Recently, John Woerth of Vanguard, posted a very insightful article about some year-end investment tidbits for 2014. In this article he ranked his top seven investment tips. Below, we will explore the rationale behind each tip on his list.
1. Invest in your company 401(k) plan up to the match.
If you have an option to invest through a company 401(k) or 403(b) you should take advantage of it, especially if your company matches any portion of your contribution. In essence, if your company matches your contribution, they are paying you to save for retirement. Although we’ve covered the potential for high 401(k) fees to eat away at your savings, there is no other investment opportunity out there where someone else will effectively pay you to save.
2. Pay off short-term, non-tax-deductible debt (e.g., credit card, car loan).
This kind of debt is also known as consumer debt and often carries high interest rates. It’s advisable to avoid consumer debt in the first place, but if you find yourself with some, you’ll want to get rid of it as soon as possible.
3. Establish an emergency fund; 6–12 months of living expenses is a good guidepost.
It’s always a good idea to have cash set aside for life’s emergencies to help you avoid borrowing to cover these unexpected events. It probably wouldn’t be a very long search to find other personal finance experts who would have this higher on the list, and we wouldn’t argue with them. However, you could make a case that a 401(k) account can be accessed in the case of an emergency, thus making it a top priority. Additionally, depending on your company’s 401(k) setup, you may be able to borrow against the plan and repay the interest into your account. It is worth noting however that, generally speaking, it’s bad practice to take from your retirement savings before the allowable age.
4. Put the maximum allowable amount in a Roth IRA.
In a previous post we wrote about the flexibility of Roth IRAs because they are filled with after-tax dollars. In addition to this flexibility, Roths are a great complementary retirement savings tool because there is no required minimum distribution age, unlike 401(k)s and traditional IRAs. Because of this you can allow your Roth to grow as your take distributions from your 401(k) at the required time.
5. Put the maximum allowable amount in your company 401(k) plan.
We think the rankings for tips 5-7 should vary based on your personal aversion to debt. Nonetheless, Vanguard has maxing out your 401(k) highly ranked because money that goes into a 401(k) account is made up of pre-tax dollars and 401(k)’s have a maximum contribution limit that greatly exceeds any Roth or traditional IRA. Meaning, maxing out your 401(k) is a great way to reduce your tax burden and maximize savings for retirement.
6. Invest the remainder in taxable accounts.
Investing in taxable accounts before paying down your mortgage could be advantageous if you are taking a long-term passive investment approach. However, if you intend to frequently trade in this account, taxes and fees will add up quickly, making it difficult to outperform your home loan interest rate through investment return.
7. Pay down tax-deductible debt (e.g., home mortgage, student loans).
With the way housing prices have fluctuated over the last 15 years, if you don’t have much equity in your home, you’ll probably want to rank this higher to avoid being upside down on your mortgage. Regardless of how you prioritize paying off your mortgage or student loans, you do get some relief from the taxman through this kind of debt.
How do these seven tips rank in your financial situation? Leave us a comment below! Need help determining your rankings? Send us an email at gettingstarted@arkfi.com or call at (719) 599-1919 and we’d be glad to help out.
Photo credit: LendingMemo.com
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