Today we have a question from Greg. His household income increased greatly over the last two years and he has some questions. I’ll try my best, but I don’t have any experience with this level of income. My advice might not be on target so I’d love some help from everyone.
My wife is a physician who finished residency a year and a half ago. Her salary has increased 700%. I have also doubled my salary in the last 4 years. Our total income now stands at about $450k – $500k annually (depending on bonuses). We have paid off all student debt and only have a car loan because interest rates are so low.
Here are my questions:
We bought a house 3 months ago to make sure that we got locked in before interest rates increase. House cost $670k and we locked in 15 year loan @ 2.5% (we were able to put 20% down). Based on our income, did we overspend?
(Joe) The rule of thumb is to spend less than 30% of your monthly income on housing. It looks like you’re way below that. The price of the home seems very reasonable for your income as well. I don’t think you overspend.
Retirement – I have maxed my 401k ($18k + 8% match = $27k) and my wife is able to contribute $50k in her account totaling $77k a year in retirement. Too much or too little saved? Other retirement avenues? We make too much for Roth IRA.
(Joe) That is a really good start, but I think you should save more. Saving more will help keep your lifestyle in check and it will make a big difference in the long run due to compound interest.
One way to save a little more for retirement is to use the “back door” Roth IRA. Basically, you contribute to a traditional IRA and then convert it to Roth IRA. The limit is only $5,500 per year so it is not much extra saving.
Another option is to open a taxable brokerage account and invest there separately. You can earmark that account for retirement.
Have you checked with your employer to see if you can contribute after-tax dollars to your 401k? That would be a great option if it’s available in your 401k.
529 for our son – we contribute $6k to account annually (can only write off $4k in state taxes). If amount doesn’t cover total college, will pay the rest in after-tax accounts. Too much, too little?
(Joe) You might want to consider front-loading this account. The 529 plan’s distribution (withdrawal) will be tax-free if you use it for qualified expenses. If you save a larger amount up front, you’ll benefit more from the compounding effect.
We contributed extra to RB40Jr’s 529 for the first few years. Our kid will be 5 in 2016 and his account is worth around $45,000 currently. I’m trying to reach $50,000 and then ratchet back to around $4,000 per year.
After tax investments – we put all of our extra money in the last 18 months towards my wife’s med school debt ($200k) and a down payment for a house to lock in an interest rate before they potentially go up ($150k), so we are pretty much starting from scratch (worked out, however, since the school loan was 6% and I am not aware of many investments that did better than that from late 2014 – 2015). Right now I have budgeted about 20% of take home pay to after tax investments. This will yield $50k in contributions annually. Too much, too little? Investment allocation strategies?
(Joe) Congratulations on paying off your debt in such a short time. That’s a fantastic accomplishment! Great job locking in a nice rate, too.
$50,000 is great, but you were able to pay off $200,000 in 18 months. Can’t you just switch from paying debt to investing? It seems like your saving rate is going to be reduced quite a bit. I guess you have more expenses now due to the house and kid. I would try to save a bit more than 20%. Is it possible to save 30%?
Asset allocation can be a bit tricky. You never know how much risk tolerance you have until you go through a few stomach churning bear markets. You can check out my asset allocation post. I listed some sites that can help you figure out your asset allocation. You should also consider hiring a good fee-only financial advisor. They should be able to help you come up with a personalized investment strategy.
The most important thing to remember is to keep investing. Don’t panic sell when the market drops.
Emergency fund – how much? In what type of account (do you consider invested money emergency fund)?
(Joe) If your jobs are very stable, then 3 months of expenses probably would be plenty. I’d keep that in a regular saving account. You need to be able to access your emergency fund easily.
In my opinion, we have done well in fighting off lifestyle inflation (paying off all debts & no other large purchases other than home) and want to continue down that path without hoarding money just for the sake of hoarding money. After all of the above has been setup, we are still about $7k in the black each month.
Thanks in advance for any insight.
(Joe) Great job on holding off lifestyle inflation. That’s probably the most difficult challenge you will face over the next few years. People tend to ramp up their lifestyle too quickly when they start making better income. Your household income is fantastic so you need to be extra vigilant.
I would invest as much as you can right now to take advantage of compound interest. The earlier you invest, the better off you’ll be in the future. I know it’s been a long road for you to get to this point, but consider investing more while you’re still relatively young. You didn’t mention your age, but I assume you’re in your early/mid 30s.
Also, you didn’t indicate your net worth, but I assume it’s probably not that high because you mentioned starting from scratch earlier. At this point, you’re way ahead of your age group in income, but probably behind on net worth. I’d focus on building up your net worth for a few years and then ease up on the saving rate. Good luck!
What’s your advice to Greg? Do you think he should save more or am I being too hard on him?
A little more info from Greg
Age – early 30s.
Long term goals – Greg prefer to retire in his mid 40s, maybe in about 15 years. His wife probably will continue to work in some capacity. They plan to have 2 kids.
Current net worth – About $350,000. That’s pretty good for their age. Their net worth should increase tremendously over the next 15 years.
Image credit: by Håkan Dahlström
For 2018, Joe plans to diversify his passive income by investing in US heartland real estate through RealtyShares. He has 3 rental units in Portland and he believes the local market is getting overpriced.
Joe highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help every investor analyze their portfolio and plan for retirement.
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