Author Topic: New grad, need advice investing and saving for financial independence  (Read 2994 times)

sid111

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Hello all,

I've been following MMM's blog for the past year and found that his advice resonates with my own reasoning. So I figured that this was the best place to ask for advice since I'm starting a new job and want to save for financial independence. Little background:
I'm 25 now and aiming to be FI by the time I'm 40, so 15 years. In the next 15 years I want to be able to become stable enough to not work for anyone else, if I choose to not do so.

Current monthly salary after tax and health insurance: $4600
Betterment Build Wealth account (90/10): 2000$
Current checking + primary savings: $3000
Emergency Fund: $3000 (in a couple of online savings accounts + $1000 (40/60)  Betterment account).

I dont think my employer matches anything for 401k, so I've not contributed anything yet.

For expenses:
Rent & Utilities: $500 /month (approx) I have some fun roommates to share the expenses, that's why its not so much.
Food: $120 / month
Shopping/House stuff: $100
Gas: $120 / month
Car maintenance: $100 (saved up for repairs, car is paid off)
Cell Phone: $35
"Fun money": $100
Yearly spending average is around $12,000 & I've never crossed $15,000 living extravagantly.
I have a few credit cards which I use to pay for these monthly expenses and its always paid in full... always!

I do have a student "debt" of $75,000 .. I owe it to my parents who paid for my education, It will act as a retirement buffer for them. Its not accruing any interest but I would like to secure their future asap. They already have retirement savings, enough to never need this buffer (I hope so) but this needs to be there for medical emergencies. Typical US retirement options are not available to them. I dont have much more information about their savings...
I'm not married and don't think there's any prospect of that for the next few years :P

I would like to invest my spare income into something that would help me achieve FI but I'm confused where and what to invest in. I would prefer something hands off, as I'm not savvy enough to go at the market myself.

I currently have a Betterment account with about $2000 in it that's invested in mostly a bucket of Vanguard ETF's & some bonds.

What are some other avenues I should explore ? Where do these things overlap ? Should I be using my employers 401k or other typical retirement accounts ? What should I explore to create a diverse portfolio ?

I would appreciate any advice.

MDM

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Here is one set of whats and whys.  Other ordering can also be defensible.

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 Roth or Traditional IRA based on income level
5. Max 401k (if 401k fees are lower than available in an IRA, 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 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: trad if current marginal rate is 25% or higher; Roth if 10% or lower; flip a coin in between. 
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. If you make enough to exhaust tax-advantaged space, congratulations!

For a more detailed traditional vs. Roth analysis you need to estimate the marginal rate for withdrawal vs. the marginal rate at contribution.  This can get complicated.  For now, the rule of thumb is probably good enough for you.

nereo

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I agree with everything MDM said.

Also - for general knowledge, read JL Collin's stock series.  Lots of very good info in 28 easily digestible posts.
http://jlcollinsnh.com/stock-series/

Cwadda

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The general investing strategy is that you want to use tax-advantaged accounts first before anything taxable. It's to my understanding that Betterment serves as a taxable account, so I would move that out into a tax-sheltered account.

Examples:
A 401(k) allows you to decrease your taxable income by your contributions. The max is $18,000 for this year. This $ will be taxed when you take it out.

A Roth IRA lets you contribute up to $5500 per year and grows tax-free (because you are contributing to it with money that has already been taxed).

An HSA lets you contribute $3350 per year if you have a high deductible health insurance plan. This money can be invested if you wish.

My thinking is that you should contribute to one or more of these. The general totem pole is this:
-401(k)
-Roth IRA/Traditional IRA
-HSA
-Taxable

Ideally you should be doing the first three. But that would be $18,000 + $5,500 + $3350 which is a lot of income to be stashing away. It looks like your income is about $55,000 whereas your expenses are only $15,000. Seems like you'd be able to do all of these tax-advantaged accounts, which is fantastic.

Not only that, but the 401(k) and HSA contributions would be deducted from your taxes. This effectively makes your income $55,000 - $21,350 = $33,650. That puts you in a pretty low tax bracket even though you're stashing away a lot. :)

If you want to pay off loans, that's possible too. There's a way to get the right strategy for your case.

Edit: I agree with everything MDM said as well, I just went into a bit more detail.
« Last Edit: August 13, 2015, 10:22:54 AM by Cwadda »

sid111

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Thank's @MDM, @Cwadda for going in depth.
A couple of clarifications & follow up questions:
 - Does it make sense to contribute to a 401k if there is no employer match ?
 - Since 401K is locked down till age 60, I would have to go 401K convert -> traditional IRA -> Roth IRA (so called Roth IRA ladder) or does 401k convert -> Roth IRA ?
    [should have noticed the stickied post just above mine!]
 - I need to research this mega backdoor roth .. Sounds like savings!
 
My gross income is nearly $6666/month or $4600/month after tax and health insurance (which is $300) ..I will get about $3000 - $4000 back as a refund next year. Even after $18,000 in 401k & deductions available to me, I'm stuck in the 25% tax bracket :(
I haven't opted for the HSA because, I have some health issues that require regular checkups & doctor follow ups, I'd end up paying the entire deductible each year.. that is what I understand.
 
I will :
 + Increase emergency fund to $12,000.
 + Max Traditional IRA to reduce tax.
 + Max out 401K (no match) to reduce tax.
 + Invest in Taxable accounts for the rest.

@nereo
Thank you for that link, I'll be sure to share it with other people. I will try to get through one post a day..

Edit: nevermind about the 401k to IRA question, I didn't notice the stickied post.
« Last Edit: August 13, 2015, 11:23:49 AM by sid111 »

nereo

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To answer a few of your questions:

1) yes it still makes sense to contribute to a 401(k) even if there is no match because it will reduce your taxable burden and allow you to do a rollover down the road.  The only reason NOT to use a 401(k) in your situation would be if your investment options are truly terrible (e.g. very high fees). Even then, invest for several years and then roll-over.

2) the 401(k) is NOT "locked down" until age 60.  There are several ways of accessing that money before you turn 59.5, including SEPP and conversions/pipeline.

3) A mega-backdoor roth is indeed a good strategy for people who have a high income like you.  See this post.

note; after contributing $18k to your 401(k) and $5500 to an IRA, plus your personal exemption very little of your income will be taxed at 25% (about $15k, depending on your deductions).  your average tax rate should be somewhere around ~18%.

MDM

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after contributing $18k to your 401(k) and $5500 to an IRA
Might need/want to put some of that $5500 into a Roth due to the deductibility phase-out as MAGI goes from $61K to $71K - depends on exactly how much in pre-tax deductions, other income, etc.

You can recharacterize your 2015 contributions before filing taxes in 2016, so don't agonize over exact amounts now - but do remember this next February or so and check to see how 2015 ended.

TomTX

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I currently have a Betterment account with about $2000 in it that's invested in mostly a bucket of Vanguard ETF's & some bonds.


Ugh, that sounds WAY WAY too scattered. People spend WAY too much effort on "diversifying" when you are ALREADY diversified by simply being in an ETF. You must be putting like less than twenty five cents into each stock. Ugh. Pick a single Vanguard ETF*. I like the total stock market, but whatever is a reasonable index. You are now diversified across hundreds or thousands of stocks.

Put everything there. Keep doing so until you have at least $50,000.  THEN start thinking about maybe a bond fund. If you don't get around to it until you have $250k, that's fine too.

*Once you have $10k, think about going directly with Vanguard with an Admiral shares fund. Why bother with paying Betterment to act as a middleman?

sleepyguy

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"I dont think my employer matches anything for 401k, so I've not contributed anything yet."

This is HUGE... go ask!  You could be missing out on 50% to 100% instant gains.