Asset allocation for a young investor

[Magnus357]

Hello everyone!

I graduated college last summer and began work this fall. My current goals are to save approximately 20% of my gross salary for retirement, which currently ~ $10,000/yr. I've opened a Roth IRA with eTrade and begun participating in my company's 401k program. My current plan is to max out my Roth then contribute 5% to my 401k because my company matches 100% of 5% in company stock with a five year vesting program.

Would it be to my advantage to place the remainder of the money I plan to save each year into my 401k, as pre-tax money, or into a regular mutual fund program where it would be more liquid? The other issue I have with my 401k is the limited investment options. A few options of each category of mutual funds and bonds are offered but no index fund options exist. I currently have an asset allocation of the following in my 401k:

50% - Large Cap
20% - International
20% - Mid Cap
10% - Small Cap

Because of the limited avaliablity of funds in my 401k account, the decision was relatively easy, but for my Roth IRA and other mutual fund accounts the decision is much harder. I know that I want to have a program based around low-cost no-load index funds that uses a buy and hold strategy with semi-aggressive investments. My time horizon is in the area of 30 years. What I don't know much about is what asset allocation would be good for me and what some quality funds are.

I understand most people do not like to divulge specific investment information, but if anyone has any suggestions I would greatly appreciate it.

 

[brewer12345]

I think your allocation is fine, and at your age I would probably put all I could into tax-deferred retirement accounts. However, you should probably take a close look at the expense ratios on the funds available in your 401k. If they are high (over 1%) you might be better off just putting the money in after-tax mutual funds that charge less (under 1/2%).

Aside from your retirement portfolio, you need to establish an "emergency fund" in liquid funds (savings account, CD with a nominal early withdrawal penalty, etc.). I would suggest that you build this up over time to 6 months' worth of living expenses. Whne the commode hits the windmill (and it will) you will be happy to have something to fall back on.

You might also consider what else you want to save for between now and retirement: house, car, etc.

 

[Ed_The_Gypsy]

Great plan, Magnus!

I am advising my kids to do much the same. Roths are a gift from God. Smart of you to shoot for 20%, too. It took me a lifetime to figure out that is what I should have been saving, which is why I am still working.

Your allocations look just fine. Expect downturns. They could last as long as ten years. These frightened me once. Now I have nerves of steel. Do not expect to have to rebalance often. I only do it once every 2 or 3 years. Best idea: put the new money into the down assets. Don't bother to sell one to buy another for many years yet.

Best of luck

Ed

 

[Marshac]

I would max out a roth account prior to maxing out a 401k. It's almost a given that taxes will be higher in the future, and the roth will shield you from that horrible future

 

[brewer12345]

I would max out a roth account prior to maxing out a 401k. It's almost a given that taxes will be higher in the future, and the roth will shield you from that horrible future

Unless we shift to a national sales tax...

 

[Magnus357]

I would max out a roth account prior to maxing out a 401k. It's almost a given that taxes will be higher in the future, and the roth will shield you from that horrible future

With my current plan, I will max out the Roth IRA and max out the 5% of my salary that my company matches 100% with about $4400 left to invest else where. I guess I need to run some number to find out if the tax savings with be worth it to place that extra captial into my 401k.

Could anyone recomend any books or informational website on buy and hold index fund investment stratagies?

 

[Ed_The_Gypsy]

www.coffeehouseinvestor.com

 

[BigMoneyJim]

Sounds like you're on the right track.

No specific advice here, but I'm wondering about 100% stock funds. I was ~100% stock funds for quite a while, but my current allocation target is 60/40 - 70/30 (for simplicity, leaving out complications with some international and REIT thrown in) and maintaining about that ratio throughout accumulation and withdrawals as opposed to mostly stocks early gradually transitioning to mostly bonds in withdrawal phase. (Disclosure: I think I'm still shy of my portfolio bond allocation target; partially due to a goof that overweighted REIT, partly to stock performance and partly to being gunshy on going more "conservative".)

 

[Dawg52]

I like your allocation as well. Having said that, it can be difficult to maintain an all stock  strategy during a tanking market. Easy for your emotions to take over. So.............you might want to try a 80/20 or 70/30 mix just for some added diversification. A target fund would be a great choice!

Good luck with your plans! Sounds like you have a good head on your shoulders.     

 

[Sisyphus]

Magnus,

Congrats on your plans and putting them into action.

One suggestion is to consider tweaking your allocation to be a bit more aggressive (reduce the amount of large caps). Time is on your side, so use it to your advantage.

With the extra dollars you have left, first make sure that first you're covered from a disability insurance and (term) life insurance policy. For what it costs at your age, these are worth the protection. Some folks on this board may slap me around for suggesting that, but with the amount you're already saving, you should also take the step of protecting yourself.

Lastly, I would pile any excess into funds rather than the 401K (assumiung the Roth is maxed out). If you're not getting any match beyond the 5%, why lock that money in a 401K so you can't touch it for several decades without harsh penalties? I know others commented on that, but you should think it over... especially if you plan to retire early. On top of that, your 401k probably offers very limited investment options and fairly high fees on the funds they offer. Meet your company match, max the Roth, and invest the rest in other funds. That's my two pesos. This also assumes you have some other savings in money market or something as an emergency fund.

If you have intrests in specific markets like health care or real estate, there are funds that focus exclusively on those markets among others. Depending on your risk tolerance, you may want to consider those avenues as well for your "extra" cash.

Best of luck!

 

[wildcat]

One suggestion is to consider tweaking your allocation to be a bit more aggressive (reduce the amount of large caps). Time is on your side, so use it to your advantage.

Magnus -

I am pretty young as well. As Sisyhpus pointed out, small (life is hard play short) isn't a bad way to go if you have time on your side. With that being said I am pretty heavy on the small cap side. But you know your risk tolerance better than anyone here. I do like your efforts to throw some money into the international markets. You didn't mention the specifics but I have been better off by investing in the emerging markets index separately from EAFE index so you may want to split the 2. Overall not too shabby.

 

[azanon]

Magnus,

The first question you need to ask is whether that extra money you're not using to max your 401(k) is really for retirement or not. If its really and truly for retirement, its no contest, a no brainer, not even subject to opinion; a taxable account always loses to an IRA of any type, including your 401(1). The power of tax-deferred growth is tremendous. If you're thinking you'll need the money sooner than 20-30 years, then the money isnt really for retirement, now is it?

The second question is do you really want to devote 20% of gross strictly for retirement despite the fact that you're getting a match and will have Social Security. I'm of the same opinion as Motley Fool, and most likely the majority of people, that anything beyond 15% of gross earmarked strictly for retirement is just excessive.... unless you really hate your job/working. The magic of compounding requires time, unfortunately, and mathematically you have to save exponentially more to knock more and more years off of your retirement date. Thus, eventually, the pain involved in making an even earlier retirement date would be greater than the benefit of pulling it off. I believe the sweet spot for me is 15% of gross (with a match similar to yours).

Someone should do a chart showing the amount needed to be saved vs age of retirement, with other variables fixed. I guarantee you, that for every year earlier for a hypothetical retirement, it will show that you have to save exponentially more to do it (because you lose those last, powerful years of compounding).

Azanon

 

[SteveR]

I'm of the same opinion as Motley Fool, and most likely the majority of people, that anything beyond 15% of gross earmarked strictly for retirement is just excessive.... unless you really hate your job/working.    The magic of compounding requires time, unfortunately, and mathematically you have to save exponentially more to knock more and more years off of your retirement date.  Thus, eventually, the pain involved in making an even earlier retirement date would be greater than the benefit of pulling it off.    I believe the sweet spot for me is 15% of gross (with a match similar to yours).

Azanon

In my case, the whole point of accelerated retirement saving is to get out of a boring and thankless mind numbing daily existence. I started saving 15 years ago so my long term growth will need to come after my retirement. Saving more than 15% of gross income has become a need and not a want for both of us to be able to RE at 55; two years from now with an income that will be more than adequate to fund our lesiure time activities.

For younger folks looking at a much longer time-frame, I believe your estimate would be closer to reality, but for those of us who did not get the FIRE message until later in life, we must save like crazy to make it happen.

I wish I had started earlier but my situation did not allow it. A divorce and the resultant LBYM lifestyle started me on the straight and narrow path to FIRE. I don't feel deprived in anyway and having my 401k account maxed out every year along with making deposits in my after tax investment accounts ( for retirement as well as other expenses) is getting me where I want to be. 15 years is not a lot of time to go from a high 5 digit negative net worth to where we are today.

I can see the end of the tunnel and the light ahead is NOT a train coming at me.

 

[azanon]

For younger folks looking at a much longer time-frame, I believe your estimate would be closer to reality, but for those of us who did not get the FIRE message until later in life, we must save like crazy to make it happen.

To an extent, i'm not going to argue with this.  Certianly, it will be much easier for me since i started my IRAs at 25 years old.   But then again, i would only take catch-up contributions to a certain extent if I had not started early as to not seriously hinder my present day life.  Working does indeed suck;  I dont like it that much either.  But living on "a fraction" of your net income just so you can retire a few years earlier than your friends isnt all that much fun either.    Would i want to retire at 58, but have lived on 85K a year  or 52 and have lived on 55K?    I'd choose the former /shrug.

Obviously at some point, the pain of today created artifically by an extreme savings rate could surpass the pleasure derived from an earlier retirement.  And it is true, matematically, the more you save, the less benefit you get in terms of an earlier retirement date.

As for compounding after retirement, i dont really count that.  Like most of you, i'll still have investments after i retire, but the goal of these accounts then will not be to grow in terms of net value; rather to deplete them in an intelligent manner as i near my expected mortality date.  I have no interest in leaving a fortune to my heirs.

By the average person's standards, i'll definitely be an early retiree.  By you guys standards, i'm probably a hyper-consumer. I know of at least a few financial gurus that would agree a 15% of gross savings for retirement is plenty strong (some of them dead), such as David Ramsey, David Beck, Charles Givens, plenty of others. Beck said in one of his books, "if you want to be really rich, save 15%".

 

[SteveR]

Like has been said many times here....it is all about balance. Each of us has their own drivers to wanting to ER or we would not be here. Mine are not the same as yours or anyone elses. Our time-frames differ so our methods to get to ER differ accordingly. What works for you would not work for me and vice versa.

I plan on living 35 years in retirement with my DW. That means we need to continue to increase our NW for that time to avoid eating cat food at age 92. We plan on gifting to grandkids 529 funds along the way and to personal gifts for the kids before we depart this world. If there is anything left in the vault when we die then so be it but the main focus is funding an active retirement without fear of running out of money. That kind of funding along with keeping the inflation wolf away from the door, requires a constant increase in NW for all of those 35 years in retirment.

I save to invest and invest to fund my future income streams. If I overdo the savings I am sure I can find a way to enjoy what that will buy me once I am retired. I don't see what we are doing as a sacrifice. We want for nothing and have a very good life. We do shop carefully but we don't dumpster dive or do garage sales.

 

[azanon]

I don't see what we are doing as a sacrifice.  We want for nothing and have a very good life.  We do shop carefully but we don't dumpster dive or do garage sales.

If this is really and truly the case, I'd be hard pressed to fault you.  I'd definitely be a liar if i said that though.  Though i consider myself generally happy and content, there are certainly some things i'd love to have today that I dont have due to limited resources.  There is also a vacation or two i didnt go on this year but would have liked to given enough funds.

If i ever do hit a point where i dont want anything else beyond what i have now, sure i'll save more (as opposed to spending it for no good reason at all).

I sure wish my (rich) dad would have started a 529 for my only son!   My wife and I started one though cause, well, someone needs to!   I'd never actually ask him to do that though, i'd have to be a gift.   But it would be a gift i'd graciously accept! I hope you're not doing it as a surprise because your son/daughter might have started one too since they think you didn't.

 

[lazyday]

limited avaliablity of funds in my 401k account

You've probably already coinsidered this, but there's no need to split each investment account up to look like your total allocation.
For example, if your 401K funds are all expensive except for a largecap fund, it might make sense to have the 401k be mostly or entirely in that cheap largecap fund, and then use the Roth and other accounts to get the other asset classes you want, using funds with lower expense ratios.

I'm not trying to imply that after 5% you should use aftertax accounts instead of 401K though. Which you should pick depends on a lot of factors, including what bracket you're in now and expect to be in the future. And future tax laws, and how young you retire. And probably a few more.

Book suggestion: W Bernstein's Four Pillars of Investing

 

[katb]

Regarding asset allocation... if my hope is to retire early and not have to use retirement accounts to do it, should I be mirroring my asset allocations and percentages in my taxable and retirement accounts?

Also, if you are building your taxable accounts to live off of and therfore receiving income, while you are still working and have a $100,000+ income, are there any recomendations for making that transition to minimize taxes?

Thanks for your insights!

 

[Trace]

Regarding asset allocation... if my hope is to retire early and not have to use retirement accounts to do it, should I be mirroring my asset allocations and percentages in my taxable and retirement accounts? 

Also, if you are building your taxable accounts to live off of and therfore receiving income, while you are still working and have a $100,000+ income, are there any recomendations for making that transition to minimize taxes?

Thanks for your insights!

katb, 

I try to look at my asset allocation as a whole.   It's important to have "tax friendly" investments in taxable accounts.  Vanguard's Total Stock Market Index and S&P 500 Index funds are excellent choices.  They have a very low turnover ratio and minimal expenses.   Another option is Vanguard's Tax Managed investments.   You can also take advantage of the favorable tax treatment on dividends & capital gains by purchasing qualified individual stocks. 

I currently keep all of my bonds in the 401K & Roth (Bonds are 25% of my total 401K & Roth balances).    Taxable bonds in a taxable account generate income and can negatively impact taxes.   I look at asset allocation in total.   I avoid mirroring my AA based on Tax Deferred vs. Taxable.   

Just my two cents...

 

[katb]

Trace,
Thanks for your feedback! I wonder though how I can get enough income from the taxable accounts to live on if my investment choices are designed to reduce taxes and therfore income. As you said, bonds produce income which I could live on, but they would be in my retirement accounts because they produce income. It's seems like a catch-22. Good point on the DIVs and cap gains.

Best,
=kat=

 

[SLC Tortfeasor]

Sorry this is off-topic, but ...

SISYPHUS:  MORE COWBELL!!!

ROTFLMAO.

 

[Trace]

Trace,
Thanks for your feedback! I wonder though how I can get enough income from the taxable accounts to live on if my investment choices are designed to reduce taxes and therfore income. As you said, bonds produce income which I could live on, but they would be in my retirement accounts because they produce income. It's seems like a catch-22.  Good point on the DIVs and cap gains.

Best,
=kat=

I now understand you are looking to preserve your taxable capital.   I initially thought you were looking to deplete taxable assets while tax-deferred assets continue to grow. 

I would utilize the Firecalc calculator on this site to determine the maximum withdrawal percentage (probably around 4%).  This may cause you to take the dividends plus some capital each year.  However, a low enough burn rate should maintain (and possibly grow) the initial taxable amount (calculator will give you the historical success percentages).  I know some on this board (Grumpy, I believe) have a portfolio of stocks that pay dividends in excess of 4% per year.     

BTW, I believe we are about the same age (36 soon to be 37 for me).   Thanks..