Age 24: How should I allocate my excess cash flow?

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Moranall
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Joined: Mon Jul 22, 2013 2:31 am

Age 24: How should I allocate my excess cash flow?

Post by Moranall » Sun Jul 28, 2013 8:05 pm

Emergency funds: ~$10k (~5 months or so; additional support if needed from parents)
Debt: Student loans, car (see below)
Tax Filing Status: Single, no kids
Tax Rate: 25% Federal, 4.24% State ($67,500 income)
State of Residence: AZ
Age: 24
Monthly expenses: ~$2-2.2k/month after rent/utilities (excluding loans)
Monthly income: ~$3.7k/month

Investments:
Taxable: $4,700
Trad IRA: $1,700
Roth IRA: $1,300
HSA: $1,500/year
New 401k: 8%

I graduated last December with a BSE in aerospace engineering and started my first 'professional' job in January. I just started up my 401k this month (currently at 8% which is max employer match; should have started in January but was 'waiting' until I got my company match in September). I have debt as follows:

Student loans:
$24,600 @ 6.8% (fed)
$4,460 @ 5.6% (fed)
$6,600 @ 5.0% (private)
$5,450 @ 4.5% (fed)
$5,450 @ 3.4% (fed)
$6,000 @ 2.0% (private)

Car loan:
$17,100 @ 0% for 5 years ($10,700 left, $290/month)

Credit Cards:
I have 3 credit cards with various rewards, but I have not paid interest on a credit card in at least 3 years (as far back as I could see). I use my credit card for virtually everything and pay it off each month.


So far this year, paid off the interest on the loans (about $4,000) to prevent capitalization and made another $2,500 in payments before my repayment period began this month. My current monthly payments are now $105 for my two private loans and $440 for my private loans.

Over the past 6 months, I've spent about $2-2.2k per month for all my expenses. I live pretty modestly (rent a house with two friends: ~$550 after rent + utilities) and primarily spend my money on food and gas. My girlfriend just moved to California for a 6-month job and my expenses have gone down quite a bit over the last three weeks since she moved. Here is how my cash flow currently looks:


$3,700 (income) - $2,200 (expenses) - $550 (student loans) - $290 (car) = $660 excess cash flow.


My question is where should I be directing that excess cash? Should I be directing 100% of it to my high-interest student loans? Should I increase my 401k, IRA, or HSA contributions? Other?

My take is that I should be primarily focusing on my student loans. While it's nice to avoid taxes, I don't think I should really look into increasing my 401k, yet. I've used several online calculators and using conservative criteria (assuming ~3% salary increase per yer, inflation = 3%, average return = 6%), my 401k 'floor' appears to be a little over $2,000,000 when I hit 65. I'm young, so I have a long time to increase my contributions if necessary. I'm also unsure if I really need to put anything into my IRAs right now (they are both rollovers from prior 401k). One of my goals is to develop a large individual investment fund for wealth in my 30s and 40s. But right now, what should I focus on?

Stonebr
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Re: Age 24: How should I allocate my excess cash flow?

Post by Stonebr » Sun Jul 28, 2013 8:11 pm

All in all, you are in pretty good shape. My recommendation is to get out of debt, stay out of debt, live below your means, and save and invest like crazy.
"have more than thou showest, | speak less than thou knowest" -- The Fool in King Lear

Mudpuppy
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Re: Age 24: How should I allocate my excess cash flow?

Post by Mudpuppy » Mon Jul 29, 2013 2:18 am

You didn't say if the private student loans are fixed or variable rate loans. If they are variable rate, I'd get rid of them now before rates go higher, starting with the one currently at 5%. Then start chipping away at the 6.8% loan.

Moranall
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Re: Age 24: How should I allocate my excess cash flow?

Post by Moranall » Mon Jul 29, 2013 3:26 am

Ah, good catch. Everything is fixed rate.

monocle
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Re: Age 24: How should I allocate my excess cash flow?

Post by monocle » Mon Jul 29, 2013 7:48 am

Sell the car. Buy a one for under 10,000.
Then put your excess 660 and 290 car payment on the student loans.
Pay off your loans in about 2 years.

NoVa Lurker
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Re: Age 24: How should I allocate my excess cash flow?

Post by NoVa Lurker » Mon Jul 29, 2013 8:51 am

OP, I like your approach for the most part. Congrats on the job and relatively modest expenses. A few questions for you to consider:

1. Any chance you will go back to school, or are you planning to work indefinitely? If you might go back to school, there are a number of different considerations (e.g., having a bigger cash buffer vs. qualifying for more financial aid, depending on the degree).

2. You mentioned the long-distance girlfriend. You are still young, but do you envision marriage, a house, and/or kids eventually? A big mistake that very thoughtful, hard-working people make in their 20s is to put money into retirement accounts and pay off (relatively low-interest) school loans, but then keep almost no liquid savings for expenses that will likely arise in their late 20s / early 30s. Even worse, many people think they have a long investment horizon, so they invest their taxable liquid funds in stocks - then the stock market can tank right when they would want to use the money (for a home downpayment, wedding, long-distance move, etc.) Think about your 10-year horizon, and make sure that your financial planning incorporates that.

3. Do you consider yourself a disciplined person? Can you sock a bunch of money in a taxable account and not be tempted to spend it?

4. Can you consolidate the school loans? There might not be much financial benefit, if they are all already fixed rate, but at least it will be a little easier to keep track of the payments.

No matter what your answers are above, contributing up to the employer match in the 401k is a must. Make sure to keep doing that. I would target maxing out your 401k by age 27 or 28 unless you plan to go back to school.

You are still in a relatively low tax bracket and will probably be in a higher tax bracket later, so I would consider a Roth 401k for the next few years (but at $8k/yr, it honestly doesn't make a ton of difference vs. a traditional 401k).

The school loans are fairly burdensome at over $50k, and you will be much happier when they are repaid. But depending on your answers to #2 and #3 above, I would suggest using about half your excess cash flow to prepay the student loans, and use the other half to build up a bit more "emergency funds." These would not really be emergency funds, but more like "life funds," so that you have more flexibility in the future for anything, whether that's moving to California and changing jobs, going back to school, buying a home, etc. If you might not be disciplined enough to let that money build up without spending it, or if you would feel psychologically better about getting rid of the student loans ASAP, then it seems best to attack the student loans.

Personally, I attacked my student loans in my 20s, and I was happy with that, but it might have been smarter if I held back a little more liquidity instead of repaying student loans at 2% when 30-yr mortgages were at 6%.

exeunt
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Re: Age 24: How should I allocate my excess cash flow?

Post by exeunt » Mon Jul 29, 2013 10:12 am

Focus on getting out of that 6.8% loan (although you may luck out and Congress may eventually reduce the rate on it).

MoonOrb
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Re: Age 24: How should I allocate my excess cash flow?

Post by MoonOrb » Mon Jul 29, 2013 10:15 am

My choice would be to max out a Roth IRA and then devote anything additional to your 401k. Only then would I start paying off the debt. Allowing your investments to grow on a tax-deferred basis is of enormous value--the reason to put money into a 401k is not simply because it reduces your current tax burden.

An exception may be if you want to own a home: there's an advantage to reducing your debt to income ratio so you qualify for financing. (On the other hand, you'd also need to save up lots of money for a down payment, too, and since you didn't mention this, I'm guessing it's not in the foreseeable future).

Also, you mention this idea that you can just "catch up" by investing later in your 30s and 40s. While this is sort of true, the enormous impact of compound interest means you'll have to invest a lot more later in life to get the same return you'd get by investing a smaller amount now.

So, a back of the envelope hypothetical based on the idea of waiting until you're in your 30s or 40s to catch up. Let's assume that you invest the $660/mo today for the next 13 years (until age 37). We'll assume an average return of 6% for the purpose of this hypothetical. If, after 13 years you completely stopped investing that $660, by the time you reached age 65, you'd have about $830k. In order to achieve that same $830k by starting to invest when you were 37, you'd have to invest $950/mo, every month, for 28 years. So, you could achieve the same amount at age 65 with about 2/3 of the monthly investment for less than half the time. This is obviously just a rough example and is meant to illustrate only the value of investing what you can as early as possible rather than using "I can catch up later" as a reason to make some other choice.

On the topic of paying down debt, one other thing to think about is that often people discuss paying down debt as earning some kind of return equal to the interest rate. This is true in a theoretical sense, but you only truly capture the full value of this return if, when your debt is paid off, you turn around and devote the entire amount you were paying on your debt to investing. So in this sense it's a behaviorial issue, not just a financial issue. When you pay off your debt, your net worth is higher, but instead of having an investment that's growing, what you have is a larger income stream. If you don't take all of that income stream and then invest it, you sort of fritter away some of the benefit of having paid down the debt early. And a final note on this: by paying down the student loan debt, you give up an above the line tax deduction, so the "return" on your debt paydown is slightly less than just your interest rate.

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greg24
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Re: Age 24: How should I allocate my excess cash flow?

Post by greg24 » Mon Jul 29, 2013 10:23 am

I would increase 401k contributions. Every additional dollar you put in your 401k, you save 29 cents in taxes. Your highest student loan at 6.8% is very small in comparison.

playtothebeat
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Re: Age 24: How should I allocate my excess cash flow?

Post by playtothebeat » Mon Jul 29, 2013 10:30 am

When you said your living expenses are $2000-2200/month, before any debt, and you live in AZ, I assumed you have a mortgage (figured you might view everything other than your mortgage as "debt"). However, I kept reading and saw you rent a house, and pay only about $550/month. What do you spend the other $1500 on? Seems like a huge amount for "spending" when you're 24, especially if that number does not include your student loans or car loan. I'm trying to think back to when I was 24 (only 3 years ago..), while living in Los Angeles (far more expensive than AZ), i think my overall expenses for rent/utilities/bills/entertainment (so, before student loans) were around $2200/month, and my share of the 2br apartment I rented with a friend was $1250/month before any utilities.

playtothebeat
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Location: southern california

Re: Age 24: How should I allocate my excess cash flow?

Post by playtothebeat » Mon Jul 29, 2013 10:33 am

greg24 wrote:I would increase 401k contributions. Every additional dollar you put in your 401k, you save 29 cents in taxes. Your highest student loan at 6.8% is very small in comparison.
6.8% student loan interest means its a guaranteed return of 6.8% on your money. The S&P 500 has returned 6.7% since 1850 (adjusted for inflation and dividends). You'll still have to pay taxes on your 401 at some point when you start drawing on it.

Batousai
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Re: Age 24: How should I allocate my excess cash flow?

Post by Batousai » Mon Jul 29, 2013 10:49 am

Start at the top of your student loan debt and work your way down. If you want to pay off the 3.4% and 2.% loans is debatable, but the 5%+ is pretty clear cut. There are some small tax advantages that you probably won't be able to take advantage of for student loan debt that might make you delay paying off the sub 5% loans, but that's a question that can wait 5 years.

Live modestly and be happy. Saving is a lot like dieting, starvation plans rarely work long term and generally lead to splurging.

You've gotten your match from your 401K which is smart.

Now it's time to go play work politics well and get some good raises (note, that's not the same thing as doing hard work, or even good work).

Moranall
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Re: Age 24: How should I allocate my excess cash flow?

Post by Moranall » Mon Jul 29, 2013 11:27 am

playtothebeat wrote:When you said your living expenses are $2000-2200/month, before any debt, and you live in AZ, I assumed you have a mortgage (figured you might view everything other than your mortgage as "debt"). However, I kept reading and saw you rent a house, and pay only about $550/month. What do you spend the other $1500 on? Seems like a huge amount for "spending" when you're 24, especially if that number does not include your student loans or car loan. I'm trying to think back to when I was 24 (only 3 years ago..), while living in Los Angeles (far more expensive than AZ), i think my overall expenses for rent/utilities/bills/entertainment (so, before student loans) were around $2200/month, and my share of the 2br apartment I rented with a friend was $1250/month before any utilities.
I was curious on this too. Chase doesn't have any tools to see how your spending on your credit card so I was just using my reward points (which are deposited once/month) to determine how much I was spending (which includes everything except rent and my student/car loans). Turns out that was over-estimating.

First, I was including all of the utilities when I only pay a third. So that saves ~$400 a month right there from my monthly expenses. And I get bonus points from a variety of sources and it was adding up. I signed up for Mint, which worked wonders in tracking my expenses.

Here's a better look at my expenses from June:
$400 rent
$845 dining/groceries (including a few nice places with my GF for her last month in town)
$190 utilties
$308 gas + insurance
$247 entertainment

That's about $2,000 right there excluding debt, but that was also my most expensive month of the year, primarily due to spending my last month with my girlfriend. I'm not eating out nearly as much this month and my food/dining is down to about $450 this month. Entertainment is down to $150. Girls are expensive! But I'm looking around closer to $1500 per month now. The only expense that is really bad anymore is the fact that I eat at my work cafeteria everyday ($8-10/day). I could save money by bringing a lunch. But food is essentially my vice and the cafeteria is a good way to get away. That will be a hard habit to break.


PS: To the other posters - thanks for the replies. I'm certainly absorbing your information. I'll try to reply to you when I get a longer break, this just stood out to me.

5buffalo
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Re: Age 24: How should I allocate my excess cash flow?

Post by 5buffalo » Mon Jul 29, 2013 9:21 pm

You are still young, but do you envision marriage, a house, and/or kids eventually? A big mistake that very thoughtful, hard-working people make in their 20s is to put money into retirement accounts and pay off (relatively low-interest) school loans, but then keep almost no liquid savings for expenses that will likely arise in their late 20s / early 30s. Even worse, many people think they have a long investment horizon, so they invest their taxable liquid funds in stocks - then the stock market can tank right when they would want to use the money (for a home downpayment, wedding, long-distance move, etc.) Think about your 10-year horizon, and make sure that your financial planning incorporates that.
I have struggled with this question as well- thanks for putting it in such concise and clear terms. So much advice out there is geared towards always maxing out your tax-advantaged/retirement savings, but as a young investor you have to think about reasons you might need the money sooner and provide for those possibilities too.

I can't speak to the debt as I was very fortunate not to have any, but after receiving some similar advice myself, I ended up reducing my 401k contributions, maxing out my Roth IRA contributions, keeping my cash emergency fund as is, and putting all excess towards taxable investing (at a lower AA than my retirement investing).

The Roth IRA is advantageous both for tax reasons and because you can withdraw your contributions without penalty, useful as a "plan c" if you are uncertain about your exact financial future.

I know this doesn't fully answer your question, but in the event that it might help to know what another young investor is doing, there you go.

Mudpuppy
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Re: Age 24: How should I allocate my excess cash flow?

Post by Mudpuppy » Mon Jul 29, 2013 10:42 pm

Moranall wrote:That's about $2,000 right there excluding debt, but that was also my most expensive month of the year, primarily due to spending my last month with my girlfriend. I'm not eating out nearly as much this month and my food/dining is down to about $450 this month. Entertainment is down to $150. Girls are expensive! But I'm looking around closer to $1500 per month now. The only expense that is really bad anymore is the fact that I eat at my work cafeteria everyday ($8-10/day). I could save money by bringing a lunch. But food is essentially my vice and the cafeteria is a good way to get away. That will be a hard habit to break.
Do you have a microwave and fridge available at work? I find bringing frozen leftovers to work to be a great way to make the lunch packing a quick experience in the morning. I'm so used to the routine, I accidentally grabbed a frozen lunch this morning, even though I had a business lunch scheduled. It helps to have a lunch waiting in the fridge that is tastier than all the options around work. As for getting away during lunch, there's nothing saying you have to eat your leftovers at your desk. Reheat them and head to another part of the building to eat. Depending on the cafeteria policies, you might even be able to snag a table down there to eat. In a different area, I'd say you could also eat outside, but that probably isn't fun in AZ in the summer, heh.

island
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Re: Age 24: How should I allocate my excess cash flow?

Post by island » Mon Jul 29, 2013 10:55 pm

I'd concentrate on getting rid of the high interest loans

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BL
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Re: Age 24: How should I allocate my excess cash flow?

Post by BL » Tue Jul 30, 2013 12:14 am

How about putting yourself on a financial diet while your girlfriend is gone and really attack the loans with everything possible! You also need to come up with a balance of spending vs saving/paying loans when she gets back. If she likes to spend lots of money, that may mean you are not compatible or you are both going to suffer the consequences later when you still owe lots and have low retirement funds.

Moranall
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Re: Age 24: How should I allocate my excess cash flow?

Post by Moranall » Wed Jul 31, 2013 5:20 pm

Thanks to everyone for the replies. I think we got a bit sidetracked into my expenses versus what I should be doing with my extra cash. As it stands, I don't think my expenses are out of hand and my girlfriend isn't expensive at all (just one month after her graduation, essentially). I'm sure there's room for improvement but it's not my focus right now. I've thought about buying a house, but I decided on drastically knocking out my loans first. I'm also not sure where I'll be job-wise in three years (I might be making my first career hop at that point and don't want to be tied down to Phoenix), so the house is going to wait. I'm not going to get married or think of marriage for several years. I'm also ruling out paying off or selling my car for several reasons.

So, with that out of the way, where should I go? I'm pretty much stuck between putting all my extra money into student loans or bumping up savings a bit and then putting the rest into my loans.

Currently, I'm thinking of putting more into my savings (401k, IRA, etc) and then using the rest to my loans. I feel it'll help me get 'used' to saving a higher percentage of my paycheck and establish a better saving habit going forward. And of course, the power of compound interest.

But instead of upping my 401k beyond the 8% required for employer match, I'm thinking of putting any additional money into my Roth IRA. Here's why:

1) (I might be wrong on this) I can just setup an automatic deposit from my checking to my E*TRADE account (where my Roth IRA is) to automatically deposit XX amount every paycheck, instead of using my employer's automatic Roth IRA option. This will give me access to a HUGE selection of funds (including, but not limited to, the Vanguard family of index funds).

2) Take advantage of my current tax bracket (25%)

3) I could also use it as a pseudo savings account. I can withdraw any contributions I make tax-free, so if I decide to buy a house later down the road, I can always pull from here if needed.

Thoughts?

MoonOrb
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Re: Age 24: How should I allocate my excess cash flow?

Post by MoonOrb » Wed Jul 31, 2013 5:36 pm

This is a good plan: 401k up to match, Roth IRA, max out 401k. Beyond that your choices are basically pay off loans/taxable investing account. I'd probably pay off the higher interest loans.

awval999
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Re: Age 24: How should I allocate my excess cash flow?

Post by awval999 » Wed Jul 31, 2013 6:00 pm

Spend the excess to drive/fly to Cali once a month to see the girlfriend.

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