Author Topic: Great at saving, looking to become great at investing.  (Read 7267 times)

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Great at saving, looking to become great at investing.
« on: December 04, 2012, 08:54:53 AM »
Hello Everyone!

I am 24, and have been very lucky in life thus far; steady ~$40k/yr. career in finance. No debt whatsoever. In the next 6 months or so I should be transferring in my existing company, get a salary bump to $50-55k (potentially more), and be able to live at home for free. I am currently saving well over 2/3 of my income, and I should be able to get close to 70-80% in the next year or so. I have been getting into many finance blogs/articles over the last 6 months and am almost caught up with MMM. Per his advice, I recently tossed my savings in Vanguard's VFIAX mutual fund. I have read on here that I probably should not have done that since I now have to pay taxes on the gain for this year. Oh well, lesson #1 out of the way.

Here is my question. As a naive 24 year old, Lending club appeals to me to no end. I have rumbled through 20 articles/forums in the past 24 hours to get an idea of how safe I feel investing with them. I want to put in about $3,600 of savings from closing my local bank account. Should I deposit this in the traditional way as an investor, or should I consider setting this up as an IRA?

1) Can I do that?
2) I have a 401k, and I am aware of the $5,000 IRA contribution limit for 2012, I am not sure if that is for each individual account, or if I have to establish what I have contributed to my 401k, subtract that from $5,000, and then limit my contribution to the difference.
3) Assuming I am limited to $5,000 per account, should I move $5,000 of my VFIAX funds to an IRA with Vanguard? Can I have more than one IRA account with them?
4) What else would you recommend given my circumstances?

Many thanks!


mlipps

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Re: Great at saving, looking to become great at investing.
« Reply #1 on: December 04, 2012, 09:30:04 AM »
1. Maybe, I'm not super familiar with those Peer to Peer sites, but when I looked into one of them (I can't remember if it was Lending Club or Prosper), you had to have a net worth of something like $100k+, and then a minimum initial investment. You might need to read more first. I wouldn't use my IRA money for it though, it's too risky. It's more something "fun" to do when you can afford to take a risk, after maxing out other traditional tax deferred vehicles.
2. Your 401k contribution limit for 2012 is $17,000. Separately, you can contribute an additional $5,000 to an IRA, either Roth or Traditional, or any mix of the two up to $5,000 total. Does that make sense?
3. Yes, I would use that $5,000 to fund an IRA. It's senseless to pay taxes when you still have tax deferred options open. Read up on the differences between a Roth and a Traditional; if this is most of your emergency fund, you might consider a Roth since the funds are still accessible.
4. Are you contributing anything to your 401k?

iamlindoro

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Re: Great at saving, looking to become great at investing.
« Reply #2 on: December 04, 2012, 09:34:14 AM »
Per his advice, I recently tossed my savings in Vanguard's VFIAX mutual fund. I have read on here that I probably should not have done that since I now have to pay taxes on the gain for this year. Oh well, lesson #1 out of the way.

You only have to pay taxes on the gains you realize by selling, or on dividends earned.  The value of the fund simply going up costs you nothing without a taxable event (selling).  The dividends, unless you put a LOT of savings into the fund, though be a very small taxable amount if you only recently put it there.

EDIT:  And if you bought the fund through Vanguard and set the dividends up to reinvest directly with them, then even the dividends shouldn't be taxed right now I believe.

1) Can I do that?

Yes, you can do that, though a Roth IRA may afford you more flexibility and you would qualify to contribute up to the $5000 maximum with your income.  Since the money is coming from savings, having similar accessibility to funds in the Roth may appeal to you.

2) I have a 401k, and I am aware of the $5,000 IRA contribution limit for 2012, I am not sure if that is for each individual account, or if I have to establish what I have contributed to my 401k, subtract that from $5,000, and then limit my contribution to the difference.

3) Assuming I am limited to $5,000 per account, should I move $5,000 of my VFIAX funds to an IRA with Vanguard? Can I have more than one IRA account with them?

It's $5,000 across all IRAs, and the 401k and IRA contribution limits are distinct from one another.  You can deposit up to $17,000 across any and all your 401Ks *AND* $5,000 across any and all IRAs-- But it's not 17K per 401k and It's not $5K per IRA, it's those amounts across all of them.
« Last Edit: December 04, 2012, 10:04:17 AM by iamlindoro »

COguy

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Re: Great at saving, looking to become great at investing.
« Reply #3 on: December 04, 2012, 09:34:44 AM »
There are investing requirements for Lending Club:

http://www.lendingclub.com/kb/index.php?View=entry&EntryID=113

Basically, most states you need an income of $70,000/yr and $70,000 net worth or $250,000 net worth. 

Also, if you haven't read it yet.  Read Brave New Life's blog posts on P2P lending.  He has some good wisdom about filtering loans and such on there.

http://www.bravenewlife.com/07/my-lending-club-experiment/


skyrefuge

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Re: Great at saving, looking to become great at investing.
« Reply #4 on: December 04, 2012, 10:50:55 AM »
EDIT:  And if you bought the fund through Vanguard and set the dividends up to reinvest directly with them, then even the dividends shouldn't be taxed right now I believe.

No, if held in a regular taxable account, dividends paid by mutual funds are taxed, even if you automatically reinvest them. Also, mutual funds *can* produce capital gains even if you don't sell the fund (they come from the fund itself selling underlying shares), and those are also taxed.

If the fund is instead held in a Roth IRA, taxes never have to be paid on dividends or gains.

That said, I don't think the OP has really lost anything significant (yet!) by initially making his investment in a taxable account. If he puts it under the cover of a  Roth IRA before it produces any dividends or capital gains, it might not matter at all.

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Re: Great at saving, looking to become great at investing.
« Reply #5 on: December 04, 2012, 11:59:40 AM »
Ok, Great responses so far, thanks much!

EDIT:  And if you bought the fund through Vanguard and set the dividends up to reinvest directly with them, then even the dividends shouldn't be taxed right now I believe.

No, if held in a regular taxable account, dividends paid by mutual funds are taxed, even if you automatically reinvest them. Also, mutual funds *can* produce capital gains even if you don't sell the fund (they come from the fund itself selling underlying shares), and those are also taxed.

If the fund is instead held in a Roth IRA, taxes never have to be paid on dividends or gains.

That said, I don't think the OP has really lost anything significant (yet!) by initially making his investment in a taxable account. If he puts it under the cover of a  Roth IRA before it produces any dividends or capital gains, it might not matter at all.

The account has been open for about two weeks, it has appreciated some, but no dividends yet. It seems that I can only convert $5,000 of it to a Roth IRA. So I would need to report any dividends I get this year on my 2012 return. If I sell 10% of all my shares this month after moving the $5k to a Roth IRA, I would need to report the capital gain from selling the non-Roth shares, but not any gain from the sale of the Roth shares. Do I have that correct?

4. Are you contributing anything to your 401k?

Yes, my employer automatically puts in 1%, and they match my contributions up to 5%. In other words, the account receives contributions totaling 11% of before tax pay.

There are investing requirements for Lending Club:

http://www.lendingclub.com/kb/index.php?View=entry&EntryID=113

Basically, most states you need an income of $70,000/yr and $70,000 net worth or $250,000 net worth. 

Also, if you haven't read it yet.  Read Brave New Life's blog posts on P2P lending.  He has some good wisdom about filtering loans and such on there.

http://www.bravenewlife.com/07/my-lending-club-experiment/



I was aware of those restrictions. I assume many people ignore them, I may or may not. Without implicating anyone else or myself, let's assume I do ignore them (the restrictions, not lendingclub) for now.

1) Does it makes sense to put more before tax pay into my 401k?
2) It looks like I should move $5,000 into an IRA before the year ends, I assume they do not pro-rate this, so I can move the $5,000 as long as it is done before December 31st. Would you put it in LC's IRA, or just do the transfer with my current Vanguard portfolio?

mlipps

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Re: Great at saving, looking to become great at investing.
« Reply #6 on: December 04, 2012, 12:05:02 PM »
Personally, Lending Club is not a risk I would take w/money I need/want for retirement. It's fine for "monopoly money" type investing, which lots of people do, but I just can't see using it until I've exhausted 401k & IRA space. Others of course may have different opinions.

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Re: Great at saving, looking to become great at investing.
« Reply #7 on: December 04, 2012, 12:09:50 PM »
Personally, Lending Club is not a risk I would take w/money I need/want for retirement. It's fine for "monopoly money" type investing, which lots of people do, but I just can't see using it until I've exhausted 401k & IRA space. Others of course may have different opinions.

That seems to be a prevalent opinion. As a 24 year old with little to lose, and willing to bear plenty of risk provided I have done the appropriate research, I think it is something I am willing to take a chance on. I am already so frugal that it is not a question of if I will retire early, but rather when I will retire early...

mlipps

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Re: Great at saving, looking to become great at investing.
« Reply #8 on: December 04, 2012, 12:41:22 PM »
Really? Have you actually extrapolated using something like Fire Calc how much money you'll have to retire on? 11% of a $40 or 50k salary isn't going to be enough to retire early on. I think you should really crunch the numbers and figure out what you need, get to that point, then play with things like Lending Club for fun.

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Re: Great at saving, looking to become great at investing.
« Reply #9 on: December 04, 2012, 01:45:13 PM »
Really? Have you actually extrapolated using something like Fire Calc how much money you'll have to retire on? 11% of a $40 or 50k salary isn't going to be enough to retire early on. I think you should really crunch the numbers and figure out what you need, get to that point, then play with things like Lending Club for fun.

Clearly we have some mis-communication here. The 11% figure is only what gets put into the 401k account I have through my employer. I am saving/investing the rest of my "take-home" savings with Vanguard and soon to be other investments.

Here is a rough breakdown:

$20k VFIAX
$3600 waiting to be invested
$3000 in my checking/savings. I use this for my Direct Deposit, paying the bills, transferring money to investments, as my emergency fund, and as a reminder how little interest banks are paying nowadays.

I will be able to save approx. $30k next year after all expenses, and after my withholding for my 401k. After that, it should be $35k per year plus a raise of 1-2% depending on performance.

I have tried all of the retirement calculators suggested by MMM in his blog, and I found all of them helpful, but ultimately lacking.

I am good with excel/google spreadsheets and have tracked every penny I have had in my possession from 1/1/2011 in a spreadsheet, as well as mint.com. I know my annual expenses very well, and understand that they will increase about 3% per year. I am working on a retirement calculator specific to me. It is coming along well, and seems to dictate and early 30s retirement as long as I pick a cheap place to live, which I am fine with.

Kriegsspiel

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Re: Great at saving, looking to become great at investing.
« Reply #10 on: December 04, 2012, 04:51:22 PM »
If I were you I would diversify my investments, not put everything in the SP 500. 

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Re: Great at saving, looking to become great at investing.
« Reply #11 on: December 04, 2012, 05:37:08 PM »
If I were you I would diversify my investments, not put everything in the SP 500.

For sure. This is why I am considering LendingClub. I think I know the risks well enough to start an IRA with them. I will give it a few more weeks of mulling over. If anyone asks, I will make sure to win a $250,000 jackpot before I invest so I am not breaking the rules...

grantmeaname

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Re: Great at saving, looking to become great at investing.
« Reply #12 on: December 04, 2012, 05:41:43 PM »
Can you earn enough of an excess return in LendingClub that it's worth the dramatically higher risk that comes with it compared to investing in index funds?

grantmeaname

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Re: Great at saving, looking to become great at investing.
« Reply #13 on: December 04, 2012, 05:44:39 PM »
Clearly we have some mis-communication here. The 11% figure is only what gets put into the 401k account I have through my employer. I am saving/investing the rest of my "take-home" savings with Vanguard and soon to be other investments.
Saving is good, and you're doing a phenomenal job of it. You'd get a little further by maximizing the amount that you put into your 401k, though. If you're looking to save $35k or more a year, you can definitely afford to stash the full $17.5k in your 401k and the full $5.5k in your Roth IRA next year.

chucklesmcgee

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Re: Great at saving, looking to become great at investing.
« Reply #14 on: December 04, 2012, 06:06:11 PM »
I have a lot of experience with P2P lending as I'm one of Prosper's biggest investors. I have my Roth 401k and Roth IRA invested there too, but that's complicated. Not sure about Lending Club's structure, but I think it's similar. It's obviously prone to fluctuations, but if you invest only $25-50 in a loan, $3600 will be unlikely to deviate significantly from the site's average returns.

If you're young and can afford to lose it, I say go for it. P2P lending seems to be one of the very few investments where aren't tightly correlated with the markets.

3. You can have as many IRAs as you want and as many funds within the IRAs as you want. Only thing that's limited is the total annual contribution to all of your combined accounts.

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Re: Great at saving, looking to become great at investing.
« Reply #15 on: December 04, 2012, 06:21:02 PM »
Can you earn enough of an excess return in LendingClub that it's worth the dramatically higher risk that comes with it compared to investing in index funds?

I would love to know the answer to that. According to their site, right now 56% of people are seeing a return over 9%. Due to the low average age of the loans, the default rate is artificially low. If I were to buy and hold 3 year notes today, I think my default rate would be about twice what the site has now. See the link below if you haven't already checked it out http://www.p2panalytics.com/august-6-2012-on-lending-club-defaults-and-their-effect-on-your-portfolio/

Realistically, the risk of investing in the stock market when I plan to keep my money in it for 50 years is basically 0. The risk of losing money with LC is <0.9%, if I invest the $3,600 as they suggest. With the likely increase in default rates, I doubt the risk of losing money would be any higher than 2%. At 24, I can bear that if it means good diversification.

I have a lot of experience with P2P lending as I'm one of Prosper's biggest investors. I have my Roth 401k and Roth IRA invested there too, but that's complicated. Not sure about Lending Club's structure, but I think it's similar. It's obviously prone to fluctuations, but if you invest only $25-50 in a loan, $3600 will be unlikely to deviate significantly from the site's average returns.

If you're young and can afford to lose it, I say go for it. P2P lending seems to be one of the very few investments where aren't tightly correlated with the markets.

3. You can have as many IRAs as you want and as many funds within the IRAs as you want. Only thing that's limited is the total annual contribution to all of your combined accounts.

For #3 - That explains it perfectly, thank you. It is also nice to see that contribution amount going quickly over the past 10 years.

Do you have any data on prosper's default rates? I believe they are slower growing than LC, so maybe their rates are more reliable?

Ben

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Re: Great at saving, looking to become great at investing.
« Reply #16 on: December 07, 2012, 12:12:25 PM »
Under_Score,

Great work with your savings rate! Here are the steps I recommend to become great at investing:

1. Determine your desired asset allocation (read the Intelligent Asset Allocator or Four Pillars of Investing by William Bernstein).

2. Use your tax-advantaged space first (max out 401k / IRA before investing in taxable savings).

3. Focus on passive index funds for your core holdings (80-100% of your portfolio).

4. Plan for any major purchases in the next 3-5 years (e.g. home, wedding, car, etc), and save accordingly.

5. Don't break the law regarding P2P lending. Those laws are in place to protect people with small portfolios and limited investing experience, like yourself (although both of those will be increasing quickly over the next couple of years!). I think the $250,000 threshold is a reasonable target for your core holdings before giving yourself investment 'play money.' You'll hit the $70k limit in less than two years, so if you boost your income you would get there sooner.

As an aside, don't get too fixated on P2P lending, especially if you are easily persuaded by financial blogs. It sounds like a sweet way to make money and has a personal touch (a la Kiva) but should be the sprinkles on your savings sundae- added near the end, and not necessary for an awesome dessert. One reason every blogger talks about Prosper, Lending Club, etc. is because it PAYS to talk about them. Most do it with clean motives and clear disclosure, but beware- it is riskier than it seems. Your biggest risk is NOT bad luck with a series of loan defaults, but institutional insolvency and/or fraud.
 
6. The fact that you dumped all of your savings into VFIAX based on a blog article before understanding the tax implications or fully thinking through your asset allocation suggests that you might benefit from the "read more, do less" approach, at least for a season. You are kicking butt in the savings and financial learning domains, so it may be good to let your investing knowledge badassity catch up to your savings badassity for a few months before making additional purchases (except in your 401k, of course).

Ben

PS Two of my favorite articles ever:
http://jlcollinsnh.wordpress.com/2011/06/08/how-i-failed-my-daughter-and-a-simple-path-to-wealth/
http://jlcollinsnh.wordpress.com/2011/06/14/what-we-own-and-why-we-own-it/

Ben

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Re: Great at saving, looking to become great at investing.
« Reply #17 on: December 07, 2012, 12:19:44 PM »

Here is a rough breakdown:

$20k VFIAX
$3600 waiting to be invested
$3000 in my checking/savings. I use this for my Direct Deposit, paying the bills, transferring money to investments, as my emergency fund, and as a reminder how little interest banks are paying nowadays.


FYI, I recommend that you consider all money in taxable and tax-advantaged to be in the same large pot when determing your asset allocation. Some investments may make more or less sense in tax advantaged space, so your separate taxable/tax-advantaged mix will probably look very different. For example, if you are holding bonds, they are less efficient than long-term stock holdings, and should therefore go into tax-advantaged accounts, while a US or Intl stock index fund could go into either.

http://www.bogleheads.org/wiki/Principles_of_Tax-Efficient_Fund_Placement