What do you invest your savings in?

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Lukky

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What do you invest your savings in?

Post by Lukky » Thu Sep 10, 2020 12:47 pm

I know there's a personal finance thread, but this is more specifically about picking investments.

I know index funds are a popular recommendation (also it's pretty much the only thing you can invest in if you're in biglaw). I know very little about this stuff, so I was wondering what types of index funds people invest in. Are there index funds that rebalance less (lower fees from spreads)/ have greater tax efficiency (I've heard ETFs are a little better tax-wise)? What's your balance between equity and debt (being on the younger side, I pretty much want 0 bonds in my portfolio)? Total market vs. small cap vs. large cap? Do you diversify into any international markets, and, if so, through which funds? Also, do you invest in any industry-specific index funds (i.e. tech sector)? Thoughts on REITs in retirement accounts?

Any insight into this stuff would be really helpful.

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nealric

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Re: What do you invest your savings in?

Post by nealric » Thu Sep 10, 2020 1:15 pm

Lukky wrote:
Thu Sep 10, 2020 12:47 pm
I know there's a personal finance thread, but this is more specifically about picking investments.

I know index funds are a popular recommendation (also it's pretty much the only thing you can invest in if you're in biglaw). I know very little about this stuff, so I was wondering what types of index funds people invest in. Are there index funds that rebalance less (lower fees from spreads)/ have greater tax efficiency (I've heard ETFs are a little better tax-wise)? What's your balance between equity and debt (being on the younger side, I pretty much want 0 bonds in my portfolio)? Total market vs. small cap vs. large cap? Do you diversify into any international markets, and, if so, through which funds? Also, do you invest in any industry-specific index funds (i.e. tech sector)? Thoughts on REITs in retirement accounts?

Any insight into this stuff would be really helpful.
There's often no real difference between an ETF and a Fund. For example VTI and VTSAX (vanguard total market fund) are essentially the exact same thing, except VTI is in an ETF "wrapper". The practical difference is it means you can do intraday trades with VTI, but you have to buy in terms of number of "shares" instead of a dollar amount.

As for what to invest in: I'm a big proponent of VTI as the backbone of any portfolio. It's essentially the entire market (not just S&P 500 members). Other low-cost providers (i.e. Fidelity, Shwab) have similar funds that should perform more or less identically. Just be mindful of fees- seemingly small annual fees (like .75%) actually work out to huge sums of money over the course of an investing lifetime. The problem with weighting small/vs large or sectors is you are actually reducing your diversification as compared to a total market fund.

The advantages of public REITs are mostly for retired folks who are looking for a high-yield investment. For long term capital appreciation, you are better off with a more diversified investment. That said, if you really like REITs, it's not that big of a deal to have a small allocation to them. Never ever invest in private REITs except as part of an internal corporate tax planning arrangement. Private REIT investors give up liquidity in exchange for nothing in return.

As for tax: be mindful of what sort of account you are investing in. You have, at a minimum, $25,000 of tax-advantaged space available to you (401k+ Backdoor Roth). Fill that first before even thinking about a taxable account (beyond your cash emergency fund). If your employer allows post-tax contributions and in-service rollovers, you can get another $37,500 of Roth space (known as mega backdoor roth). If you have a high deductible health plan, there's another $3,500 in an HSA (double for families). Then, if you have kids and want to pay for their college, you can do another $15k/parent in a 529 without having to deal with filing a gift tax return. All in, it's possible to have more than $100k of tax-advantaged space available before you even have to think of tax efficiency.

Once you are in taxable investing land, the main thing to keep an eye on (assuming you are keeping as simple index portfolio) is tax lost harvesting. Essentially, you can swap between very similar but not identical funds (i.e. VTI to a S&P 500 fund) when there's a substantial market downturn. This operates as tax deferral, and also net savings to the limit of offsetting ordinary income with capital losses. There are funds that try to operate tax efficiently, but those tend to attract higher fees and are open to active management mistakes, so I'm not really sold on them.

Debt/equity ratio: I'm at 80/20, but this is very much a matter of personal taste. It's easy to say you want to be at 100% equity when the market is doing well, but it can take a strong stomach not to do something during periods like this last March. Having some debt provides ballast to your portfolio (both on the way up and down). Historically, 100% equity is likely to give you the most overall returns, but that does you no good if you panic sell when your portfolio is down 50%.

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Re: What do you invest your savings in?

Post by alawyer2018 » Thu Sep 10, 2020 1:55 pm

nealric - which companies do you recommend for setting up the ira/roth ira accounts? Vanguard? Fidelity? I want to start taking advantage of the backdoor Roth contributions and am looking for recs.

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Re: What do you invest your savings in?

Post by M458 » Thu Sep 10, 2020 1:58 pm

The above is a great summary of the general approach most people should be taking.

I'd put in a personal plug for the Vanguard LifeStrategy and Targte Retirement funds - both platforms give you exposure to just about the entire World market in stocks and bonds (via 4 underlying index funds) and have very low expense ratios. Only difference is the LifeStrategy platform has a static asset allocation while the Target Retirement platform has a "glide path" as you near the retirement year.

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Re: What do you invest your savings in?

Post by rshackleford123 » Thu Sep 10, 2020 2:04 pm

alawyer2018 wrote:
Thu Sep 10, 2020 1:55 pm
nealric - which companies do you recommend for setting up the ira/roth ira accounts? Vanguard? Fidelity? I want to start taking advantage of the backdoor Roth contributions and am looking for recs.
My 401(k)/529 is at Fidelity and my brokerage/backdoor Roth is at Schwab.

I like Fidelity, but ultimately picked Schwab for my other accounts because I like its interface better. Schwab also has a roboadvisor portfolio that automatically does tax loss harvesting once your account is in the $50,000 range, though I don't have any money in there currently. My Schwab experience has been pretty straightforward and I haven't run into any weird issues with my brokerage or backdoor Roth. (The backdoor conversion process is pretty straightforward, though I imagine all of the big shops are similar in this regard.)

Each of Vanguard/Schwab/Fidelity have their own index funds/ETFs that are all pretty cheap, so it probably comes down to a matter of preference.

To the extent it matters: Schwab does have a co-branded Amex Platinum where you can redeem points for cash in a Schwab account, and the annual fee for the card goes down by $100 once you have $250k with Schwab. Fidelity also has a card that does 1-2% cash back that is directly deposited into your Fidelity account. Not sure if Vanguard has anything similar. Credit cards aren't a reason to pick between the three, but they're nice perks.

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Lukky

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Re: What do you invest your savings in?

Post by Lukky » Thu Sep 10, 2020 2:04 pm

Thank you nealric! That was a god-tier post.

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Re: What do you invest your savings in?

Post by The Lsat Airbender » Thu Sep 10, 2020 2:50 pm

Agree generally with nealric except that people should consider international exposure in addition to a US total-market fund like VTI/VTSAX. Something like 30-50% of your equity portfolio; Vanguard even has its "Total World" fund that automatically pegs its weighting to market cap. Don't want to start a holy war over this topic, as there are reasonable arguments on both sides:

Some pros of international exposure:
  • Hedge against U.S.-specific economic issues (although U.S.-based companies already have enough exposure to foreign markets to mitigate this somewhat, and American economic crises tend to be global ones anyway)
  • U.S. and international equities take turns outperforming each other—a cap-weighted portfolio of both captures the bull runs, wherever they might be (last decade was U.S.; the 2000's were international)
Some cons of international exposure:
  • Exposure to legal regimes and currencies that tend to be less stable/investor-friendly than the USA and the dollar
  • International equities tend to have higher dividend ratios, which is tax-inefficient for a U.S. income taxpayer (but maybe this just means U.S. equities are overpriced!)
Personally I'm about 55/45 in US/international, but you wouldn't be crazy to go all-in on American equities, especially if you "believe in" the American economy. (The U.S. equity market is arguably the only one big and diverse enough for this to make sense.)

Also, and this is super minor, but some people argue that a 90/10 equity-to-debt ratio, rebalanced often enough, will tend to outperform 100/0 because the bond cushion allows one to take advantage of buying opportunities (i.e., downturns in either bonds or equities). The math makes sense, at least. Anywhere between 80/20 and 100/0 is fine for someone with a healthy risk appetite (generally, one who doesn't plan on selling assets in the next decade).

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nealric

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Re: What do you invest your savings in?

Post by nealric » Thu Sep 10, 2020 3:30 pm

alawyer2018 wrote:
Thu Sep 10, 2020 1:55 pm
nealric - which companies do you recommend for setting up the ira/roth ira accounts? Vanguard? Fidelity? I want to start taking advantage of the backdoor Roth contributions and am looking for recs.
Vanguard, Fidelity, and Schwab are all good. I've also had decent experience with my Wells Trade account (set up so I can keep enough with them to get a higher-tier checking account that has more free services). An account with a specific brokerage does not tie you to their funds, though there are some funds that are restricted to account holders. But ultimately, it boils down to whether you like their interface and customer service (Everyone will have both good and bad stories).

I would avoid two types of brokerages: 1) Active managers that charge hefty fees. Edward Jones is one of the largest offenders, but there are others like Ameriprise and various smaller outfits. It's not uncommon for them to charge hundreds of dollars for simple trades that would be free or nearly free at a discount brokerage. That's on top of the parasitic AUM fee (often 1-1.5% of your entire portfolio). 2) Brokerages that steer you into proprietary investments that lock you in and can't be rolled over in-kind to another brokerage- Wealthfront is an example.

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nealric

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Re: What do you invest your savings in?

Post by nealric » Thu Sep 10, 2020 3:39 pm

The Lsat Airbender wrote:
Thu Sep 10, 2020 2:50 pm
Agree generally with nealric except that people should consider international exposure in addition to a US total-market fund like VTI/VTSAX. Something like 30-50% of your equity portfolio; Vanguard even has its "Total World" fund that automatically pegs its weighting to market cap. Don't want to start a holy war over this topic, as there are reasonable arguments on both sides:
I'm not categorically against international, but I'd argue that 50% is really high. Historically (post WWII), international stocks have not done as well for any long-term period (10yrs+) except for specific country booms (like the Japan bubble). I'd also note that many "International" funds are really just European funds, and that many "Emerging Markets" funds include countries like South Korea or Taiwan when you might be expecting exposure to places like India and Africa.

It's also worth noting that emerging and frontier markets (places like Africa) can be frustrating to invest in. They have so much growth potential, but you may be unable to capture that growth through investments in public companies. There can also be endemic problems with accounting and financial fraud. There's no good passive way to invest in the small businesses that power those economies.

Even if you are 100% domestic, I'd point out that the U.S. index includes a lot of global companies that draw their income from all over the world, and that investors from all over the world often invest in the U.S. rather than their home economies. You get global exposure either way.

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Re: What do you invest your savings in?

Post by gunrun » Thu Sep 10, 2020 7:14 pm

This is all pretty good advice, but I'd recommend scouring the Bogleheads wiki page/website for a full rundown on investing, provided you have the interest and attention span to get through it. The "Personal Finance 101 for Young Lawyers" thread on TLS is helpful, as it is specific to lawyers, but that thread is really just a summary of the Bogleheads approach. I can't tell you how helpful that wiki page/website/forum has been to me and others. (I swear I am not associated with the website! There are a lot of Jack Bogle fanatics like me out there.)

You don't need to have a mastery of every type of investment and pitfall to get start. Do some research, make a general plan, and then you'll figure it out as you go along. You WILL make mistakes. The biggest mistake, though, is never getting started.

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Re: What do you invest your savings in?

Post by The Lsat Airbender » Thu Sep 10, 2020 7:51 pm

nealric wrote:
Thu Sep 10, 2020 3:39 pm
The Lsat Airbender wrote:
Thu Sep 10, 2020 2:50 pm
Agree generally with nealric except that people should consider international exposure in addition to a US total-market fund like VTI/VTSAX. Something like 30-50% of your equity portfolio; Vanguard even has its "Total World" fund that automatically pegs its weighting to market cap. Don't want to start a holy war over this topic, as there are reasonable arguments on both sides:
I'm not categorically against international, but I'd argue that 50% is really high. Historically (post WWII), international stocks have not done as well for any long-term period (10yrs+) except for specific country booms (like the Japan bubble). I'd also note that many "International" funds are really just European funds, and that many "Emerging Markets" funds include countries like South Korea or Taiwan when you might be expecting exposure to places like India and Africa.

It's also worth noting that emerging and frontier markets (places like Africa) can be frustrating to invest in. They have so much growth potential, but you may be unable to capture that growth through investments in public companies. There can also be endemic problems with accounting and financial fraud. There's no good passive way to invest in the small businesses that power those economies.

Even if you are 100% domestic, I'd point out that the U.S. index includes a lot of global companies that draw their income from all over the world, and that investors from all over the world often invest in the U.S. rather than their home economies. You get global exposure either way.
All great points. Personally, I'm fine with market-cap weighting because I'm comfortable with developed markets like Japan and France and bearish on domestic stocks—I'm not a doomsayer about the American economy by any means but I do think P/E ratios are unsustainably high and could get corrected downward sometime in the next 20 years.

The only big foreign market I'm not thrilled about is China. The legal/political landscape there scares me as an investor. If there were a cheaper/easier way, I'd switch to an ex-China strategy (moving that weight back to US domestic so I don't overweight other markets).

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Re: What do you invest your savings in?

Post by Pulsar » Thu Sep 10, 2020 8:19 pm

I do a lot of what nealric says. Almost all my investments are with Vanguard. After bonus season, I fund a traditional IRA in January and then backdoor it to Roth a few weeks later. I set 401k contributions to be pretty high (max that out by april) and dump extra money into a taxable Vanguard brokerage account.

The reason for maxing tax-advantaged accounts early in the year is that, if you think the market is likely to on average drift higher over the course of the year (and if you don't, why are you investing?), then you might as well get tax-advantaged gains locked in early.

Most of my stuff is in VTSAX and VTI (about $350k in just those two). There is also a little in a growth-focused mutual fund (which is really just a vanguard mutual fund that is heavy into the popular tech-focused names you hear of). And an equivalent amount in an "international growth" fund. I didn't pick a total world stock index, as I worry some countries just suck (who wants to invest in Russia, etc.) and a little more selectivity/stock selection might be nice for that reason. Keep in mind that most companies in the SP500 have some international exposure built into them, so buying domestic stocks doesn't really mean you're isolating yourself to just the US economy. International investing is optional for this reason imho.

I would avoid "target date" or lifestrategy funds -- you'll end up buying 10-20% bonds, which are going to suck and not do anything in this period of low, low interest rates. A 1% online savings account is about as renumerative and is more flexible. The only advantage of buying bonds in this environment is that it gives you something to sell and transfer into stocks whenever stocks crash (AKA, you have a reserve to take advantage of buying opportunities with). But in the long run, you're unlikely to time those opportunities well, and so overall it's better to just have stocks, at least until interest rates normalize (something which is probably decades away).

Really the most important thing is to keep expense ratios down (Vanguard funds are nice for this reason) and to keep buying even through down periods. Don't sell for a loss and remember the best time to buy is when blood is in the streets, even if it's your own (a thought which felt pretty real this past March).

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nealric

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Re: What do you invest your savings in?

Post by nealric » Thu Sep 10, 2020 9:06 pm

Pulsar wrote:
Thu Sep 10, 2020 8:19 pm
I do a lot of what nealric says. Almost all my investments are with Vanguard. After bonus season, I fund a traditional IRA in January and then backdoor it to Roth a few weeks later. I set 401k contributions to be pretty high (max that out by april) and dump extra money into a taxable Vanguard brokerage account.

The reason for maxing tax-advantaged accounts early in the year is that, if you think the market is likely to on average drift higher over the course of the year (and if you don't, why are you investing?), then you might as well get tax-advantaged gains locked in early.

Most of my stuff is in VTSAX and VTI (about $350k in just those two). There is also a little in a growth-focused mutual fund (which is really just a vanguard mutual fund that is heavy into the popular tech-focused names you hear of). And an equivalent amount in an "international growth" fund. I didn't pick a total world stock index, as I worry some countries just suck (who wants to invest in Russia, etc.) and a little more selectivity/stock selection might be nice for that reason. Keep in mind that most companies in the SP500 have some international exposure built into them, so buying domestic stocks doesn't really mean you're isolating yourself to just the US economy. International investing is optional for this reason imho.

I would avoid "target date" or lifestrategy funds -- you'll end up buying 10-20% bonds, which are going to suck and not do anything in this period of low, low interest rates. A 1% online savings account is about as renumerative and is more flexible. The only advantage of buying bonds in this environment is that it gives you something to sell and transfer into stocks whenever stocks crash (AKA, you have a reserve to take advantage of buying opportunities with). But in the long run, you're unlikely to time those opportunities well, and so overall it's better to just have stocks, at least until interest rates normalize (something which is probably decades away).

Really the most important thing is to keep expense ratios down (Vanguard funds are nice for this reason) and to keep buying even through down periods. Don't sell for a loss and remember the best time to buy is when blood is in the streets, even if it's your own (a thought which felt pretty real this past March).
One thing to be careful with if if you are maxing our early is that can cause problems with some company matches. It’s often capped at some fraction of your paycheck, which means you lose on match that would otherwise be available. Most biglaw firms don’t match so not an issue there.

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Re: What do you invest your savings in?

Post by alawyer2018 » Fri Sep 11, 2020 6:32 am

nealric wrote:
Thu Sep 10, 2020 1:15 pm

As for tax: be mindful of what sort of account you are investing in. You have, at a minimum, $25,000 of tax-advantaged space available to you (401k+ Backdoor Roth). Fill that first before even thinking about a taxable account (beyond your cash emergency fund). If your employer allows post-tax contributions and in-service rollovers, you can get another $37,500 of Roth space (known as mega backdoor roth).
Could you explain how you arrive at the $25,000 figure above? Given a big law salary, I thought I was effectively capped at the $19,500 contribution limit for my 401k in terms of tax-advantaged space because I don't get to take any deduction for contributions to an IRA. Of course, there's no limit to how much you can backdoor into a Roth IRA, but that's not "tax-advantaged" up front. (I'm not trying to be critical of your post, I just want to make sure I'm not mistaken in my analysis.) Thanks.

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Re: What do you invest your savings in?

Post by Anonymous User » Fri Sep 11, 2020 7:30 am

alawyer2018 wrote:
Fri Sep 11, 2020 6:32 am
nealric wrote:
Thu Sep 10, 2020 1:15 pm

As for tax: be mindful of what sort of account you are investing in. You have, at a minimum, $25,000 of tax-advantaged space available to you (401k+ Backdoor Roth). Fill that first before even thinking about a taxable account (beyond your cash emergency fund). If your employer allows post-tax contributions and in-service rollovers, you can get another $37,500 of Roth space (known as mega backdoor roth).
Could you explain how you arrive at the $25,000 figure above? Given a big law salary, I thought I was effectively capped at the $19,500 contribution limit for my 401k in terms of tax-advantaged space because I don't get to take any deduction for contributions to an IRA. Of course, there's no limit to how much you can backdoor into a Roth IRA, but that's not "tax-advantaged" up front. (I'm not trying to be critical of your post, I just want to make sure I'm not mistaken in my analysis.) Thanks.
The $19,500 401(k) and $6,000 backdoor Roth is your tax-advantaged space (getting you to $25,500). Although you do not get a deduction for the backdoor Roth, it is still tax-advantaged because you are not taxed on the gains later. Add in the HSA and you are looking at another $3,550 (for single) to $7,100 (for family) in pre-tax savings.

Also, you are limited on the backdoor Roth to whatever the annual contribution limit to an IRA is (currently $6,000). However, if your 401(k) plan offers after-tax contributions and either in-plan Roth conversions or in-service distributions, you can make after-tax contributions and do the mega backdoor Roth. If you only contribute deferrals into the 401(k) plan and do not receive any company contributions, you can add another $37,500 to your tax-advantaged space. The total that can be contributed to a 401(k) plan each year is $57,000, so if you receive any employer contributions that $37,500 number goes down.

If you are over 50, you can defer an additional $6,500 into the plan without regard to the limits above.

Edit: accidental annon.

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Re: What do you invest your savings in?

Post by alawyer2018 » Fri Sep 11, 2020 7:58 am

Anonymous User wrote:
Fri Sep 11, 2020 7:30 am

The $19,500 401(k) and $6,000 backdoor Roth is your tax-advantaged space (getting you to $25,500). Although you do not get a deduction for the backdoor Roth, it is still tax-advantaged because you are not taxed on the gains later. Add in the HSA and you are looking at another $3,550 (for single) to $7,100 (for family) in pre-tax savings.

Also, you are limited on the backdoor Roth to whatever the annual contribution limit to an IRA is (currently $6,000). However, if your 401(k) plan offers after-tax contributions and either in-plan Roth conversions or in-service distributions, you can make after-tax contributions and do the mega backdoor Roth. If you only contribute deferrals into the 401(k) plan and do not receive any company contributions, you can add another $37,500 to your tax-advantaged space. The total that can be contributed to a 401(k) plan each year is $57,000, so if you receive any employer contributions that $37,500 number goes down.

If you are over 50, you can defer an additional $6,500 into the plan without regard to the limits above.

Edit: accidental annon.
I really appreciate that explanation (I hadn't realized there was a 6k cap on IRA contributions). I'll also have to check with my employer whether I can make after-tax contributions to my 401k. Thanks.

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Re: What do you invest your savings in?

Post by nealric » Fri Sep 11, 2020 9:36 am

alawyer2018 wrote:
Fri Sep 11, 2020 7:58 am
Anonymous User wrote:
Fri Sep 11, 2020 7:30 am

The $19,500 401(k) and $6,000 backdoor Roth is your tax-advantaged space (getting you to $25,500). Although you do not get a deduction for the backdoor Roth, it is still tax-advantaged because you are not taxed on the gains later. Add in the HSA and you are looking at another $3,550 (for single) to $7,100 (for family) in pre-tax savings.

Also, you are limited on the backdoor Roth to whatever the annual contribution limit to an IRA is (currently $6,000). However, if your 401(k) plan offers after-tax contributions and either in-plan Roth conversions or in-service distributions, you can make after-tax contributions and do the mega backdoor Roth. If you only contribute deferrals into the 401(k) plan and do not receive any company contributions, you can add another $37,500 to your tax-advantaged space. The total that can be contributed to a 401(k) plan each year is $57,000, so if you receive any employer contributions that $37,500 number goes down.

If you are over 50, you can defer an additional $6,500 into the plan without regard to the limits above.

Edit: accidental annon.
I really appreciate that explanation (I hadn't realized there was a 6k cap on IRA contributions). I'll also have to check with my employer whether I can make after-tax contributions to my 401k. Thanks.
The plan also needs to allow in-service rollovers for the strategy to work.

The Roth is not "tax advantaged" up front, but if you do the math, it actually doesn't matter whether you get the tax benefit on the front end (401k) or the back end (Roth) if your tax rate is the same at both ends. There's an argument that your tax rate should be lower in retirement, but it's impossible to really predict. You don't know what the tax laws might look like in 20, 30, 40, 50 years. The point is that while the money is in the account, you don't have to worry about tax efficiency of the investments themselves.

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UnfrozenCaveman

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Re: What do you invest your savings in?

Post by UnfrozenCaveman » Fri Sep 11, 2020 10:11 am

ETFs are more tax efficient in a taxable account.

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nealric

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Re: What do you invest your savings in?

Post by nealric » Fri Sep 11, 2020 10:33 am

UnfrozenCaveman wrote:
Fri Sep 11, 2020 10:11 am
ETFs are more tax efficient in a taxable account.
Generally true but depends on the fund/ETF. The differences often aren't material due to tax loss harvesting and other strategies within funds.

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Re: What do you invest your savings in?

Post by Stevenmilbe » Fri Sep 11, 2020 12:03 pm

Open a Vanguard account. Put your money in VTSAX, and if you want to minimize risk slightly you can put some (20%) in a total bond index and some (10%) in international. I have 100% in VTSAX b/c I am young and my risk tolerance is high (and it will stay that way until I start considering retirement).

If you want to learn more:

https://www.biglawinvestor.com/the-bigl ... portfolio/

Also Read: The Simple Path to Wealth by JL Collins

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Re: What do you invest your savings in?

Post by showusyourtorts » Fri Sep 11, 2020 1:35 pm

nealric wrote:
Fri Sep 11, 2020 9:36 am
alawyer2018 wrote:
Fri Sep 11, 2020 7:58 am
Anonymous User wrote:
Fri Sep 11, 2020 7:30 am

The $19,500 401(k) and $6,000 backdoor Roth is your tax-advantaged space (getting you to $25,500). Although you do not get a deduction for the backdoor Roth, it is still tax-advantaged because you are not taxed on the gains later. Add in the HSA and you are looking at another $3,550 (for single) to $7,100 (for family) in pre-tax savings.

Also, you are limited on the backdoor Roth to whatever the annual contribution limit to an IRA is (currently $6,000). However, if your 401(k) plan offers after-tax contributions and either in-plan Roth conversions or in-service distributions, you can make after-tax contributions and do the mega backdoor Roth. If you only contribute deferrals into the 401(k) plan and do not receive any company contributions, you can add another $37,500 to your tax-advantaged space. The total that can be contributed to a 401(k) plan each year is $57,000, so if you receive any employer contributions that $37,500 number goes down.

If you are over 50, you can defer an additional $6,500 into the plan without regard to the limits above.

Edit: accidental annon.
I really appreciate that explanation (I hadn't realized there was a 6k cap on IRA contributions). I'll also have to check with my employer whether I can make after-tax contributions to my 401k. Thanks.
The plan also needs to allow in-service rollovers for the strategy to work.

The Roth is not "tax advantaged" up front, but if you do the math, it actually doesn't matter whether you get the tax benefit on the front end (401k) or the back end (Roth) if your tax rate is the same at both ends. There's an argument that your tax rate should be lower in retirement, but it's impossible to really predict. You don't know what the tax laws might look like in 20, 30, 40, 50 years. The point is that while the money is in the account, you don't have to worry about tax efficiency of the investments themselves.
I'd posit that we can refine that to say that the plan must allow either (1) in-service rollovers OR (2) in-service conversions to a Roth 401(k) for the strategy to work. In the latter scenario, though you wouldn't be able to put your money into the Roth IRA while you're employed (and thus lose the ability to immediately withdrawal principle without penalty), you are still able to make the most out of your annual contribution limits by stuffing tax-advantaged space AND the growth once within the Roth 401k is still tax-free.

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showusyourtorts

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Re: What do you invest your savings in?

Post by showusyourtorts » Fri Sep 11, 2020 1:49 pm

One perk to the mega backdoor roth (MBDR) that I don't see mentioned too frequently is that it allows for immediate penalty-free withdrawal of principal.

The immediate penalty-free withdrawal of principal is subject to minor exceptions due to the Roth IRA ordering rules, which can largely be planned around. The Roth IRA ordering rules require that you withdraw any "taxable conversions" before "non-taxable conversions" (i.e. your MBDR principal amounts) that were made in the same year. This can become an issue in the MBDR context given Roth IRAs' 5-year conversion rule, which states that the principal associated with any "taxable conversions" into a Roth IRA are penalized if withdrawn within 5 years. In this context, a "taxable conversion" would refer to any growth associated with your after-tax 401(k) contributions before those amounts are punted into a Roth space (whether into your Roth IRA or into your Roth 401(k). Thus, you can immediately withdraw all principal from your Roth IRA without penalty if you are able to avoid "taxable conversion" amounts. You can do so by either (1) avoiding any such tax-free growth in the first place [i.e. not being lazy and immediately shoving money from the after-tax 401(k) right into your Roth space before it's had the chance to grow] OR (2) simply putting the after-tax growth into your traditional IRA when you do move funds into your Roth IRA. The latter option shouldn't interfere with your normal backdoor Roth procedures because the normal backdoor Roth's pro rata aggregation rule refers to pre-tax amounts in your traditional IRA, whereas any such growth would be considered after-tax amounts.

For me, that ability to withdraw funds from the MBDR has changed the game in how I view paying off debt versus investing in the market. Although I have ~170k debt, it's refinanced at 2.5%, which obviously in the long-term will be beaten by the market, but especially so in a tax-advantaged space. I'm planning to put MBDR funds into my Roth IRA and hold them VERY conservatively over the next few years so that I can effectively pull the principal to pay off loans at my leisure if shit goes south. To the extent that I pull principal, then it seems that there’s no harm besides perhaps a small differential in the guaranteed loan rate of 2.5% versus whatever my conservative investment made over those couple of years. To the extent that I don’t pull principal, I end up stuffing a tax-advantaged space that can grow for another ~40 years.

TL;DR: MBDR contributions can be withdrawn immediately penalty-free and can arguably still be a very useful option for associates with high debt.

Lukky

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Re: What do you invest your savings in?

Post by Lukky » Fri Sep 11, 2020 6:08 pm

So, do biglaw firms typically allow the type of 401k plan that allows for MBDR? Are people taking advantage of them here?

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Re: What do you invest your savings in?

Post by Anonymous User » Fri Sep 11, 2020 9:14 pm

Lukky wrote:
Fri Sep 11, 2020 6:08 pm
So, do biglaw firms typically allow the type of 401k plan that allows for MBDR? Are people taking advantage of them here?
Clifford Chance allows us to contribute $10K on top of the standard $19.5K.

Neff

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Re: What do you invest your savings in?

Post by Neff » Sat Sep 12, 2020 12:37 pm

Pulsar wrote:
Thu Sep 10, 2020 8:19 pm
I do a lot of what nealric says. Almost all my investments are with Vanguard. After bonus season, I fund a traditional IRA in January and then backdoor it to Roth a few weeks later. I set 401k contributions to be pretty high (max that out by april) and dump extra money into a taxable Vanguard brokerage account.
I thought you just had to convert a traditional IRA account to backdoor Roth once and that's it (i.e. future contributions will be Roth contributions)? Are you implying that after you contribute each year, you have to separately backdoor that contribution annually? Or am I misunderstanding?

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