Bogleheads

[Ricky]

Hi everyone, I'm new here and very excited to be a part of the community. I appreciate all the help in advance and I hope to help you also in the future!

I would really appreciate some feedback on my plans for my familes future porfolio.

Here's a quick snapshot of our situation. Me and my wife both just turned 27 years old this month. We have NOT started any investing yet. We are completely debt free and in 3 months will have a fully funded emergency fund of $50,000 in a Vanguard Money Market Fund.

My wife and I are both in the Air Force. I'm getting out of the Air Force in 4 months to run our business full time (which is why we carry 1 year of salary in our FFEF). We also run an internet based business that grosses about 500K per year.

We have two kids that are 2 yrs old and 3 yrs old we would like to save for college for.

Here's what I was thinking. Any and all advice is welcome.


FIRST STEP: Set up SIMPLE IRA's for me and the wife and max out Vanguards Target Retirement Fund 2035 (VTTHX) for both of us.

SECOND STEP: Take all leftover money and divide them up 20% a piece into the following 5 accounts and invest monthly.

Vanguard 500 Index Fund Investor Shares (VFINX) Domestic

Vanguard Balanced Index Fund Investor Shares (VBINX) Balanced

Vanguard Total International Stock Index Fund (VGTSX) International

Vanguard Growth Index Fund Investor Shares (VIGRX) Growth

Vanguard Small-Cap Index Fund Investor Shares (NAESX) Small Cap

THIRD STEP: Fund kids college via Index Funds or 503B plans

FOURTH STEP: Pay off mortgage ASAP


Any thoughts, advice, suggestions?

Thanks!

[Laura]

Ricky,

Welcome to the Diehards forum. It sounds like you are well positioned to start investing.

The first step to investing is to develop an investment plan. This plan should include your desired asset allocation and should take into account all your investing goals like a new house, car, education for your children, and retirement. Each of these goals might have a different time frame but you should start making plans for all of them now. Money you need soon can go in the money market fund with your emergency money.

Your asset allocation will come as a result of your investment plan and is determined by balancing your NEED to take risk with your ABILITY to take risk. Since you currently have no money invested you have the NEED. How will you handle the volatility in the market? If the value of your portfolio drops 30% will you panic and sell out of a fund or will you stay the course? You need to select an asset allocation that makes both you and your wife comfortable. It can be expressed as 80/20 (80% equities and 20% bonds), etc. Most everyone should have some bonds. Studies have shown that your asset allocation will be responsible for 90% of your return.

Here is a table offered by Larry Swedroe based on the 1970s bear market showing the amount of decline for various stock/bond allocations:

Max Equity - Exposure Max loss
20%...............5%
30%..............10%
40%..............15%
50%..............20%
60%..............25%
70%..............30%
80%..............35%
90%..............40%
100%.............50%

If you haven't done any reading on investing I highly recommend you start there. The Bogleheads' Guide to Investing is a terrific place to start developing your asset allocation. Rick Ferri has a great online book Serious Money that you can start now. The Coffeehouse Investor is another favorite. Vanguard can also help you Create an Investment Plan.

Once you have your desired asset allocation you need to determine how much international you want as part of your equity allocation. Most people select a number between 20% and 40% of equity.

Last, you begin by creating one unified portfolio that builds around all of your different investment accounts and your wife's accounts. When investing in taxable accounts like you are proposing you need to pay close attention to tax efficiency otherwise you will lose much of your return each and every year. Taylor Larimore posted this list that helped me.

4-Step Rule for Tax Efficient Fund Placement:

1. Put your most tax-inefficient funds in 401ks, 403bs, Traditional IRAs and similar retirement accounts. When full..
2. Put your next most tax-inefficient funds in your Roth(s). When your Roth(s) are full-
3. Put what's left into your taxable account.
4. Try to use only tax-efficient funds in taxable accounts.

Here is a list of securities in approximate order of their tax-efficiency. (Least tax efficient at the top.):
Hi-Yield Bonds
Taxable Bonds
TIPS
REIT Stocks
Stock trading accounts
Small-Value stocks
Small-Cap stocks
Large Value stocks
International stocks
Large Growth Stocks
Most stock index funds
Tax-Managed Funds
EE and I-Bonds
Tax-Exempt Bonds

Right off the bat I see that you are proposing the balanced index fund in your taxable account. This fund holds bonds which should be held in your new SIMPLE accounts and not in a taxable holding. The S&P 500 fund is a great fund but the Total Stock Market fund is better in taxable. Why? Because it holds large cap, mid cap, and small cap all in one fund. As companies grow and shrink the fund does not have to sell the company so it is very tax efficient. It also includes growth and value funds all in one fund. The Total Stock Market fund includes the funds from the growth index and small cap index that you listed.

When constructing your portfolio you want to make sure you have a low cost, tax efficient, broadly diversified portfolio. By using Vanguard you are guaranteed low cost. Tax efficient depends on where you place the different funds and is up to you. Broadly diversified comes by constructing a portfolio that covers the many different boxes in the Callan Table. You can see that each year one different type of asset class will do well. No one can predict which one will rise to the top each year but they change frequently. Your portfolio should cover all the boxes in the chart so that you always know you are benefiting. If you look at the list of top performing funds each year you will find them clustered into one type of fund. That just shows that the sector is doing well not that the funds are doing well. Also remember that risk and return are related so the more risk the higher the return but also the greater chance for loss. You can get build a great portfolio by Investing in Total Markets as your core.

So, after writing all of this what should you do. Well it depends on you doing the steps listed earlier but you could end up with a portfolio that looks like this:

taxable
money market fund (emergency fund)
Total Stock Market

his SIMPLE
Total Intl Stock Market
REIT

her SIMPLE
small cap value
Total Bond Market

On the subject of children's education you should look into 529 accounts that let the college money grow tax free. Each State offers a different version. Start by determining if your state offers a tax deduction. If not, you can invest in any State plan and Vanguard participates in many. You can find more information and plan comparisons at Savings for College.

Finally, paying off your mortgage is a good plan once you have all the other items taken care of.

I also thought I should mention wills and life insurance. The military is good at making sure people have thought about these items but make sure you and your wife both have a will naming a guardian for your children if something should happen to both of you. Also make sure you have enough life insurance to protect the children and/or parent in case something happens to one of you. You should also look into disability insurance and business insurance since your income would be significantly impacted if your new business had a problem or you were disabled and unable to work.

Well this is a really long post. You are in a great position to benefit from your Internet company. Take the time to do some reading and you will avoid most of the mistakes many of us on this forum made before we took the time to do a little reading and educate ourselves.

Good luck on your investing journey.

Laura

[livesoft]

Hey there Ricky, may I suggest you go read some books on the subject? I have never seen Vanguard Growth Index Fund (VIGRX) in anyone's asset allocation, so it was strange to me to see it in your second step. Laura has given some references to start with. Good luck!

[FEDFERS]

[SpringMan]

Ricky,
Laura is right on with her advice as usual. I might add my two cents. Don't use the balanced fund (VBINX) in the taxable account as it has avout 40% taxable bonds which are taxed as ordinary income. Use a tax exempt bond fund for your bond allocation in your taxable account. If you live in a state with income tax consider a state and federal tax exempt bond fund. I would eliminate VIGRX and just hold the blend VFINX or better maybe total stock market index. If you need small caps in your taxable account consider the tax managed small cap. They do have a 5 year redemption fee. For international, your pick is good, be aware that because it is a fund of funds, it does not qualify for the foreign tax credit. This credit is usually quite small anyway. Sounds like you are off to a fine start. Congrats,
_________________
Best Wishes,
SpringMan

[ddb]

Some unstructured thoughts off the top of my head:

When you say that your business grosses $500K per year, what do you mean? Is this gross revenue, gross profit, operating profit, net income? How is this business structured (sole prop, partnership, LLC, C-corp, S-corp)? Whatever the case, I'd be curious to hear why you think a SIMPLE IRA is the way to go for deferring some of this business income.

Will you both continue to have health insurance coverage after you leave the Air Force? If not, better start looking at your options NOW. The premiums for non-group family policies can be daunting. Look at all available plan types, including high deductible plans with health savings accounts (HSAs).

What are your goals for your money? Without knowing what it will be used for, developing a suitable asset allocation is kind of difficult.

How reliable is your business income? Do you think you can continue to make the same income each year, or is it a volatile/cyclical business model?

- DDB

[pso21]

[Ricky]

[quote="ddb"]Some unstructured thoughts off the top of my head:

When you say that your business grosses $500K per year, what do you mean? Is this gross revenue, gross profit, operating profit, net income?

We profit around $250,000 after taxes and costs.


How is this business structured (sole prop, partnership, LLC, C-corp, S-corp)? Whatever the case, I'd be curious to hear why you think a SIMPLE IRA is the way to go for deferring some of this business income.

We are an LLC and have elected S-Corp for taxation.


Will you both continue to have health insurance coverage after you leave the Air Force? If not, better start looking at your options NOW. The premiums for non-group family policies can be daunting. Look at all available plan types, including high deductible plans with health savings accounts (HSAs).

My wife is staying in the Air Force for a while so it will still be free.


What are your goals for your money? Without knowing what it will be used for, developing a suitable asset allocation is kind of difficult.

My goals are strictly long term investing. I don't see us needing this money for a while.


How reliable is your business income? Do you think you can continue to make the same income each year, or is it a volatile/cyclical business model?

It's the internet so the money could go away at any moment I'm sure. But, from what I see, the systems we have in place and the new products we're coming out with I don't see any reason that we shouldn't be making 1-2 million per year in 4 years.


Hopefully these answers help. I really appreciate the time everyone took with my question, it means a lot to us.

[Murray Boyd]

You gotta tell us what this business is.

[leonard]

If you are planning to Net $250k out of the business - and have modest living expenses - you should check out setting up a "new comparability" 401k plan for you business. Under a new comparability plan, you could potentially put away $45k for you and $45k for your wife, if she will be an employee. That could amount to $90k tax deferred savings per year!! There will be some set up and on going reporting costs on a 401k, but it would be very hard to beat putting away $90k tax deferred, if you can arrange it.

Just run an internet Search on "new comparability 401k". You may be pleasantly surprised at what you find.

[Laura]

If your wife is staying in the military make sure and contribute fully to the TSP plan every year. This is one of the best retirement programs around. That said, if you end up with a "company" 401k plan she would probably not be able to contribute to both. If you can add more to the company 401k plan rather than to the TSP that would be a better option for her. You need to explore you alternatives.

Vanguard has information on small business options on their website.

Laura

[ddb]

[mizz401k]

There is one pitfall with the SEP IRA for an LLC taxed as an s-corp.....the 25% contribution is tied to W-2 wages, not your draws (Schedule K1 income) from the business.

Many s-corp owners are reluctant to take enough W-2 to max out the SEP due to the increase in FICA tax for both employee & employer (15.3%). You may be better off with the 401(k) if you keep your W-2 at a modest level.

Also, you miss out on dollar-cost averaging, loan options, and if you are playing the "non-deductible IRA/Roth game in 2010", this will effect your taxable basis.

Just some things to consider. You should be able to find a low maintenance, low cost 401(k) for an owner-only business.

[ddb]

[Ricky]

I've been advised to open a SIMPLE IRA rather than a SEP because we have one full time employee.

Why not a SIMPLE IRA, it looks "simple".

[ddb]

[Ricky]

Double post, sorry.

[Ricky]

Is it a bad thing to just put our $21K back for me and my wife with the SIMPLE and just put the rest in taxable accounts?

It's just, if we hire more employees, I would really hate to be on the hook paying that much for all their retirements with the SEP.

[Random Musings]

Ricky,

Since it's your business model, it ultimately comes down to how you wish to compensate your employees - and how your personal savings are going to be structured may or may not impact your business model.

If you really "hate to be on the hook", I believe that eliminates one option.

RM