Where your first $18,000 of long-term savings should go
I’m making a giant assumption here. I’m assuming you are contributing, or working toward contributing, $18,000 of your income per year to your long-term financial goals. And by long term financial goals, I mean retirement. And by retirement I mean post 59 1/2 years old. And by post 59 1/2 years old, I mean you’re already getting the senior discount at Wendy’s. My professional belief is that if you are earning north of $100,000 per year, you should almost definitely be setting aside $18,000/yr for the future. I’ll explain why on another day.
Today we’ll focus on where to put that. The factors will be fees, performance, and risk. I purposefully left out “complete control”, which is a factor some folks like to consider in the midst of this conversation. I think picking your individual investments is great, but I think it’s overrated. I can only speak for myself here, and this might be where I lose you forever, but personally, I just want to keep pace with the broad market indexes. That’s me. Maybe you want to beat the market by 20 percent per year. You might also be the sort of person who drinks too much Red Bull, but I digress. Subway gives you complete control too, but that doesn’t mean you’ll find me in line barking orders at a sandwich artist.
Our attention needs to shift immediately to the role of a 401k or a Roth 401k, as they relate to this discussion. Both vehicles allow a person 49 years old or younger to put away $18,000 per year on a tax-advantaged basis, in the year 2017. Assuming your employer has a match, you’ll also have the luxury of the match deposits. For instance, if you make $100,00, you max out your 401k or Roth IRA, and your employer match is 4 percent, then you $22,000 will be deposited into your account over the course of the year. It’s very simple, clean, and maintenance free.
But. And yes, there are a few big buts. I cannot lie. And you other brothers can’t deny…
If your 401k investments are crazy expensive and have terrible performance, why would you throw good money after bad? You shouldn’t. If you can invest in better investment options on a tax sensitive basis, for much cheaper to it, or at least partially do it. Open a Roth or traditional IRA on the cheap, and fill it with low-cost ETFs. If you’re doing this on your own, with your own investment acumen and skills, fantastic. If you need a financial advisor to assist you along the way, it’s quite possible your fees will climb north of your 401k fees.
Of course, a big issue is that if you’re single, you can only contribute $5,500 (or $6,500 for 50 or older) to a Roth or Traditional IRA. What should you do with the rest? You should definitely hit the match on your 401k for starters. Back to our hypothetical $100,000 income. You put $4,000 into your 401k at work, the company matches that $4,000, and then you contribute $5,500 to a Roth or traditional IRA. You’ve set aside $9,500, and $13,500 goes into your investments because of the match. That’s not great compared to the $22,000 we were getting by maxing out the 401k. Sure, you could always then go back to the 401k and deposit the remaining $8,500. That’s a solid strategy. It’s a hair complicated, but solid.
Can a local financial advisor beat the performance of your 401k? Maybe. There are lots of factors. I can tell you more local advisors think they can do a better net job for you than the number of advisors who actually can. In my opinion, if you make $100,000 or more and your advisor is not finding a way for you to set aside $22,000 per year on a tax sensitive basis, then they’re doing you a disservice. You will NOT achieve a successful retirement outcome by simply maxing out your IRA. You just won’t. And “having access to your long-term savings along the way” is silly. A properly-funded emergency fund will prevent you from the need to withdraw from your retirement savings.
Also, don’t forget to add-in the advisor’s fees.
Don’t assume your fees and the performance of your 401k suck just because you watch Last Week Tonight with John Oliver. I’ve seen thousands of 401ks which have wonderful investment options with crazy low fees. Your goal is to get money, a lot of money, in your long-term savings accounts. If you don’t, you’ll be having a philosophical discussion about the best way to save for the future while eating ketchup soup you made after stealing ketchup from McDonalds.