Good saver asks:
My husband and I have done a recent financial checkup and in the process realized it’s time to do more interesting things with our money than build up savings in a savings account. The question is what.
We are both gainfully employed and spend an obscene amount on childcare for our toddler. We hope there might be a second little one running around wrecking havoc in the next year…. (Well maybe not running yet… but you know…). My husband is in his early 40’s. I’m in my mid 30’s. We both have highly stable jobs.
We own a house in a good neighborhood. The loan was taken out at a good interest rate (4.5%) with a good solid downpayment (25%). It’s a 30 year mortgage and we plan to be here for the next 5-15 years. We have 6 mos emergency fund. We contribute to our employer’s 403(b) programs and take the match. With this combo we contribute about 15% of our salaries to retirement automatically. We can’t drop below that contribution rate and redistribute the money elsewhere. This acct currently totals around $160,000. We also have been contributing to my husband’s Roth for the last 4 years at the max allowable contribution. We’ve been aggressively saving and have had a couple relatives die and now have significant cash sitting around ($120,000).Now that we’ve met the obvious goals, we’re not sure what to do next — How do we find people to help us think about this in a smart way? Who (broker, financial planner, bank trust dept.?) do we interview? And what are the right questions to be asking at the interviews?Do we pay off the house first and foremost (a friend strongly advocates this)? Others argue that between the mortgage deduction and the low interest rate it’s not the best way to spend our next dollar. Do we put more into retirement savings specifically for the tax break or do we just invest and not set the money aside so particularly? Do we try to rebalance the retirement portfolios into different investment devices (and if so, how much into what devices?) Do we seek to do different things with the different pots of money we have? College savings or retirement?
I can’t tell whether or not 160K is enough saved for retirement at your ages. Play with online retirement calculators to see if you’ve saved “enough” or need to up that savings amount. 15% a year is the recommended amount, but it also assumes that you’ve been saving 15% a year the entire time. If you did graduate school of any kind, or didn’t max out, or started making much less money than you are now, or had really lousy investment timing, you might be behind. That would be the first thing to check, because it’s an easy answer. If you don’t have enough saved for retirement, put more in your tax-advantaged savings vehicles. You don’t need a financial planner to help you with that, just some internet calculators. (Though, of course, you shouldn’t just take advice from strangers on the internet– our standard disclaimer applies.)
4.5% isn’t low enough to make it obvious that you shouldn’t pre-pay the mortgage, but it’s not high enough to make it obvious that you should. So there’s no clear answer there either. One thing to note is that, unlike most other forms of debt, a dollar spent early in your mortgage is worth more than one later. You can play around with the GRS mortgage amortization spreadsheet to see how much different principal payments save you– that will put a dollar value on the benefit of mortgage pre-payment. Remember also that you can unlock some of that prepayment in the case of an emergency by re-amortizing your mortgage and lowering your required monthly payment. You can do this even in situations in which the stock market has crashed (so selling stocks is a bad idea) or the housing market has crashed (so refinancing or selling the house is out of the question).
We’ve never actually dealt with financial planners. #2’s significant other recently had a windfall and will be getting a recommendation for a financial planner from a trusted wealthy friend. Most of us don’t have trusted wealthy friends, however. I point people to Walter Updgrave’s advice whenever I’m asked this question. However, I add my own caution. Many financial planners are terrible people who just want to separate you from your money by recommending high cost mutual funds and other terrible investment vehicles. DO NOT stop by your local Edward Jones office to get advice. You really do want a fee-only certified financial planner who does not get any kick-backs from recommending you high-cost funds. Personally, I’d rather figure things out myself, possibly with the help of the Bogleheads forum (or their book), but I also have a PhD in economics and like dealing with money.
In general, we can’t tell you which saving/investment things to do first or in what order. That is going to depend a lot on your own goals and your own situation. How much of your children’s education do you plan on funding? How much financial aid are you thinking you’re going to get? How much do you like your jobs? Do you want to retire earlier or later? Do you want an upper-middle-class retirement or do you want to live a simpler life? Will you have a short-term need for funds outside of your emergency fund (ex. IVF, new cars, private school, sabbatical etc.)? Do you want to leave your own (monetary) legacy?
I can tell you what we’re doing. We’re prepaying the mortgage, but not just prepaying the mortgage (and we stopped doing this so much when DH was unemployed). We’re maxing out our tax-advantaged savings (we dropped this down to the required 12% when DH was unemployed), but I’m not sure we’re going to put money in the IRAs this year. We’re hoping that we’ll be in the income bracket that keeps us paying full-tuition at private colleges or universities for our kids, and we’re planning on covering the entire bill, so we’re putting $500/month away for each kid in their respective 529 plans. As I’ll talk about next month, we still have trouble figuring out what to do with extra money… it’s a nice problem to have, but not one with an obvious answer.
In terms of where to put your retirement savings– if you have access to Vanguard, then you have one stop shopping with their Target-Date funds. Pick a date, set, and forget. If you don’t have access to Vanguard, then the Boglehead forums are a good place to look for asset balance heuristics for your particular situation. You should be looking for a combination of low fees and the right diversification of risk for your planned retirement date and risk tolerance.
Don’t worry so much about the “best place” for the next dollar. The best place in hindsight is not going to necessarily be the place you think it is because none of us can predict the future. The best you can do is to make a lot of good choices. For us those good choices are never going to be best or worst because we’re doing a number of different things with our money. That’s the essence of diversification. We’re not going to win as big on the stock market as we could because we are pre-paying the mortgage. But we’re also not going to lose as much as we could for precisely the same reason. Are we getting the percentages “right”? Well, there’s really no wrong answers. We have enough places to tap short-term that we’ll be ok in a number of scenarios, but we’re also taking advantage of many of the tax-advantages to saving for retirement.
The bottom line though, is that an extra 120K in cash on top of your 6 month emergency fund is way too much. Put that somewhere soon! Each month you delay making a decision, you’re potentially losing more money than you would if you just randomly chose any one of your good suggestions for potential vehicles*. If it were me, I’d max out the retirement for this year (there’s still time to fund your 2013 Roth!), put some in a 529, maybe put some in taxable (Vanguard Index fund) stocks (because it sounds like you don’t have any, and taxable stocks are a nice secondary emergency fund), then put the remainder into the mortgage. If you don’t need a secondary emergency fund, then skip the taxable stocks in favor of the other options. Remember that the Roth can function as a secondary emergency fund just like taxable stocks can because you can withdraw the principal. That gives it a slight advantage over just taxable funds. But anything you choose from that list you gave is going to be better than sitting in savings.
*exception: 120K is probably too much to put into one kid’s 529 plan, depending on where you think they’ll go and if they’ll be eligible for financial aid.
Grumpy Readers, What advice do you have for Good Saver?