Author Topic: What to Invest in For about 5 years  (Read 6664 times)

swimmer21

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What to Invest in For about 5 years
« on: March 14, 2013, 01:32:02 PM »
I'm 23, and earning money quite a bit faster than I would ever want to spend it on daily expenses. However, I do not want to put all of this into a 401(k)/Roth IRA, because there's a few events that I feel are possible on the horizon(~ 5 years), before I could access that money penalty free, which include:

  • New Car - My current car has 110k miles on it, and is cheap to maintain, but I'm assuming in the next few years I'll need a new car
  • House Down Payment - I may want money to buy the apartment building I'm living in, or to buy a house somewhere.
  • Start a company - I may want to have a year or two of living cheaply money in case I want to start a tech startup
  • Vacation Fund - I keep dreaming about a 8-10 week bike tour through Europe, would want some money for that.[\li]
What should I be doing with money? For the time being, I've been throwing it in Vanguard LifeStrategy Moderate Growth Fund (VSMGX), however, it seems to compare negatively to other similar funds, and I keep debating if that's too risky, or not risky enough for my goals.

shaunr

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Re: What to Invest in For about 5 years
« Reply #1 on: March 14, 2013, 04:11:05 PM »
Safe to assume you're in the ~28% tax bracket?

As hard as it is to stuff money away and plan to not touch it for 37 years, I would still recommend maxing out your 401k, plus contributing the maximum allowable to a roth.

It only takes 26.5k pre-tax per year to max the 401k.  I do not think that prevents you from achieving your other goals.  As an example, if you decide to start your own company and want to live cheaply while doing so, you can probably even withdraw from your 401k with the 10% penalty and still come out breaking even or possibly even ahead.

Since you're going to save for [60+] retirement anyways, why not get it over with while you're young and have low expenses?  You can always stop contributing after about 7 years or so and let it coast the rest of the way there.

Either way,  I strongly disagree with VSMGX in a taxable account (I doubt it's tax efficient, bond proceeds will be taxed as income, you don't give yourself the option to tax loss harvest, etc).

I would recommend reading the entire bogleheads wiki if you haven't done so yet.  Keep in mind that while the material in on tax-efficient security placement is fantastic, it doesn't completely apply to you since you will have at least two time horizons you are investing towards, and thus you should (in my opinion) have two separate portfolios.



KingCoin

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Re: What to Invest in For about 5 years
« Reply #2 on: March 14, 2013, 07:17:53 PM »
I keep debating if that's too risky, or not risky enough for my goals.

Just invest in stocks. You're 23, so there's no better time to invest in an asset that will perform well over the long term than now. Your "goals" are that you might want to use some money for some things sometime in the future.  However, given that you have a ton of flexibility around all of your "goals", that translates to a perfect opportunity to take risk.

I also tend to agree with shaunr. If you don't have any pressing needs for your cash, investing in a 401k or IRA is always a good default option, though I can't blame you for wanting 10-20k in liquid assets to negotiate big ticket items that may come up suddenly (not sure what your current liquid asset levels are).

johnnylighthouse

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Re: What to Invest in For about 5 years
« Reply #3 on: March 14, 2013, 08:59:35 PM »
Do remember that you can withdraw roth ira contributions at any time, so it might be an ideal vehicle for open-ended savings for stuff / retirement / emergency fund. Then you can let your plans evolve and decide later.

Nords

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Re: What to Invest in For about 5 years
« Reply #4 on: March 14, 2013, 09:12:04 PM »
I'm 23, and earning money quite a bit faster than I would ever want to spend it on daily expenses. However, I do not want to put all of this into a 401(k)/Roth IRA, because there's a few events that I feel are possible on the horizon(~ 5 years), before I could access that money penalty free, which include:

  • New Car - My current car has 110k miles on it, and is cheap to maintain, but I'm assuming in the next few years I'll need a new car
  • House Down Payment - I may want money to buy the apartment building I'm living in, or to buy a house somewhere.
  • Start a company - I may want to have a year or two of living cheaply money in case I want to start a tech startup
  • Vacation Fund - I keep dreaming about a 8-10 week bike tour through Europe, would want some money for that.[\li]
What should I be doing with money? For the time being, I've been throwing it in Vanguard LifeStrategy Moderate Growth Fund (VSMGX), however, it seems to compare negatively to other similar funds, and I keep debating if that's too risky, or not risky enough for my goals.
It sounds as though you're planning to withdraw at least the principal starting at the five-year point, and that you would prefer not having to wait through an equity bear market or some other erosion of capital.

Buy five-year CDs.  Yeah, the interest rates suck, but you'll have the money available when you need it.  Instead of chasing yield you'll have cash readily available for when you're ready to buy something... and that means you can negotiate a cash discount.  The money you save on the cash discount will be worth far more than chasing a few basis points of yield by taking on undue principal risk.

If you think yields on five-year CDs still suck then buy three-year CDs (or the longest period with a six-month penalty for early redemption).  That way after three years you can either renew them for three more years or go for five.

I like JohnnyLighthouse's suggestion about locking the money into a Roth IRA and then withdrawing the contributions after five years.  You can't withdraw penalty-free before the five years are up, but your gains will never be taxed.

http://the-military-guide.com/2012/01/05/save-or-invest/
http://the-military-guide.com/2011/06/22/chasing-yield/

sherr

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Re: What to Invest in For about 5 years
« Reply #5 on: March 15, 2013, 07:58:09 AM »
Buy five-year CDs.  Yeah, the interest rates suck, but you'll have the money available when you need it.  Instead of chasing yield you'll have cash readily available for when you're ready to buy something... and that means you can negotiate a cash discount.  The money you save on the cash discount will be worth far more than chasing a few basis points of yield by taking on undue principal risk.

If you think yields on five-year CDs still suck then buy three-year CDs (or the longest period with a six-month penalty for early redemption).  That way after three years you can either renew them for three more years or go for five.

I like JohnnyLighthouse's suggestion about locking the money into a Roth IRA and then withdrawing the contributions after five years.  You can't withdraw penalty-free before the five years are up, but your gains will never be taxed.

http://the-military-guide.com/2012/01/05/save-or-invest/
http://the-military-guide.com/2011/06/22/chasing-yield/

The problem with all "use your Roth IRA / 401k as an emergency fund" advice is that it prevents you from using your IRA / 401k in the way that it gives you the most benefit: as a retirement account. You can only contribute $5.5k a year to an IRA, a down-payment on a house would burn through several years worth of contributions real quick. You want to keep your money in your 401k / IRA so it can continue generating tax-advantaged interest for a long time, not withdraw it for something that is easily planned around.

I would +1 the CD advice. You won't get a lot of interest but its safe, not forcing you to make lower "real retirement" contributions to your tax advantaged accounts, and better than nothing. Of course if you are not already maxing out your 401k / IRA contributions then you should do that first if you can.

WageSlave

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Re: What to Invest in For about 5 years
« Reply #6 on: March 15, 2013, 09:05:09 AM »
I concur with the others regarding 401k & IRA.  If you have an employer match on your 401k, absolutely take advantage of that to its full extent.  Otherwise, you're effectively taking a voluntary pay cut.  Then I'd max out your Roth IRA.  And then don't touch these accounts until age 59 or whatever.

What's left is what you can put in your "5 year fund".  And for that, I like Nords's idea of CDs.  Or you can also look at "high" yield checking/savings accounts (e.g. ING Direct, Ally Bank).  Or if you want to take on a little more risk, you can look at tax-free bonds or bond funds.  Check out Vanguard's VWIUX or VWSUX: Intermediate- and Short-term tax-exempt funds, respectively.  Of course there is always interest rate risk with bonds; but the risk decreases as the term declines---but so does the coupon!

There's no perfect solution, and in the end it's back to the classic question of risk versus reward.  There's no "right" answer; it's based on your personal risk tolerance.

Equities are at or near an all-time high.  This trend could continue for five years or it could crash tomorrow (well, tomorrow is unlikely, but Monday is possible :) ).

Perhaps another way to think about it is this: for this particular pool of money (but not your overall portfolio), your profile looks like that of someone nearing traditional retirement age, when the general advice talks about wealth preservation rather than wealth building.  Likewise, your portfolio becomes more bond-weighted, but still contains some equity portion.  So maybe you could do something like 30/70 equities/bonds.

Inquizator

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Re: What to Invest in For about 5 years
« Reply #7 on: March 17, 2013, 06:43:52 AM »
The problem with all "use your Roth IRA / 401k as an emergency fund" advice is that it prevents you from using your IRA / 401k in the way that it gives you the most benefit: as a retirement account. You can only contribute $5.5k a year to an IRA, a down-payment on a house would burn through several years worth of contributions real quick. You want to keep your money in your 401k / IRA so it can continue generating tax-advantaged interest for a long time, not withdraw it for something that is easily planned around.

If the options are don't fund IRA at all + save emergency fund in cash or fund IRA + no emergency fund in cash then I think that advice does make sense. If you fund the IRA and you do have to withdraw contributions in a few years then you're no worse off than if you'd never funded the IRA to begin with. But if you discover you don't need that emergency fund, then you have a bunch of cash and you can't go back and make up those missed IRA contributions. So if it's one or the other and there's even the smallest chance you won't need it, I'd put it in the Roth.

Now, if you can fund both a Roth IRA and a cash emergency fund, then the situation is different. Dropping the emergency fund and saying the IRA covers it has exactly the issues you outline and I tend to agree in that situation.

Another Reader

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Re: What to Invest in For about 5 years
« Reply #8 on: March 17, 2013, 07:17:22 AM »
In your shoes, I would buy some I-bonds, create a CD ladder using the highest on-line rates (Ally, SallieMae, Pentagon FCU, etc.), and see if my local credit union offered a high-yield checking account where some minimum number of debit transactions are required in exchange for a higher interest rate.

I would NOT invest in bonds, except a small amount in short term bonds if the yield made sense relative to the risk.  I would not consider my Roth as a source of money, unless I had an extreme emergency.

I would also not throw everything at this fund at one time.  I would buy as funds became available, which accomplishes the laddering goal.

Over time, interest rates are likely to go up.  As CD's come due, you pick the best place then for the money.  I-bonds have an inflation component, and your yield will rise, lagging inflation by no more than a few months.

Kriegsspiel

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Re: What to Invest in For about 5 years
« Reply #9 on: March 17, 2013, 07:50:42 AM »
I'm with Nords and AR.  CDs up to the FDIC limit, then short term treasuries, then I-bonds.

arebelspy

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Re: What to Invest in For about 5 years
« Reply #10 on: March 17, 2013, 09:51:52 AM »
I like JohnnyLighthouse's suggestion about locking the money into a Roth IRA and then withdrawing the contributions after five years.  You can't withdraw penalty-free before the five years are up, but your gains will never be taxed.

You can, actually, withdraw the principal any time, penalty-free.  (I believe the five year is seasoning on a rollover.). In OP's case, he could withdraw after 3 years any contributed principal without a penalty.
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icefr

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Re: What to Invest in For about 5 years
« Reply #11 on: March 17, 2013, 04:33:24 PM »
I like JohnnyLighthouse's suggestion about locking the money into a Roth IRA and then withdrawing the contributions after five years.  You can't withdraw penalty-free before the five years are up, but your gains will never be taxed.

You can, actually, withdraw the principal any time, penalty-free.  (I believe the five year is seasoning on a rollover.). In OP's case, he could withdraw after 3 years any contributed principal without a penalty.

Not quite. The five year seasoning is on the account overall as well, at least that's what the following suggests to me: http://www.irs.gov/publications/p590/ch02.html#en_US_2012_publink1000231061

Undecided

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Re: What to Invest in For about 5 years
« Reply #12 on: March 17, 2013, 04:50:44 PM »

Not quite. The five year seasoning is on the account overall as well, at least that's what the following suggests to me: http://www.irs.gov/publications/p590/ch02.html#en_US_2012_publink1000231061

I'm not sure what exactly you're looking at, but from that IRS pub.:

"Are Distributions Taxable?

You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s)."

tylerherman

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Re: What to Invest in For about 5 years
« Reply #13 on: March 17, 2013, 05:49:22 PM »
Lending Club might be an option. Notes are 3-5 years and you can always sell them.