Help a Reader: How to Invest

Here's an email I recently received from a reader:

Background:

• 25, single
• No debt (except for credit card balance paid in full every month)
• $18k in cash
• $1,200 in individual stocks
• $27k in Roth IRA (Vanguard Target fund)
• $11k in 401k (no great options fee-wise, but not terrible)

Salary:

• $58k base
• Bonus varies but should be ~$7k this year, payable next month
• Job is secure, company is doing very well

Savings:

• $416/month to Roth IRA
• 10% pre-tax to 401k (matched at 50% of 5% but I'm only vested for 40% of that so really, only matched at an additional 1% right now)
• ~$500-$600/month in cash savings over the course of the year

I'm looking for advice on what to do with the extra $500/month and upcoming bonus, plus any salary increases & long-term incentive payouts in the next 6-12 months. I'm going to look at optimizing my asset allocation between my 401k & Roth IRA to bring expenses down but other than that, I don't really have any specific goals right now. I'd like to buy a place at some point but am not sure I'll stay in the Midwest (could move to a more expensive city on the East Coast - where I grew up - in the next 1-2 years but not definite) so I don't want to be tied down right now even though rates are so good. I also don't see myself needing a car in the near future.

So, do I:

• Keep adding to cash reserves so that I always have options?
• Add more to my 401k even though I have a good amount going to retirement and 401k fees are not great? (I plan to be at my company at least another year but maybe not much longer than that so this could be rolled over to my Roth IRA in 1-3 years)
• Invest in taxable accounts?
• 529 in case I ever decided to get an MBA?
• Any other ideas?

So, what are your thoughts for him?

Comments

[JimL]

Your retirement savings are great, so I don't think you need to do anything with that for right now. I would take the bonus and your monthly savings for the next year and add it to your cash for a stronger emergency fund. That would give you over 6 months cushion should anything happen. Further, it puts you in a good position should you decide to relocate. After that, I would take future monthly savings, LTI and bonus monies and start saving it for a potential home. It will take a few years to put together a strong down payment, so it is best to start saving early even though you don't plan to buy for awhile. Should you decide that you do not want to purchase a home, you can shift it over to your investment account or use it towards your MBA.

[Brent]

If I were you (not too different), I would max out the 401k as long as there is an employer match and then put the rest into savings (emigrant direct, ING, etc). I like to have a good amount of cash just in case but I would also put some of that $500/month into a vanguard fund/dividend stock(s) just to make a little bit more than you will in a savings account, maybe 80%cash/20%stocks.

Saving an extra $6,000 a year over time you will see your savings pay off and hopefully some returns on investments. Once you have a decent amount saved up and are settled somewhere you will have a good amount to put down on a house if you choose to do so.

This is more or less what we are doing now for our next home.

[Tyler]

Invest in a taxable account. You are 25 and and you need some flexibility over the next 10 years. Your retirement accounts are fine. Don't put additional money behind that wall. (continue funding it at your current levels) I don t know what your goals are in life, but at your age flexibility matters- MBA, engagement, house, change jobs, move, start your own business, etc.

[Petra]

I have an idea for you... read FMF's previous post about helping the poor... there's not one thing mentioned about giving or charity on your list so that might be just the right time to start to give from your abundance...

[Chris]

You do not seem to be in any immediate need of cash, with the exception of whatever amount you will need when and if you change jobs. For the time being, I would max my 401k and leave the money in whatever cash fund is offered. That way, you can roll it over to an IRA when you leave and then convert that amount to a Roth immediately after the rollover. Just keep enough cash to pay the taxes. It's a great way to get more cash into a tax free Roth. If your short term goals change, you should consider scaling back your 401k contribution. However, at your age and with your low level of expenses, the 18k you have saved should be enough for any emergencies.

[MBTN]

Since you don't have any specific goals, I would say keep the money in a taxable account. Not necessarily cash per se, but something invested conservatively. That way, you have the flexibility to use the money for buying a house, paying for an education, moving expenses, or something else that might come up.

[W A G]

Because of my age this year I have to take a required minimum distribution from my IRA. My wife is still protected from the MRD. My biggest regret is that most of our funds are not in Roth tax protected accouunts.

I tell every young person that will listen that the Roth is the way to go. No tax, no minimum distributations and control of your money free of the tax man. How much sweeter can it get?

Good luck with your future. Sounds like you are on your way.

[Jennifer Lissette]

Personally, I'd split the money between taxable accounts and cash. I'd earmark the taxable account for a far off but expensive goal such as a wedding or a house. The cash I would accumulate to a specific amount that would cover every moving expense you can think of. Cost of movers, boxes, new place's first month's rent, last month's rent and security deposit, cost of furnishing the new place, cost of cleaning up your old place before you move, etc. It'd put you in the position of letting your choice of relocation be about what's best for you, not about the money.

[Justin]

Your situation is very, very similar to mine, except I'm 10 years further down the same road you are on. And after maximizing retirement savings in order to minimize taxes, I've simply built a mountain of cash. It's not "earmarked" for anything, and I don't call it an emergency fund... There's just a shit load of cash sitting there, which I keep adding to. Occasionally I consider doing something with it (rental property or something), but I haven't touched it, and the longer I leave it, the more the possibilities for it expand.

[Margo]

I'd keep adding to your cash position. Once it gets up to $30K, move $10K over into taxable investments. Then repeat again. Investing in larger chunks helps cut the costs of trading as a %.

Second best choice is the 529 plan. I'd done this, figuring either I use it for my MBA or if I don't, then let it ride until I have a kid and change the beneficiary. Well, that was a gamble that sucked because I started my education after the crisis...I'd have been better off locking in a 5% 1 year CD before the rates cratered. You'd hopefully be buying into the upswing, but risks aren't always rewarded positively.

[STL Attorney]

1. You need to max the 401(k) to $15.5K or 15%, whatever your employer permits. As a single individual who rents, you are getting smacked on taxes (been there). Whatever the fees are in your 401(k), you're not going to get a 25% better return (your marginal tax rate) in your post-tax account. Moreover, if you switch jobs, you can roll the 401(k) over into a broker of your choosing.

2. With the remaining savings, build up your cash reserve to about $30K, and consider using a CD ladder - i.e. $5K 6 mo CD, $5K 1 year CD, $5K 2 year CD, assuming this pays a higher rate than ING or other online savings.