Author Topic: New Mustachian looking for validation of Investment Strategy for Great Success  (Read 2111 times)

MustachianInTraining

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Dear Mustachians,

I come to you as a new member, discovering the wonders and mysteries of the MMM philosophy a mere week ago. I previously read Ramit Sethi's book "I Will Teach You How to Slowly Save Money and Still Live The Luxurious Consumer Life", so I had set up fancy buckets in "high" interest savings accounts in ING (Capital One 360). This worked well and great, however I realize my employees have not been working very hard for me in these accounts.

As part of the Big Change I'd like to enact, I would love to validate my strategy with the greater wisdom of the community. Please let me know your thoughts, the validation of internet stranger Mustachians is all I need to move forward!

I've read about 20% of MMM's blog posts, and found the 401k post the most relevant for this discussion.

Some background
Age: Almost 27
Income: 90k salary
Retirement Savings: 110k (50k Roth, 60k pre-tax)
Post-tax savings: 55k

My Most Generous and Excellent Employer is very concerned about my future retirement at age 59 1/2+ and contributes a mighty 14% of my salary in exchange for a 4% contribution from me. I can contribute to a Roth 401k, which is a nice benefit.

I was saving up that 55k in anticipation of future expenses (home downpayment, wedding, next car, etc) however I don't have a specific timeframe for those activities. I expect most of that to happen in the next 10 years, but not the next 1-3 years. In this case, I have a steady supply of income coming in so I can support those activities when I have a need. In the meantime, I'd like to get my money working harder for me.

The Plan
Improve mustachian badassity so that I can put in the maximum limits to my Roth 401k and Roth IRA each year. This will be the core of my 'stash, at least to start. I want to focus on building these accounts first, since they have the amazing benefit of growing tax free! With additional savings, I will contribute to a taxable index fund account.

When I am ready to stop working prior to age 59 1/2, I will quit my job, roll over the Roth part of my 401k into the Roth IRA (as needed) and draw ~4% for living expenses. This of course will only be pulling out principal that I put in, so would not be subject to any penalty. I will eventually be able to touch the Pre-Tax 401k at 59 1/2, or will slowly convert it to Roth IRA depending on my income.

Investment Choices
105k in my 401k - currently invested in the Vanguard Target Retirement 2050 Trust with expense ratio of 0.11%. I get a reasonable asset allocation (~90% stocks) which will adjust over time to become more conservative. Open to other suggestions as I have a lot of Vanguard funds available in my plan.

5k in Roth IRA - currently invested in Vanguard REIT fund, once I get up to 10k it will have expense ratio of 0.1%. As I put more money into this fund, I think I'll want to split between another fund (maybe Target Retirement 2050), so as not to be overloaded with REIT exposure. I have the impression that for long term savings, stocks are superior, although I value diversity.

55k in savings - currently spread between Capital One 360 savings accounts and Ally bank CDs. When I put this into a taxable account at Vanguard, I'll be picking an index ETF/Mutual fund. I think I'll avoid bonds since I can have exposure to those in my tax advantaged accounts. Easy choice would be something like the Vanguard Total Stock Market Index.

What is everyone's thoughts on Tax-Managed funds, such as Vanguard Tax-Managed Small-Cap Fund Admiral Shares (VTMSX)? I'm not clear on when I would want to go with that over the standard Total Stock Market Index. From some brief reading, I'm getting the impression that it could decrease taxes when selling the shares, in which case I would be paying 0% or 15% (or something else depending on how capital gains tax laws change). If it has no affect on the taxes on dividends, then I suppose it might not be as interesting.

Risks
These are probably low-probability risks, however considering this is my Plan For The Future, I certainly need to consider them. I'd welcome any feedback on whether or not these should concern me:
  • Roth 401k/IRA laws or plan rules will change, and I won't be able to roll my Roth 401k into my Roth IRA after leaving my employer
  • Roth IRA laws will change, and I won't be able to access the principal I invested penalty free prior to age 59 1/2

Looking forward to any and all feedback and responses, thank you!
-MustachianInTraining

brewer12345

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Um, so you will have no cash at hand for all of life's little humps and bumps and or opportunities?  Keep the 55k in cash and funnel other excess cash into your investments.

You may want to revisit your choice of Roth 401k vs traditional.  If your marginal tax rate including federal and state taxes is 25% or higher, I would take the  deduction now and put the money in a traditional 401k.  You would be amazed at how low your tax rate will be in ER.

MustachianInTraining

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Thanks for the feedback. I agree I wouldn't want to put all of the 55k into investments right now, however I don't see myself needing more than 5-10k liquid in a savings account. As a single guy with limited commitments, a very stable job with excellent job security, and family in the area that I could fall back into in the event of hard times, I'm comfortable being a bit more aggressive. If I need to save for goals in a closer time horizon, I can just reduce the flow of money into the investment account for a time.

That is an interesting point about Roth 401k vs Traditional 401k. Most of my income is taxed in the 25% tax bracket now, so I do see your point. On the flip side, how much benefit do I get contributing via Roth 401k, since I can put "more" money in? This post-tax money can then grow in a tax advantaged account for a long time. I'm guessing that might not offset the advantage of just paying lower taxes (such as 15%) at a later date.

Going traditional 401k would also leave me with additional money to invest now.

brewer12345

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If you put money in a traditional 401k it leaves you more to invest now.  That can go to a roth IRA or (even better) a taxable account.  It is best to have all three: roth, traditional and taxable.  That way you can mix and match in ways that let you optimize your tax exposure over time.

I am ESRd now. I expect our federal income tax will be approximately zero this year (possibly we may get a refundable credit).  if you are not a W2 slob and you have taxable, traditional and roth to draw on, it is very easy to stay in the 10% or less bracket.

MustachianInTraining

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One question for you, why would you consider a taxable account to be superior to a Roth IRA? Dividends in the Roth IRA are tax-free, and I can withdraw the principle whenever I want. Why would I not want to max out the Roth IRA before going into a taxable account?

It makes sense that I would want to be able to draw from the three different sources of money. I will have a significant amount of pre-tax either way, here is the breakdown:

Yearly Pre-tax Employer 401k contributions: 12.5k
Yearly Pre-tax or Roth 401k contributions by me: 17.5k
Yearly Roth IRA contributions: 5.5k
Excess to taxable account

brewer12345

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The taxable account gives you the greatest flexibility, and if you are in the 15% bracket qualified dividends and LT cap gains have a 0% tax rate.  So you can load up the Roth, but try really hard to accumulate a taxable account.

Your proposed waterfall of contributions makes lots of sense to me.