off my student loans ASAP?

Income: $56,000/yr gross salary.  I'm putting about 6% of my paychecks into my 401k, with a 3% company match.  I take home about $2900 each month.

Current monthly expenses:
$1801 total
$1099 left over

$1366 total expenses w/o car
$1534 left over w/o car

$900 total expenses w/o car and student loans
$1934 left over w/o car and student loans

• $325/mo car loan (2012 Chevy Sonic 1.8LT), planning to sell it soon and have been using my bike and riding the bus instead
• $90/mo car insurance that will disappear along with the car.
• $425/mo rent and utilities
• $11/mo Spotify Premium
• $200/mo food and groceries
• $20/mo on gas for my car, which I will be using conservatively until I sell it
• $20/mo on Internet (bundled with my phone payment and left over from a previous living situation)
• $400/mo on student loans
• $100/mo on Verizon phone with data, thinking of switching to a different plan in December
• $70(ish)/mo on cat food/litter (I mix meaty wet food with dry food)
• $120/mo on bus pass
• $20/mo on art supplies, guitar strings, concerts, alcohol, etc.

Assets: $4000 in a savings account
$12,000 in 401k
Total: $16,000

Liabilities:
student loan: $3,315 at 6.55% interest
student loan: $3,100 at 3.15% interest
student loan: $7,145 at 5.35% interest
student loan: $14,081 at 6.55% interest
car loan: $12,426 left on the loan; a family member thinks he should be able to help me sell it for $10,500 or $11,000 and I'll write a check for the rest.  (He has already sold two family cars, so we're pretty confident that he'll be able to do that.)
Total: $40,067
Total w/o car: $29,067 (assuming I can sell it for $11,000 and only have to pay off $1,426)

It's my first time posting here... Please let me know if I left out any important information or if I should try to narrow down my questioning.  Thanks!

[Derrian]

My two cents:
-Your emergency/savings fund looks alright, though it would only cover a couple months of expenses. You could gradually build it to last longer. Some advocate for small emergency funds as they lose money in the long term due to lack of interest/inflation. For me, 6-8 months is ideal as long term unemployment is a possibility in the next decade but it is whatever you are comfortable with.
- Switch away from Verizon to Republic wireless and save $80 per month
-Continue to contribute to 401k to get the company match (free money), and put the rest towards paying off the student loans. Start with high interest loans first and then pay off the lower interest loans. Remember, interest on loans works the same way as interest on investments, except that it works against you instead of for you.
-Continue  401k contributions and start roth ira contributions even though you want to retire early. Both of these are tax efficient investment vehicles that eventually you will need to rely on for the last 30 years of retirement. Additionally, the company match is an additional 3%, pretty good deal. As for whether or not you want to max it out, that is mostly depends on your salary and how much you can save after maxing 401k contributions.
-After you have the loans taken care of, and you set up the 401k and roth ira, find alternative investment vehicles for building you  funds that you can use in early retirement until you hit retirement age.

It is difficult to give more specific advice as you havent listed a deadline for when you would like to retire.

[treefingers]

Thank you so much for your help! I would like to retire in 7 years if that's at all possible.

[norabird]

Absolutely switch your phone plan when it expires. I used Kitty Wireless from Page Plus on the Verizon networks--it used my existing phone and was $30 with 5Gb of data, definitely enough for my needs. I agree about keeping the 401k contribution and plowing the rest into your loans; maybe focus on the 6.55 $3k one first. I wish I had $4000 in a EF so I'm a bad person to advise you there! I think leaving it at that level for now is probably fine as long as you're comfortable with it.

Just curious, where are you buying the cat food and litter? I don't think I used to spend that much when I had cats, though I wasn't tracking my expenses at the time, so maybe I'm wrong.

Good luck on selling the car!

[Derrian]

What do you envision retirement looking like in 7 years? Are you planning on working part time, on contract, or not at all? Looking at the numbers, with a $1900 a month contribution for 7 years may not leave you with very much if you adhere to the 4% withdrawal rule.

[Cheddar Stacker]

Welcome to the forum treefingers! You are in a good position to really accelerate FIRE and you came to the right place.

Great advice so far, but I'll add this - Here's what I would do in your shoes:

1) Keep paying into the 401K to get the match, I'll assume that's the biggest match you can get, but if not get the max match.
2) Attack the 6.55% SL's first.
3) Attack the 5.35% SL next.
4) Pay the absolute minimum on the 3.15% SL - don't ever pre-pay any of this, it's nearly free money.
5) After finishing #2, Max out your 401K ($17,500), and a Traditional IRA ($5,500). Doing both of these will get you safely down into the 15% tax bracket. If doing the 401K gets you to 15%, maybe, maybe consider a Roth IRA instead of a T.IRA.
6) Put anything extra into a taxable investment account.

Questions:  I really don't want to own any houses.  Should I start investing money in the Total Stock Market Index Fund?  What's the point of maxing out my 401k contribution when I want to retire EARLY?  How much money should I put into a savings account?  Should I just try to pay off my student loans ASAP?

Total stock market index fund = yes. VTSAX is a good one.
401k and retiring early, absolutely do this. Read this thread and click around on all the links, particularly anything that links to madfientist.
Savings and student loans, Read this thread and click around on all the links. There are many people on both sides of this debate. No wrong answer, it's a personal choice, but with your current debts I'd get rid of anything over 5%.

Come back and ask some more questions after taking all that in.

Good luck!

[Seņora Savings]

I also vote to keep the EF.  You'd have trouble decreasing expenses with job loss. 

You can save $50-$120 on groceries if you 1)stop buying prepared food, 2)shop the perimeter of the grocery store, 2)cut back any meat.  Your grocery spending isn't bad, it can be optimized.

You'd be saving about 70% without loans.  A 75% saving rate should get you ER in 5 years from net worth of $0.  Considering that you plan to earn $21,000 in retirement (enough to cover non debt) you should be good to downsize life without committing yourself to an eternity of $900/month.

You might look at Early Retirement Extreme, the author spends a bit less than you.

[treefingers]

Thank you guys so, so much.  I'll take a little time to absorb your posts and then come back with questions.  :)

[treefingers]

One more detail I wanna throw out there - I'm only working 80% of full-time hours for 80% pay.  I could switch back over to full-time at $66, 000 a year if I wanted to, although I really value the extra time right now.  I think it works out toabout $3400 a month if I do that, rather than $2900.  Not sure if it's worth it, though.

[seattlecyclone]

One more detail I wanna throw out there - I'm only working 80% of full-time hours for 80% pay.  I could switch back over to full-time at $66, 000 a year if I wanted to, although I really value the extra time right now.  I think it works out toabout $3400 a month if I do that, rather than $2900.  Not sure if it's worth it, though.

Is accelerating FIRE worth sacrificing some of your free time now? That's something you'll have to answer for yourself.

Where do you live? I ask because your salary seems a bit low for a software developer even at 80% time, but it might be about average if you live in a low cost-of-living area without a sizable tech industry.

[treefingers]

I live in Minneapolis and have about two years of after-college experience.  The company is known for having great work-life balance, culture, and on-site conveniences, so I think that's another part of why the salary is below-average.

How great of an impact would saving another $500 a month have?

[treefingers]

Cheddar Stacker, I read your links (thank you), and I've been reading about the 72t, but I'm still confused about how that works.  From what I understand(?), there's a limit to how much I can take out of my 401k every year before I'm old enough, and it sounds like that limit is too low for a $21, 000-a-year lifestyle.  Will the 72t be my main source of income if I save according to your suggestions?  Will that be enough money?

[Cheddar Stacker]

Cheddar Stacker, I read your links (thank you), and I've been reading about the 72t, but I'm still confused about how that works.  From what I understand(?), there's a limit to how much I can take out of my 401k every year before I'm old enough, and it sounds like that limit is too low for a $21, 000-a-year lifestyle.  Will the 72t be my main source of income if I save according to your suggestions?  Will that be enough money?

72t is useful but can be rigid - it allows for around 3% withdrawals last I checked, and if you have $400K in your IRA that would be another $12K/year. There is also the Roth conversion pipeline. There are also investments not held within a 401K.

At your savings rate you should be able to max 401k with no problem. You could likely also do an IRA plus additional investments in a taxable account. If you can't build up a taxable account now make sure when you get closer to early retirement, like maybe 2-4 years out, you start funneling more money to the taxable account.

There are many ways to do this, just know the tax deferral/avoidance strategy can accelerate your path.

[clifp]

If you want to retire very early you'll need to work full the extra 25% pay increase a lot can be directed to savings.  Normally I'd say 21K isn't enough money (and when you factor in health insurance it may not be), but you have a laid out a detail budget which provides a bit of slack so 21k/year seems doable.   So I'd say you are doing a fine job living a Mustachian lifestyle congrats.

I think 7 years is being very unrealistic.  Even if you saved all $2900/month that is 35K a year best case that is $300K in 7 years. As you'll soon see reading the forums you'll need at 25 times your expenses to retire and given your young age probably 30x, plus paying off your student loans.  This means at least $500K and to be save probably 600K.  Going full time can make a huge difference in your saving rates since you should be able to save most all of your additional take home pay.  I'd say with smart investing a bit of luck, and continued frugal living you are well positioned to retire before 40.

[treefingers]

clifp, after reading your post, I put some more time cooking up the facts until I understood the situation a little bit better.

I did some math based on you and Cheddar Stacker's (mmmmmm, cheeeeeese) suggestions.  Maybe I did this wrong - I literally skipped a night of sleep a couple nights ago because I'm so excited about the idea of early retirement that I can't stop reading and reading and thinking and thinking about it, and I've been paying the price - but hopefully my reasoning is sound.

Here's what the tax brackets look like for 2014 (loosely defined for brevity's sake):

Taxable income	Tax
less than $36,900	$907.50 + 15% of salary
less than $89,350	$5,081.25 + 25% of salary

Here's what happens after I subtract $17,500 of my salary into my 401k before I get taxed:

At a salary of $53,000, I'd keep $35,500.  This would put me in the first tax bracket, which means that after taxes I'd make $35,500 - ($907.50 + $5,325) = $29,267.50 a year.  After $900/mo. of expenses, that leaves me with an extra $17000 per year for investing (assuming more than $100 a month of social security tax, medical/dental, etc.).

At a salary of $66,000, I'd keep $48,500.  This would keep me in my current tax bracket, which means that after taxes I'd make $48,500 - ($5081 + $12,125) = $31,294 a year.  After expenses, that leaves me with an extra $19000 per year for investing (after other taxes and insurance).

-----------------********-------------------

So with those two figures in mind, I'm looking at my 401k now, with the 3% employer match.  If I keep making $53,000, and if things hold steady at a 4% interest rate, I'll end up with $169,000 in the 401k after 7 years with the employer match (I used a simple savings calculator to figure that out, maybe that was wrong).  If I go back to making $66,000, that would be $172,400.

On top of that, if I invest at the lesser income with 4% interest, I'll end up with $136,600 more.
If I invest at the higher income, I'll end up with $152,700 more.

Living off 3% interest on 401k and 4% interest on the other investments
7 years of Part-time:  $4581 + $5464 = $10,045 total interest per year
7 years of Full-time:  $5172 + 6108 = $11,280 total interest per year

Okay, so 7 years seems totally unrealistic if I wanted to make $21,000 a year.  I was kinda copying the original Mr. Money Mustache on that one and shooting for a little less than he did.  But now that I think about it, I'm also not trying to pay for a whole family with all of this, just myself, so $12,000 would probably be fine for me too, if I kept living in a pretty frugal manner.  I think I'd just need to add another year or two of working to get there.  And I'm 100% certain that I would want to do some kind of work while I'm "retired."  I might even stay at my current job for a while longer because it's a pretty nice place to work.  I think what I'm really saving for is the feeling that if I wanted to be financially independent, I could...the idea of freedom.  Maybe that is too lofty...  But I'd really like to start taking steps with this and see where it goes.  From what everyone here is saying, I can cut down my cell phone bill by a significant amount, as well as my grocery bill.  I could probably also cut down on my bus pass spending if I choose to ride my bike more often.

Another question, if I may.  Student loans aren't quite the opposite of invested money, are they?  With invested money, you keep adding to it, and it keeps growing at a certain interest rate.  But with student loans, you keep subtracting from the amount that you owe, even though they're growing at an interest rate, so it's not like the growth into debt is as great as the growth into wealth is with investments, right?  Plus I get the interest that I paid back at tax-refund time every year, and I usually get a $1500 bonus from work every year too (after taxes).  Forgot about that!!!

Okay.  Maybe I will be able to sleep now!?  :)  Feel free to rip all of this to shreds thoroughly; I just started thinking about this stuff a few days ago, and I'm sure there are some problems with my analysis.  Anyway, thank all of you guys for your help again, wow, I can't believe I can get this kind of advice for free, you guys rock.

[Cheddar Stacker]

I literally skipped a night of sleep a couple nights ago because I'm so excited about the idea of early retirement that I can't stop reading and reading and thinking and thinking about it...

It's addicting isn't it? I never skipped an entire night of sleep, but I know what you mean. It can consume you at first.

Here's what happens after I subtract $17,500 of my salary into my 401k before I get taxed:

At a salary of $53,000, I'd keep $35,500.  This would put me in the first tax bracket, which means that after taxes I'd make $35,500 - ($907.50 + $5,325) = $29,267.50 a year.  After $900/mo. of expenses, that leaves me with an extra $17000 per year for investing (assuming more than $100 a month of social security tax, medical/dental, etc.).

At a salary of $66,000, I'd keep $48,500.  This would keep me in my current tax bracket, which means that after taxes I'd make $48,500 - ($5081 + $12,125) = $31,294 a year.  After expenses, that leaves me with an extra $19000 per year for investing (after other taxes and insurance).

I will try to fix your analysis later if someone doesn't beat me to it (I don't have time right now), but let me just say "you're doin it wrong!" Long story short, you're calculating waaaay to much federal tax in both scenarios so the picture may look even brighter than what you painted.

Another question, if I may.  Student loans aren't quite the opposite of invested money, are they?  With invested money, you keep adding to it, and it keeps growing at a certain interest rate.  But with student loans, you keep subtracting from the amount that you owe, even though they're growing at an interest rate, so it's not like the growth into debt is as great as the growth into wealth is with investments, right?  Plus I get the interest that I paid back at tax-refund time every year...

That's why you need to dig out of that hole a little. But they are very similar in that they require the use of your money and provide a return on that money. Yes, the SL interest is tax deductible which is one of the problems with your tax analysis, but you don't "get it back" as you put it, you spend a $1 and save $0.25 or $0.15.

...Feel free to rip all of this to shreds thoroughly; I just started thinking about this stuff a few days ago, and I'm sure there are some problems with my analysis.  Anyway, thank all of you guys for your help again, wow, I can't believe I can get this kind of advice for free, you guys rock.

Ripped apart enough for you?

It's a pretty cool place right? If you're going to kill some time browsing on the internet, this is likely one of the best places for learning quite a bit while you do it.

[Cheddar Stacker]

So a few things are wrong about your calculation:

1) You failed to include SS and Med tax withholdings.
2) You failed to include state taxes (if applicable) and I didn't add them since I don't know your location.
3) You are not using the tax tables properly - you are only taxed at 15% on the income > $9,075 and you calculated all the way down to $0.
4) You forgot to deduct the standard deduction and personal exemption, and SL interest, and Med/dental.

I calculated (attached) with a $13K increase in pay your net pay would increase around $10K. Plug and play if any of the assumptions are incorrect, but you would certainly have a much higher net if you worked 5 days instead of 4. I'm not trying to talk you into it, just letting you know the difference.

Good Luck!

[treefingers]

THANKS, CHEDDAR STACKER!!!  My hero!!!  I wish I could bake you cookies or something!  XD  Thanks a lot, I will obsess over your new posts throughout the remainder of the day...

[TomTX]

Here's how I would do it, while keeping a reasonable e-fund:

1) Get the full 401(k) match. FREE MONEY
2) Max out ROTH while you can*
3) Sell off car since you don't need it.
3) Pay down all loans over 5%
4) Max out other tax deferred investments (401(k))
5) Invest unsheltered money.

Reassess in 5 years or so. Think about whether you want to pay off the low interest student loans at that point, or to carry them into ER.

I'd put all the investments into a Vanguard Total Stock Market. Once you have ~$50k or so, start reading up on asset allocation and rebalancing. To me, there is no point in diversifying with smaller amounts of money. It can become a distraction, can increase cost, etc. Stocks are the main vehicle for growth anyway. Once you have more in post-taxed money, consider rental real estate. Lots of good reading on this site.

*During early ER: if you don't have enough post-tax investments to draw from, you can pull out Roth contributions with no restriction, no tax, no penalty. This can help you bridge over the 4-5 years until your Roth Pipeline starts spewing money.