Author Topic: How to best invest?  (Read 3172 times)

frugalfoothills

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How to best invest?
« on: February 15, 2018, 03:07:47 PM »
Hi, all!

I have been working hard on getting my shit together this year and during that process I’ve been doing a lot of reading and research to prepare for the day that I will be consumer debt free for the first time in my adult life (and ready to hit the ground running as far as investments go.)

I considered posting this in Investory Alley, but after I typed it up it read as more of a case study... Let me know if I need to move it!

The assumptions we will make for this exercise:

•   Zero credit card debt or car payment. Only debt is my mortgage. I have about $30k in equity
•   Gross salary is $80,000/year, but $10k is an annual bonus qualified as “supplemental income.” So for this exercise we will say gross salary is $70k. I am a single female, no kids, 28 years old. Paid bi-weekly, gross paychecks are $2,688 each
•   I have a 401k through my employer (with Fidelity) with a balance of $32,500 (today’s balance so hopefully this will be more by next January, but we will use today’s balance to simplify things). 100% allocated to stocks
•   HSA account with $2,100 cash and $2,000 invested (again hopefully will be more but using balance as of today). Must maintain that $2,100 in cash to be eligible to invest

I have been working to minimize my monthly expenses and have worked them down to $2,400/month. That includes everything, mortgage and all. At $2,400 a month, my annual spending is under $29,000.

I’ve read the Investment Order post and am aligned with the first few steps. I already have an emergency fund that I’m comfortable with, and I’m already contributing the 6% I need to my 401k to take full advantage of my company match.

It feels like I know what I need to do next (take full advantage of tax advantaged accounts, open an IRA & begin contributing, etc.) but I can’t figure out how much I should be contributing to each of those to ensure I end up with enough take-home pay each month to cover my spending. I’m super paranoid I’m going to fuck this up and short myself somehow.

My thoughts/questions are:

1.   I feel like I need to open either a Trad IRA or Roth IRA in 2019, but I don’t understand which is better for me. I know the Trad IRA offers the benefit of being tax deferred, but is it not redundant to contribute to a 401k AND a Trad IRA simultaneously? It feels like they are both accomplishing pretty much the same thing, so would it be better to skip the Trad IRA and simply bump my 401k contributions up by the $5,500 I would contribute to the Trad IRA instead?

2.   If I add the $5,500 to my 401k contributions and skip the Trad IRA, my 401k contribution rate will now be 13.8% or $9,694 per year. I suppose this option makes more sense, as I could then open a Roth IRA and contribute another $5,500 of post-tax funds to the Roth. Not an option if I open the Trad IRA, since the limit is $5,500 for Trad and Roth combined, correct?

3.   My employer matches 100% of the first 3% and 50% of the next 3%, or essentially 4.5. With their match, that’s an additional $3145, which means $12,839 per year. Is there a reason I should not max to $18,500? How do I know if I can afford that? Like I said, biggest fear is that I’ll set it and then after taxes my monthly take-home won’t be enough to cover my expenses. Can you tell math isn’t my strong suit?

4.   I plan on maxing my HSA contributions in 2019. My employer contributes $800 annually, so my contributions will be $2,650 annually, or $101 per paycheck.

Does this sound right? If I go with the above, my savings would look like:

•   PRE-TAX: 13.8% to 401k, or $9646 annually, or $371 per paycheck
•   PRE-TAX: $2,650 to HSA annually, or $101 per paycheck
•   POST-TAX: $5,500 to Roth IRA annually, or $458/month (should have noted that I have a side-hustle that pulls in $400/month, so my plan is to fund the Roth with side-hustle cash rather than my gross income)

What am I missing? What would you do in my situation for max benefit? Thanks in advance for any advice 😊

Phoenix_Fire

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Re: How to best invest?
« Reply #1 on: February 15, 2018, 05:12:31 PM »
Hi Frugal,

Your salary without bonus is close to mine. I’m ay $65k.  I’m currently maxing my HSA, 401k is at 17,500 right now and after I get a raise or bonus (or not) I will adjust accordingly to reach the max.  After that, I am putting 500 into a taxable account (you can easily do a Roth IRA) and $200 into an online savings account. These will both be used potentially for a house down payment.  I also have enough cash on hand to max out the Roth this year if I decide to. If I wasn't worried about down payment money I would be maxing the Roth along the way.

With all of that, I calculated my expected taxes in 2018, and adjusted my withholding level to 2.  My 2 week take home paycheck is $1317.83 which is $2855.30 a month.

My expenses are just under $25000 a year.

I think you can max out your HSA, 401k, Roth IRA and still have a little left over.

I would not count on your side hustle until your friend has paid you rent without issue for at least 3 months in a row.

Here is a paycheck calculator I used when I was figuring mine out:  https://www.paycheckcity.com/calculator/salary/

If you have cash available, you can open your Roth now and the contribution can still go to 2017, you have until tax day.

Laura33

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Re: How to best invest?
« Reply #2 on: February 15, 2018, 07:19:25 PM »
I believe the reason they recommend going to an IRA before maxing out the 401(k) is because some folks have crappy 401(k) plans with high fees and poor choices, whereas your IRA you control and so can throw everything into Vanguard and pay very low fees.  But if you have a decent 401(k), this is where the phrase “don’t let the perfect be the enemy of the good” comes into play:  the ultimate goal is to get as much into tax-sheltered accounts as possible.  So if it is easier to max out your 401(k) first, don’t overthink it - just do it.

The other benefit to an IRA, though, is that you have more control of your cash flow.  So for ex you mentioned being concerned you would leave yourself short of cash.  One way to manage that fear is to set your 401(k) withdrawal at the level where you are confident that you will have enough to pay your bills.  Then, if you were too cautious and have excess cash that builds up, you can transfer that into your IRA in chunks every few months.  And then next year, when you are more confident in your actual spend, you can adjust the 401(k) accordingly.  IRAs are also good for sporadic chunks of cash, like bonuses, since again you fund them yourself instead of relying on a routine payroll deduction like for your 401(k).

The other difference is likely relevant only this year:  your 401(k) is done on a calendar year basis, but you have until tax time to contribute to your IRA.  So if you have extra cash to put away, you can still put it in your 2017 IRA.

frugalfoothills

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Re: How to best invest?
« Reply #3 on: February 16, 2018, 11:53:54 AM »
Hi Frugal,

Your salary without bonus is close to mine. I’m ay $65k.  I’m currently maxing my HSA, 401k is at 17,500 right now and after I get a raise or bonus (or not) I will adjust accordingly to reach the max.  After that, I am putting 500 into a taxable account (you can easily do a Roth IRA) and $200 into an online savings account. These will both be used potentially for a house down payment.  I also have enough cash on hand to max out the Roth this year if I decide to. If I wasn't worried about down payment money I would be maxing the Roth along the way.

With all of that, I calculated my expected taxes in 2018, and adjusted my withholding level to 2.  My 2 week take home paycheck is $1317.83 which is $2855.30 a month.

My expenses are just under $25000 a year.

I think you can max out your HSA, 401k, Roth IRA and still have a little left over.

I would not count on your side hustle until your friend has paid you rent without issue for at least 3 months in a row.

Here is a paycheck calculator I used when I was figuring mine out:  https://www.paycheckcity.com/calculator/salary/

If you have cash available, you can open your Roth now and the contribution can still go to 2017, you have until tax day.

This response was super helpful, thank you! It's nice to hear from someone who is already doing what I'm hoping to do and what the numbers actually look like. I think you're right, based on this info I should be totally fine doing all three... but at the very least, maxing my 401k and HSA. Like you said, the Roth can be added to or not added to at will, so if things end up tighter than I'm expecting that can always be skipped.

Love that you remembered my roommate drama from my other post and realized that's my "side hustle." I didn't want to dive into all the details here, but needless to say, I'm not *relying* on that as much as I am hoping for it. Best case scenario: my woes are over and I can start dumping all her rent payments into the Roth without having to touch my regular income. Worst case, I should still have room in the budget to contribute to the Roth from my usual income if desired.

alanB

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Re: How to best invest?
« Reply #4 on: February 16, 2018, 12:51:47 PM »
You are doing an amazing job, and your analysis is very clear.  I would definitely not say that math is not your strong suit :)  I will use the assumptions you provided, hopefully my math is OK too.  If you have any state tax or other deductions you should adjust for that.  Don't worry too much about messing up, you can always adjust your 401K contribution or space out your IRA contributions.  I agree that you should think about 2017 IRA if possible, you still have 2 months.  If you are flexible and roughly budget over time you will do great.

Based on the numbers you provided:
Gross income: 70,000
HSA (max): 2,650
401K: 9,694
FICA tax: ~5,150
Fed. tax: ~6,000
Roth IRA (max): 5,500
Income after taxes & deductions: ~41,000
Annual spending: ~29,000
In this scenario you have an excess of ~12,000 (~$460 per paycheck)

If you increase your 401K match to max:
Gross income: 70,000
HSA (max): 2,650
401K (max): 18,500
FICA tax: ~5,150
Fed. tax: ~2,600
Roth IRA (max): 5,500
Income after taxes & deductions: ~35,600
Annual spending: ~29,000
In this scenario you have an excess of ~6,600 (~$250 per paycheck)

If you also switch to traditional IRA & max 401K:
Gross income: 70,000
HSA (max): 2,650
401K (max): 18,500
FICA tax: ~5,150
Trad IRA (max): 5,500
Fed. tax: ~2,000
Income after taxes & deductions: ~36,200
Annual spending: ~29,000
In this scenario you have an excess of ~7,200 (~$275 per paycheck)

If it were me, I would put excess in a taxable investment account.  Not really much else you can do... If your 401K is really bad you might want to contribute less there and more to taxable, that would also alleviate your concerns around cash flow.  Good luck!!

MDM

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Re: How to best invest?
« Reply #5 on: February 16, 2018, 06:20:30 PM »
•   Gross salary is $80,000/year, but $10k is an annual bonus qualified as “supplemental income.” So for this exercise we will say gross salary is $70k. I am a single female, no kids, 28 years old. Paid bi-weekly, gross paychecks are $2,688 each
Supplemental income means that federal tax will be withheld at a flat rate: 25% in 2017, and 22% in 2018.  For purposes of actual tax due, however, it is treated the same as the other $70K.

Quote
1.   I feel like I need to open either a Trad IRA or Roth IRA in 2019, but I don’t understand which is better for me. I know the Trad IRA offers the benefit of being tax deferred, but is it not redundant to contribute to a 401k AND a Trad IRA simultaneously? It feels like they are both accomplishing pretty much the same thing, so would it be better to skip the Trad IRA and simply bump my 401k contributions up by the $5,500 I would contribute to the Trad IRA instead?
As Laura33 noted, it's mostly about the fees when choosing between 401k and tIRA.  In your case, with $80K gross, you might need (depending on other pre-tax deductions) to maximize the 401k in order to deduct the tIRA.  See IRA Deduction Limits | Internal Revenue Service.

Quote
2.   If I add the $5,500 to my 401k contributions and skip the Trad IRA, my 401k contribution rate will now be 13.8% or $9,694 per year. I suppose this option makes more sense, as I could then open a Roth IRA and contribute another $5,500 of post-tax funds to the Roth. Not an option if I open the Trad IRA, since the limit is $5,500 for Trad and Roth combined, correct?
Yes, the $5,500 is a combined limit.  But saving 22% likely makes traditional better than Roth for you, unless you expect very rapid annual income growth (e.g., up to $120K/yr or higher sometime in the next several years).

Quote
3.   My employer matches 100% of the first 3% and 50% of the next 3%, or essentially 4.5. With their match, that’s an additional $3145, which means $12,839 per year. Is there a reason I should not max to $18,500? How do I know if I can afford that? Like I said, biggest fear is that I’ll set it and then after taxes my monthly take-home won’t be enough to cover my expenses. Can you tell math isn’t my strong suit?

I’ve read the Investment Order post and am aligned with the first few steps. I already have an emergency fund that I’m comfortable with....

It feels like I know what I need to do next (take full advantage of tax advantaged accounts, open an IRA & begin contributing, etc.) but I can’t figure out how much I should be contributing to each of those to ensure I end up with enough take-home pay each month to cover my spending.
You might put your numbers into the case study spreadsheet.  It will handle the math - you just need to provide realistic expenses. ;)

If the $10K bonus is pretty much guaranteed, it's probably best to do the cash flow analysis on $80K/yr.  Also, adjust your withholding so you owe/get a a refund of ~$0 when filing taxes.

Because the bonus comes in a lump sum, you can
  • a) have your e-fund at the "desired" amount just prior to getting the bonus, immediately after which the e-fund balance can be (desired amount) + (after-tax bonus amount), then dwindle until replenishing after the next bonus, or
  • b) have your e-fund at the "desired" amount just after getting the bonus, then letting the e-fund dwindle until replenishing after the next bonus (assuming the desired e-fund amount is greater than the after-tax bonus amount), or
  • c) something between "a" and "b".
The main point is that the e-fund protects you against short term cash flow fluctuations, and you can change your 401k contribution amount if the e-fund gets extremely low due to unforeseen events.

Quote
4.   I plan on maxing my HSA contributions in 2019. My employer contributes $800 annually, so my contributions will be $2,650 annually, or $101 per paycheck.
Well done!

frugalfoothills

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Re: How to best invest?
« Reply #6 on: February 19, 2018, 12:26:55 PM »

Quote
2.   If I add the $5,500 to my 401k contributions and skip the Trad IRA, my 401k contribution rate will now be 13.8% or $9,694 per year. I suppose this option makes more sense, as I could then open a Roth IRA and contribute another $5,500 of post-tax funds to the Roth. Not an option if I open the Trad IRA, since the limit is $5,500 for Trad and Roth combined, correct?
Yes, the $5,500 is a combined limit.  But saving 22% likely makes traditional better than Roth for you, unless you expect very rapid annual income growth (e.g., up to $120K/yr or higher sometime in the next several years).

I think this is where it gets confusing for me. It sounds like I definitely need to go ahead and max my 401k contributions, so I'll bump those to $18500 or just under 23% of my gross pay (at $80k). So you're saying that the Trad is probably better for me because after that $18500, my MAGI would be low enough that the full $5,500 would be deductible, correct?

So I'd have $18,500 to my 401k and $5,500 to a Trad IRA, plus the $2,660 to max my HSA, totaling $26,660 in tax advantaged accounts.

That feels like the correct way to go here, right?

MDM

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Re: How to best invest?
« Reply #7 on: February 19, 2018, 01:37:52 PM »
2.   If I add the $5,500 to my 401k contributions and skip the Trad IRA, my 401k contribution rate will now be 13.8% or $9,694 per year. I suppose this option makes more sense, as I could then open a Roth IRA and contribute another $5,500 of post-tax funds to the Roth. Not an option if I open the Trad IRA, since the limit is $5,500 for Trad and Roth combined, correct?
Yes, the $5,500 is a combined limit.  But saving 22% likely makes traditional better than Roth for you, unless you expect very rapid annual income growth (e.g., up to $120K/yr or higher sometime in the next several years).

I think this is where it gets confusing for me. It sounds like I definitely need to go ahead and max my 401k contributions, so I'll bump those to $18500 or just under 23% of my gross pay (at $80k). So you're saying that the Trad is probably better for me because after that $18500, my MAGI would be low enough that the full $5,500 would be deductible, correct?

So I'd have $18,500 to my 401k and $5,500 to a Trad IRA, plus the $2,660 to max my HSA, totaling $26,660 in tax advantaged accounts.

That feels like the correct way to go here, right?
Yes, subject to the "unless you expect..." caveat noted above.  See Traditional versus Roth - Bogleheads for more.

CalBal

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Re: How to best invest?
« Reply #8 on: February 20, 2018, 11:25:02 AM »
I didn't read all the responses but your gross income is very similar to mine. You didn't mention what your mortgage in your original post, but I pay $1500/mo on mine (P+I payment + escrow + insurance + extra payment), and I fully fund my 401k and my Roth (this year I went to traditional) IRA, so you likely can too. If you fully fund 401k it will significantly decrease your tax burden.

frugalfoothills

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Re: How to best invest?
« Reply #9 on: February 20, 2018, 11:35:01 AM »
I didn't read all the responses but your gross income is very similar to mine. You didn't mention what your mortgage in your original post, but I pay $1500/mo on mine (P+I payment + escrow + insurance + extra payment), and I fully fund my 401k and my Roth (this year I went to traditional) IRA, so you likely can too. If you fully fund 401k it will significantly decrease your tax burden.

Thanks for the info! Always good to hear from someone in a similar situation.

Mortgage is $1064/month, which includes everything. I'd love to refinance in 2018 and drop the PMI, but it's an FHA loan and I know there are some rules about dropping PMI for those. I think you need 70% LTV? My home is worth much more than my original mortgage (I bought for $154,000 in 2013 and would probably pull $180,000 selling it today), so I need to work out the specifics of how to go about doing that/whether it's even an option.

It sounds like I will absolutely be safe to max the 401k & HSA, and still potentially have funds left over to throw at a Traditional IRA, too. Amazing what you can do when you kill the debt, right???

 

Wow, a phone plan for fifteen bucks!