Maxed out 401k... Now what?

[cbengals]

I recently received a promotion at work and I will now have extra income to invest. I have already maxed out my $18k contribution to my employeer's 401k and need some advice on what to do with the additional income. Currently I have been investing in Vanguard Index Funds. My goal is to keep my funds somewhat liquid as I plan to purchase a house in the next 5 years and would like to keep money on hand for a potential downpayment. Are there any investment options for my situation that would be better than the passive index funds I am currently using? Any advice would be helpful to this novice investor.

Thank you!

[Jack]

• Max your IRA if you aren't already. Up to $10,000 can be withdrawn from a traditional IRA without penalty for use as a first-time-buyer down-payment (and all contributions, but not gains, can be withdrawn without penalty from a Roth). However, note that you lose all the tax-free growth that money would have otherwise had, so if you can afford to take money from taxable accounts instead, do that.
• Max your HSA if you're eligible for one (not for down-payment money)
• If you have someone who will have future education expenses (e.g. kids), fund a 529 account (also not for down-payment money)
• Once you've run out of tax-advantaged space, open a taxable account. 5 years is too short a time horizon to keep your down-payment money in stock funds; the usual advice for that is that a money-market or high-interest savings account at about 1% APY is about the best you can do.
• I just came up with a theory that maybe a residential REIT index would work for investing down-payment funds, since it should be correlated with house prices (i.e., if the fund loses money it's "okay" because the house you want to buy would be cheaper too) but that's probably really bad advice and I suggest you ignore it unless you want to do a lot of research to see if it makes sense.

[Cheddar Stacker]

This comment from Middlesbrough on an old thread (click any name if you want the full thread):

At best, all the poll results reveal is what fraction of the MMM readership is "risk-averse" in some general, nebulous sense (corresponding to the extent the "pay off debt" vote exceeds 50%).

Great observation Jack. This was part of the reason for asking the question in the first place (aside from what I said in the original post). I'm curious how many people are taking a safe, risk averse approach to FI and are relying mostly on their savings rate and badassity. There's nothing specifically wrong with that approach, but it's not really what I'm doing.

I know there are others here who take extreme, calculated risks. That's not really what I'm doing either. I think I'm somewhere in the middle with an aggressive stock/bond mix, and a willingness to take some small calculated risks like carrying debt in an attempt to achieve higher returns to accelerate FIRE.

I guess I have debt now that I could be putting more money to (college loans), but it isn't important to me. It is fixed interest rate and I am only aggressively paying down the above 4.5% parts. The rest I will only continue to make the minimum payments until the 10 year window closes it. To me, the important things to get done are maxing out my Roth IRA, which I control and say what is put in it, and throw as much as possible in a Roth 401k and traditional 401 to minimize marginal tax rates, company has good investments but still have record keeping fees, ugh.

I plan on taking my end of the year bonuses and throw them into the market. The market will then decide how quickly I have a down payment to a house. Or if interest rates go through the roof, pay for a house in straight cash homie!

And my reaction to it:

The market will then decide how quickly I have a down payment to a house. Or if interest rates go through the roof, pay for a house in straight cash homie!

I LOVE this! Let the tail wag the dog every now and then. Most people set a deadline then align their cash/investments/debt according to the deadline. You're doing it backwards, which is brilliant. I applaud you.

Seems like it fits here.

If you have the personality and life circumstances for it, statistically your best bet would be to invest all the extra funds into stock indexes and buy a house as soon as that account accumulates into enough money. If you must buy in 5 years, any investment will put that goal at risk somewhat.

[cbengals]

Thank you guys for the comments. I definitely need to look into an IRA thank you for that advice. I don't believe my employer offers an IRA just our 401k so any advice on the best place to start one? I am comfortable with Vanguard would that be a good place? As for the timeframe of the purchase the 5 years is just an estimate I am constantly checking the market and have about 10% saved in my credit union but I am working to build to 20% down so wouldn't it be better to take the tax hit in an index fund gaining 5-6% a year versus sitting in a credit union earning less than 1%?

[Cheddar Stacker]

Thank you guys for the comments. I definitely need to look into an IRA thank you for that advice. I don't believe my employer offers an IRA just our 401k so any advice on the best place to start one? I am comfortable with Vanguard would that be a good place? As for the timeframe of the purchase the 5 years is just an estimate I am constantly checking the market and have about 10% saved in my credit union but I am working to build to 20% down so wouldn't it be better to take the tax hit in an index fund gaining 5-6% a year versus sitting in a credit union earning less than 1%?

You normally can't get an IRA at work, except maybe the SIMPLE IRA. Just call Vanguard, or go to their website. You have until 4/15/16 to fund it for 2015, the deadline is 4/15 each year.

If you make 6% investing the money and pay 25% tax on that, it's still 4.5% net which beats 1%. The problem is the interest is a stated rate, the investment return is variable. As long as you're comfortable with that 10% going down to 8%, then up to 11%, down to 9%, up to 14%, and down to 12%, then go ahead and invest it.

[Jack]

Thank you guys for the comments. I definitely need to look into an IRA thank you for that advice. I don't believe my employer offers an IRA just our 401k so any advice on the best place to start one? I am comfortable with Vanguard would that be a good place?

One of the great things about IRAs is the very fact that they aren't tied to an employer (which means you get to choose the broker and the investments, rather than being stuck with whatever the idiots at your employer -- who probably know less about investing than you will by the time you finish talking to us -- pick). Yes, Vanguard would be an excellent choice (that's where my IRAs are).

That last statement was plural, by the way, because IRAs are individual accounts and not shared between spouses. In my case, there are a total of 3 accounts: my traditional, my wife's traditional, and my wife's Roth. The Federal annual contribution limit (currently $5,500) is per-person, so if you're married you can contribute up to $11,000 total. Make sure that if you're married, you max out that spousal IRA too.

As for the timeframe of the purchase the 5 years is just an estimate I am constantly checking the market and have about 10% saved in my credit union but I am working to build to 20% down so wouldn't it be better to take the tax hit in an index fund gaining 5-6% a year versus sitting in a credit union earning less than 1%?

Paying taxes on long-term capital gains (in a taxable account) is perfectly fine. Even foregoing tax-advantaged growth by withdrawing from a retirement account (as I mentioned before) is acceptable, although not ideal. What you really want to avoid is getting hit with the 10% (or 20% in the case of withdrawing from an HSA) penalty for failing to correctly abide by the withdrawal rules.

However, taxes are the issue when deciding between account types (e.g. a tax-advantaged account vs. a taxable account), which is a mostly* separate and orthogonal issue from deciding between investments (e.g. an index fund vs. a money-market fund). In other words, you can choose any combination: an index fund in an IRA, an index fund in a taxable account, a money-market fund in an IRA, or a money market fund in a taxable account.

The real issue when choosing between investments is volatility: instead of growing 5-6% a year, your stock index fund might lose 6% a year (or more!) instead. But as long as you're sure that you're okay with the idea that in a strong bear market you might have to delay your purchase, putting your down-payment money in a stock index fund is fine.

(*Sometimes investment choices can have tax implications; read Principles of Tax-Efficient Fund Placement for the details. Also read the rest of that wiki.)

[cbengals]

This is all great advice thank you guys. So in summary with the assumption that I am willing to accept the market risk of the IRA/Index Fund my current investment strategy should be:

1. Max out my 401k contribution ($18,000)
2. Max out my IRA contribution ($5,500)
3. Various post tax savings (checking, savings, indexes)

I have no need for a Health Spending Account or Education savings at this time or in the near future.

[Jack]

This is all great advice thank you guys. So in summary with the assumption that I am willing to accept the market risk of the IRA/Index Fund my current investment strategy should be:

1. Max out my 401k contribution ($18,000)
2. Max out my IRA contribution ($5,500)
3. Various post tax savings (checking, savings, indexes)

I have no need for a Health Spending Account or Education savings at this time or in the near future.

Yep. And read the Bogleheads wiki to figure out what you want your asset allocation to be and in which accounts you want to put the different asset types.