Today we have an email from Chris. His household is making a nice income and he’s wondering if there is anything he could do to improve his personal finances. Let’s see if we can help him with some useful advice.
My age: 31
Wife’s age: 29
Total take home gross salary of ~$125K. Sometimes we get extra income from a bonus but I do not like to include that in my planning numbers.
Currently investing per year
- $32,000 going intopre-tax accounts (max 401K for me plus a 3% match and about 14K for wife. The 3% match is not in this number)
- $11,000 total into two Roth accounts
- $140,000 in long term investments
- $25,000 in short term investments likeCDs and a Bond
- $100,000 in checking/savings (I know, this is a lot in checking/savings – That’s why we are here looking for help!)
- Owe about $103,000 on our house that is worth around $180,000. Have a low interest 15 yr mortgage with 9 years left on it
- No other debt – We did have quite a bit of school debt after we both went back and got our master’s. But thankfully we finished paying that off last year around this time.
- $3,700/month – Includes the extra $200 we pay on the mortgage
- This will need to increase as we are just about to have our first child
- We track everything dollar coming in and out
So right now with our vehicles, and deducting taxes for the long term investments, our net worth is around $350,000.
Long term, we are hoping to retire by 50. We would love to retire earlier so looking forward to some feedback. As far as income at retirement goes – I’m really not sure. We don’t plan on having a big expensive house or anything, but we would like to travel and golf, etc. Also want to be in a position to pay for the kids college, etc. We plan to have two kids.
So looking for thoughts on how we are doing number one and some other ideas of what to do next. I feel like the long term investments we are doing OK on, but if we retire at 50, we won’t be able to touch any of that money until 59.5. Unless of course we take out the Roth principal or if we want to pay the tax penalty, which we definitely don’t want to do. We are not planning on doing a 529 plan for the child, but that’s because I am still not sold on them since they are for education only. But then again, we are already maxed in Roth and heavy in checking/savings where we are earning basically nothing in interest. Also I feel like the monthly budget is high, but have a hard time getting the number down. We donate a decent amount each month, then groceries do get a bit expensive since we try to buy mostly fresh items.
Live in the Midwest, Great Lakes region. Cost of living is much lower compared to the west coast.
First of all, congratulation on paying off your student loan debts and establishing a great foundation with your personal finance. I think you are doing really well and just need a few little tweaks. Great job on tracking your cash flow too. I think that’s the first step to mastering your finance. Here are my recommendations.
Max out your wife’s 401k
I sent Chris a follow up email and he said his wife is reluctant to increase her 401k contribution because she makes about $40,000 per year. Actually, that’s all the more reason to increase her 401k contribution. She is making less so she needs to save more while she can. I would try to convince her to increase her contribution. It will help reduce their tax liability too.
Come up with a cash deployment plan.
I can see that Chris wants to invest some of his cash position. I think that’s way too much cash to hold at this age. They need to invest while they are young so they can take full advantage of compound interest. Chris needs to come up with a methodical plan for this volatile stock market. Here is an example.
- Keep $20,000 in cash.
- Invest $30,000 by dollar cost averaging over 12 months.
- Invest $10,000 if S&P 500 index drops 10%.
- Invest additional $10,000 if S&P 500 index drops 20%.
- Invest additional $10,000 if S&P 500 index drops 30%.
- Invest additional $10,000 if S&P 500 index drops 40%.
- Invest additional $10,000 if S&P 500 index drops 50%.
This is just an example and Chris should come up with something he is comfortable with. It’s probably a good idea to stick with low cost index funds for the bulk of this. Also, he should figure out his target asset allocation.
Chris and his wife have 20 years to work on their passive income so I think they are in a great position. I think they should invest in the stock market and consider rental properties. With 20 years left, I’d say invest in stock that you can hold for the long term. Holding stock for the long term will minimize their tax liability. Once they get near retirement, they can convert some of those to dividend paying stocks and high yield bonds to help fund early retirement.
Chris also should try being a landlord and see if he is good at it. Maybe when they move, they can rent out their old home and see if it works out. If he is not cut out to be a landlord, he can sell and move the money to REIT or stock.
Early Retirement withdrawal option
Here is an option that Chris might now know about. Early retirees can access their retirement funds without paying the penalty by using the IRS rule 72(t). This could be a good option if their retirement accounts are in a really good shape when they’re 50. There are some downsides, though. If he retires at 50 and use rule 72(t) to access his retirement fund, he would need to keep withdrawing every year until he is 59.5. I think this is a good way to convert your retirement account to the taxable side because you won’t have to pay much tax after you take early retirement. I have not done this so everyone will need to keep reading until I try it. (Maybe in 14 years or so…)
Extra payment on mortgage
It’s always a good thing to pay down your loan. However, I would consider putting that $200/month toward his wife’s 401k instead. It’s probably not worth making extra payments if the interest rate is low.
Congratulations on your first child! Life will be totally different very soon. Your cost of living will increase, but you will get some extra tax benefit too. Lifestyle inflation is inevitable, but try to minimize it. I think you are doing great so far and retiring in 20 years is a good possibility. You just need to keep saving and investing. Good luck!
Do you have any advice for Chris and his wife?