Author Topic: Investment Order  (Read 333652 times)

MDM

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Re: Investment Order
« Reply #100 on: May 19, 2021, 10:55:42 AM »
I'm curious if there's an investment order for those who are self employed?
With the availability of Solo 401(k) plans, it's not clear how that would differ.  What do you have in mind?

Archipelago

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Re: Investment Order
« Reply #101 on: May 19, 2021, 07:19:40 PM »
I'm curious if there's an investment order for those who are self employed?
With the availability of Solo 401(k) plans, it's not clear how that would differ.  What do you have in mind?

There aren't any other investment vehicles to add into the mix? SEP IRA, how to use profit sharing for maximizing tax sheltered $, how to get a health insurance plan that allows for HSA?

MDM

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Re: Investment Order
« Reply #102 on: May 19, 2021, 07:52:56 PM »
I'm curious if there's an investment order for those who are self employed?
With the availability of Solo 401(k) plans, it's not clear how that would differ.  What do you have in mind?
There aren't any other investment vehicles to add into the mix? SEP IRA, how to use profit sharing for maximizing tax sheltered $, how to get a health insurance plan that allows for HSA?
Solo 401k, SEP, and SIMPLE IRAs would all fall under the "401k" label as they are "employer plans" as opposed to "regular" IRAs that one opens separate from any particular employer, and are covered by "SIMPLE/etc." in the first sentence of the post (after the "appropriate for investors in the US" intro).

Niche topics, e.g., cash balance pension plans, might indeed be appropriate for a "high income self employed investment order."  I'm not familiar enough with that world to venture there.

Financial.Velociraptor

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Re: Investment Order
« Reply #103 on: July 09, 2021, 10:22:54 AM »
@arebelspy

Headline post (OP) needs update to include quick link to the "Canada" section.  Just a little housecleaning item when you get a chance!

Imanuels

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Re: Investment Order
« Reply #104 on: January 17, 2022, 01:09:52 PM »
I'm currently wondering about the point
2. Pay off any debts with interest rates ~5% or more above the current 10-year Treasury note yield.

I have a loan with 3.19% interest rate. So far I've been investing any spare money instead of paying off the loan above the required monthly payment. Inflation currently is higher than the interest rate. Our 10y government bonds have negative return.
Recently I'm wondering if 3.19% guaranteed return is actually not quite acceptable given the current market valuations as well as the possible rate hikes.

Any thoughts on this subject?

This ordering is appropriate for investors in the US.

In the lists below, thinking "first your governmental 457 (if you have one), then your 401k/403b/SIMPLE/etc." wherever "401k" appears is likely correct -            
   unless your governmental 457 fund options are significantly worse than those in the 401k/403b -         
   due to penalty-free access to governmental 457 funds at retirement, even if younger than 59 1/2.
   Non-governmental 457b plans have deficiencies, including the inability to roll the balance into an IRA.

"Max _____" means "contribute up to the maximum allowed for _____, subject to your ability to pay day-to-day expenses."            

Differences of a few tenths of a percent are not important when applicable for only a few years (in other words, these are guidelines not rules).            
            
The 10-year Treasury note yield over the past year has been ~1.0%.  See http://quotes.wsj.com/bond/BX/TMUBMUSD10Y.
            
WHAT            
0. Establish an emergency fund to your satisfaction            
1. Contribute to your 401k (traditional or Roth - see "Why #4" below) up to any company match            
2. Pay off any debts with interest rates ~5% or more above the current 10-year Treasury note yield.            
3. Max Health Savings Account (HSA) if eligible.
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
    - you need the 401k deduction to be eligible for (and desire) a tIRA deduction, or
    - you earn too much for an IRA deduction and prefer traditional to Roth, then
    swap #4 and #5)            
6. Fund a mega backdoor Roth if applicable.         
7. Pay off any debts with interest rates ~3% or more above the current 10-year Treasury note yield.            
8. Invest in a taxable account and/or fund a 529 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 for that purpose.
    At worst, the HSA behaves much the same as a tIRA after age 65.
4. Rule of thumb: traditional if current federal marginal rate is 22% or higher; Roth if 10% or lower, or if MAGI is too high to deduct a traditional IRA; flip a coin otherwise. 

   For those willing to expend a little more energy than it takes to flip a coin, consider comparing current marginal tax saving rate vs. predicted marginal withdrawal tax rate.
      If current > predicted, use traditional.  Otherwise use Roth.
   See Credits can make Traditional better than Roth for lower incomes and other posts in that thread about some exceptions to the rule.
   See Traditional versus Roth - Bogleheads for even more details and exceptions.
   The 'Calculations' tab in the Case Study Spreadsheet (CSS) can show marginal rates for savings or withdrawals*.
   Remember to include all income-dependent effects in your marginal tax rate.
      The CSS does include most federal and state brackets, credits (Child Tax, Education, ACA, Earned Income, etc.), phase-ins, phase-outs, and IRMAA tiers. 
      It may not include some state tax details, FAFSA Expected Family Contribution, and other items irrelevant to most but important to some.

5. See #4 for choice of traditional or Roth for 401k.  In a 401k there are no income-based limits for deductions or contributions.      
6. Applicability depends on the rules for the specific 401k.  See Mega Backdoor Roth IRA.
7. Again, take the risk-free return if high enough.  Note that embedded in "high enough" is the assumption that your alternative is "all stocks" or a "fund of funds"
   (e.g., target retirement date) that provides a blend of stock and bond returns.  If you wish to consider separate bond funds, compare the yield on a fund
   with a duration similar to the time remaining on the loan, and put your money toward the one with the higher after-tax interest/yield.
8. Because taxable earnings will still help your FI journey.  If your own retirement is in good shape, and you choose to provide significant help for children's college costs,
   a 529 plan may be appropriate.  Similar to "put on your own oxygen mask before assisting others," do consider funding your own retirement before funding 529 plans for children's college costs.

Speaking of things to do first, see Getting started - Bogleheads if this is all new.  Working through that post and the links therein is also a good refresher, even if personal finance isn't completely new to you.

The emergency fund is your "no risk" money.  You might consider one of these online banks: http://www.magnifymoney.com/blog/earning-interest/best-online-savings-accounts275921001, or possibly use a Roth IRA as an emergency fund.

It is up to you whether to consider "saving for a house down payment" as a "day to day expense", vs. lumping the down payment savings in with "taxable investments" at the end.

If you are renting, you may not be throwing away as much on rent as you might think.  See http://jlcollinsnh.com/2012/02/23/rent-v-owning-your-home-opportunity-cost-and-running-some-numbers/ for some thoughts.            
               
For those concerned about "locking up" money in retirement accounts until age 59.5, see How to withdraw funds from your IRA and 401k without penalty before age 59.5.

If your 401k options are poor (i.e., high fund fees) you can check the Expensive or mediocre choices section of the Bogleheads 401(k) wiki for some thoughts on "how high is too high?"

See MAGI - Bogleheads for the MAGI calculations applicable to Roth IRA contributions and traditional IRA deductions.
Then see IRA Contribution Limits and IRA Deduction Limits for the IRS limits on those MAGI amounts.

If one can swing the cash flow, getting in and out of an ESPP is ~"free money".  But if one has to make a choice between deferring income in a 401k vs. taking the income and using it for an ESPP, it isn't the same.  The benefits of employee stock purchase plans (ESPPs) relative to other opportunities is highly dependent on tax rates, because ESPP benefits all occur in taxable accounts. 
 - For someone paying 12% tax on ordinary income, and 0% on dividends and capital gains, ESPPs can be very favorable, perhaps competing with high interest rate loans in step 2. 
 - For someone paying 22% tax on ordinary income, and 15% on dividends and capital gains, ESPPs are not as favorable, perhaps coming between steps 6 and 7.

Priorities above apply when income is primarily through W-2 earnings.  For those running their own businesses (e.g., rental property owner, small business owner, etc.),            
   putting money into that business might come somewhere before, in parallel with, or after step 5.         
            
Why it is likely better to invest instead of paying a low interest rate mortgage early, if you have a long time until the mortgage is due:            
   https://www.thebalance.com/rolling-index-returns-1973-mid-2009-4061795      
   http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html


*Estimating withdrawal tax rates is not an exact science, but here is one approach:
1) Estimate any guaranteed income.  E.g., pension you can't defer in return for higher payments when you do start, rentals, etc.
2) Take current traditional balance and predict value at retirement (e.g., with Excel's FV function) using a conservative real return, maybe 3% or so.  Take 4% of that value as an annual withdrawal.
3) Take current taxable balance and predict value at retirement (e.g., with Excel's FV function) using a conservative real return, maybe 3% or so.  Take 2% of that value as qualified dividends.
4a) Decide whether SS income should be considered, or whether you will be able to do enough traditional->Roth conversions before taking SS.
4b) Include SS income projections (using today's dollars) if needed from step 4a.
5) Calculate marginal rate on withdrawals from traditional accounts using today's tax law on the numbers from step 1-4.
6) Make your traditional vs. Roth decision for this year's contribution
7) Repeat steps 1-6 every year until retirement

The steps above may look complicated at first, but you don't need great precision.  The answer will either be "obvious" or "difficult to choose".  If the latter, it likely won't make much difference which you pick anyway.

You may want to do more complicated planning if you expect your earning history to vary greatly over the course of your career.  The usual example is "MDs still in residency" but if you reasonably expect your inflation-adjusted annual earnings to increase by, say, a factor of 3 or more this may apply.  See Estimating withdrawal tax rates for more discussion.

Note the possibility of self-defeating predictions:
a) predict high taxable retirement income > contribute to Roth > get low taxable retirement income
b) predict low taxable retirement income > contribute to traditional > get high taxable retirement income

Also, if you pick traditional and that ends up being wrong it will be because you have "too much money" - not the worst problem.
If you pick Roth and that ends up being wrong it will be because you have "too little money" - that could be a problem.
Thus using traditional is a "safer" choice.

MDM

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Re: Investment Order
« Reply #105 on: January 17, 2022, 04:12:26 PM »
I'm currently wondering about the point
2. Pay off any debts with interest rates ~5% or more above the current 10-year Treasury note yield.

I have a loan with 3.19% interest rate. So far I've been investing any spare money instead of paying off the loan above the required monthly payment. Inflation currently is higher than the interest rate. Our 10y government bonds have negative return.
Recently I'm wondering if 3.19% guaranteed return is actually not quite acceptable given the current market valuations as well as the possible rate hikes.

Any thoughts on this subject?
There is this: "Note that embedded in "high enough" is the assumption that your alternative is "all stocks" or a "fund of funds"
   (e.g., target retirement date) that provides a blend of stock and bond returns.  If you wish to consider separate bond funds, compare the yield on a fund
   with a duration similar to the time remaining on the loan, and put your money toward the one with the higher after-tax interest/yield."

The debate between "lower guaranteed" vs. "higher expected but not guaranteed" has no definitive answer - except in hindsight.

secondcor521

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Re: Investment Order
« Reply #106 on: January 17, 2022, 04:41:16 PM »
I'm currently wondering about the point
2. Pay off any debts with interest rates ~5% or more above the current 10-year Treasury note yield.

I have a loan with 3.19% interest rate. So far I've been investing any spare money instead of paying off the loan above the required monthly payment. Inflation currently is higher than the interest rate. Our 10y government bonds have negative return.
Recently I'm wondering if 3.19% guaranteed return is actually not quite acceptable given the current market valuations as well as the possible rate hikes.

Any thoughts on this subject?

This ordering is appropriate for investors in the US.

Note the first line of what you quoted.  It's for US investors.  You're listed as being in Germany, and your comment about your government's negative rates would match that.

I think in general you might take your note rate minus your negative government 10 year bond rate and see if that guaranteed rate is tempting to you given your investment alternatives, as @MDM hints at.

So it would be something like 3.19% - ( - 0.03 % ) = 3.22%.  That wouldn't be attractive here in the US, especially since you'd still have to account for taxes and inflation.  But maybe it is in Germany.

Imanuels

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Re: Investment Order
« Reply #107 on: January 18, 2022, 02:58:15 PM »
Yes, I'm in Germany.
Thanks for your suggestions. I called my bank to further clarify and apparently I'd have to pay 1% penalty for all the sum that's paid back too early. Thus, the math gets even less attractive for paying off the loan. Seems like I'll just stick with investing.

Heckler

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Re: Investment Order
« Reply #108 on: August 10, 2022, 08:04:20 PM »
CANADA

What:
0: Pay off any high interest debts and establish emergency fund based on your risk tolerance
1: Max out your contributions to your TFSA
2: If you are saving for a downpayment of your first home, max out FHSA in 2023 (link below)
3: Contribute to your RRSP (remember that $25,000 can be used for a down payment through the first time home buyer's plan if you have not owned a house in the last 4 or 5 years)
4: Pay off your mortgage and low interest debt
5: Invest in non-registered funds

Why:
0: High interest debt is a huge drag on your money, and you'll be much happier without it. An emergency fund is a fairly personal decision, if you are risk averse or work in a boom/bust industry then a substantial emergency fund can help you sleep at night. If you have a very stable career and are comfortable with 'springy debt' as described in the Australia section you probably don't need much.
1: The TFSA is a pretty amazing investment vehicle, particularly if you're young. You contribute after tax dollars and never pay tax again on the money, regardless of how much it grows. You have the option of withdrawing money and preserving the contribution room in the following year, but withdrawals should be avoided unless there's a really good reason for it (people often invest their mortgage downpayment in their TFSA, which may be appropriate if you're planning on buying 'in a few years').
2: If it is as advertised in 2023, FHSA is just as good as TFSA if you are a first time home buyer, and want to buy a home.
3: RRSP are a reasonable tax deferred investment vehicle, you don't pay tax (or are refunded taxes if you contribute after tax dollars) on the contributions, but do pay tax when the money is withdrawn. You will pay taxes on the withdrawn money as income, rather than potentially more favourable capital gains and dividend tax rates. In general, the fact that your RRSP can grow for years tax free should balance the potential tax consequences. If you are discovering MMM after working for a few years, you will probably find that you have fairly vast contribution room in your RRSP (it grows at 18% of your salary/yr).
4: Low interest in this context means 'close to or less than the expected return on your investments'. Less debt is pretty great. You may decide to invest in non-registered (taxable) accounts rather than paying off your mortgage at this phase, either way is fine and it will depend primarily on your risk tolerance and what your best guesses are on what your interest rate will be.
5: Shovel money into your taxable accounts. Remember that eligible Canadian dividends are taxed at a preferential rate (as are dividends from VCN or similar index funds), but that this is not true of international dividends.

Possible Variations:
- If your income in retirement is likely to be higher than your working income, you should avoid investing in your RRSP. This is possible if you have a lot of money in your RRSP, a relatively low income and are approaching 71, when you you will be required to start withdrawing a percentage of your RRSP. You can probably avoid this by retiring earlier and drawing down your RRSP in a controlled manner prior to control your taxes.
- If your income is very high, and you expect it to be lower in retirement (eg. you started saving late in life but have a high salary) then it might be optimal to be contributing to your RRSP before your TFSA.
- RRSP income is considered as 'income' for tax purposes, as is your Canadian Pension Plan (CPP).  In a perfect world you'll be able to keep your income below ~ $71,000/yr after you reach 65 years so that you can receive the Old Age Supplement. It's hard to know whether this program will change if you're currently relatively young, but if you're in your 50s then it's worth looking at your taxes pretty carefully to try and make sure you're not inadvertently limiting your wealth by having a suboptimal withdrawal strategy.
- Mortgage choices are pretty personal, and depend a great deal on where you live. Between the TFSA and First Time Home Buyer Plan you should be well on your way to a downpayment if you don't own a house. If a purchase is imminent (6 months or a year?) then you should be invested in something very safe (eg. GICs) or in cash.


https://forum.mrmoneymustache.com/canada-tax-discussion/another-tax-free-savings-method-for-your-first-home-purchase/

A new tax free account coming (promised?, announced before an election?).  I'd put this one between TFSA and RRSP, if you are a committed first-time home buyer.
« Last Edit: August 12, 2022, 01:25:18 PM by Heckler »