Author Topic: Advice on next steps after the basics  (Read 2663 times)

kdw133

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Advice on next steps after the basics
« on: October 05, 2016, 04:18:12 PM »
I unintentionally lived a mustachian lifestyle throughout my 20’s knowing considerable expenses were on the horizon (car, house, kids, etc.).  My main financial goal was simply to save, save, save so I had cash on hand for when these events occurred.

Fast forward a decade or so and, good news, I was prepared to handle these things.  Now my problem (which is a good problem to have) is what to do with the left over savings?  Even accounting for a generous emergency fund of 1 year living expenses, we still have about $100k left sitting in savings.  It has always been in a “high yield” savings account, but that is not going to get us very far at 1% these days.  I know I have to do something with it now that all of the dust of early adulthood has settled, but the question is what?  A lot of the advice I read is either too simplistic (pay off debts, get company 401k match) or very detailed and situation specific.

I’ve quickly learned maximizing tax advantaged options is very important. 15% and 25% tax brackets dwarf investment returns, whether they’re 6%, 8%, or even 10%.  With that in mind, our savings priority list is:

$11,000 IRAs (Roth)
$37,000 401ks (Roth/Traditional)
$3,000 529 (max state deduction)

Even with maxing out these items, we still find ourselves saving a little every month and not even touching the excess cash.  Some of the things I am considering:

Make a lump sum payment towards mortgage.  However, at 3.625%, it doesn’t seem to make a lot of sense when I should get substantially more out of an investment.  However, I need to actually make that investment in order for that line of thinking to pay off.

Refinance to a 15 or 20 year mortgage.  A variation on making a lump sum payment towards the mortgage, it has the added bonus of obtaining a slightly lower interest rate.  However, the higher payment must be made no matter what and it has an even lower return compared to what I could expect in the market.

Open a taxable investment account.  For some reason, I’m irrationally hesitant to take the plunge on an investment account.  I don’t know if it’s the further tax complications or the fear it puts the money at risk even though I know it should pay off in the long run.  Is it as simple as moving the money to Vanguard or Schwab and putting it in a target retirement date fund?

Do a mega backdoor Roth.  I have only a passing knowledge of this and would have to do further research on the mechanics.  Also am aware that tax law could change at any time, rendering this option void.

Are there any other options I should be considering?  Would love to know where fellow mustachians are funneling their excess savings.

tonysemail

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Re: Advice on next steps after the basics
« Reply #1 on: October 05, 2016, 04:39:38 PM »
hey, welcome to the forums.

you seem like you have answered your own questions.
Yes, those options would all improve your finances.

People here may quibble about which is best.. I'd open a taxable investment account.
It's as simple as opening an account at vanguard and dumping it in your favorite mutual fund.

I'm assuming you have your 401k invested in the market with an asset allocation appropriate for your risk tolerance.
If you don't have an IPS, a good next step is to write one.

You seem to care about minimizing taxes.
I'd suggest reading about tax loss harvesting.
You can do it on your own and it's a solid step to take if you're looking for something beyond the basics.

MustacheAndaHalf

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Re: Advice on next steps after the basics
« Reply #2 on: October 06, 2016, 08:41:13 AM »
I’ve quickly learned maximizing tax advantaged options is very important. 15% and 25% tax brackets dwarf investment returns, whether they’re 6%, 8%, or even 10%.
That's not how capital gains work.  If you put $100 into the market and it grows 10% to $110, you are taxed on the gain - not the entire $110 amount.  So it's 25% of the $10 gain, or $2.50.

Another way to view it:
if you make a 10% profit, and sell, the IRS wants 2.5% and you keep 7.5%.

I point this out because I think you're using this logic to avoid any investments in taxable accounts.  You can certainly make a profit in taxable, especially with passive index funds.  They don't realize gains very often until you sell, so most years there's nothing for the IRS to tax (except the 2% dividend: you keep 1.7% and they take 0.3% owing to 15% tax on dividends).  If you've been holding off taxable investing, take another look at it.

talltexan

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Re: Advice on next steps after the basics
« Reply #3 on: October 06, 2016, 09:03:17 AM »
I would emphasize traditional 401(k) over the Roth. If you're the sort of person who fell backwards into a Mustachian lifestyle, than you're probably accustomed to a lifestyle far below $75 K in annual expenses, which means that when you are retired, your effective tax rate is even lower.

MDM

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Re: Advice on next steps after the basics
« Reply #4 on: October 06, 2016, 09:29:42 PM »
Make a lump sum payment towards mortgage.  However, at 3.625%, it doesn’t seem to make a lot of sense when I should get substantially more out of an investment.  However, I need to actually make that investment in order for that line of thinking to pay off.
kdw133, welcome to the forum.  Both your howevers are correct.

Quote
Refinance to a 15 or 20 year mortgage.  A variation on making a lump sum payment towards the mortgage, it has the added bonus of obtaining a slightly lower interest rate.  However, the higher payment must be made no matter what and it has an even lower return compared to what I could expect in the market.
Again, both your sentences are correct.  I generally lean toward the "don't tie up too much of your net worth in your house" side of this argument, but reading between the lines that probably wouldn't be the case with you.  Given that, lowering your interest cost is a good thing.

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Open a taxable investment account. ...Is it as simple as moving the money to Vanguard or Schwab and putting it in a target retirement date fund?
Yes, it is.

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Do a mega backdoor Roth.  I have only a passing knowledge of this and would have to do further research on the mechanics.  Also am aware that tax law could change at any time, rendering this option void.
Thus, if you are currently eligible, there is no time like the present.  Here are some links for your research:
http://thefinancebuff.com/in-service-withdrawal-the-law-and-the-plan-rules.html
https://www.kitces.com/blog/irs-notice-2014-54-acquiesces-on-splitting-after-tax-401k-contributions-for-roth-conversion/
https://www.bogleheads.org/forum/viewtopic.php?f=2&t=137366
http://forum.mrmoneymustache.com/investor-alley/mega-backdoor-roth/

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Are there any other options I should be considering?  Would love to know where fellow mustachians are funneling their excess savings.
You seem to have it pretty well figured.  See the 'Investment Order' tab in the case study spreadsheet for more details.

Also consider How To: Write a "Case Study", whether you post or merely use that as a guideline for self-analysis.

Good luck!

etselec

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Re: Advice on next steps after the basics
« Reply #5 on: October 12, 2016, 08:25:09 PM »
I hear you! I just took the plunge (to open a taxable investment account) earlier this year.

While it is the simplest, a target date fund in a taxable account is not ideal. Bogleheads has a bunch of great articles about tax strategy in investing, but the tl;dr is that bonds pay a lot more dividends (taxable every year no matter what) and stocks have more capital gains (not taxable until you sell) so you want to hold stocks, not bonds, in taxable accounts.

Congrats on getting this far, and good luck taking the next steps!

talltexan

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Re: Advice on next steps after the basics
« Reply #6 on: October 14, 2016, 10:20:42 AM »
If you want to pay a lower rate on your mortgage, consider a 5/1 ARM. You'll get rates that look more like the 15-year rate. If you're concerned about the eventual increase in rates, then you should over-pay up to what the 30-year fixed payment would be so that higher rate will apply to a lower loan balance.

MDM

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Re: Advice on next steps after the basics
« Reply #7 on: October 14, 2016, 10:45:22 AM »
While it is the simplest, a target date fund in a taxable account is not ideal. Bogleheads has a bunch of great articles about tax strategy in investing, but the tl;dr is that bonds pay a lot more dividends (taxable every year no matter what) and stocks have more capital gains (not taxable until you sell) so you want to hold stocks, not bonds, in taxable accounts.
That's debatable, even among Bogleheads.  E.g., see https://www.bogleheads.org/wiki/Tax-efficient_fund_placement#Criticisms_of_this_tax_placement_strategy.

See also this post and the ones below for some discussion on target date fund fees.

By "debatable" I do mean exactly that.  There are pros and cons, and the "correct" answer depends on the assumptions one makes.

Grogounet

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Re: Advice on next steps after the basics
« Reply #8 on: October 17, 2016, 11:20:59 PM »
I would consider a side gig to supercharge your income too

kdw133

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Re: Advice on next steps after the basics
« Reply #9 on: October 21, 2016, 12:32:59 PM »
Sorry, didn't mean to post and run.  That's not a very good mustache community member.  I have been devouring info over the last few weeks through from not only MrMoney Mustache, but also places like jlcollinsnh, RootofGood, and the MadFientist.  Learned a lot and hope to continue.

Since so many people took the the time to give their thoughts on my post, I'd like to give them a response.

tonysemeail
Yes, all these options would improve your finances.
But which one is best?  I need the best, most efficient, optimized solution!

You seem to care about minimizing taxes.
I care only in that avoiding 15% or 25% "losses" off the top goes a long way towards building wealth.

MustacheAndaHalf
Thanks for the encouragement towards a taxable investment account.  My reference to avoiding taxes was income taxes, not capital gains taxes, which is why everyone recommends maxing out tax advantaged accounts first.

talltexan
I would emphasize traditional 401(k) over the Roth...when you are retired, your effective tax rate is even lower.
You hit on a key point I have picked up from some other sources as well.  In the past I did some pretty extensive reading in the "mainstream" financial world on Roth vs. Traditional.  Since there was no clear answer, I decided to keep it roughly 50/50.  However in the FIRE world, there is a huge advantage to avoiding taxes in your working years and then "paying" them on withdrawal.  The trick is your income is so much lower in the withdrawal phase, that your effective tax rate can be extremely low.  I think MadFientist says a couple can withdraw up to $43,000 per year and pay only a couple hundred in taxes.  If that withdrawal is from a tax deferred account, you essentially never pay income taxes on that money.

This is the biggest mistake I found I was doing.  I have switched everything possible over to Traditional rather than Roth.

MDM
Thanks for the links on the mega backdoor Roth.  My decision is down to that or just a taxable investment account.  Also, a huge thank you for pointing out the "Investment Order" tab in the case study spreadsheet.  The What and Why is the most thorough yet simple advice I think I have ever seen.

etselec
Thanks for steering me towards an index fund rather than a target date fund in a taxable account.  Makes sense if I go that way.

Grogounet
Thanks for the suggestion, but we're looking to work less, not more, even in the short-term.


Based on the Investment Order, it looks like we're on #6 (mega backdoor Roth) or #8 (taxable account).  Paying extra on the house just doesn't make any sense when rates are so low.

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
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

I'm continuing to learn about the mega backdoor Roth and will go that way if it works out.  Otherwise, I will just open a taxable account and buy a bunch of VTSMX per jlcollinsnh.
« Last Edit: October 21, 2016, 12:35:16 PM by kdw133 »