Is my investment strategy a good one?

[Chris918]

Hello everyone and I hope you are enjoying your 2020 so far.

I'm 27 and starting in a few months I will have no debt besides my mortgage. I can't wait to get there and to prepare I've tried to organize a strategy in the meantime. After all my necessities are paid and with some fun money set aside I will have $1000 to invest each month. My current plan is as follows:

Investment Plan (Each month)
$500 to ROTH IRA -Vanguard
$200 to Brokerage - Vanguard
$200 mortgage principal payment
$100 to High Interest Savings - Ally (until I reach 6 months of expenses)

My current 401k contribution rate is 7% with a 2% company match. We usually get an additional 2-3% contribution at the end of the fiscal year based on salary but that isn't always 100% guaranteed. I think I've received it 6 of the 8 years I've been employed at my work. I am using any raises I get to increase my 401k contribution up to 15% and then I planned on stopping.

Current questions/clarifications:
1. I have PMI. The additional house payment is to get rid of PMI. Is it worth it to continue paying on the house after PMI is gone or should I invest that extra money and not worry about the house?
2. Is it best to increase my 401k contribution beyond 15%? I budgeted for a brokerage account as shown above, but the 401k has the tax benefit and the brokerage doesn't. However the brokerage is more liquid and I can withdraw the money without penalty.

Please tell me what you all think. Thank you and I can't wait to get started.

 

[Cassius King]

How much PMI do you have remaining? I would continue the Roth contributions, and if you're close on the PMI being removed, have the money currently going to brokerage go to it as well. PMI is wasted money, and I'd focus on eliminating it first.
Once the PMI is gone, I wouldn't pay extra on the mortgage and pile up the brokerage, savings and up the 401k.

 

[Chris918]

How much PMI do you have remaining? I would continue the Roth contributions, and if you're close on the PMI being removed, have the money currently going to brokerage go to it as well. PMI is wasted money, and I'd focus on eliminating it first.
Once the PMI is gone, I wouldn't pay extra on the mortgage and pile up the brokerage, savings and up the 401k.

Thank you for replying to me. My initial mortgage was $159k. I am currently at 143k. Sites like Zillow estimate my home to be closer to 171k-176k now so it has appreciated a bit since I bought it. I'd need to get to 128k without refinancing.

 

[NgineER]

How much PMI do you have remaining? I would continue the Roth contributions, and if you're close on the PMI being removed, have the money currently going to brokerage go to it as well. PMI is wasted money, and I'd focus on eliminating it first.
Once the PMI is gone, I wouldn't pay extra on the mortgage and pile up the brokerage, savings and up the 401k.

Keep the $500 to ROTH IRA only at this point

Sink the additional $500 into getting rid of the PMI and then stop and re evaluate where to put your money. I'm currently at about 48% traditional IRA/47% Roth IRA and 5% taxable. I need to boost the taxable account to be in a more comfortable position myself, but I keep buying rental properties and spend the money there.

Your Roth contributions and credit cards can be your emergency fund until you have a better cash flow situation.

 

[Chris918]

Keep the $500 to ROTH IRA only at this point

Sink the additional $500 into getting rid of the PMI and then stop and re evaluate where to put your money. I'm currently at about 48% traditional IRA/47% Roth IRA and 5% taxable. I need to boost the taxable account to be in a more comfortable position myself, but I keep buying rental properties and spend the money there.

Your Roth contributions and credit cards can be your emergency fund until you have a better cash flow situation.

Ahh I see. Where would you put the money after the PMI is gone? I'm a long term planner and I love to have the next steps ready so I can stick to my goals and the overall game plan. So keep doing the $500 in the ROTH and pay off the PMI. What after that? Should I keep increasing 401k contribution? Brokerage? Thank you for your time and helpful information.

 

[cooch96]

Keep the $500 to ROTH IRA only at this point

Sink the additional $500 into getting rid of the PMI and then stop and re evaluate where to put your money. I'm currently at about 48% traditional IRA/47% Roth IRA and 5% taxable. I need to boost the taxable account to be in a more comfortable position myself, but I keep buying rental properties and spend the money there.

Your Roth contributions and credit cards can be your emergency fund until you have a better cash flow situation.

+1.

After the PMI is complete, I’d focus on maxing your 401k contribution. If you have anything left after that, contribute to your brokerage fund. Do you have access to a HSA? That’s a another tax shelter which should have priority over the brokerage accounts.

 

[Chris918]

+1.

After the PMI is complete, I’d focus on maxing your 401k contribution. If you have anything left after that, contribute to your brokerage fund. Do you have access to a HSA? That’s a another tax shelter which should have priority over the brokerage accounts.

Thanks for chiming in. That was one of the bigger questions I had. So it's definitely a better option to max out a 401k rather than invest in a brokerage account due to the tax benefit?

 

[cooch96]

Thanks for chiming in. That was one of the bigger questions I had. So it's definitely a better option to max out a 401k rather than invest in a brokerage account due to the tax benefit?

Nothing is definite, but all else being equal, minimizing your tax burden with an IRA, 401k, and possible Health Savings Account is a smart move.

 

[Aiming_4_55]

Will 15% toward 401k get you to the annual max contribution allowed? If not, be open-minded to a higher percentage to lower tax burden if your budget allows. This is with the assumption your 401k plan has reasonable investment options with low expense.

Depending on your current mortgage interest rate, you might want to explore a no/low cost refinance as rates has inched down over the last 12 months just a little and see if you can eliminate the PMI with the higher home value.

 

[DrRoy]

After the PMI is gone, if your typical return from investments is higher than the mortgage rate, then invest all you can. If you are not getting the return that you pay for the mortgage (after tax), pay down the mortgage. I would expect that the first case holds.

 

[pb4uski]

Thanks for chiming in. That was one of the bigger questions I had. So it's definitely a better option to max out a 401k rather than invest in a brokerage account due to the tax benefit?

It depends. What is your current marginal tax rate?

Generally speaking, if you are single and your income is under $52,625 in 2020 then you're in the 12% bracket... between $52,626 and $97,925 you're in the 22% tax bracket.

If it is 12% or lower then IMO you are better off with a Roth as it is unlikely that your marginal tax rate in retirement will be less than 12%.

If your current marginal tax rate is 22% then it requires a bit more thinking to assess what your tax rate in retirement will be... if you think it will be 22% then it doesn't matter... if higher than 22% then save money pre-tax since today's tax savings exceed tomorrow's tax cost... if less than 22% then go with a Roth since today's tax savings are less than tomorrow's tax cost.

 

[The Cosmic Avenger]

Agreed, we max out our 401(k) and Roth IRA contributions now that we can, and once you get to the 22% or 25% brackets, it's definitely worth it IMO, because every $10K you put in, your net income only goes down by $7.5-7.8K (the rest you get "rebated" as a lower tax burden due to the $10K reduction in taxable income). pb4uski makes a great point, although if you cannot keep your retirement income below the 25% bracket, that's still a great problem to have! And since you're already working on a Roth, you'll have a little flexibility to control your taxable burden in retirement by withdrawing from your Roth, on which you won't be taxed at all.

 

[Montecfo]

Generally I am in agreement with PB4uski's comments.

I applaud you that you are doing a lot that is right. If you have a HDHP, definitely consider an HSA. Works best if you can avoid accessing it such as if you have low medical costs. Triple tax benefit. It can also act as part of your e-funds if you have paid medical outside of it

It sounds as if you may not be getting a tax benefit from your mortgage. If that is correct, paying it down will make more financial sense compared to growing taxable investing since the effective after tax rate of return equals the face interest rate of your loan (and even more of it allows you to eliminate PMI).

I wonder if you need 6 months of low-earning cash as e-funds if you also have sufficient taxable investments you can access via a margin loan if needed. This depends on your evaluation of the risks and your needs. If you keep that much ready cash throughout your career as net worth grows, it is a large opportunity cost, for instance.

Keep up the good work!