Interested in investing? By the end of this “thinking-out-loud” post I secured a financially feasable $1.1M projected retirement. (Down from not-feasable $1.4M.)
Recently I contracted a serious illness: “Thinks-he-knows-everything-college-graduate Syndrome”
It’s OK, I’m on meds now.
I made a huge mistake. But I ended up learning a lot. So much so that I decided to re-balance my entire financial system.
As it turns out, I am saving a lot more than I should. Surprisingly, even though maxing out my Roth IRA is a great idea, with my income, I would have to live very frugally in order to support myself and continue contributing the maximum each year off my salary.
So my options are to triple my salary (more on that later) or rebalance my income distribution. I decided that I would re-balance. It’s actually encouraging to rebalance my income distribution because I feel like I have a lot more money. Before I was saving about 67% of my income, leaving me with just 33% to spend on whatever I wanted. Granted, I am living at home still and my expenses are low, I would not be able to support myself off 33% of my income if I were to move out. So this is a good change for me.
Note: A Roth 401(k) is money that was taken from your paycheck before you got it. This is amazing because not only is there a pre-tax employer match, but then your money grows tax free, and when you withdraw you don’t pay any taxes.
Put another way, not only is this FREE MONEY, its TAX-FREE FREE MONEY.
If that doesn’t convince you to setup your Roth 401(k) with your employer, I don’t know what will. 🙂
Here is what you should try to aim for.
The Ideal Income Distribution:
Roth 401(k) – 3% (My employer match is 3% — always contribute at least what your employer will match)
Wedding Savings – 4%
House Savings – 4%
Emergency Fund Savings – 2%
Roth IRA – 7%
Bills and Miscellaneous spending – 80%
BUT, if you are like me, you aren’t perfect and can’t fit your income into this distribution.
Take a look below on my thought process to make this work.
And if you aren’t interested in seeing my work, just skip to the end to see what I ended up with.
Below examples are all from my monthly income of $2240.20:
Income Distribution (BAD) Example: My Income
Roth 401(k) – 0% (My employer match is 3% — always contribute at least what your employer will match) [At the time I was not eligible for the 401(k) match yet.]
Wedding Savings – 1% $22.4
House Savings – 1% $22.4
Emergency Fund Savings – 40% $900
Roth IRA – 22.3% $500
Bills and Miscellaneous spending – 36% $806.47
As you can see this extremely conservative as I was only spending about 36% of what I made each month. Not exactly the YOLO swag lifestyle I dream about.
And as I am sure you are wondering, what savings account am I keeping all of this extra CASHOLA each month? None other than Ally Bank.
After re-balancing according to the following, I was able to still be conservative, but allow myself to have enough money to survive on my own.
Income Distribution (NOT AS BAD) Example: My Income
Roth 401(k) – 3% (My employer match is 3% — always contribute at least what your employer will match) $67.21
Wedding Savings – 4% $89.61
House Savings – 4% $89.61
Emergency Fund Savings – 2% $44.80
Roth IRA – 7% $156.81
Bills and Miscellaneous spending – 80% $1792.16
Re-balancing made me realize that the $1.4M (!) retirement fund I was building, while amazing to look at, cannot be achieved unless I plan to continue living at home, or make significantly more money. It was an awesome wake up call for me, so hopefully if there is anyone else in my situation, they can also realize the potential of maxing out their Roth IRA, but also how expensive it is to do so. [Edit: by the end of this “thinking-out-loud” post I secured a financially feasable $1.1M projected retirement.]
Q: What broker/investment service do you use?
A: Fancy you should ask. I use Wealthfront. Get $15,000 managed for free using my link, wealthfront.com/tom.
I went ahead and calculated how much you need to put into your Roth IRA to max it out each year.
Monthly contribution = $458.33
Recommended Roth IRA contribution % of income = 5%
$458.33 is 5% of $9166.60
$9166.60 is the after-tax monthly income from two paychecks.
Knowing that we can calculate the annual post-tax income by multiplying by 12. (9166.6*12 = $109,999.20)
Since this is post tax we should calculate pre-tax income for negotiation purposes in interviews. ($109,999.20/.74 = $148,647.57)
Q: But TOOOOM, I’m not smart like you I can’t do this.
A: One, that’s not a question. Two, Psychology recommendations aside, I would recommend reading this book to get started: I Will Teach You to Be Rich
This means that in order to make your Roth IRA contribution 5% of your post-tax income and still max out your contributions, you would need to make $148,647.57 per year.
Since this income is uncommon, the best alternative is to make your Roth IRA contribution more than 5% of your post-tax income. Lets try using 7% right now.
Using 7% of income as a Roth IRA contribution we can bring down pre-tax income to $106,176.84. Much more attainable (sarcasm).
So the ultimate solution that I came up with is to simply prioritize the Roth IRA contribution of ~$459 over everything else.
In my case that equals 21% of my take-home income. Add on the 3% employer match and you get to 24% of my income going to my investments. That’s about 1/4th.
Ugh… Trying to figure this all out. -_-
So here it is, my perfectly balanced (according to my goals.) income distribution:
Income Distribution (GOOD) Example: My Income
Roth 401(k) – 3% (My employer match is 3% (pre-tax) — always contribute at least what your employer will match) $88.80
Wedding Savings – 4% $89.61
House Savings – 4% $89.61
Emergency Fund Savings – 2% $44.80 (total savings = 10%)
Roth IRA – 21% $459 (total investments = 24%)
Bills and Miscellaneous spending – 66% $1478.53
So, there you have it folks.
Banking: Ally Bank
Financial Software: Mint.com