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401k OR how I learned to stop worrying and love being an adult with retirement plans
GameHat
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Registered User regular
This thread is about...401(k) plans! Whee!
So what the deuce is a 401(k)? Shamelessly copied from Wikipedia:
So!
I currently have been investing in a 401(k) since I started working a "real" job, January 1 2005. Since I started, I've been putting 7% of my pre-tax income into my 401(k)
Like Wiki says, this investment is pre-tax - so the 7% gets deducted before the damnable 30+% removed for income taxes and the "Social Security" fraud. Hooray! It gets taken out before the State and Federal Government takes their cut.
For my current time of employment (<5 years) The company matches my contribution, up to 3% of my income. I'm on a vesting schedule, whereby the "matched" funds from my company become "mine" at the rate of 20% a year. Since this is my third year, I'm 60% vested so $0.60 of every $1 matched by the company would be mine if for some reason I was fired or quit.
When I hit my 5th year of employment, not only am I fully vested but the company match goes up to 6% of my current salary.
My current split is about 80% in a US Index Fund, 20% in a "Foreign" Index fund.
Since I've been working I have about 33.7% of my current yearly salary invested with 82.4% of that being "vested".
So what are my questions?
1) Am I putting enough into my 401(k)? I feel like as long as I'm doing a bit more than gets me the full company match that's good.
2) Should I cut back on 401(k) to open a Roth IRA? Briefly, a Roth IRA is somewhat similar, however: taxes are NOT deferred on the income. There are no taxes, however, on withdrawl.
3) Is an 80/20 domestic/foreign split on index funds reasonable? I'm young (mid 20s) so I will be in the market for a long time before retirement.
What makes me wonder:
I have a current debt load of about just about half of my current yearly salary. 80% is a car loan (2007 Mustang GT ;-)) and about 20% is credit debt. I'm not struggling to make payments now, and I'm paying significantly more than the minimum each month but as it stands it will be probably 6 months before I clear the credit debt (my credit rating is damn good, I've checked) and of course I won't pay off the auto debt for 4 years at the current schedule.
I also am renting right now. With the mortgage market in serious trouble, it seems like I might be able to get a steal on some property. However as it stands my current cash reserves are almost zero, I'm going paycheck to paycheck just on rent+credit+auto with admittedly little budgeting on my part.
I don't expect EXPERT ADVICE from this forum but if there are some people with some experience (maybe 5-10 years in the workforce) I would welcome some voices on the investment/retirement topic!
So what the deuce is a 401(k)? Shamelessly copied from Wikipedia:
Wikipedia wrote:The 401(k) plan is a type of employer-sponsored retirement plan in the United States and some other countries, named after a section of the U.S. Internal Revenue Code. A 401(k) plan allows a worker to save for retirement while deferring income taxes on the saved money and earnings until withdrawal. The employee elects to have a portion of his or her wage paid directly, or "deferred", into his or her 401(k) account. In participant-directed plans (the most common option), the employee can select from a number of investment options, usually an assortment of mutual funds that emphasize stocks, bonds, money market investments, or some mix of the above. Many companies' 401(k) plans also offer the option to purchase the company's stock. The employee can generally re-allocate money among these investment choices at any time. In the less common trustee-directed 401(k) plans, the employer appoints trustees who decide how the plan's assets will be invested.
So!
I currently have been investing in a 401(k) since I started working a "real" job, January 1 2005. Since I started, I've been putting 7% of my pre-tax income into my 401(k)
Like Wiki says, this investment is pre-tax - so the 7% gets deducted before the damnable 30+% removed for income taxes and the "Social Security" fraud. Hooray! It gets taken out before the State and Federal Government takes their cut.
For my current time of employment (<5 years) The company matches my contribution, up to 3% of my income. I'm on a vesting schedule, whereby the "matched" funds from my company become "mine" at the rate of 20% a year. Since this is my third year, I'm 60% vested so $0.60 of every $1 matched by the company would be mine if for some reason I was fired or quit.
When I hit my 5th year of employment, not only am I fully vested but the company match goes up to 6% of my current salary.
My current split is about 80% in a US Index Fund, 20% in a "Foreign" Index fund.
Since I've been working I have about 33.7% of my current yearly salary invested with 82.4% of that being "vested".
So what are my questions?
1) Am I putting enough into my 401(k)? I feel like as long as I'm doing a bit more than gets me the full company match that's good.
2) Should I cut back on 401(k) to open a Roth IRA? Briefly, a Roth IRA is somewhat similar, however: taxes are NOT deferred on the income. There are no taxes, however, on withdrawl.
3) Is an 80/20 domestic/foreign split on index funds reasonable? I'm young (mid 20s) so I will be in the market for a long time before retirement.
What makes me wonder:
I have a current debt load of about just about half of my current yearly salary. 80% is a car loan (2007 Mustang GT ;-)) and about 20% is credit debt. I'm not struggling to make payments now, and I'm paying significantly more than the minimum each month but as it stands it will be probably 6 months before I clear the credit debt (my credit rating is damn good, I've checked) and of course I won't pay off the auto debt for 4 years at the current schedule.
I also am renting right now. With the mortgage market in serious trouble, it seems like I might be able to get a steal on some property. However as it stands my current cash reserves are almost zero, I'm going paycheck to paycheck just on rent+credit+auto with admittedly little budgeting on my part.
I don't expect EXPERT ADVICE from this forum but if there are some people with some experience (maybe 5-10 years in the workforce) I would welcome some voices on the investment/retirement topic!
GameHat on
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Second, you definitely want that 3% to get the full match in the 401(k). However, in the long term, without the matching contribution, odds are the Roth is going to pay off better than the 401(k), despite the short-term benefit of the tax deduction, though this is going to largely depend upon your income. You're probably going to have to sit down with a financial planner and do some math.
Trying to buy property right now without some serious cash reserves is crazy. I'm assuming you're familiar with the law of supply and demand, right? Well, with the mortgage market being what it is, yeah, the demand went down quite a bit, but at the same time, a lot of the mortgage brokers went out of business, too, which reduced the supply of cash available for mortgages a fuckton. In addition, the people investing that money into mortgages realize they're taking a bigger risk, so they're asking for a high rate of return.
Lastly, fuck index funds. I mean, good investment and all, but they're for old people. You're young, you can afford not to give as much of a shit, and you've got 40 years until retirement. Stick your retirement money into small-capital mutual funds; over a 20-year period, a well-diversified small-capital portfolio has never failed to out-perform every other well-diversified investment. Choose any 20-year period you like. Now, that 20 years will, without a doubt, be a rollercoaster ride, but since you're in it for the long-haul, you don't care as much if it drops 10% of its value your first year out, especially once it gives you a 40% return the next year. Personally, I've got a third of my Roth IRA in what's called a "contrarian fund," that gives the people running the fund a lot of freedom as far as what they want to invest in (historical lifetime return on that one around 15%), and 2/3 in a small-cap international fund (a little less risky, with a lifetime rate of around 14%). Since you're young, losing everything (and the odds of that are minuscule with a well-diversified portfolio) isn't that big of a deal, but hitting a home run (large return) is huge, since that money over time redoubles and re-redoubles. If you're not taking risks with your retirement at your age, you're basically throwing away money.
401K vs. roth IRA:
pay taxes now or pay them later. if your marginal tax rate is low now (or you expect it to go up by the time you retire) then roth IRA is funded with your post-tax hard earned ducats, but if you make a killing investing, you keep it all, tax-free.
if your marginal tax rate is high now (or you expect it to stay steady or go down by the time you retire ... most younger people don't think this, unless they're wealthy CEOs) then the 401K means you fund the investment account with pre-tax funds, and you get taxed when you're 62.5/65 at this future tax rate.
and IRA (roth or traditional) $4K annual cap
401K has $14K annual cap (i think)
and you should listen to me ... because i'm a billionaire
My credit card debt interest rate is ~12% APR
Auto is 5.9%
I dunno - I think that with company match, I might be better off with 401k in the short term, though I'd need some more research to do the proper math on it.
Though, why would you want your mutual fund to match the Dow for return just about perfectly? Personally, I like the fact that my mutual fund is going to be kicking the shit out of the Dow. I mean, really, from 1982-2000, the Dow pulled down about a 12.9% rate of return, the best they've ever done, and that was through the tech bubble. A 15% lifetime average (similar 20-year average) is a huge difference over time, even estimating an average-case scenario for the mutual fund versus a best-case scenario for the Dow. But, hey, it's your money.
You should absolutely continue putting in the maximum amount your company will match in that 401k. You should also start a Roth IRA and contribute as much a you can per year if your salary will allow it. I may be mistaken but I believe the contribution limit recently went up to $6,000 per year in your case. This is good because the more you can contribute the better. The government really wants to borrow yo money. Then once you retire from your company or move to another and collect the rewards of your 401k you can roll it right into your already swelling IRA. You mentioned percentages of where your funds are invested. Do you have control over that? Could you put more into foreign markets? Can you find out more about those markets and where they are? What they go to? I'm not going to elaborate any further because I hate to give advice for free, but these are all reasonable questions.
edit: Shit, on that IRA bit, the contribution will increase to 5k in 2008. It would be 6k if you were age 50+. My bad yo.
Shogun Streams Vidya
Put in 10% of each pay check till you hit max (you're company will automatically "stop" your contribs once you hit the ceiling).
Preferable put in 14K on Jan (use your previous years bonus)
Roth/Traditional IRAs are capped at 4K per year. Put in 4K flat on January each year. (it is getting bumped up to 5K in 2008
The problem with Roth IRA is that if you total income (from all sources) is greater then around ~90K range then you can't get one
The second kick in the nuts if you can't get a roth then your also the income level that you also can't deduct Traditional either
https://flagship.vanguard.com/VGApp/hnw/accounttypes/retirement/ATSTradIRAWhoContributeContent.jsp
So you can still get a traditional, but no tax benefits.
Also another thing you should research is to see if your company has a employee stock purchase program. They are good if A) they give a good match and/or discount and
As for your portfolio, I would personally diversify a bit and probably get a bit more aggressive. It just depends on how much time and research you're willing to put in.
Lots of these finical "gurus" say "hey, you're young; get aggressive - take some risk!" whcih is more or less bullshit advice. The second part of that should be "if you're willing to take the time to research it properly". Just hanging your money over to some "aggressive fund manager" is asking to be screwed over. It's ok and sometimes good to take on some risk, but learn for yourself on all in the ins and outs on each position you take on and also how to hedge it.
Secondly, I don't know if I would be 80% in US Index funds.... I'd try to diversify that a bit... the dollar is really weak right now.
Personally I like ETFs a lot. There is a lot of shitty funds out there, but find some you like.
management fees -> these guys actively managing the fund are actually doing something (as opposed to a computer algorythm just tracking something) so they deserved to be compensated. certainly, in the long run most of them don't beat the market, but there are plenty of funds out there that have had better 1-yr, 3-yr, 5-yr returns than their "market" comparisons, even when factoring in the management fees. get rich by figuring out which ones are going to perform well in the future.
but keeping a lot in index funds is fine too, just saying that avoiding management fees is not the only way to discriminate between funds to maximize returns (i would love to have fidelity contrafund). ETF's can give you exposure that some index funds cannot (USO for example, tracks spot price of oil) and they usually have low operating fees.
eventhough your debt on the car is at 5.9%, you're probably losing another 5-15% on it per year on depreciation (front loaded, it ought to depreciate at a slower rate as it ages). so that should also be considered high-interest debt, and attacked with surplus funds.
However, if your choices are making a higher payment on debt you're only paying 5.9% on, or contributing tax-deductible money to an investment you should be pulling in at least 8-10% on, there's really no doubt that you're better off contributing to the retirement account in the long-run.
and depending upon where you live a car is most definitely more of an asset than a liability, not one that helps you to retirement, but one that might make your life better or give you more control over your time. autonomy is good, and some places don't have great public transport, and i'd rather commute in a car or cycle than a bus if I had to. if you needed cash now, a paid-for car can be sold to raise funds.
so assuming that not owning a vehicle is not an option, depreciation increases the overhead of that loan (because the thing you can sell when you're free and clear of the loan is worth less than the loan underwriter valued it when they sold it to you), on a 5 year ownership time horizon the net loss is like 10-12% annually (that's probably conservative). that doesn't figure fixed overhead on the car itself like gas, maintenance, and insurance, which all make a strong case against car ownership if you're maximizing towards retirement.
To the OP: I suppose there's an argument to be made for paying down the car so that you have it available to sell, but unless you really, really value very small increases in liquidity, or you don't plan to keep the car for very long, I'd pay it down at the planned rate, and keep investing in retirement.
You have money that you will not be touching for a long time. You can either invest it in something relatively safe, like an index fund, or something relatively risky, like a small-cap mutual fund. Let's assume it's a traditional small-cap mutual fund. Said small-cap fund is pretty much going to move in the same direction in the market, only in a more exaggerated manner; when the market has a bad year, it's going to have a terrible year, but when the market has a good year, it's going to have a great year, and when the market has a mediocre year, it's probably going to have a good year. Now, what happens more often: the market does well, the market does mediocre, or the market does poorly? The general trend is one of the first two. The market tends to create wealth. The reason you don't invest in a small-cap mutual fund for everything is that you want additional liquidity, the ability to tap your money earlier without taking a loss. However, if it's a Roth IRA or a 401(k), you're not able to tap that early (except under very limited circumstances). So, essentially, you're going to leave it in there for the next 40 years. Now, a small cap portfolio over a 20-year period will always beat every other well-diversified investment, unless you have the shittiest 20 years in the history of the market, which is to say it always has beaten every other investment. Yeah, you might have a bad year or two, which is why you don't stick your money in a small-cap fund for only a year or two. Seriously, your average year with a lot of the small-cap funds out there will beat your best year with a Dow index fund.
Heh, I didn't in any way expect the car purchase to be an investment. I bought the car because I loved it. And let's say that when I finally do pay off the car in 4 years, it's market resale value is $0 (which it won't be, it's a nice car and will hold some value forever). I don't care! I have a great time driving it every day. I'm certainly not foolish enough to expect that I'll ever sell it and make back the costs.
Yeah, financially the car was a probably not a great purchase. But emotionally it was. I thought about all that before deciding to buy it, and decided that the enjoyment I'd get from it was enough to justify the financial loss in buying it.
Some good points!
At the moment, I work for a large chemical company that is not publicly traded, so there is no stock option for investment.
At 10% investment with employer match I wouldn't hit the 401(k) limit of $14k in a given year. Just don't make that much yet.
On the 80/20 US/Foreign - that's definately something I'm wondering about. Do you think 70/30 would be better? 60/40? Yeah, the dollar is a bit soft now but looking long term it seems to be pretty strong.
They match 3% right now.
Of that, I'm only vested 60% (3 years service)
So if I quit today, I get 60% of the 3% match they've been doing since I started. They would then pull back the other 40%
When I hit 5 years, not only am I vested 100% (ALL company match funds are mine, no matter what) but the match doubles to 6%.
Thanks for the posts, Thinatos.
My options for my 401(k) are a bit limited. I have maybe 30 different funds I can invest into.
I have 2 small-cap growth mutual funds that your post made me interested in. I'm not a financial guy - help me with the math. Both beat my current main US Index fund in a 10 year period (~10% v. 7% return).
But the management fee/expense ratio for the small-caps is ~0.7% vs. the index fund which is 0.15%. That's what made me wary of them initially, plus the fact that I got all my initial advice from The Motley Fool which said forget mutuals, go with indices.
MOAR ADVICE? Since I will be "investing" for at least 30 years, I think you might be right about switching to some small-cap growths while I'm young
As for whether or not you should invest more in foreign markets: I have 2/3 of my Roth IRA in an international fund, and 1/3 in a mixed contrarian fund. That may or may not be right. There are probably investments that are going to do better than those, there are almost certainly investments that are going to do worse. It really depends on who you want to listen to. We could invent a cheap way to make plastic out of garbage next year, and I'd be an idiot for investing foreign, or the Chinese could do it, and I'd be a genius. That's a call you really have to make for yourself, and anyone who tells you they know that one will beat out the other for sure is a liar.
You should definitely talk to a financial planner, though, if you haven't already.
And while I wouldn't have bought American, enjoy the fucking car, man. Yeah, sure, if you'd've stuck the money in a retirement fund instead, you could buy it without a second thought 40 years, but there's something to be said for having shit that's fun while you're young enough to enjoy it.
Shogun Streams Vidya
Man, I ain't rich or anything!
If the dollar reaches £1 = $2.50/$3.00 then it will begin to become cheaper to live in the US and fly back and forth to work in the UK once a week! People with relatively trivial levels of cash in the UK will be multi-millionaires in the US. Seriously, the dollar is as weak as it can be. Barring massive inflation inside the US that is.
I can see the rates being back at 1=1.50 within a decade. As the chinese economy grows stronger its going to want to import more goods, and to start exporting low paid jobs elsewhere. If trends in the US follow those in the UK many of the service/call center jobs which were exported to india/china will be brought back since people soon realised that although they could pay much less in India/China, the people there didnt have the understanding of domestic issues in the UK to deal with the calls quickly.
This is true. Got attached to my point. 5.9% is really some of the cheapest debt you can have right now, and for awhile.
re US dollar: so the fed cut rates cause the us economy is going so great?
In fact if the US economy did slow down it could afford to buy fewer imports and thus the price of the dollar would rise, since America's balance of payments would move closer to being balanced.
Keep in mind that the dollar being cheap also means that foreign investing is more expensive.
i think inflation is being under-reported in the US, and has been since at least greenspans final term.
i guess, it's easy to point out if "this" goes "that" way, then badness ensues, but what's pressuring the dollar up? i can see negative pressure, and plenty of potential negative pressure.