How to invest for unknown, lumpy future expenses

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Topic Author
Ken-Sheridan
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How to invest for unknown, lumpy future expenses

Post by Ken-Sheridan »

Debt: Student debt (2.5%); Mortgage (3.2%) -- Both tax-deductible

Tax Filing Status: Married Filing Jointly

Tax Rate: 22% Federal, 5% State

Age: Mid-late 30s

Desired Retirement Asset Allocation: 90/10 (open to being a bit more aggressive, but also happy at this level)

His Company 401k:
Vanguard Target Retirement 2060 (VTTSX) (0.15%).

Both His & Her Roth IRAs (with Vanguard)
Vanguard Target Retirement 2060 (VTTSX) (0.15%)

Her Company 401k:
State Street Target Retirement 2050 (SSDLX) (0.07%)

Her Company 457B (post tax):
State Street Target Retirement 2050 (SSDLX) (0.07%)

Not currently maxing out contributions to any of these accounts.

(We like the relatively low expense ratios and convenience of these target funds.)


My wife and I are currently saving about 20% of our income in retirement accounts (including contributions from our employers). Various retirement estimators suggest that we're comfortably on track in terms of our retirement goal. We have a chunk of cash beyond our emergency fund and outside of retirement accounts that's currently in cash, as well as a few hundred a month coming in that we'd like to invest. (We're also making small contributions to a 529 for our toddler and planning to do so for the one on the way).

Here's the thing: We know that big-ticket things are going to come up and there are big-ticket things that we might want to do, but we don't know exactly what or when. As just some examples: We'll need a new furnace and new (to us) car *at some point*, we're thinking about adopting a third child in the next few years (but might not), we'll likely want a new garage *at some point*, we may want a small addition on our house when our little ones are older, etc.

With that in mind, and given that we don't anticipate ever being very high earners (we're both in education), it seems to make sense to have a modest chunk of money invested outside of retirement accounts so that we don't have to turn to credit/loans for $5k here and $20k there. If that's right, how much should we keep outside of tax-advantaged accounts and in what kinds of investments? Or should we turn to HELOC for stuff like that and just max out all retirement accounts? I assume we should keep the emergency fund for true emergencies.

Thanks for any insights you can offer!
Last edited by Ken-Sheridan on Thu May 06, 2021 2:12 pm, edited 2 times in total.
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retired@50
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Re: How to invest for unknown, lumpy future expenses

Post by retired@50 »

Ken-Sheridan wrote: Wed May 05, 2021 10:54 am
Thanks for any insights you can offer!
Welcome to the forum. :happy

Many people use an ordinary taxable brokerage account for expenses like you describe.

You can invest in conservative (low risk) investments like a short term bond fund, or you can choose to put the money into a (riskier) tax-efficient stock index fund. Either of these would be suitable depending on your risk tolerance.

Conservative short term bond fund: https://investor.vanguard.com/mutual-fu ... file/VUBFX

Riskier stock index fund: https://investor.vanguard.com/mutual-fu ... file/vfiax

Regards,
This is one person's opinion. Nothing more.
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ruralavalon
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Re: How to invest for unknown, lumpy future expenses

Post by ruralavalon »

Welcome to the forum :) .

Ken-Sheridan wrote: Wed May 05, 2021 10:54 am My wife and I are in our late 30s, earn about $130k a year, and are currently saving about 20% of our income in retirement accounts (including contributions from our employers)---almost all in Vanguard 2060 Retirement Fund to keep things simple (hoping to retire around 2045-2050). Various retirement estimators suggest that we're on track in terms of our retirement goal. We have a chunk of cash beyond our emergency fund and outside of retirement accounts that's currently in cash and VBIRX, as well as a few hundred a month coming in that we'd like to invest. (We're also making small contributions to a 529 for our toddler and planning to do so for the one on the way).

Here's the thing: We know that big-ticket things are going to come up and there are big-ticket things that we might want to do, but we don't know exactly what or when. As just some examples: We'll need a new furnace and new (to us) car *at some point*, we're thinking about adopting a third child in the next few years (but might not), we'll likely want a new garage *at some point*, we may want a small addition on our house when our little ones are older, etc.

With that in mind, and given that we don't anticipate ever being very high earners (we're both in education), it seems to make sense to have a modest chunk of money invested outside of retirement accounts so that we don't have to turn to credit/loans for $5k here and $20k there. If that's right, how much should we keep outside of tax-advantaged accounts and in what kinds of investments? Or should we turn to HELOC for stuff like that and just max out all retirement accounts? I assume we should keep the emergency fund (~$25k) for true emergencies.

Thanks for any insights you can offer!
Are you making the maximum annual employee contributions ($19.5k each) to both employer plans? Do you make maximum annual contributions ($6k for each of you) to an Roth IRA for each of you?

What is your desired asset allocation (the stock/fixed income mix, and domestic/international stock mix) that you want to aim for?

For unspecified spending at indefinite times, I suggest investing "as if" for the long-term. This can be in Roth IRAs or a joint taxable at a low cost fund firm like Vanguard, Fidelity or Schwab.

Regular contributions to a Roth IRA (but not earnings) can be withdrawn at any time for any reason without penalty or tax liability.

In a joint taxable account use very tax-efficient stock index funds. Wiki article "Tax-efficient Fund Placement", link. Examples of very tax-efficient stock index funds include Vanguard Total Stock Market Index Fund (VTSAX) or the ETF share class (VTI)and Vanguard Total International Stock Index Fund (VTIAX) or the ETF share class (VXUS).

Withdrawals from the taxable account are penalty-free, only capital gains are taxed, and long-term gains are taxed at a lower rate than ordinary income.

If you use a taxable account, then adjust the stock/bond mix in your accounts with the employer plans to maintain your desired asset allocation.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started
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Svensk Anga
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Re: How to invest for unknown, lumpy future expenses

Post by Svensk Anga »

I like I series savings bonds for both emergency funds and lumpy spending with unknown timing. You need to bear in mind that they cannot be sold within the first year, so it is likely best to trickle in your desired funding. They keep up with inflation (at least before taxes), and so are better than any fixed income alternative with good safety currently.
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ruralavalon
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Re: How to invest for unknown, lumpy future expenses

Post by ruralavalon »

Svensk Anga wrote: Wed May 05, 2021 1:05 pm I like I series savings bonds for both emergency funds and lumpy spending with unknown timing. You need to bear in mind that they cannot be sold within the first year, so it is likely best to trickle in your desired funding. They keep up with inflation (at least before taxes), and so are better than any fixed income alternative with good safety currently.
I bonds certainty have a good interest rate now. "The composite rate for I bonds issued from May 2021 through October 2021 is 3.54 percent. This rate applies for the first six months you own the bond." link.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started
Sam_78
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Re: How to invest for unknown, lumpy future expenses

Post by Sam_78 »

We’ve been using youneedabudget and setting long term savings goals for roof, planned surgery, Christmas, a pair of paddle boards (just ordered yesterday!), flooring repairs. The money has been in cash or cash equivalents and also acts as part of the emergency fund/cash buffer for bills, but will eventually move some into bonds. Enjoying this as when the time came to spend the money it was planned out and didn’t feel guilty for spending it. Also having a bunch of money in cash and all bills on autopay with enough to cover months of expenses eliminates checking the balance before mortgage or other big bills.
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ruralavalon
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Re: How to invest for unknown, lumpy future expenses

Post by ruralavalon »

Sam_78 wrote: Wed May 05, 2021 4:37 pm We’ve been using youneedabudget and setting long term savings goals for roof, planned surgery, Christmas, a pair of paddle boards (just ordered yesterday!), flooring repairs. The money has been in cash or cash equivalents and also acts as part of the emergency fund/cash buffer for bills, but will eventually move some into bonds. Enjoying this as when the time came to spend the money it was planned out and didn’t feel guilty for spending it. Also having a bunch of money in cash and all bills on autopay with enough to cover months of expenses eliminates checking the balance before mortgage or other big bills.
But those are known, lumpy expenses.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started
Topic Author
Ken-Sheridan
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Re: How to invest for unknown, lumpy future expenses

Post by Ken-Sheridan »

Thank you, everyone, for your thoughtful responses!

To ruralavalon's question, we're not currently maxing out our tax-advantaged retirement contributions, because we thought we might want to have access to money without penalty for some of these expenses that may or may not occur at unknown times. To be honest, I don't totally understand how withdrawing from Roth IRAs penalty-free works, but I can say that we're each contributing a couple hundred bucks a month to one. (Most of our retirement savings, though, is in 403b/401k.).

The bottom line for us is that on one hand we don't want to get stuck with big bills that we can't pay for in cash, but also don't want to have a bunch of money sitting around losing real value over time. It's just tricky when we're not saving for a particular expense at a particular time.

I will definitely look into I bonds! Any opinions about choosing between them and something more aggressive, like the tax-efficient stock funds people mentioned? As far as AA, were more or less following a glide path like Vanguard' Retirement funds, but pegged to about 10 years after we actually plan to retire. Right now, for retirement funds only that's about 90 stocks (60% of which is U.S., 40% of which is international) and 10% bonds. But, truthfully, I had never thought about AA across retirement and non-retirement.

In any case, thanks again, everyone---very helpful input!
KlangFool
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Re: How to invest for unknown, lumpy future expenses

Post by KlangFool »

Ken-Sheridan wrote: Wed May 05, 2021 8:43 pm Thank you, everyone, for your thoughtful responses!

To ruralavalon's question, we're not currently maxing out our tax-advantaged retirement contributions, because we thought we might want to have access to money without penalty for some of these expenses that may or may not occur at unknown times. To be honest, I don't totally understand how withdrawing from Roth IRAs penalty-free works, but I can say that we're each contributing a couple hundred bucks a month to one. (Most of our retirement savings, though, is in 403b/401k.).
Ken-Sheridan,

You should learn that and max up 2 X Roth IRAs instead of keeping extra money in the taxable account and pay taxes.

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ruralavalon
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Re: How to invest for unknown, lumpy future expenses

Post by ruralavalon »

Ken-Sheridan wrote: Wed May 05, 2021 8:43 pmTo ruralavalon's question, we're not currently maxing out our tax-advantaged retirement contributions, because we thought we might want to have access to money without penalty for some of these expenses that may or may not occur at unknown times. To be honest, I don't totally understand how withdrawing from Roth IRAs penalty-free works, but I can say that we're each contributing a couple hundred bucks a month to one. (Most of our retirement savings, though, is in 403b/401k.

The bottom line for us is that on one hand we don't want to get stuck with big bills that we can't pay for in cash, but also don't want to have a bunch of money sitting around losing real value over time. It's just tricky when we're not saving for a particular expense at a particular time.
It's best to make maximum annual contributions of $6k to two Roth IRAs, one for each of you. This should be a priority over investing in a taxable brokerage account. Wiki article "Prioritizing Investments", link.

There is a 10% penalty for early withdrawal from a traditional IRA. There is no penalty for withdrawal from a Roth IRA. The way it works? You just withdraw money when you need it. "Regular Contributions [but not earnings] can be withdrawn at any time with no tax and no penalty." Wiki article " Roth IRA" link, "Distributions".

This is why you can readily use your Roth IRAs for those unknown, unscheduled, lumpy expenses. If the money is not needed for an unknown, unscheduled, lumpy expense then it's available for retirement. Roth IRAs give you the flexibility you need.

This is different than for your 401k and 403b. If you withdraw from those accounts before age 59.5 there is a 10% penalty, and income tax to pay at whatever age you withdraw.

In a Roth IRA I generally suggest using stock funds such as Vanguard Total Stock Market Index Fund (VTSAX) and Vanguard Total International Stock Index Fund (VTIAX). However for simplicity you could use a target date fund in the Roth IRAs too.

What target date fund do you currently use in your 401k and 403b accounts? What other funds are offered in those plans? Please give fund names, tickers and expense ratios. Please see this for format: Asking Portfolio Questions. You can simply add this to your original post using the edit button (the pencil icon near the upper right corner of your post),it helps a lot if all of your information is in one place.

Depending on the funds and their expense ratios in the 401k and 403b, making maximum annual contributions to two Roth IRAs might also be a priority over contributions to the 401k and 403b. Wiki article "Prioritizing Investments", link.

Ken-Sheridan wrote: Wed May 05, 2021 8:43 pmI will definitely look into I bonds! Any opinions about choosing between them and something more aggressive, like the tax-efficient stock funds people mentioned?
I savings bonds can be useful for unknown, unscheduled, lumpy spending. But there are limits. "I Bonds cannot be redeemed during the first year, and if you redeem them within the first five years after purchase, you lose the most recent three months' interest."

The current interest rate is good. "The composite rate for I bonds issued from May 2021 through October 2021 is 3.54 percent. This rate applies for the first six months you own the bond", link.

You each could buy up to $10k annually in I savings bonds. "Series I Savings Bonds (often called I Bonds) are government savings bonds issued by the U.S. Treasury that offer inflation protection. I Bonds offer tax-deferral for up to 30 years and are free from state and local taxation. I Bonds are not marketable securities and cannot be traded in the secondary market."
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started
Topic Author
Ken-Sheridan
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Re: How to invest for unknown, lumpy future expenses

Post by Ken-Sheridan »

Thank you again for your thoughtful replies and for helping me understand how to use the forum appropriately!

I updated the original post with information about our investments. I included as much info as I was comfortable posting online. If this is insufficient and people are unable to weigh in, I completely understand. In any case, I'm very grateful for the helpful information I've received!
lazyinvestor30
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Re: How to invest for unknown, lumpy future expenses

Post by lazyinvestor30 »

Ken-Sheridan wrote: Thu May 06, 2021 2:14 pm Thank you again for your thoughtful replies and for helping me understand how to use the forum appropriately!

I updated the original post with information about our investments. I included as much info as I was comfortable posting online. If this is insufficient and people are unable to weigh in, I completely understand. In any case, I'm very grateful for the helpful information I've received!
There are many different strategies one can follow. I have grappled with this issue for a while and I ended up with Option 2 below.

1. Consider everything as 1 asset allocation and re balance accordingly when things change. I get the allure of this approach. But sometimes in reality of 401k accounts not being flexible, user friendly etc, this might be a problem. I don't like this approach because, I too like the similarity of target date funds in 401k and don't want to re balance these, as they are typically my largest portfolio.

2. Use a bucketed approach. This is certainly not tax efficient, but for small amounts this is okay I guess. For investing in the taxable account, think of number you need, say about 50,000 you need in 5-7 years. This can be invested in a allocation 50% stock and 50% bonds. A fairly standard conservative portfolio. Then once your taxable balance goes beyond the 50k number, then invest only in stocks after. You can use two accounts 2 if needed. This way that 50k can be used for expenses that might be lumpy. Then you refill this again after you have taken money out of it. this way you don't sacrifice gains, if you never use this money.

Hopefully this makes sense, but ask for any clarifications.
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Re: How to invest for unknown, lumpy future expenses

Post by ruralavalon »

Ken-Sheridan wrote: Thu May 06, 2021 2:14 pm Thank you again for your thoughtful replies and for helping me understand how to use the forum appropriately!

I updated the original post with information about our investments. I included as much info as I was comfortable posting online. If this is insufficient and people are unable to weigh in, I completely understand. In any case, I'm very grateful for the helpful information I've received!
Because all of your accounts are tax-advantaged, it's fine to use target date funds in all accounts. State Street target date funds are excellent choices for you.

Tax-efficiency doesn't come into play at all unless you have a taxable brokerage account, which you don't.

I still suggest making maximum annual contributions to both Roth IRAs as the top account funding prioity.

I still suggest contributions to the 401ks as a priority ahead of contributions to a taxable brokerage account, and making contributions to a taxable brokerage account only if first making the maximum annual employee contributions to both 401k accounts.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started
Topic Author
Ken-Sheridan
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Re: How to invest for unknown, lumpy future expenses

Post by Ken-Sheridan »

ruralavalon wrote: Thu May 06, 2021 2:38 pm Because all of your accounts are tax-advantaged, it's fine to use target date funds in all accounts. State Street target date funds are excellent choices for you.

Tax-efficiency doesn't come into play at all unless you have a taxable brokerage account, which you don't.

I still suggest making maximum annual contributions to both Roth IRAs as the top account funding prioity.

I still suggest contributions to the 401ks as a priority ahead of contributions to a taxable brokerage account, and making contributions to a taxable brokerage account only if first making the maximum annual employee contributions to both 401k accounts.
Thank you! This really helps with prioritizing. Good to know that the State Street funds are good ones, too.
Last edited by Ken-Sheridan on Thu May 06, 2021 5:36 pm, edited 1 time in total.
Topic Author
Ken-Sheridan
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Re: How to invest for unknown, lumpy future expenses

Post by Ken-Sheridan »

lazyinvestor30 wrote: Thu May 06, 2021 2:30 pm
There are many different strategies one can follow. I have grappled with this issue for a while and I ended up with Option 2 below.

1. Consider everything as 1 asset allocation and re balance accordingly when things change. I get the allure of this approach. But sometimes in reality of 401k accounts not being flexible, user friendly etc, this might be a problem. I don't like this approach because, I too like the similarity of target date funds in 401k and don't want to re balance these, as they are typically my largest portfolio.

2. Use a bucketed approach. This is certainly not tax efficient, but for small amounts this is okay I guess. For investing in the taxable account, think of number you need, say about 50,000 you need in 5-7 years. This can be invested in a allocation 50% stock and 50% bonds. A fairly standard conservative portfolio. Then once your taxable balance goes beyond the 50k number, then invest only in stocks after. You can use two accounts 2 if needed. This way that 50k can be used for expenses that might be lumpy. Then you refill this again after you have taken money out of it. this way you don't sacrifice gains, if you never use this money.

Hopefully this makes sense, but ask for any clarifications.
This is very helpful insight on the taxable-account side of things. Thank you!
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