Investment Newb - In need of advice

[freedomohyeah]

What an amazing website! It has already changed my life perspective and outlook on retirement. This is my first post in this forum so I'll get straight to the point. Having never invested in stocks, I'm still somewhat scared to take the first step. I know that I should be looking into Vanguard Index funds like REIT, International Stock Index & Total Market Index but is that really it? I've never been great at risk tolerance so I think that is why this all seems scary to me:( Here is a breakdown of my situation:

34 years old
No children
No debt
Just purchased my first (very modest & affordable) home in 2015 - I am making extra principal payments on my mortgage
Avid saver (nest egg of $150k)
No 401k (never worked for a company that offered a 401k plan)
No IRA

I realize that it is silly & counterproductive to not put my savings to work. How would you invest and diversify the money I already have saved (and future savings) so that I too can hit my ER goal of $600k?  I get that my question is pretty elementary but I would absolutely love some guidance to get on track!

[Telecaster]

Max out your IRA.  I recommend a traditional IRA.  You can make a contribution for 2015 up until April 15.   And you can make a contribution for 2016 anytime, so do both right away.

And then yes, move the cash into VTI.  As you learn more about investing, you may wish to diversify, but VTI is perfectly fine for now.   The market may drop, which could be gut wrenching to watch, but don't second guess yourself.   

[Curbside Prophet]

One problem with index funds is they overlap so you may be heavier weighted in certain areas if you choose multiple funds.  In your example, you would be heavy international and real estate since both are already part of the total stock market index.  VTI (or VTSMX) is basically diversifying so by trying to diversify more by adding funds, you're actually diversifying less.  Hope that makes sense.

My suggestion to you is to dollar cost average.  You can google the term but basically you are putting a fixed amount of money into the market at equal intervals.  So when the market is expensive, you buy less, when it's cheap, you buy more.  This smooths out a lot of the volatility you would get if you were to, say, invest all 150k at one time. 

[MustacheAndaHalf]

Having never invested in stocks, I'm still somewhat scared to take the first step. I know that I should be looking into Vanguard Index funds like REIT, International Stock Index & Total Market Index but is that really it? I've never been great at risk tolerance so I think that is why this all seems scary to me:(

Inflation scares very few people, but 30 years from now everything will have doubled in price.  Keeping your retirement in cash won't help with rising prices - stocks have historically been the best way to do that.  So I urge you to get scared about inflation.

You might try using the "rule of 72" when you look at inflation, savings accounts, and stocks.  If a CD pays 2%, you divide 72 by 2, and get 36 years until your money doubles using a CD.  But if inflation is 2%, the cost of everything also doubles (72 / 2 = 36) in 36 years.  Stocks range somewhere in the 6%-8% range by current estimates... call it 7%, and you get (72 / 7) = 10 years for stocks to double.  Essentially, stocks will double, then double, then double before you retire.  Money invested in stocks can actually let you buy more than you put in.  That's not going to happen if you remain comfortable in online savings accounts or cash.

You don't have to plunge into Vanguard Total Stock Market.  You could open up an IRA and buy "Vanguard Target Retirement 2045" and let that fund do the work for you.  It's not perfect, but it puts you ahead of many bad choices out there.  You also won't have much to invest, and it diversifies better than most individual funds.  Later, with more money in retirement accounts, you can figure out if you want to make more choices.

[povertystrickenbastard]

What's the debt level and interest rate on your mortgage?  150K is a lot of savings for someone with a mortgage.

[Telecaster]

Inflation scares very few people, but 30 years from now everything will have doubled in price.  Keeping your retirement in cash won't help with rising prices - stocks have historically been the best way to do that.  So I urge you to get scared about inflation.

That's great advice.  I'm an old[er] timer who remembers when there was inflation.  It murdered, murdered people's savings.  People sometimes wax nostalgic about 5% passbook savings accounts.  Yeah, those were great.  You were only losing 3% a year.  Where do I sign up?

The folks who brought us the Global Financial Crisis tell us they understand stuff now and it can't happen again, cuz they are smart.  Makes me feel warm and fuzzy knowing smart folks like that are in control.

But even low rates of inflation over ten years can make dramatic differences.  The power of compounding works both ways. 

[freedomohyeah]

Thanks to everyone that has commented:

A few thoughts regarding some of your comments....

MustacheAndaHalf - Inflation does scare me :) The "rule of 72" is a very helpful way of thinking about inflation, savings accounts, and stocks. Thank you for that insight! In terms of an IRA, how does this type of investing aid in early retirement goals? I thought that you cannot withdraw funds until 59 1/2? And what about this Vanguard Target Retirement 2045? I'm hoping to retire in 10+ years....

povertystrickenbastard - The home was $107k. I out down 5% so that I could afford some much needed rehab (plumbing, electrical, energy efficiency related expenses). I currently owe $100k with an interest rate of 4.125% (30 year). I pay an extra $200/month towards principal. I also pay every other week instead of a "once a month" mortgage payment. That means 26 "half" mortgage payments per year - or 13 "full" payments. The "extra" payment gets applied directly to principal.....so I'm essentially making an additional $3000/year payment towards principal. Hope that made sense. Should I be paying off the home even faster?

Curbside Prophet - Your explanation of diversification did make sense, thank you. I did not realize that the Index funds that I mentioned overlapped so much. I did research dollar cost average. That totally makes sense and I recall reading about the same concept on the MMM blog. Do you have a suggested monthly fixed amount (I'm just assuming the interval would be monthly) ? And what about bonds? I see a lot of information about asset allocation via stocks, bonds & cash. Am I getting ahead of myself? Should I just focus on (slowly?) moving the savings into one of the suggested Vangurd Index funds?

Telecaster - Why do you recommend the traditional IRA? I've researched the difference between traditional and ROTH....and the ROTH seems to make more sense to me. Also, like I asked MustacheAndaHalf....how does an IRA help achieve the goal of early retirement? I thought you cannot touch the money without paying penalties ( I know there are certain exemptions like buying your first home). I guess that I have been oversimplifying my understanding of ER by thinking that you just need 25 x's your annual spending working for you in some index funds and then you live off 4%.

Again, thank you for all of your responses and for your patience! This MMM forum rocks!

[Woody Viet]

A mixture of the total stock market and international market fund (maybe 50/50), would be a great way to start with investing. Carrying around 150k in cash is a huge sum and you probably want to get this invested sooner rather than later. Investing is mainly about avoiding doing really stupid things. With this in mind what seems like a simplistic solution is actually an excellent one.

I would recommend reading the jhcollins stock series as a good primer. Also take a look at If You Can, an online pamphlet written by William Bernstein (it has lots of supplemental material). If this whet's your appetite then read some Warren Buffet, Ben Graham and Jeremy Siegel. This will give you a look into the traditional value investing approach.

[Telecaster]

Telecaster - Why do you recommend the traditional IRA? I've researched the difference between traditional and ROTH....and the ROTH seems to make more sense to me. Also, like I asked MustacheAndaHalf....how does an IRA help achieve the goal of early retirement? I thought you cannot touch the money without paying penalties ( I know there are certain exemptions like buying your first home). I guess that I have been oversimplifying my understanding of ER by thinking that you just need 25 x's your annual spending working for you in some index funds and then you live off 4%.

Again, thank you for all of your responses and for your patience! This MMM forum rocks!

A couple reasons:  In theory, it doesn't matter if you pay say 25% taxes now, and get the gains tax free (Roth), or save the taxes now and pay 25% tax on the gains later (TIRA).  Mathematically it is the same. 

But that's not how it works in practice.  Each dollar you put into a TIRA lowers your taxes at the top marginal rate you pay.   But when you withdraw, they come out at the lowest marginal rate first.   Plus in theory when you stop working, you are in a lower tax bracket anyway.  So you sort of get a double dip tax savings.   

Another thing is that because you get the tax savings now, you have more dollars you can save and invest right now in other investments outside the IRA.  So the TIRA has a little edge there too.   Plus the bird in the hand thing.  You know what the tax deduction is now, but you don't know what it will be in the future.

Also, you can withdraw money early from a TIRA.   MMM has an article on it, I think.   Also here:

https://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Substantially-Equal-Periodic-Payments

[brad3184]

I have a couple questions:

>What is your income?  Out of this, while you're still paying a mortgage, how much have you been saving per month?

>On what were you basing your ER goal of $600k?  The 4% rule floating around here assumes you have stock exposure

>Being conservative - a guaranteed 4.125% is found in paying off your house ASAP.  It may help you from a foundation of zero debt anywhere to build from.  It would let you do more dollar cost averaging in as you get comfortable with the market.  It would save you probably $500/month on a 30 year mortgage to just put that behind you (I'd do that personally).

>Paying off the house gives you the benefit that you now need less of a stache built because it's one more expense you now DON'T have

>Is the goal to retire as soon as possible?

[Curbside Prophet]

Curbside Prophet - Your explanation of diversification did make sense, thank you. I did not realize that the Index funds that I mentioned overlapped so much. I did research dollar cost average. That totally makes sense and I recall reading about the same concept on the MMM blog. Do you have a suggested monthly fixed amount (I'm just assuming the interval would be monthly) ? And what about bonds? I see a lot of information about asset allocation via stocks, bonds & cash. Am I getting ahead of myself? Should I just focus on (slowly?) moving the savings into one of the suggested Vangurd Index funds?

You can do weekly, bi-weekly, monthly, it's really up to you depending on how quickly you want to be fully invested in the market.  Two considerations, commissions and taxes.  Doing weekly contributions will incur a lot more commissions than monthly and is a lot more record keeping to keep track of your basis.  Vanguard offers DRIP, which will eliminate commissions but you still need to keep good tax records. 

Bonds are a good way to diversify.  When the market goes down, investors tend to run to the safety of bonds pushing prices up and yields down (they work inversely from one another).  I would recommend a bond fund rather than buying individual bonds. 

Since you have an aggressive goal, you want to be heavily weighted in stocks but 10-20% in bonds is a fine way to diversify.  This might go against the MMM philosophy, I'm also new to this concept but not to investing in general.

[freedomohyeah]

I have a couple questions:

>What is your income?  Out of this, while you're still paying a mortgage, how much have you been saving per month?

>On what were you basing your ER goal of $600k?  The 4% rule floating around here assumes you have stock exposure

>Being conservative - a guaranteed 4.125% is found in paying off your house ASAP.  It may help you from a foundation of zero debt anywhere to build from.  It would let you do more dollar cost averaging in as you get comfortable with the market.  It would save you probably $500/month on a 30 year mortgage to just put that behind you (I'd do that personally).


>Paying off the house gives you the benefit that you now need less of a stache built because it's one more expense you now DON'T have

>Is the goal to retire as soon as possible?

-My take home pay is $4k/month. I am saving 50% of my net pay. I'm basing my ER goal of $600k on my current annual cost of living @ $24k/year. I do understand that the 4% rule assumes you have stock exposure and other investments. I am also engaged and my partner works. With some spending restructuring, she could easily save an additional $2k/month.

-My goal is definitely to become financially independent asasp. I desire to remove myself from the rat race and stop working for someone else as a full time employee...but I would still work on passion projects and income generating hobbies.

-I have considered paying off the house totally - but was not sure that was the best decision given my options. Sure, it would eliminate a monthly expense and save me from paying a ton of interest but isn't that a bit like putting all my eggs in one basket? I am already paying it off much faster than if I were just making minimum payments.

[freedomohyeah]

A mixture of the total stock market and international market fund (maybe 50/50), would be a great way to start with investing. Carrying around 150k in cash is a huge sum and you probably want to get this invested sooner rather than later. Investing is mainly about avoiding doing really stupid things. With this in mind what seems like a simplistic solution is actually an excellent one.

I would recommend reading the jhcollins stock series as a good primer. Also take a look at If You Can, an online pamphlet written by William Bernstein (it has lots of supplemental material). If this whet's your appetite then read some Warren Buffet, Ben Graham and Jeremy Siegel. This will give you a look into the traditional value investing approach.

Thanks for the recommendations. I listened to this video today....kind of a long one but I found it very educational.

https://www.youtube.com/watch?v=HrYUOtCTHuk

[brad3184]

I have a couple questions:

>What is your income?  Out of this, while you're still paying a mortgage, how much have you been saving per month?

>On what were you basing your ER goal of $600k?  The 4% rule floating around here assumes you have stock exposure

>Being conservative - a guaranteed 4.125% is found in paying off your house ASAP.  It may help you from a foundation of zero debt anywhere to build from.  It would let you do more dollar cost averaging in as you get comfortable with the market.  It would save you probably $500/month on a 30 year mortgage to just put that behind you (I'd do that personally).


>Paying off the house gives you the benefit that you now need less of a stache built because it's one more expense you now DON'T have

>Is the goal to retire as soon as possible?

-My take home pay is $4k/month. I am saving 50% of my net pay. I'm basing my ER goal of $600k on my current annual cost of living @ $24k/year. I do understand that the 4% rule assumes you have stock exposure and other investments. I am also engaged and my partner works. With some spending restructuring, she could easily save an additional $2k/month.

-My goal is definitely to become financially independent asasp. I desire to remove myself from the rat race and stop working for someone else as a full time employee...but I would still work on passion projects and income generating hobbies.

-I have considered paying off the house totally - but was not sure that was the best decision given my options. Sure, it would eliminate a monthly expense and save me from paying a ton of interest but isn't that a bit like putting all my eggs in one basket? I am already paying it off much faster than if I were just making minimum payments.

Thanks for answering a few of those:

-You take home 4k/month - you save 2k/month (it sounds like after paying extra on the mortgage).  I'm estimating the payment at $500/month Principal & Interest plus the $200/month you've been throwing extra at it.  So if I'm hearing you right, if it were paid off your monthly expenses would now just be $1300??  ($4000 take home pay - $2000 savings now -$700 from mortgage being gone).

-Assuming that's right, your 4% stache (or 25x your annual expenses) is $1300 x 12 x 25 which = $390,000 stache at 4% withdrawal gets you the $1300/month. This is a drastic reduction in the size nest egg you need to grow.

-Do I think you can long term do better than your 4.125% mortgage rate in the market?  Yes - but it's not risk free.  You mentioned being new to getting into the stock market and having $150k.  Get yourself a guaranteed 4.125% on your money by paying off the mortgage.  You still have $45k - set aside maybe $8k in an emergency fund (6 months of expenses) and invest the rest ($37k).

-By my math - $37k initially invested in the market (all in the stock market, I think your need for bonds is less b/c you have such a firm foundation of no mortgage + a VERY high savings rate ($2700/mo off of $4000 = 67.5%).  Assuming you earn 7%/yr on your investments you are about 7.5 years out from being Financially Independent.


This is how I would go at it - but I feel it's an especially good way to handle your situation given your experience with the stock market.  By the way - if you hate having a paid off house a banker will always write you another mortgage.

[PhysicianOnFIRE]

You're on the right track, freedomohyeah!

Draft your own Investor Policy Statement
https://www.bogleheads.org/wiki/Investment_policy_statement

It takes a little time and thought, but it will guide you for years.

A big part of your IPS is your desired asset allocation.  Apply it across your accounts and you'll be well on your way.

The funds you mentioned can be cornerstones.  Look up the 3-fund and 4-fund portfolios on Bogleheads if you haven't already.

Cheers,
-PoF

[freedomohyeah]

Thanks again everyone! This has been a very educational forum thread :)

[MustacheAndaHalf]

MustacheAndaHalf - Inflation does scare me :) The "rule of 72" is a very helpful way of thinking about inflation, savings accounts, and stocks. Thank you for that insight! In terms of an IRA, how does this type of investing aid in early retirement goals? I thought that you cannot withdraw funds until 59 1/2? And what about this Vanguard Target Retirement 2045? I'm hoping to retire in 10+ years....

If you pay high taxes now and expect low taxes later, you can use a retirement plan that's more flexible.  You could either contribute to a Roth IRA (pay tax now), and you can withdraw your contributions as needed.  The amount of growth in your Roth IRA cannot be withdrawn until 5 years have passed.

But you can also contribute to a Traditional IRA now (tax deductable), and when you retire use a Roth conversion to turn all or part of the Traditional IRA into a Roth IRA (and pay tax, but hopefully at future low rates).  So if you're seeing different tax rates between now and retirement, there's some choices to investigate.

If you're retiring aggressively, I think you'll hit max contributions each year and need to save the rest outside retirement accounts.  Mostly a problem if you solely have Traditional IRA and Traditional 401(k), and no Roth IRA.

[Greenroller]

Subbing

[Mother Fussbudget]

Since your company doesn't offer one, you could consider setting up an individual 401K plan - most brokerages offer them.
Roth IRA might indeed be the savings vehicle of choice for you, just keep in mind a ROTH is income limited - you can't contribute if you will earn >$117K in 2016.  Traditional IRA is not limited, and you can 'back-door' those funds directly to a Roth IRA by 'converting'.  (search on those topics).

JLCollin's stock series may be a bit deep, but it's good reading.  See the 'review' link at the top first to see if it's for you.

Also realize that you can buy ETF's in these accounts without paying commissions *IF* you have an account at that brokerage.
EXAMPLE:  Buy Vanguard Exchange Traded Funds (VTSAX) in your Vanguard brokerage account, pay $0 commission per transaction.  Same thing at Fidelity with equivalent Fidelity funds (FXTMX).  I was an investor for DECADES before I discovered this money saving tidbit.

[MustacheAndaHalf]

Since your company doesn't offer one, you could consider setting up an individual 401K plan - most brokerages offer them.

Non-OP here.  I'd never heard of this, so I looked and found this description from the IRS:

"The one-participant 401(k) plan isn't a new type of 401(k) plan. It's a traditional 401(k) plan covering a business owner with no employees, or that person and his or her spouse."
https://www.irs.gov/Retirement-Plans/One-Participant-401(k)-Plans

Sounds like OP has to be the business owner to setup an "individual 401(k) plan"?