Author Topic: Recent grad learning how to properly invest; looking for friendly advice!  (Read 5864 times)

Ozymandeus

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Greetings fellow Mustacians!

My girlfriend just recently introduced me to MMM and the concept of early retirement.  Once I started reading I became very excited, because as MMM described his target audience, it seemed to fit me exactly.  I've been fortunate though my life to never really have too many financial concerns, but also because of that I've never had any financial goals either.  The concept of retiring in 6-8 years instead of of 30+ is amazing, and I think I can do it.  My problem is that up to this point I've never really learned much about investment, and for me that is the biggest source of concern.  I have the money, I just need to know how to get it to work for me.  Most sources of information on investment and retirement are not based off early retirement, so I don't want to mistakenly put my money somewhere where it won't help me until 60.  I'm hoping for a little guidance to help grow my peach fuzz into a nice bristly 'stach.

My current target goal to trigger early retirement:  $700,000
My current estimated years til goal, assuming 7% growth: ~7-8yrs

My Background:

  • 27yr old male, 3 yrs out of college with an annual salary of $125k.
    Spent the last 2 years paying off student and car loans, finally debt free!  Now I have excess cash and don't know what to do with it.  First world problem, I know.
    Current Living Expenses ~$25k, working to bring that down.
    Estimated yearly net income after expenses: $50k
Current net worth:
  • $40,000 in cash in the bank (Trying to best determine where to put this is a main goal of mine)
    $50,000 in my traditional 401k (Fidelity, through employer)
    No IRA yet.  I know I wasted some years not contributing the $5k maximum, and this is another goal of mine. 
    Currently renting an apartment @ $950/mo.

My employer matches 5% of my first 6% into my traditional 401k, and I was smart enough to at least take all the free money for the first 2 years.  I very recently bumped my 401k contribution up to the $17k maximum.  I don't know much about how good or poor my 401k distribution is, this is one area I am distinctly lacking in knowledge:

21% VINIX
21% Company Stock
16% FSKTX
15% CRMMX
7% FDIVX
7% PTTRX
The remainder is in either "Stable Value" which I'm not sure what that is, and "SSGA GLB EQ EX-US C" at about 7% each.

My Main Questions:

#1 What do I do with all my cash, and future cash?
1a.  $5k into an IRA per year seems to be the next best thing I should do.  I'm fairly certain I'm over the normal limit for a Roth IRA, should I do a normal IRA or this fancy "backdoor Roth IRA" I've been reading about?
1b.  After maxing an IRA (I assume I can only have one at 5k/yr) and maxing my 401k to $17k, I have no idea where to best invest my remaining income (estimated $45k)... help?

#2  My employer recently began offering a Roth 401k.   Should I put some, or all of my 401k contribution into the Roth 401k, and will my employer's match end up in the normal or Roth 401k if I do so?  From what I've read it seems I should just stick with traditional, but I'm not sure if one works better with early retirement.

#3  Should I change my existing 401k distributions?  I think having 21% in my company stock is too high, but if I take it out where should I move it to?  Some or all to VINIX, as MMM seems to suggest?

#4  Assuming my target retirement age of 34 works out, do I have to structure my current investments in a certain way in order to have access to enough dividends/income to pay for living expenses?

Thanks for any and all advice!  The financial world is pretty daunting, and while I'm learning slowly, nothing beats asking the experts!

grantmeaname

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#1 What do I do with all my cash, and future cash?
1a.  $5k into an IRA per year seems to be the next best thing I should do.  I'm fairly certain I'm over the normal limit for a Roth IRA, should I do a normal IRA or this fancy "backdoor Roth IRA" I've been reading about?
You make enough that you're in the 28% bracket even after all your deductions, right? (That is, AGI at least $85,650?)
Now, with a Roth or Traditional retirement vehicle, you're only paying taxes on contributions once, and so you only need to determine when you want that to be. With a Roth IRA/401k, you're paying taxes before you contribute the money, so the contributions are taxed at your marginal tax rate while you're working. For you, that's 28%. With a Traditional IRA, you don't pay taxes on the money you contribute, but you do pay taxes on the money when you withdraw it in retirement. So it gets taxed at your effective tax rate in retirement. For you, the retirement effective tax rate will be much lower than 28%, so it's probably better to contribute to a Traditional IRA. As velocistar points out, your earnings disqualify you from deducting your traditional IRA contributions. Depending on your MAGI, you should either contribute directly to a Roth IRA, or if that's impossible contribute to a Traditional IRA and convert it.

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1b.  After maxing an IRA (I assume I can only have one at 5k/yr) and maxing my 401k to $17k, I have no idea where to best invest my remaining income (estimated $45k)... help?
After you've maxed your 401k and your IRA, you should contribute to a regular brokerage account at Vanguard (or somewhere else, if you prefer, but Vanguard is the one many like here). There will be no favorable tax treatment, so it's best to contribute only after the other two are maxed.

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#2  My employer recently began offering a Roth 401k.   Should I put some, or all of my 401k contribution into the Roth 401k, and will my employer's match end up in the normal or Roth 401k if I do so?  From what I've read it seems I should just stick with traditional, but I'm not sure if one works better with early retirement.
For the same reason that a traditional IRA is better for you, a Traditional 401k is better for you. (For the record, if you contribute to a Roth 401k, the company pays your match into your traditional 401k.)

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#3  Should I change my existing 401k distributions?  I think having 21% in my company stock is too high, but if I take it out where should I move it to?  Some or all to VINIX, as MMM seems to suggest?
Having anything in your company stock is too high. It's only a good idea to have any if you're eligible for a discount via an Employee Stock Purchase Plan, and even then you should sell the stock as soon as you can do so without penalty. By owning your employer's stock, you're doubling down on risk because your income and a fifth your assets are all in the same basket (your company's continued success). You may do great work, and your company may be well managed, but everyone thought Enron was a stable and well managed company in September 2001, didn't they?

As far as your overall asset allocation: I'd recommend you read The Intelligent Asset Allocator if you want to be thorough, or the Bogleheads start up kit and especially the Asset Allocation determination page if you want a quick and good enough understanding of the issue. In general, you will receive optimum overall returns by spreading your portfolio out among several asset classes (stocks, bonds, real estate), and your risk tolerance will determine what ratio of these you hold (and what types of each, for that matter). In general, early retirees can afford to retire a year or two later or make big lifestyle cuts that older retirees can't, so they tend to have more tolerance for risk. If that applies to you, your portfolio could be relatively heavy on stocks (at least 70%, as high as 90% depending on your disposition) and light on bonds, and your specific picks within each asset class can include more risk (like small-cap and international stocks, for example).

You should also be considering your asset allocation across all your accounts when you get to the point that you have others. Your asset allocation is the set of rules for your portfolio as a whole, and it's generally not best to have each account contain an even ratio of each asset type. For how to place your funds best in the ecosystem of your three different accounts, check this article out.

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#4  Assuming my target retirement age of 34 works out, do I have to structure my current investments in a certain way in order to have access to enough dividends/income to pay for living expenses?
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Most sources of information on investment and retirement are not based off early retirement, so I don't want to mistakenly put my money somewhere where it won't help me until 60.
To use retirement funds before 59.5, they have to be in a Roth IRA, and they have to have been in the Roth IRA for at least 5 years. In your case, when you retire in 2019, you'll move all the money you need to cover your 2024 expenses from your traditional 401k and IRA to your Roth IRA; in 2020, you'll move 2025 expenses, and so on. Each year, you'd pay income tax on the amount of money you rolled over (remember, money is taxed before it goes into Roth accounts).

To cover your living expenses from 2019-2023, you can use money that you contributed to a Roth IRA during your working career (this is an awful idea for you because of the tax implications), you can earn income with side jobs and consulting, or you can use money from your brokerage accounts. The last option is a great fit for you because you'll be contributing to a brokerage account anyway.
« Last Edit: July 11, 2012, 07:17:03 AM by grantmeaname »

velocistar237

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For you, the retirement effective tax rate will be much lower than 28%, so it's probably better to contribute to a Traditional IRA.

Are you sure, Grant? The OP won't get the deduction, so wouldn't a Roth IRA be better than a Traditional IRA, after maxing out the Traditional 401k?

To cover your living expenses from 2019-2023, you can use money that you contributed to a Roth IRA during your working career (this is an awful idea for you because of the tax implications), you can earn income with side jobs and consulting, or you can use money from your brokerage accounts. The last option is a great fit for you because you'll be contributing to a brokerage account anyway.

With $50K going into brokerage accounts vs. $22K into tax advantaged accounts every year, you'll have plenty to cover your expenses until the Roth rollovers kick in.

grantmeaname

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Are you sure, Grant? The OP won't get the deduction, so wouldn't a Roth IRA be better than a Traditional IRA, after maxing out the Traditional 401k?
Sorry, you're right. I should have double checked that before posting.

Uncephalized

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Grant, how old do you expect to be at FI? I wish I had started learning this stuff before 20... And I'm only 24! Hardly an old man. Are you in school?

grantmeaname

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I've been taking a year off to serve in Americorps, but I'll be back in school in about a month. The goal is to finish a monstrously long 6 year undergraduate education at 22, and retire by 30. I'm remarkably lucky that I found MMM as young as I did!

Uncephalized

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Heh, I'm not too far behind your curve, then, if you're not working yet...

Good luck with your goals!

What are you studying, if you don't mind my asking?

grantmeaname

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It was math and anthropology my freshman year, but I decided that math didn't make me happy and dropped it. (Young and naive? Maybe. Worth it? Definitely.)

Then I all but finished my Anthro degree my sophomore year.

During my Americorps service this year, I decided I had enough scholarship time left that I should really do something with it. So I'm going to spend 2.5 years getting a BSBA in Accounting and another half year getting a Masters of Accounting.

All told, I'll have a BS-honors in Anthropology, a BSBA-honors in Accounting, and a MAcc.

Uncephalized

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Haha, cool. Interesting mix of degrees. Probably smart to go for the accounting degree, earning-potential-wise. :-D CPAs make bank, no?

grantmeaname

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Compared to archaeology grad students, they do.

Ozymandeus

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Been busy, sorry for the delay responding but I wanted to give a big thanks for the advice!

So far all I've done is reallocate all my company stock in my 401k to my other funds and took them out of my distribution.  I'm looking  for the best way to reallocate my existing $50k I have in the bank into an index stock fund of some sort.

I had one other question I was hoping someone could help me with.  I know Index Funds are some of the best choices because they are low risk as your risk is spread over many various companies.  Should I have multiple index funds to spread the risk out even further, or is it perfectly acceptable to dump the vast majority of my stock holdings into a single Vanguard Index Fund?  A few other index funds I was looking at had a higher "maintenance fee" (I can't remember the exact term) somewhere in the .6% to 1%.  Those seemed high compared to the Vanguard Index Fund which was around 0.4%, so it seems that if I can just put the vast majority of my funds in a low fee Vanguard Index Fund that would be the best choice.

Thanks again for the help!

Kriegsspiel

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It sounds like what you're referring to is slicing and dicing.  IE, instead of holding a total stock fund, you divide it up into the constituent funds, like large cap, small cap, etc.  I think that the common consensus is that this strategy is better for taking advantage of some of those diced funds doing better (small caps are doing really well, large caps aren't, when you do your reallocation, you are buying more low and selling more high than if you just had one fund, and were reallocated to bonds). 

However, having fewer funds is much simpler, easier to reallocate, and easier for taxes. 

Uncephalized

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I'm planning on dumping all my investment money into VTSMX (80%) and VBMFX (20%), personally. That's the total stock and total bond indexes (once I have enough put away I'll switch to the lower-cost Admiral versions but I'm just starting out).

I'm mimicking that allocation as closely as I can in my 401(k) as well, by putting 72% into a large-cap index, 8% into a small-cap index, and 20% into an investment-grade bond fund, all the lowest-expense funds I can pick out of my available options, averaging out to about 0.55% expense ratio. Not as low as Vanguard but what can you do?

Tyler

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To use retirement funds before 59.5, they have to be in a Roth IRA, and they have to have been in the Roth IRA for at least 5 years.

There's also the 72t option for a traditional IRA.  And since you're thinking about this early enough, you can also look at how much you need to keep in a taxable account to bridge the gap.

BTW, congrats on saving well and thinking about these things at 27!