Compounding Interest vs. Mortgage

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Hube4
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Joined: Wed Jul 10, 2019 5:05 pm

Compounding Interest vs. Mortgage

Post by Hube4 » Wed Jul 10, 2019 5:16 pm

Hi,
I am 23 and new to investing. I contribute 15% of my income to my 401K, have a 6 month emergency fund, have no debts, and rent an apartment. I have been focused on building up my emergency fund, but now that I have it, I'm thinking it might be worth trying to max out my 401K (Roth) and maybe also getting a Roth IRA. I have about $1600 extra every month (after tax). My goal is to save up for my next car when my current one dies (which I'm hoping won't be any time soon) and to save up for a down payment on a house (total around $50,000). Should I be maxing out my 401K and IRA first (because compounding interest is magical and I don't mind renting for a while) or should I save up for the house before diving too deep into tax sheltered investing? Or should I do a combination? Maybe max out 401K while saving up for the house and add on the Roth IRA later if I am able to?
Any advice would help!

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Watty
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Re: Compounding Interest vs. Mortgage

Post by Watty » Wed Jul 10, 2019 6:46 pm

You will get better responses if you post your information using this suggested format as a guideline.

viewtopic.php?f=1&t=6212

dbr
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Re: Compounding Interest vs. Mortgage

Post by dbr » Wed Jul 10, 2019 7:01 pm

These things are really up to you. I have to read between the lines to sense your real priorities but I would say your chnoice really is to max your 401k and your Roth IRA rather than jumping into a house. Is owning your own home a compelling want for you at this point? You should absolutely be sure you are contributing enough to the 401k to get all the match if there is one. You might note that you can take $10,000 from a Roth IRA at any age for a first time home purchase, so you can start there for sure.

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grabiner
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Re: Compounding Interest vs. Mortgage

Post by grabiner » Wed Jul 10, 2019 9:19 pm

Welcome to the forum!

You should definitely max out your Roth IRA, because you can take contributions out of the Roth IRA tax-free and penalty-free at any time (and another $10,000 of earnings if you have had the Roth IRA for at least five years and you use it to buy a house). This makes the Roth IRA better than taxable investment.

But it's probably best to keep your car fund outside your 401(k) (as long as you get the full employer match). You aren't really losing out on the ability to invest money in the 401(k) by doing this; by avoiding the car loan, you can contribute money to the 401(k) that would otherwise have gone to car payments.

The house is a different issue. A house is not a good investment, but it may be a good thing to buy because of your own housing preferences. You don't invest to make dollars; you invest to have money to spend, and a house is something which is often worth spending that money on, as long as you can handle the costs.
Wiki David Grabiner

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FiveK
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Re: Compounding Interest vs. Mortgage

Post by FiveK » Wed Jul 10, 2019 11:25 pm

See Investment Order for some generic suggestions.

For the specific question about a down payment, as it says there, "It is up to you whether to consider "saving for a house down payment" as a "day to day expense", vs. lumping the down payment savings in with "taxable investments" at the end."

JJP88
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Re: Compounding Interest vs. Mortgage

Post by JJP88 » Thu Jul 11, 2019 9:05 am

Without more specifics like how much your income is and the dollar amount going into your 401k, this will be more general advice.

Biggest fact is you have $19,200 a year to put towards savings/investments, this is on top of 15% 401 k contribution (I assume there is an employer match of some sort). I don’t know the exact amount going into your 401k, but my guess is it is substantial.

Your goal options
Max Roth (6k)
Max 401k
Save for next car (???)
Save for downpayment (50 k)

What I would do if I were you:

Max Roth: You have a time window each year to contribute to this investment vehicle, if you have the ability do this. Especially since you have a 6 month emergency fund. Once the tax year closes, a person loses out on the opportunity to put that money away,

Start a car fund: Figure out what vehicle you would replace your current car with, and the price of that car. You say your current vehicle is in great shape and plan on driving it for a long time. Let us just say you plan on driving that car for another 5 years or so, you want to have the dollar amount of that car put away by then. So set a % of your savings each month towards that purpose, and by the end of year 5 you will not have to take out an auto loan etc. Also think of this as a car maintenance fund. Put this money in a seperate high yield savins vehicle, in either a separate account or add to your emergency fund.

Bump your emergency fund up to a year: This is more of a personal preference, but I like security and like having a year’s savings put away just in case. You have plenty of saving to put a % each month towards this.

A fun account: You are 23 and put some money aside to have fun with, such as hobbies and vacations.

House Downpayment: Create a separate account away from your emergency fund, possibly even a brokerage account if you do not plan on getting a home in the next 5-10 years. Put a % away each month to reach 50k by the time you are thinking you are ready to buy a home.

Put rest towards 401k: I put this last on the list because you are already contributing 15% 401k and have put 6k into a Roth (if you choose to follow my advice).

Without knowing exact numbers, your goals, and when you hope to retire this is just general advice.

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Nate79
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Re: Compounding Interest vs. Mortgage

Post by Nate79 » Thu Jul 11, 2019 9:47 am

Hube4 wrote:
Wed Jul 10, 2019 5:16 pm
Hi,
I am 23 and new to investing. I contribute 15% of my income to my 401K, have a 6 month emergency fund, have no debts, and rent an apartment. I have been focused on building up my emergency fund, but now that I have it, I'm thinking it might be worth trying to max out my 401K (Roth) and maybe also getting a Roth IRA. I have about $1600 extra every month (after tax). My goal is to save up for my next car when my current one dies (which I'm hoping won't be any time soon) and to save up for a down payment on a house (total around $50,000). Should I be maxing out my 401K and IRA first (because compounding interest is magical and I don't mind renting for a while) or should I save up for the house before diving too deep into tax sheltered investing? Or should I do a combination? Maybe max out 401K while saving up for the house and add on the Roth IRA later if I am able to?
Any advice would help!
Unless the money in your retirement accounts are actually in savings accounts or CD's then there is no "compounding interest" in your investments. I hope you understand the difference between a savings account that pays interest vs investments that grow thanks to growth in the underlying businesses, they pay out dividends, etc.

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grabiner
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Re: Compounding Interest vs. Mortgage

Post by grabiner » Thu Jul 11, 2019 1:29 pm

Nate79 wrote:
Thu Jul 11, 2019 9:47 am
Unless the money in your retirement accounts are actually in savings accounts or CD's then there is no "compounding interest" in your investments. I hope you understand the difference between a savings account that pays interest vs investments that grow thanks to growth in the underlying businesses, they pay out dividends, etc.
While there is no compounding of interest, it is still the case that returns compound, which works to your advantage. If you invest in a stock fund which returns 8% annually, $10,000 in two years becomes $11,664, not $11,600, and the account doubles in value in nine years.

(Conversely, compounding interest on liabilities works to your disadvantage, which is why it may be desirable to save money in order to avoid taking out a car loan.)
Wiki David Grabiner

bloom2708
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Re: Compounding Interest vs. Mortgage

Post by bloom2708 » Thu Jul 11, 2019 1:56 pm

You should max your pre-tax 401k and Roth IRA. Then, use tax savings (State + Fed) to save for the down payment.

If your marginal tax bracket is 22% and state is 6%, deferring the tax means your paycheck is 28% more (28% of the $19k). Use that to fund your $6k Roth IRA and/or House Down Payment.
"We are not here to agree with you; we are here to provoke thoughtfulness." Unknown Boglehead

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FiveK
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Re: Compounding Interest vs. Mortgage

Post by FiveK » Thu Jul 11, 2019 4:50 pm

bloom2708 wrote:
Thu Jul 11, 2019 1:56 pm
You should max your pre-tax 401k and Roth IRA. Then, use tax savings (State + Fed) to save for the down payment.

If your marginal tax bracket is 22% and state is 6%, deferring the tax means your paycheck is 28% more (28% of the $19k). Use that to fund your $6k Roth IRA and/or House Down Payment.
The sentiment is good. Do need to be clear on "compared with what?"

E.g., assume AGI with no 401k contribution is $75K, and state tax is assessed on federal AGI. Take home pay would be
75000 gross
-4650 Soc. Sec.
-1088 Medicare
-9675 Federal
-4500 State
55087

After contributing $19K to a 401k, take home pay would be
56000 gross
-4650 Soc. Sec.
-1088 Medicare
-5495 Federal
-3360 State
41407

The take home pay is actually ~25% less, so one can't "use that to fund" anything.

If the comparison is vs. a Roth 401k, the take home from that would be 55087 - 19000 = 36087. That is 5320 (28% of the $19K) less than with a traditional 401k.

tesuzuki2002
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Re: Compounding Interest vs. Mortgage

Post by tesuzuki2002 » Thu Jul 11, 2019 4:54 pm

Hube4 wrote:
Wed Jul 10, 2019 5:16 pm
Hi,
I am 23 and new to investing. I contribute 15% of my income to my 401K, have a 6 month emergency fund, have no debts, and rent an apartment. I have been focused on building up my emergency fund, but now that I have it, I'm thinking it might be worth trying to max out my 401K (Roth) and maybe also getting a Roth IRA. I have about $1600 extra every month (after tax). My goal is to save up for my next car when my current one dies (which I'm hoping won't be any time soon) and to save up for a down payment on a house (total around $50,000). Should I be maxing out my 401K and IRA first (because compounding interest is magical and I don't mind renting for a while) or should I save up for the house before diving too deep into tax sheltered investing? Or should I do a combination? Maybe max out 401K while saving up for the house and add on the Roth IRA later if I am able to?
Any advice would help!
Savings rate is KEY especially early on in your career.. I wished I would have saved another $30-40K in my mid 20s... But Instead I bought a house.... so it's a balance. I'm 37 and have a paid for home... but My investments could have another $150K in them had I invested that money in the market 15 years ago...

I personally do a mix of both investing and including property as part of my over all investing..

MotoTrojan
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Re: Compounding Interest vs. Mortgage

Post by MotoTrojan » Thu Jul 11, 2019 5:07 pm

If you can save enough to max a Roth IRA and Roth 401k you should likely be considering traditional 401k contributions.

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