In the past three months or so I have drastically changed the way that I view money. It has been a great experience learning about investing, compounding interest, and spending money efficiently. Each investment listed below will summarize its benefits and the order of importance we place on each. Recently, I have read many articles from personal finance bloggers. The most influential have been Mr. Money Mustache, Jim Collins, and Mike and Lauren. Many of the articles and videos on those sites talk about investing. All of the authors are slightly different in their focus and stage in life. I recommend them heartily, especially the Stock Series from Jim Collins.
I wanted to share our family’s approach to finances after receiving the information from the aforementioned sources. Some of it will be specific to us, so try to keep the following in mind:
- We are a one income family with three young kids and a house.
- What works for us may not work for you – but it certainly could. Evaluate your investments and financial habits with a critical eye to make sure you are doing what you want with your money.
- We are out of debt except for our mortgage payment, and that payment will be done before our eldest child reaches college.
- You should evaluate your financial situation before adopting any advice given here. I don’t have any investment credentials.
- I did not stay at a Holiday Inn Express last night.
So after reading many articles on those sites, my wife and I have concluded the following represent our current investment priorities.
Spend (a lot) less than we earn
This is the first step that enables all of the other ones. If we were not spending less than we earn, then we would be going into debt and that would suck. Mr. Money Mustache (MMM) has a blog post that explains how simple the math is to retire early. Increasing your savings rate does two significant things for you. First, it increases the amount of money you can save every month. Seems simple. Second, it reduces the amount of money you need in order to make your house run. If you can cut your household expenses and only spend money where you want to spend money (instead of out of habit, more on this later) then you don’t need to have as large of a pile of money to support your life in retirement.
We are working towards a sustainable 50% savings rate. That would enable us to retire on our investments in less than 16 years if we were starting from zero. It has been easy increasing our savings rate in the past few months and more will be coming on the simple ways in which we did that.
Obtain (or maintain) a 4-6 months emergency fund in cash
The place we keep our emergency fund right now is Capital One 360. I’ve had an account there since before we got married. This emergency fund is crucial because it is like debt insurance. If something comes up, you can pay for the unexpected expense from the emergency fund instead of charging it to a credit card.
We prioritize our investments in the following ways. You may think this approach is less than optimal. I am always open to hearing new perspectives and changing our approach given compelling new information. Here is the high level overview of our investment priorities before I expand on each item:
- 401(k) with company match
- Health Savings Account (HSA)
- Max Roth IRA contributions
- Max 457 plan contributions
- Max 401(k) contributions
- 529 accounts
401(k) with company match
My employer offers a 50% match up to 3% (I have to put in 6% to get 3%). This is a great employee benefit that is sometimes overlooked. 3% compounded over 25-35 years turns into a huge amount of money. It is free money and you should take advantage of it if your employer offers something similar. Evaluate the options for your 401(k). They can range wildly from expensive mutual funds with large fees to excellent Vanguard index funds with extremely low expense ratios. Our money is split 90/10 in VINIX/VBTLX. The expense ratios for both of these funds are less than ten basis points, preventing us from paying large amounts of money in fees over the lifetime of the fund. Contribution level at this step: 6% pre-tax income.
Health Savings Account (HSA)
The HSA can be used to pay for out of pocket medical expenses (including some like glasses or dental work) that you incur provided you have deposited money into an account beforehand. This money can go in pre or post tax, but the smart money goes in pre-tax. After your account gets to a certain amount, you are able to invest money in the stock market. We have yet to get to this level yet, but when we are able to, we will invest in Vanguard index funds, namely VTSAX.
Also, you don’t have to take the money out to pay for your medical expenses right away. You can save your receipt for years in order to keep your money investing in the stock market. If after many years you decide you need to withdraw money from the HSA, you can withdrawn all of the money you originally qualified for without taxes. At age 65, the HSA behaves like a traditional IRA. Very cool. Maximum annual contribution: $6,750 pre-tax
Max Roth IRA contributions
We chose to use the Roth IRA since our income level (you have to have less than $183K/annual income if married filing jointly) permits and the contributions will grow tax free. All “Roth” means is you are paying for your investment using after-tax dollars. The location we chose to put this money is with Vanguard. The index fund we put all of the money in is VTSAX, the total stock market index fund from Vanguard. This fund provides instant diversification as you are investing in nearly every single publicly traded company in the US stock market. Index funds maximize rewards for their investors while simplifying investing. Our 100% stock asset allocation is aggressive, but we have a few decades before we will be concerned about retiring. Maximum annual contribution: $5,500 post-tax for each of us (Mary and me).
Max 457 plan contributions
The 457 plan is available to municipal employees and is better than the 401(k) plan in many ways. Primarily, the 457 plan can be accessed before age 59.5 without an IRS penalty. New changes to the laws governing 401(k) programs can permit some employees to access the 401(k) before 59.5 as well. Now, this isn’t a winning strategy for investing long term, but if you are interested in early retirement or simply want to be able to withdraw the money in the event of a life emergency that exceeds your emergency fund, putting the money into the 457 is the plan for you. The money goes in pre-tax and it is taxed as regular income when it is withdrawn. Our investments are in the same VINIX/VBLTX 90/10 split stated above. Maximum annual contribution: $18,000.
Max 401(k) contributions
Invest additional funds into our 401(k) until we reach the annual maximum contribution: $18,000.
That’s right! You can save $18,000 pre-tax for each the 401(k) and the 457! That is a huge benefit.
In lieu of a taxable investing account, we will add money to the 529 accounts we have established for our kids. These accounts enable post-tax dollars to be invested. Any appreciation can be used tax-free for qualified educational expenses. This is the last of our priorities as we can always borrow money to help the girls pay for school later on; however, no one will help us pay for our retirement. Additionally, we plan to have more disposable income after our mortgage is paid off. Fortunately, this will coincide with the beginning of college.
Each one of these accounts/arrangements could be written about exhaustively, but this will serve as an investing primer for later discussion.
What are your investing priorities? Let me know in the comments below!