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401(k) vs Investing - Where to put extra money?

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Kinaen
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401(k) vs Investing - Where to put extra money?  Reply with quote  

First time poster here. I'm hoping I can get some good advice on this subject... I've posted some background information near the end of the post in case it's necessary.

So here is my question:
Would it be wise to reduce what I'm contributing to my 401(k) pre-tax (by any amount down to 8%) and direct that into stocks as long as I have a buy and hold strategy (perhaps 5-10 year timeline)? The obvious issue here is the difference in gains between the tax-deferred 401(k) and the performance of the after-tax investment amount.

I would normally just adjust my allocations in my 401(k), but my interests are a bit more specialized than what it offers. One of the funds I have my eye on is an index fund that tracks companies that produce smart phone components, which is where I'd put at least 80% of this extra money, possibly 95%. I'd put the rest in one or two individual companies.

I expect to have a comfortable retirement at my current contribution level, even with modest market gains. So much so that I wonder if I'm focusing too much on retirement and not enough on the time until then.

Background:
I'm in my mid 30's, so I probably have another 35 years until SS kicks in (with medicine advancing at the current rate, I expect the retirement age to conservatively be somewhere around 70-72 by the late 2040's).

My wife is a student, and I'm employed full time at Boeing.

We have 6 months expenses saved, pay our credit cards off in full every month and have 1 loan outstanding for roughly $10k, on which we're making extra payments every month.

No kids (but maybe soon). We currently rent, but would like to get a house as soon as we save up the monstrous amount of 10-20% here in the Seattle market.

My 401(k) balance is very healthy. Given the peer-comparison feature our company's 401(k) manager provides, I seem to be managing my fund very well. I contribute 15% pre-tax, mostly in low-maintenance index funds, and no more than 5% in company stock. They match 75% of the first 8% I contribute (so 6% basically).
Post Wed Jul 17, 2013 9:32 pm
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clydewolf
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Re: 401(k) vs Investing - Where to put extra money?  Reply with quote  

quote:
Originally posted by Kinaen
First time poster here. I'm hoping I can get some good advice on this subject... I've posted some background information near the end of the post in case it's necessary.

So here is my question:
Would it be wise to reduce what I'm contributing to my 401(k) pre-tax (by any amount down to 8%) and direct that into stocks as long as I have a buy and hold strategy (perhaps 5-10 year timeline)? The obvious issue here is the difference in gains between the tax-deferred 401(k) and the performance of the after-tax investment amount.

I would normally just adjust my allocations in my 401(k), but my interests are a bit more specialized than what it offers. One of the funds I have my eye on is an index fund that tracks companies that produce smart phone components, which is where I'd put at least 80% of this extra money, possibly 95%. I'd put the rest in one or two individual companies.

I expect to have a comfortable retirement at my current contribution level, even with modest market gains. So much so that I wonder if I'm focusing too much on retirement and not enough on the time until then.

Background:
I'm in my mid 30's, so I probably have another 35 years until SS kicks in (with medicine advancing at the current rate, I expect the retirement age to conservatively be somewhere around 70-72 by the late 2040's).

My wife is a student, and I'm employed full time at Boeing.

We have 6 months expenses saved, pay our credit cards off in full every month and have 1 loan outstanding for roughly $10k, on which we're making extra payments every month.

No kids (but maybe soon). We currently rent, but would like to get a house as soon as we save up the monstrous amount of 10-20% here in the Seattle market.

My 401(k) balance is very healthy. Given the peer-comparison feature our company's 401(k) manager provides, I seem to be managing my fund very well. I contribute 15% pre-tax, mostly in low-maintenance index funds, and no more than 5% in company stock. They match 75% of the first 8% I contribute (so 6% basically).

I do not see any reason for you to invest outside of your 401k. Keep contributing at your current rate. The index funds are really OK.

Sector investing is risky, especially if you are going to stay in one sector. Even if you decide to switch sectors, you must have a trigger when to switch and move to the next sector which is???

When you have extra money put that in a savings account for down payment on your home. Aim for 20% or more for your down payment. Remember that when you become a home owner there are additional expenses that are now included in your rent.

And when you have a family, there are still more expenses.

You are doing well, keep at what you are doing.
Post Thu Jul 18, 2013 12:42 am
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oldguy
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quote:
and direct that into stocks as long as I have a buy and hold strategy (perhaps 5-10 year timeline)?


Yes - but, from an investor viewpoint, buy & hold is about 30 yrs. The most successful of the past generation accumulated incrementally and never sold - ie, never tried to time the market. The corallary is that the clients that tried to sell into dips and "wait for the market to recover to get back in" were the train wrecks, they were in that 5 to 10 yr range.

quote:
The obvious issue here is the difference in gains between the tax-deferred 401(k) and the performance of the after-tax investment amount.


Maybe not so much difference. I normally used 11%/yr products for all three tax-type accounts - taxable, pretax, posttax. I consider return to be the key point - a million is a million no matter what accounts you keep it in. And all 3 accounts are taxed, some at the back end, some at the front end, some at both ends.

quote:
I have my eye on is an index fund that tracks companies that produce smart phone components, which is where I'd put at least 80% of this extra money, possibly 95%. I'd put the rest in one or two individual companies.


I think of the SP500 as a representative of the broadest market, those 500 corporations have all of the world sectors and contain 80% of the US capital market. Most any sectors/stocks are selected form that population of 500 - so ultimately, given enough time, the returns tend to revert to the mean. Ie, they all get about 11%/yr even tho a sector may excel for a decade, then fail for a decade. If that is close to true, then when you narrow your focus from the Index to a Sector, you are taking an uncompensated risk, ie, you are risking sector failure but getting the same 11%. And if you further narrow your focus to one individual company, you add the risk of a corporate failure only to get the same return, more uncompensated risk.
Risk & return are directly proportional, you need risk - but not uncompensated risk.

quote:
1 loan outstanding for roughly $10k, on which we're making extra payments every month.


Why prepay - is it a bad rate?

I like your thoughts on SS, I think you are correct. But I hear many 20 & 30-somethings whining becasue they will neer collect - seems short-sighted to me.

If your 21% 401k investing is around $20k/yr and you use an 11% index, that's $4.4M in 30 years. (You are probably over-limit for Roths). But a taxable fund is a good idea, you need some non-59 1/2 money that is immediately available for your family (a good fallback EF so that 6 months EF can be cut back to $5K).

Since 90% of your family wealth will be in your >$4M portfolio some day, that is the priority. Eg, you don't want to derail a $4M plan to make a big down payment on a house - or prepay a $10,000 note. Very Happy
Post Thu Jul 18, 2013 12:45 am
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coaster
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Re: 401(k) vs Investing - Where to put extra money?  Reply with quote  

quote:
Originally posted by Kinaen
One of the funds I have my eye on is an index fund that tracks companies that produce smart phone components, which is where I'd put at least 80% of this extra money, possibly 95%. I'd put the rest in one or two individual companies..

That's an awfully narrow index; you may as well invest in an individual company in that sector if a sector allocation is your purpose. 10 percent of your total portfolio in one sector is probably more than enough. My opinion.

~Tim~
Post Thu Jul 18, 2013 4:18 am
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Kinaen
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Thanks for the advice.

I'm getting around 7% for the loan I'm paying atm. In my mind, paying that down faster is (in a way) like getting 7% ROI, but maybe that's not exactly true...

That's a good point about the S&P, but I'm not convinced it will outperform the smartphone sector. I have more of my holdings in the S&P in my 401(k) than anything else (with an international market index a close second). If I had to pick just one fund to buy and hold for 30 years, S&P would be it, but I wonder if I should expand a bit...

The smart phone index fund I'm looking at is FONE. I don't see smart phones as a fad, and I don't see any reason why demand would drop (what else would replace it?) so shouldn't it be an ok mid-term investment vehicle for a housing down-payment? I realize when you're saving for something in the near to mid future that it's a good idea to have stability, but do you all view an index fund in this sector as high-risk?

I would absolutely like to save 20% (and if I could, I'd save 100%), because I despise the thought of paying PMI and despise even more paying someone else to use their money. Is it true that 80% of a mortgage payment for the first 5 years goes to interest?

However, 20% in this market is easily 70k, which isn't easy to pony up on a single income household. I think 10% would be a reasonable goal, and use anything over that to have the flexibility to make extra payments, or for all the stuff a house needs that apartments don't, like lawn equipment, unforeseeable repairs, etc.
Post Thu Jul 18, 2013 3:26 pm
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oldguy
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quote:
because I despise the thought of paying PMI and despise even more paying someone else to use their money. Is it true that 80% of a mortgage payment for the first 5 years goes to interest?


'Despise'? lol - OK - but it is better to use math instead of emotion when investing. Eg, with our rental houses, I often refi and remove equity. Say I take out $50k. That costs about $300/m, ie $108,000 total, $58k for the use of that capital. I place the $50k in an 11%/yr fund for 30 years and grow it to $1,100,000. So, for me, I'm happy to pay $58k to rent that capital. In fact, US mortgage loans are nearly the cheapest capital in the world, all other nations require resets at around 10 yrs, the US is the only nation where Joe Sixpac can wander into a bank , ask for $200,000, ask for a 4% fixed rate, ask for 30 years guaranteed, and walk out with the loan.


FYI - with a $100k 4% 30 yr loan, the Remaining Balance at Y5 is $90,447. so, of your $28,644 payments, $9553 went to principal & $19091 went to interest. So it looks like about 67% of your paymewnts goes to interest. (But the 80% number is probably correct for some interest rate). The total 30-yr interest cost is $71,870.

quote:
but I'm not convinced it will outperform the smartphone sector.


Nor am I. But the difference is - I don't care. I became wealthy after I QUIT trying to beat the market and learned to make money IN the market. In fact, it was liberating to grasp that - all those individual stocks, sectors, options, covered calls, short sales, corn futures, that was a lot of work for a tiny (if any) return.

In your case, I would be careful not to derail your $4 million wealth-building core plan. If you divert income stream to avoiding PMI, loan interest, prepaying small loans, playing w/ 'flyers', yada, the 'end game' cost could easily be 6 figures.

quote:
I'm getting around 7% for the loan I'm paying atm. In my mind, paying that down faster is (in a way) like getting 7% ROI, but maybe that's not exactly true...


No, you have it right, it is like having a 7% CD. And that is probably a good choice. But it is close - I keep all <6% money and invest elsewhere. Your decision tree is - at my age, should I buy an X% CD (guaranteed) or should I add to my 11%/yr core wealth building. For me, when X =<6% I invest. But it's a personal call, lots of folks (seniors) want 3% returns. And young folks in their wealth-building years, need more risk, more return.
Post Thu Jul 18, 2013 5:22 pm
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littleroc02us
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Since your in your early 30's you easily have another 30 years to save for retirement. Look into Total stock index funds that track over 3k different American stocks. Since inception they have averaged around 8 to 9%. If you maxed out Roth IRA's for 30 years you'd have around 1.6 million tax free. I'd take that anyday.

Risk comes from not knowing what you're doing. (Warren Buffet)
Post Thu Jul 18, 2013 7:21 pm
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Kinaen
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quote:
Originally posted by oldguy
'Despise'? lol - OK - but it is better to use math instead of emotion when investing. Eg, with our rental houses, I often refi and remove equity. Say I take out $50k. That costs about $300/m, ie $108,000 total, $58k for the use of that capital. I place the $50k in an 11%/yr fund for 30 years and grow it to $1,100,000. So, for me, I'm happy to pay $58k to rent that capital. In fact, US mortgage loans are nearly the cheapest capital in the world, all other nations require resets at around 10 yrs, the US is the only nation where Joe Sixpac can wander into a bank , ask for $200,000, ask for a 4% fixed rate, ask for 30 years guaranteed, and walk out with the loan.


Very sound advice, and I suppose 'despise' is a bit too strong. Currently, I don't have anything to refi, unfortunately, otherwise I'd probably look to do the same as you. But wouldn't you agree that it's best to avoid paying interest when you can't use that money for something that gives a better return?

I wouldn't say I'm really trying to "beat" the market, at least in terms of day-trading or anything. My 401(k) plan has a tech fund, but the management fees are extremely high compared to the index funds I have (like 2.3% or something). I see it as a way to diversify.

I'm not planning to over-extend myself into this new sector. I'm going to start with maybe $500 and add whatever amount I would remove from my 401(k) contributions, which would probably only come to $50 a month or so.
Post Thu Jul 18, 2013 8:07 pm
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Kinaen
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quote:
Originally posted by littleroc02us
Since your in your early 30's you easily have another 30 years to save for retirement. Look into Total stock index funds that track over 3k different American stocks. Since inception they have averaged around 8 to 9%. If you maxed out Roth IRA's for 30 years you'd have around 1.6 million tax free. I'd take that anyday.


I agree. Although I have more in the S&P than anything else, my third largest holding is in the Russell 2000. It's been doing very well for quite some time, and a 3000 has probably performed just as well if not better.

Thanks, I'll consider this.
Post Thu Jul 18, 2013 8:10 pm
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Kinaen
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quote:
Originally posted by oldguy
quote:
The obvious issue here is the difference in gains between the tax-deferred 401(k) and the performance of the after-tax investment amount.


...a million is a million no matter what accounts you keep it in. And all 3 accounts are taxed, some at the back end, some at the front end, some at both ends.

But do you think one account will make that million faster? If I invest $1,000 pre-tax vs., say, $780 after tax, would that $1,000 leave me with more after taxes (assuming the same tax bracket in both situations)?
Post Thu Jul 18, 2013 8:15 pm
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oldguy
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quote:
But do you think one account will make that million faster? If I invest $1,000 pre-tax vs., say, $780 after tax, would that $1,000 leave me with more after taxes (assuming the same tax bracket in both situations)?


They are the same. Eg, say that they both grow by 100X. You have $100,000 in one account and $78,000 in the tax-free account. But you owe 22% on the $100,000 (you sell it over a few years to avoid jumping to a higher bracket) - $78,000 net.

quote:
I'm not planning to over-extend myself into this new sector. I'm going to start with maybe $500 and add whatever amount I would remove from my 401(k) contributions, which would probably only come to $50 a month or so.


That makes my point. You are comfortable putting 6-figure amounts into your core fund - but you have the good sense to limit the FONE Flyer to $500 (due to risk). So consider your goal - if you hit a home-run and double it you have a $1000, ie, almost no help to a $100,000 portfolio. Obviously you could invest $50,000 in FONE, then your home-run would be a major famly event - but so would losing $50,000 (and having your wife leave you).
Meanwhile, that $500 + $50/m for 30 years is $132,000 that you WON'T have in your 401k in 2043.

Ponder this - investing is very complex in theory but deceptively simple when reduced to practice. There are 1000s of books, programs, about investing, beating the market. The random walk theory, Elliot Waves, Fibonnaci Ratios, point and figure charting, cup & saucer, head and shoulder formations, PE ratio, PEG, call options, 'put' options, writing covered calls, stocastics, channeling, yada. But they all draw conclusions from history and extrapolate it to a 'like' situation in the future. But in truth tomorrow's market will happen due to something that happens tonite - and we don't know what it is. If the market could be predicted, one little book would be enough - except that the little book would be self-defeating. In practice, all you need is an index of the generic market and the patience to accept its return. IMO that's the surest way to your $4.4M.

And I'm surprised that so few people do it - from 6/1983 to 6/2013 the SP500 returned 10.54%/yr. So $20k/yr = $4,030,000. Most 30 yr-blocks return 11%/yr, the most recent one was a bit weak - but not a reason to declare failure either. Yet at the Fortune 500 company that I retired from, our 401k sign-up rate was barely 30% - and almost no one maxed it.
Post Thu Jul 18, 2013 9:29 pm
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Kinaen
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quote:
Originally posted by oldguy
They are the same. Eg, say that they both grow by 100X. You have $100,000 in one account and $78,000 in the tax-free account. But you owe 22% on the $100,000 (you sell it over a few years to avoid jumping to a higher bracket) - $78,000 net.


Great, thanks for that.

quote:
Originally posted by oldguy
That makes my point. You are comfortable putting 6-figure amounts into your core fund - but you have the good sense to limit the FONE Flyer to $500 (due to risk). So consider your goal - if you hit a home-run and double it you have a $1000, ie, almost no help to a $100,000 portfolio. Obviously you could invest $50,000 in FONE, then your home-run would be a major famly event - but so would losing $50,000 (and having your wife leave you).
Meanwhile, that $500 + $50/m for 30 years is $132,000 that you WON'T have in your 401k in 2043.


I can see your point. It's obviously not a large amount of money in comparison. However, that's money that would be available for other things like a down-payment on a house.

So how about this...

How much leeway do you all allow yourself to enjoy your current situation at the cost of a lower retirement account? Where/how do you strike a balance? At what point do you guys see your portfolio and say, "That's too much money for retirement. I'm going to hold back a little and enjoy myself a bit more."?
Post Thu Jul 18, 2013 10:23 pm
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oldguy
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quote:
How much leeway do you all allow yourself to enjoy your current situation at the cost of a lower retirement account? Where/how do you strike a balance? At what point do you guys see your portfolio and say, "That's too much money for retirement. I'm going to hold back a little and enjoy myself a bit more."?


If you build a plan that builds the wealth that you want to have, then you can enjoy spending the rest of your income stream, safe in the knowledge that you will have your $X million later.
Do that by identifying the goal and then backing into the required monthly invcestment & rate of return. Make that the family priority and then spend the rest.
Families often direct to income to bills and invest what is leftover at month-end - but that is alwasy zero - paycheck to paycheclk living. So do the opposite - invest first, live on what is left.

And think of the income stream as a finite amount that has to be directed somewhere. Eg, you can't suddenly save up for a new car w/o directing income from elsewhere. (like the down payment for a house). But should you commit your income to a 20% DP? Or buy the house with a minimal DP and direct your income to its highest and best use?

People often worry about saving for later vs having fun now - IMO the problem is usually misdirecting the income stream - with planning most families can do both.
Post Thu Jul 18, 2013 10:48 pm
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HerbertH
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Nice chain of conversation. I have been reading all the posts, and like what the Oldguy says: Invest first and live on what is left. Once you buy the house, you would learn to identify whether your investments are going perfect or need some more in that direction.
Post Mon Aug 19, 2013 12:18 pm
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