23 yr old needs some advice from the pros

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lastchance88
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23 yr old needs some advice from the pros

Post by lastchance88 » Fri Jun 08, 2012 3:33 pm

First some requested background info:

Emergency Funds: Yes, about 6 months worth (not included in percentages below)

Debt: None, 1 credit card that I pay off every month

Tax Filing Status: Single

Tax Rate: Federal 15%
State (PA) 3.07%

Age: 23

Desired Stock/Bond Allocation: 85/15

Desired Domestic/International Allocation: 70/30 (I just kind of picked this out of thin air, not at all set in stone)

Current Portfolio (just over $20k total):

Taxable: 60.5% ($12k)
Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX) – 47.5%
Vanguard Total International Stock Index Fund Investor Shares (VGTSX) – 13.0%

Roth IRA: 29.2% ($6k)
Vanguard Total Bond Market Index Fund Investor Shares (VBMFX) – 15.0%
Vanguard REIT Index Fund Investor Shares (VGSIX) – 14.2%

401k: 10.3% ($2k) (Currently in the moderately aggressive model, but am looking to get out of it so I have more flexibility. Pretty insignificant amounts in each but I’ll include anyway.)
Allianz AGIC Growth Admin (PGFAX) (1.06%) – 1.9%
American Funds EuroPacific Growth (REREX) (.85%) - 0.6%
Artisan Mid Cap Value Inv (ARTQX) (1.20%) – 0.4%
C.S. Mckee Small Cap Core Equity (12640L104) – 0.8%
Columbia Acorn Int’l Select (ACFFX) (1.25%) – 0.6%
Fed U.S. Gov’t Secs: 2-5 Year Trust (FIGTX) (.59%) – 0.8%
Ivy Mid Cap Growth Fund (WMGAX) (1.49%) – 0.4%
JPMorgan High Yield Fund (OHYAX) (1.16%) – 0.4%
PIMCO Total Return Fund (PTTAX) (.85%) – 0.9%
Putnam Equity Income Fund (PEYAX) (1.12%) – 1.8%
Vanguard 500 Index (VFINX) (.17%) – 1.7%

Other 401k Fund Options:
American Funds Money Market R4 (RADXX) (.43%)
Manning & Napier Pro Blend Extended Term (MNBAX) (1.09%)

New Annual Contributions:
Roth IRA: $5,000
401k: $5,040 (10% + 4% match)
Taxable: $5,000 (this is just a guess)


I certainly don’t make a whole lot of money, but I obviously plan to increase these amounts as my salary increases. Just something to keep in mind, in the somewhat near future (<5 years) I anticipate getting married and purchasing my first house. So having money available for those expenses is on my radar.

I guess the most pressing issue is what should I do with my 401k. A lot of those funds have fairly large fees (at least compared to the Vanguard fund), so I would imagine there is a better way to allocate. Suggestions?

My thought is to hold most or all of my bonds in my Roth, and then use the 401k and taxable account for stocks. I prefer not having to constantly re-allocate. I ended up adding the REIT fund (after much debate, couldn’t decide between that and small cap) in April to max out my contributions for the year but not throw off my 85/15ish allocation. Thoughts on this strategy?

Any other observations in general about my strategy/investments? I am completely open to help and suggestions.

Thanks in advance!

Ryan

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rdmayo21
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Re: 23 yr old needs some advice from the pros

Post by rdmayo21 » Fri Jun 08, 2012 4:22 pm

My suggestions:

1. Forget about taxable, since you can use 401k contributions for your first home purchase (I'm assuming this is your first).

2. For the 401k, put everything into the 500 fund.

Edit: I didn't account for penalties when withdrawing from 401k. Therefore, I suggest you keep what you currently have in taxable, but buy I-bonds from here on out.
Last edited by rdmayo21 on Wed Jun 13, 2012 9:19 am, edited 2 times in total.

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Kevin M
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Re: 23 yr old needs some advice from the pros

Post by Kevin M » Fri Jun 08, 2012 4:32 pm

I won't comment much on putting so much into taxable. If saving for a house down payment, this could make sense. Just make sure that if you hold stocks in taxable you plan to have 2X what you expect to need for the shorter-term goal, to account for a possible 50% drop in stocks.

I would use only Vanguard 500 Index (VFINX) in the 401k for now. Use taxable and IRA for international and fixed income, and possibly a small-cap or extended-market fund to get you more total US market exposure (in a ratio of 4:1, S&P500:small or extended market). There simply is no need to be spreading your relatively small 401k around all those expensive funds.

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Grt2bOutdoors
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Re: 23 yr old needs some advice from the pros

Post by Grt2bOutdoors » Fri Jun 08, 2012 4:35 pm

[quote="rdmayo21"]My suggestions:

1. Forget about taxable, since you can use 401k contributions for your first home purchase (I'm assuming this is your first).

I disagree with point #1 above - monies needed in 5 years or less for downpayment, emergency, what have you, should not be placed at risk. OP if you do as suggested and the market drops by 50%, are you willing to lose 50% of your downpayment and wait possibly years to recoup it? House money should be placed in CD's, stable value, short-term bond fund or cash (if yield is there - right now, there is no yield).

Other than that, agree with rdmayo, s&p 500 index is lowest er choice in the 401k plan.
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ruralavalon
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Re: 23 yr old needs some advice from the pros

Post by ruralavalon » Fri Jun 08, 2012 4:43 pm

Welcome to the forum :) .

The most important thing for you to do at the start is get your savings rate as high as you can comfortably maintain: please see -- http://www.bogleheads.org/forum/viewtop ... 1291908362 .

I agree, put all of your 401k in Vanguard 500 Index (VFINX) (.17%) .

You should be sure to contribute enough to the 401k to get the full match, before contributing to any other account. The match is free money, never turn down free money. When you say "4% match" exactly how is that computed? 4% of your salary whether you contribute or not? Match at xx cents on the dollar of your contribution up to 4% of your salary? If you contribute enough to get the full match, how much would you be contributing?

How much do you think you want to be setting aside for the house purchase in ~ 5 years?

You can add this data to your original post using the "edit" button.

You have done a good job of putting tax-efficient funds in the taxable account, and putting tax-INefficient funds in the Roth IRA.
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Watty
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Re: 23 yr old needs some advice from the pros

Post by Watty » Fri Jun 08, 2012 5:16 pm

One thing that I would add is to start up a separate car fund so that you will be able to pay cash for your next car(new or used). By making your "car payment" to yourself and always being able to pay cash for you next car you will save a lot over the next 40 years or so.

Be sure that you get a good balance in the "now vs later" decisions.

It looks like you are saving maybe 40% of your income which is great if you are still able to have enough to do some "fun" stuff. You are young, single, don't have any debt, don't have any kids, and are presumably in pretty good health. Even though your income might not be very high right now don't underestimate the value of the rest of your situation. You can do some things like modest travel right now that will be much more expensive later in your life if you are able to do them at all.

If you do things like stay in hostels, don't eat out a lot, and go in the shoulder season then it is possible to travel well on a very modest budget. I've done trips to Alaska and Europe this way and it is very doable without spending a lot. You might want to have something like $50 dollars out of each paycheck deposited into a separate travel fund, it will add up pretty quickly.

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Re: 23 yr old needs some advice from the pros

Post by Elbowman » Fri Jun 08, 2012 5:37 pm

Wow, a half dozen people beat me to "all of your 401k in the Vanguard 500". So instead of simply repeating, I'll add some numbers.

You say you want 85% in stocks. Of that, you want 70% domestic. When approximating the total stock market (highly recommended here) 80% of your domestic stocks go in the S&P 500. So 85% * 70% * 80% = 47.6%. So you can put about half your retirement portfolio in the Vanguard 500.

So, I think its OK to use the 1/3 401k, 1/3 Roth IRA, 1/3 taxable distribution you mentioned, for now. The 401k and Roth IRA you can devote to your retirement, with the 401k all in the Vanguard 500, and the Roth IRA in Vanguard Extended Market, Vanguard Total International Stock Market, and Vanguard Total Bond Market to round out your retirement. Then you can put your taxable into something more stable like CDs or short term tax exempt bond funds, and use the money there for your house down payment.

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RyeWhiskey
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Re: 23 yr old needs some advice from the pros

Post by RyeWhiskey » Fri Jun 08, 2012 6:21 pm

Greetings Ryan,

I'm only 3 years older than you with a similar (slightly larger) sum in my investments at the moment. My thoughts are as follows:

1. Everything in your 401k into the Vanguard S&P Index. It's vastly cheaper which will help you exponentially in the future. Also, if you can contribute more to the 401k to get more of a match, do so. As members have noted, free money is free money.
2. Your Roth ought to contain the funds necessary to round out your retirement portfolio: TBM (check), REIT (check), International Equity (currently in taxable), Extended Market Index (this compliments your S&P Index).
3. Your taxable should contain the funds you'll need in the near-future (you mentioned buying a house) in safer securities: I-Bonds (didn't see these mentioned yet), Short-Term Treasuries, CDs perhaps.
4. Save and maximize your contributions. 401K first, round out the Roth second (you can do this with some of the TSM funds if you wish, such as buying the extended market index VEXMX), then stock-pile the liquid assets last with all remaining funds.

This is basically what others have said, but it never hurts to hear it again. This plan gives you a great future retirement allocation of domestic stocks, international stocks, REITS, and fixed-income, and also allows you to save for your home purchase while keeping these funds secure and with less risk.

Note: There is an extended-market index offered in your 401K at a ridiculous 1.09% ER. Check out Vanguard's Index VEXMX instead at a cool 0.24% ER. You can later work this fund into your Roth and get the same thing for 0.85% less cost.
This post was brought to you by Vanguard Total World Stock Index (VTWSX/VT).

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Kevin M
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Re: 23 yr old needs some advice from the pros

Post by Kevin M » Fri Jun 08, 2012 6:38 pm

I'll just repeat that it's OK to own stocks in taxable for a shorter-term goal as long as you will have 2X what you need to meet the goal. If that's not the case, I would not hold stocks in taxable. If it is the case and stocks drop 50%, you sell, fund your goal, and buy stocks in your tax-advantaged accounts to restore your AA to its target. Of course you hold safe fixed-income investments in tax-advantaged accounts in the meantime that are essentially targeted for your short-term goal. Since money is fungible, it doesn't matter where you hold the safe fixed income as long as you'll have enough of whatever assets you hold in taxable to fund the goal.

Also, there's very little reason, other than convenience and liquidity, to hold treasuries (or any bond fund really) in an IRA when a good CD provides a much better return/risk tradeoff. You can get 2.4% on a 7-year PenFed CD and 1.9% on a 5-year CD. Comparable to TBM yield with no credit risk and minimal interest-rate risk (limited to the early withdrawal penalty). You can easily hold these in your IRA or in a taxable account. For something like a house down payment targeted for 5-7 years from now, why take any credit risk or interest rate risk if you don't have to?

I Bonds in taxable also are excellent for shorter-term goals (at least one year away), assuming you decide not to hold stocks in taxable.

Kevin
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Elbowman
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Re: 23 yr old needs some advice from the pros

Post by Elbowman » Fri Jun 08, 2012 8:43 pm

Kevin M wrote:If that's not the case, I would not hold stocks in taxable.
Its definitely true that, all else being equal, you don't want to invest your long term savings in taxable while you have unused tax advantaged space. But his proposed AA requires 52% in indices other than the Vanguard 500, and if it comes down to using one of his non-Vanguard 401(k) choices vs. holding a Vanguard fund in taxable, the later may be the better choice. I can't find it now :oops: , but just today I saw someone do the math showing that the Tax + ER of holding TISM in taxable was pretty low, perhaps < 0.4%, and definitely better than his 401(k) international stock choices. However, this does not account for the tax deduction (which is low in his case).

Not a sure thing, but something to consider.

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Re: 23 yr old needs some advice from the pros

Post by Bob's not my name » Sat Jun 09, 2012 5:16 am

rdmayo21 wrote:Forget about taxable, since you can use 401k contributions for your first home purchase
You can if your plan allows early withdrawals, but you'd still pay tax and penalty, so I don't understand this advice.

You can withdraw Roth IRA contributions for any purpose without penalty (or tax, since you paid the tax up front), and you can withdraw $10,000 of TIRA contributions and earnings penalty-free (but not tax-free) for a first home purchase. (Tax here means federal. PA treatment of retirement plans is unusual.)

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Re: 23 yr old needs some advice from the pros

Post by bdpb » Sat Jun 09, 2012 10:53 am

Bob's not my name wrote:
rdmayo21 wrote:Forget about taxable, since you can use 401k contributions for your first home purchase
You can if your plan allows early withdrawals, but you'd still pay tax and penalty, so I don't understand this advice.

You can withdraw Roth IRA contributions for any purpose without penalty (or tax, since you paid the tax up front), and you can withdraw $10,000 of TIRA contributions and earnings penalty-free (but not tax-free) for a first home purchase. (Tax here means federal. PA treatment of retirement plans is unusual.)
If you had no plans to use the Roth contributions for the down payment, then you should change your plan.
Since a Roth and a deductible 401k are tax adjusted equal, there is very little reason to favor Roth over deductible.
So, you should shift your 5k taxable into 401k (7k pre-tax) and allocate your Roth contributions as your house
down payment. You won't end up paying taxes on the down payment earnings.

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Re: 23 yr old needs some advice from the pros

Post by Bob's not my name » Sat Jun 09, 2012 11:57 am

bdpb wrote:5k taxable into 401k (7k pre-tax)
5.9k in his bracket. PA doesn't exempt 401k contributions, so the 3% state tax (and, in Philadlephia, 4% local tax) is not avoided.

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Kevin M
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Re: 23 yr old needs some advice from the pros

Post by Kevin M » Sat Jun 09, 2012 3:28 pm

Elbowman wrote:
Kevin M wrote:If that's not the case, I would not hold stocks in taxable.
Its definitely true that, all else being equal, you don't want to invest your long term savings in taxable while you have unused tax advantaged space. But his proposed AA requires 52% in indices other than the Vanguard 500, and if it comes down to using one of his non-Vanguard 401(k) choices vs. holding a Vanguard fund in taxable, the later may be the better choice. I can't find it now :oops: , but just today I saw someone do the math showing that the Tax + ER of holding TISM in taxable was pretty low, perhaps < 0.4%, and definitely better than his 401(k) international stock choices. However, this does not account for the tax deduction (which is low in his case).

Not a sure thing, but something to consider.
I'm not sure what your point is, since you quoted me out of context. The "if that's not the case" refers to anticipating that you will have at least 2X what you expect to need for the shorter-term goal. If that is the case, then I would consider holding stocks in taxable, since it is somewhat more tax efficient (at current low rates, and at the OP's low tax rates, tax-efficiency is less of a concern).

The main point is that I would not hold any stocks in taxable if I projected that I would have less than 2X what I expected to need to meet my shorter-term goal assuming 0% returns on stocks. It doesn't matter whether it's international stocks, US stocks, or any other kind of stocks. If you don't build in this cushion and stocks drop 50% shortly before the date of your intended purchase, you won't have the money to fund the purchase (unless you borrow from your 401k or withdraw the funds from one of your TA accounts).

For example, say I expected to need $50K in five years for some anticipated purchase. If I expected that I could save $100K in a taxable account while funding the 401k to maximize the match, and perhaps also maxing out my IRA, then I might consider holding stocks in taxable, and holding the safe fixed-income intended to fund the $50K purchase in tax-advantaged accounts (money is fungible). However, by doing so I'd be giving up the tax benefit and opportunity to grow my tax-advantaged space by making larger contributions to the 401k, so I'm not sure it would be such a good idea.

Now if you are able to borrow from your 401k, or expect to save enough in your Roth IRA to cover at least half of the shorter-term goal (or some combination of borrowing from 401k and withdrawing from Roth), then it still could make sense to hold stocks in taxable. Worst case (assuming 50% drop in stocks is worst case) you withdraw your Roth contributions tax and penalty free to cover the half the purchase, and sell your stocks (booking a loss you can deduct against $3K of ordinary income and carry forward the rest) to cover the other half.

Kevin
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Elbowman
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Re: 23 yr old needs some advice from the pros

Post by Elbowman » Sat Jun 09, 2012 9:53 pm

Kevin M wrote:I'm not sure what your point is, since you quoted me out of context.
Sorry about that. All I wanted to point out is that there is some point at which the ER of a bad 401k fund becomes so high that it negates the tax advantages of a 401k. If he is able to save enough that his Roth IRA is not large enough to contain his non-S&P 500 indices, this should be considered (just considered, perhaps not acted on) before he invests in the other funds in his 401k.

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Kevin M
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Re: 23 yr old needs some advice from the pros

Post by Kevin M » Sat Jun 09, 2012 10:42 pm

Elbowman wrote:
Kevin M wrote:I'm not sure what your point is, since you quoted me out of context.
Sorry about that. All I wanted to point out is that there is some point at which the ER of a bad 401k fund becomes so high that it negates the tax advantages of a 401k. If he is able to save enough that his Roth IRA is not large enough to contain his non-S&P 500 indices, this should be considered (just considered, perhaps not acted on) before he invests in the other funds in his 401k.
True, but I don't think that has anything to do with anything I've said; hence my confusion.

At this point the OP's 401k is so small relative to other accounts that holding only the S&P 500 index in it is pretty much a no-brainer. Some of the other choices in it aren't too bad, and I would use them before going to taxable (in general, if looking only at retirement savings). For example, American Funds EuroPacific Growth (REREX) is a common choice in 401k plans, and although the ER is a bit on the high side, this fund has tracked VG Total International quite closely over the last five years, has a fairly large number of holdings, and has fairly low turnover (relative to many other actively managed funds). I would use it for international in my retirement portfolio rather than give up the tax-advantaged space.

Kevin
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lastchance88
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Re: 23 yr old needs some advice from the pros

Post by lastchance88 » Mon Jun 11, 2012 9:22 pm

First of all, thank you to all who contributed. I’m frankly a little overwhelmed at how much you guys are willing to pour out to a complete stranger and newbie (poster at least) to the forum. It’s very much appreciated.

To start off, there were a lot of comments about the 401k match, so let me clarify: 100% match up to 4% of my salary, so at 10% I am not leaving any free money on the table. That was a no brainer from the beginning.

It’s pretty clear from all the replies that my entire 401k should be in the Vanguard S&P 500 fund. That’s what I figured, but I was a little concerned about throwing off the balance of my portfolio. And then there’s the issue of having money available for a down payment on a house within the next 5 years. So after reading all of the posts and carefully considering my options, this seems to be the leading option:

401k: 10.2% (2k)
Vanguard 500 Index

Roth IRA: 49.4% (10k)
Vanguard Total Bond Market Index Fund - 15.0%
Vanguard Total International Stock Index Fund - 19.4%
Vanguard Extended Market - 15.0%

Taxable: 40.4% (8k)
Some Total Stock Market to balance, rest in something safer like I-bonds, short term treasuries, etc.

It'll be a little heavily weighted toward extended market (3k minimum per fund), but it will slowly even out as 401k contributions build up. I was a little confused with the posts about moving money from taxable into 401k. I'm not too familiar with how that works, but it sounds like I would have to pay the 15% + 3% tax, even though it's already been taxed once? That doesn't sound too appealing, but maybe I've got that wrong.

I honestly have no clue how much I hope to have set aside for a house. I know the traditional downpayment is 20%, so maybe around 30k or so. But again, I haven't really thought much about that yet.

Obviously not everyone is going to agree on one solution, which is great, I love hearing different options even though it can be overwhelming. Thanks again to all who contributed and those who will continue the conversation.

One last note to Watty, I appreciate the point about traveling and having fun. Not to worry, I've spent many months of my life traveling abroad, and honestly I would gladly sacrifice some savings if/when more opportunities come along :D

Ryan

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Kevin M
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Re: 23 yr old needs some advice from the pros

Post by Kevin M » Tue Jun 12, 2012 9:28 am

Point on paying taxes on taxable account. No matter what you hold there, you will pay taxes. If you hold a bond fund or CDs, you pay taxes on the dividends/interest (and the cap gains tax on any increase in value in a bond fund). If you hold stocks, you pay taxes on dividends and cap gains, which generally are taxed at lower rates (at least at federal level), subject to possible changes in tax laws. The latter point is why holding stocks in taxable generally is more tax efficient.

Whatever you hold where, you should hold whatever you plan to save for house down payment in relatively safe fixed income; e.g., CDs, I Bonds, or a short-term bond fund. If you hold these in a tax-advantaged account and hold mostly stocks in taxable, just be sure to target having maybe 2X what you expect to need for the house down payment in taxable. Do you understand this point?

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lastchance88
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Re: 23 yr old needs some advice from the pros

Post by lastchance88 » Tue Jun 12, 2012 11:37 am

Kevin - Yes all of that makes sense, thank you. The only thing I'm a little confused about is when a couple people mentioned transferring taxable money into my 401k. How exactly does that work? (not that I'm necessarily going to do that, I just didn't even know it was an option)

Ryan

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Kevin M
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Re: 23 yr old needs some advice from the pros

Post by Kevin M » Tue Jun 12, 2012 6:03 pm

lastchance88 wrote:Kevin - Yes all of that makes sense, thank you. The only thing I'm a little confused about is when a couple people mentioned transferring taxable money into my 401k. How exactly does that work? (not that I'm necessarily going to do that, I just didn't even know it was an option)

Ryan
It's a "virtual" transfer. The idea is you can hold stocks in taxable, then when you sell the stocks to fund your short term goal, you buy a similar stock fund in your 401k (exchanging from the bond fund or stable value fund that you were holding in the 401k). This is what people mean when they say "money is fungible".

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Re: 23 yr old needs some advice from the pros

Post by Duckie » Tue Jun 12, 2012 7:09 pm

lastchance88 wrote:The only thing I'm a little confused about is when a couple people mentioned transferring taxable money into my 401k. How exactly does that work? (not that I'm necessarily going to do that, I just didn't even know it was an option)
Another interpretation of "transferring taxable money into my 401k" is that you raise your 401k contribution $7K for the calendar year (so each paycheck would be smaller) and use the taxable $5K to cover living expenses. This gets more money into a tax-sheltered plan and works as long as you aren't maxing your 401k already.

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Re: 23 yr old needs some advice from the pros

Post by ruralavalon » Tue Jun 12, 2012 8:49 pm

Money set aside for use in 5 years should not be invested in the stock market. It should be in investments unlikely to lose value, examples would be CDs of less than 5 years duration or good quality short-term bond funds. I use a short-term bond fund in my example.

You will want your down payment money in either the taxable account or the Roth, so that you can easily and rapidly get at it without tax penalty or tax liability when needed. Roth contributions, but not earnings, can be withdrawn at any time without penalty. Wiki article link: Roth IRA .

Bond funds are not very appropriate in a taxable account, as they are not very tax-efficient. Wiki article link: Principles of Tax-Efficient Fund Placement .

Here is a portfolio idea for you, which should accommodate your desire to accumulate money for a home down payment of about $20 -30k in about 5 years. Adding $5k/yr to the short-term bond fund in the Roth should put you at your goal for the down payment in about 5 years.

Taxable (61%; $12k; add $5k/yr.)
40% Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX), er = 0.18%
20% Vanguard Total International Stock Index Fund Investor Shares (VGTSX), er = 0.22%

Roth IRA (30%; $6k; add $5k/yr)
15%, Vanguard Total Bond Market Index Fund Investor Shares (VBMFX), er = 0.22%
15%, Vanguard Short-Term Investment-Grade Fund Investor Shares (VFSTX), er = 0.20% <= just an example, any Vanguard short-term bond fund would do

401k (10%; $2k; add $5k/yr)
10%, Vanguard 500 Index (VFINX) (.17%)

This should also give you approximately your desired asset allocation (with the addition of bond fund for the down payment), and requires relatively little change from what you currently have.

When the time comes for the home purchase, you can either: (1) take the down payment directly out of the bond funds in the Roth; or (2) take the down payment out of the equity funds in the taxable account, and then in the Roth exchange some bond funds for equity funds to get back to your desired asset allocation.

I hope that this helps.
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Re: 23 yr old needs some advice from the pros

Post by pingo » Fri Jun 15, 2012 4:39 pm

Kevin M wrote:If you hold stocks, you pay taxes on dividends and cap gains, which generally are taxed at lower rates (at least at federal level), subject to possible changes in tax laws. The latter point is why holding stocks in taxable generally is more tax efficient.
I don't know if this needs pointing out (and I doubt it changes anything), but I want to be sure it is mentioned that at the 15% tax bracket, one pays 0% taxes on capital gains, as I understand it—subject to possible changes in tax laws, as stated.

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