Hi :) I'm at a loss, after rebuilding credit, what direction to go!

[Anonymous]

Hi everyone

I have an age & goal based question, because I am torn about what direction to (temporarily) take my financial endeavors in. (Invest... or save!?)

I am a 25 year old, married, with an income of approximately $37,000. Up to this point I have been investing, heavily (16% of every paycheck, coupled with 25% of every paycheck directly into savings) into my 401(k) offered by my employer, of which they match 4% of my contributions. My wife and I are dead-set on building a home in 3 years, and have already set a myriad of other actions into effect during the past 2 years to get us to that point. (We have immediate family member(s) in the building trade, who have already built homes for other family members with mind blowing results and savings vs.. hiring a regular contractor, which further exaggerates our tenacity to build within 3 years).

My question is, after seeing our situation/age/income, would it be more advantageous to continue saving at such a breakneck speed and delay building a home even further, or taking my young age into consideration the the decades I will surely have to contribute to my 401(k) on a higher level after our primary goal of construction is realized. We are already home owners, and are using that property as an investment in order to build ongoing equity and stability to use towards our future property purchase to build on. (The savings in not investing at all into the 401(k) would move us within inches of our financial benchmark we must realize before breaking ground on our new home... but will open us up to risk by missing the next 3 years of POTENTIAL stock-market/mutual-fund profit increases that COULD have grown my portfolio).

Thank you so much for your consideration and thought, I greatly appreciate it!

Message Edited by fantasticfico on 11-02-2009 08:47 AM

[Anonymous]

PS: Most of what I've done in the past four years to truly focus on building and refining my credit and subsequent ability to purchase our first home, was learned through MyFico!

I have been around the forum for a long time, never signed up because I was concerned about having to give so much info to register, but I'm GLAD I did now that I'm part of such a great forum.

**I just wanted to add onto my original post, that my opinion - is to curtail the 401(k) investments, JUST for the proceeding three years until we break ground on our home, and then reinvest at a higher rate to catch up. I believe time is on my/our side, and after all the stock market is not doing so well right now, so I think I should put that potential savings cash away into an account, so it is liquid and ready for us when it comes time for items such as furniture, pouring the driveway, etc. THANKS FOR ANY THOUGHTS!!

[Anonymous]

Bump

I am leaning towards simply adjusting my 401(k) to 4-5% to match my employer's contributions, and using the rest in an even ratio to pay down my current investment mortgage to build equity and putting the rest into a savings account.

Any thoughts?

[Lel]

Hi fantasticfico, and welcome to the forums.

It is virtually impossible to tell you what you should do with regard to your future homebuying plans, since they are so far into the future.  You should be commended, however, for recognizing the importance of advance planning for your retirement.

You should definitely continue whatever 401(k) contributions are necessary in order to receive the maximum match.  That's free money that you don't want to forgo.  Contributing more than this will allow some deferment of income taxes.  But with your current income, your marginal tax bracket is only 15% for Federal taxes, so this may not be the most advantageous tax move for you.  If you expect your retirement income tax bracket to be higher than it is now, then you'll end up paying a greater proportion of your income in taxes at retirement than you would otherwise pay now.

Having money in a 401(k) also limits what you can do with it.  Generally, withdrawals from a 401(k) are not permitted without some hardship and some penalty.  You may be able to take a loan from your 401(k), but you have to pay yourself back which will be included in your debt-to-income calculations.  Also, if you leave your currently employer, you may not be able to take a loan at all.

You should consider opening a Roth IRA.  The money contributed is after-tax, and capital gains at retirement are tax-free.  Also, you are allowed to withdraw your contributions at any time without penalty (I think this is still the case) or you may withdraw $10,000 for the purchase of your first home (which probably won't apply to you; check the rules on how this is defined though.  A Roth IRA may be the more favorable tax move for you, if you think your retirement tax bracket will be higher. 

Here's an example to illustrate this: let's say you put an extra $1000 into your 401(k) now.  You don't pay taxes on this contribution.  If it appreciates at 5% a year for 10 years, you'll have $1629.  If your marginal tax bracket is 25% after 10 years, this $1629 will be reduced to $1222.

If you don't put this $1000 into your 401(k), it will be taxed at your highest marginal tax bracket of 15% - so you're left with $850.  If you put this $850 into a Roth IRA and it appreciates at 5% per year, you'll have $1385, tax-free.

I didn't include the state tax effect, which could be considerable if you live in a high tax state. 

[Anonymous]

A walking wikipedia! THANKS a lot... this is similar to some advice I had previously gotten this week when I began to have these huge questions regarding the most beneficial financial strategy to navigate these next 36 months until construction begins.

I am really thankful for your explanation, I want to get a Roth IRA today! The only thing I'm weary of, is with a Roth IRA since it's self funded, after-taxes, I don't get an employer contribution - can I have BOTH if I wanted to?

THANKS AGAIN

[Lel]

You can contribute to your 401(k) to get your match, and open a separate Roth IRA.  They're not mutually exclusive (as long as you don't make too much money).

[Anonymous]

Phew..... thankfully (lol) I am in NO danger of that happening.

Thank you for your help, I am going to set up a Roth, is this something I can manage and invest in on my own, or do I have to go through a bank, or financial advisor. I have been reading, studying, and obsessing over investments for a while now, and I know how I want to diversify and in what ratios, so I don't see the true necessity of having an advisor.

[Lel]

Opening a Roth IRA is pretty easy - just about any brokerage firm or mutual fund company offers Roth IRAs.  You can invest your Roth in just about any way imaginable.

If you go with a mutual fund company, you will only be able invest in funds offered by that company.  That not a bad thing, though, because many companies offer a dizzying array of choices anyway.  If you open one up with a major brokerage firm, you can invest in individual stocks, bonds, mutual funds for numerous companies, ETFs, etc.  The options are overwhelming.

Since you're young, many people will argue that you can afford to be aggressive in your investment goals, because your retirement horizon is far off.  However, this doesn't apply to your situation, since you anticipate tapping into this reserve within a few years, so you may want to focus on capital preservation.

Disclaimer: none of the above statements should be construed to represent financial advice from myFICO.com, Fair Isaac, or any of their affiliates.  Nor does it represent financial advice from me - I'm not in the financial industry, and my investing track record is frankly quite lousy. 

[Anonymous]

I'm going to have some research bouts ahead of me on brokerage firms!

I liked your disclaimer too. In all honesty even if your track record for investing hasn't been stellar, it doesn't in any way immediately invalidate the solid and valuable advice your offered me today. I sincerely thank you.

[Anonymous]

Make small charges and repay perfectly monthly. This will boost your credit score for future things like a house.

Si senora