401K
Investor · Yukon, OK · Member since 2015 · 11 posts · 3 votes
Hey Greg - I would take a page out of Dave Ramsey's book and pay off your "bad debts". It doesn't matter what the match is when you have dumb debt affecting your personal cash flow which impacts your long-term ability to grow and invest. Might be worth taking some time off in the short term to knock that out.
using the match is essentially 100% ROI
most people are going to tell you to use the match, but no more. It's not liquid, the fund options are usually lousy, and they can be costly.
I take the match and use the rest for REI
Put as much as you need to get the free money (the match) and that's it.
@Greg Mitchell I would say that if your management fees are eating up your investment then maybe talk to your employer about getting some lower cost funds like vanguard.
Even if your management fees are 10% that's still a net 90% return due to the employer match. I understand you being torn between 401k and investing in RE but free money from your employer should always be taken even if it's means that we are playing the snail game in RE.
It may be best to continue growing the 401k and later transfer it to an IRA for investing in real estate.
Hey Greg - I would take a page out of Dave Ramsey's book and pay off your "bad debts". It doesn't matter what the match is when you have dumb debt affecting your personal cash flow which impacts your long-term ability to grow and invest. Might be worth taking some time off in the short term to knock that out.
using the match is essentially 100% ROI
most people are going to tell you to use the match, but no more. It's not liquid, the fund options are usually lousy, and they can be costly.
I take the match and use the rest for REI
If employer contributes 3% of the 6% that is 50% return (not 100%), immediately, which is still great!
The way I look at it, the company match basically protects my contribution from inflation, and any fund increase is a good bonus, BUT much of that is eaten up by management fees.
My question is, would it be better to keep that money (even though it will be taxed) in my paycheck and put it toward RE investing or bad debt reduction?
Greg, the 3% match on your 6% contributions is equal to 50% immediate return on your money. You can't get that in real estate as a beginner so it would not be a wise financial decision to stop this. Contribute up to the march and rest use towards paying off bad debt. You really need to knock the bad debt down (get rid of it completely) before starting investing.
“The borrower is servant to the lender.” (Proverbs 22:7)
I work in the mutual fund industry and am curious to know what you mean by "eaten up by fees." Give me some numbers to work with here. Also, I wouldn't look at the ER match as a protection against inflation. Inflation is essentially built into the returns of the funds, so that is your protection - not sitting in cash.
I'll probably get banned for this, but I would keep your 401k contribs going for now. Assess paying off the bad debts (what do you mean by that). Then work on saving for your Real Estate ventures. If this seems like it is going to take too long, then start trimming down your bad debt payoffs then your 401k last. Your 401k is going to be your back stop, and your just-incase-this-real-estate-venture-doesnt-payoff retirement. Most of the time your 401k money is protected from creditors.
I know BP makes REI look sexy and people are really making good money, but if you've got responsibilities, I wouldn't stop getting the free money from your ER.
And ffs if you have any decent investment options in your 401k, don't go with an Index fund.
The way I look at it, the company match basically protects my contribution from inflation, and any fund increase is a good bonus, BUT much of that is eaten up by management fees.
My question is, would it be better to keep that money (even though it will be taxed) in my paycheck and put it toward RE investing or bad debt reduction?
Greg, the 3% match on your 6% contributions is equal to 50% immediate return on your money. You can't get that in real estate as a beginner so it would not be a wise financial decision to stop this. Contribute up to the march and rest use towards paying off bad debt. You really need to knock the bad debt down (get rid of it completely) before starting investing.
“The borrower is servant to the lender.” (Proverbs 22:7)
Dmitriy, how do you feel regarding the military TSP which does not offer employer matching.
Andrey, if your employer does not offer any matching I would then first maximize contributions to an IRA, both for your and your wife. You have more control and more investment choices with an IRA compared to any employer sponsored retirement accounts such as TSP. Then, only if you need additional tax deductions, you can shelter some of your additional income into your employer's program.
The TSP is one of the best investment vehicles (if not the best) out there when it comes to index funds. The expense ratios can not be beat, it is basically a free index fund. Even compared to Vanguard funds, they are incredibly low. However, since there is no matching for us military folks, I agree with @Dmitriy Fomichenko by investing in your Roth IRA first (make sure you are not paying high management fees or buying funds with high ERs) then the TSP. I am also assuming your income levels allow for a Roth. The other benefit is the TSP loan, I have used that twice to fund rehabs while paying myself interest back into my TSP account. Win-win, a strategy I am getting ready to use again if my cash out refi doesn't close in time for the next project.
To the OP, @Greg Mitchell I would suggest speaking to your employer or HR office to see why there are no low fee funds in your 401k option. Are you sure there aren't? A lot of people don't take the time to see if they have a low fee index fund option in their 401k program. Employers are required to give you a low cost option and you could make it painful for them if you start pulling that thread especially if you aren't the only employee who feels that way. There are so many funds out there with low expense ratios that perform well, you should have that option.
As for putting that money into REI, I'd take the free money first with matching and then see how I can deploy other funds to pay down the debt or see what kind of return I could make on my own.
Andrey, if your employer does not offer any matching I would then first maximize contributions to an IRA, both for your and your wife. You have more control and more investment choices with an IRA compared to any employer sponsored retirement accounts such as TSP. Then, only if you need additional tax deductions, you can shelter some of your additional income into your employer's program.
When you say more control and more investment choices... The TSP allows traditional and Roth options, also the ability to borrow from it anytime (up to $50k I believe), and to pay the loan back with interest TO YOURSELF. Are the penalties for withdrawing earlier from an IRA less so than for a (tsp) 401k?
I talked to my employer today and they actually pay the management fees, which I wasn't aware of.
I guess I'm leaning towards staying contributing, but the temptation of having that money work for me now instead of waiting 20 years (I'm almost 40) to have access is very strong. Also, I've only had a 401K for 3 years, so it's not like I'm going to have a big nest egg anyway.
He is right that you have a lot more options and I suspect the control comment may be about lots of different vehicles to invest in when it comes to the IRA. You can look into self directed IRAs enabling you to invest in real estate with your IRA if you want. Those options cannot be done inside of the TSP. You are limited to the index funds that they provide which consist basically of the domestic market index, international index, bonds and fixed income. That answers the limited options portion. The withdrawal from an IRA is possible but you are much more limited than you are with the TSP. You can also withdrawal your roth IRA contributions anytime you want but good luck getting them back in.
There is a limit on investment choices with a TSP, which are confined to the stock market. If you go with an IRA, you can pick pretty much any mutual fund that is out there. Or you can do self-directed IRA which would make your investment choices pretty much limitless.
There is no such thing as loan with an IRA, you can not borrow from it.
I think a lot of people here need to read Mr Money Mustache.
Savings matter, your safety net is your 401k. You need to know how to use it.
Do not forget tax savings. Even if your tax rates are 10% that amount you put into 401k is less of that. So in effect your deferred taxes are paying for Management fees, plus more.
Ideally you want to put 18k in 401k with lowest fee good return options. Then another 5.5k into a roth ira. Then live off rice and beans.
You should still be able to house hack your first investment and roll that on to next as you learn the ropes.
If you feel you arent earning enough to do this read more of Mr Money Mustache.
If you have other complaints, read even more of Mr Money Mustache.
There is also another way to look at this depending upon how skilled you are in using real estate to achieve your investment goals.
In a 401k plan you are locking away your money until you are at least 59 1/2. You are going to be at the mercy of the stock market and it's vagaries.
If you know what you are doing in real estate, you can create your own "match". It is very easy to do in single family home buy and hold. When you purchase and/or renovate a property below it's market price, you have created equity or "matched" your contribution.
( If you put 10K down and gain 5K in equity you have a 50% equity "match")
It is a capital gain, just like it would be in the 401K, but you can later access that money through lines of credit, second mortgages, or an outright sale (making it a long term capital gain at worst, or a 1031 exchange at best).
If you are renovating the property, the deductible costs of renovation will give you a tax deduction (just like your pre-tax contribution).
What people often seem to not take into account with 401K plans is that the money that you have in there is not really your money. The easiest way to prove this is to have you try and go and get it all and spend it. The average person will lose close to 40% of the value right off the bat with ordinary income taxes and penalties. Also, you may have a vesting schedule with your employer so that the "matched" funds take time to actually be "yours". So yes, it works as a forced savings vehicle but it does not materially improve your current life situation.
No one retires early "investing" in a 401K.
I'm going to agree that you should keep the 401k. I like to diversify, and using both 401k and real estate investing allows me to do that.
No one will get rich quickly with a 401k, but they will be following Warren Buffett's advice on how to get rich - invest in low fee index funds. Time in the market is more important than timing the market.
For those that see not being able to withdraw the funds until age 59.5 as a bad thing, I say just the opposite. Most retail investors get returns far below average because they pull their money out at the worst times. Decreasing liquidity to an extent can help save you from yourself.
There is also another way to look at this depending upon how skilled you are in using real estate to achieve your investment goals.
In a 401k plan you are locking away your money until you are at least 59 1/2. You are going to be at the mercy of the stock market and it's vagaries.
If you know what you are doing in real estate, you can create your own "match". It is very easy to do in single family home buy and hold. When you purchase and/or renovate a property below it's market price, you have created equity or "matched" your contribution.
( If you put 10K down and gain 5K in equity you have a 50% equity "match")
It is a capital gain, just like it would be in the 401K, but you can later access that money through lines of credit, second mortgages, or an outright sale (making it a long term capital gain at worst, or a 1031 exchange at best).
If you are renovating the property, the deductible costs of renovation will give you a tax deduction (just like your pre-tax contribution).
What people often seem to not take into account with 401K plans is that the money that you have in there is not really your money. The easiest way to prove this is to have you try and go and get it all and spend it. The average person will lose close to 40% of the value right off the bat with ordinary income taxes and penalties. Also, you may have a vesting schedule with your employer so that the "matched" funds take time to actually be "yours". So yes, it works as a forced savings vehicle but it does not materially improve your current life situation.
No one retires early "investing" in a 401K.
100% agree with Eric. I am currently switching employers and would like to take that vested amount with company matching in my 401k to invest in a multi family. The problem is that if I take this out in cash, the Feds will withhold 20% of it for taxes right off the back and although I do not think NY state will withhold as well it still a substantial amount to lose. I am currently leaning more towards just rolling it over into a Traditional IRA where at least I can have some sort of "control" with lower expense ratios than the BS mutual funds offered in 401ks. Anyone with solid reasoning on why taking the tax hit and buying the multi family is a better idea, I am all ears.
@Pierre StreatYou could roll into a self-directed IRA (with specialized servicing companies) that allows you to buy and hold RE. You have to stay hands-off on the asset. You can't even change a light bulb on the property. But it is an option.
Or you could use the money to partner with someone on a larger deal where you are a minor partner. You stay completely out of management that way.
I agree that an employer match is a good thing. My company does a 75% match of first 8%. But what people neglect to mention in these discussions is the use of leverage during the purchase of real estate.
If I put aside $10K a year, my employer will give me $7.5K. That's $17.5K for the year.
Using the average return of 8.324% (the S&P 500 index returned that for the last 30 years), you should have $131,000.
Now let's take that same $10K and invest in a $50K SF rental. Assumptions: Expenses at 58% including management, CapEX, maintenance, etc. Starting cash flow of $100/month on rent of $800/month. 4.5% rate for 30 years. 2% increase yearly in income, expenses, and appreciation.
Because I reinvest all of my cash flow (this is a retirement play, correct?), I purchase another property in year 10 (after I have accumulated enough of the cash flow for another down payment), another in year 15 (because I have cash flow off of two properties), another in year 20 and another in year 25. Results:
Property 1 is paid off. It has equity of $88K. Generates $6.5K/yr in cash flow.
Property 2 has 10 years left. Equity of $53K. Generates $2.9K in cash flow.
Property 3 has 15 years left. Equity of $39K. Generates $2.4K in cash flow.
Property 4 has 20 years left. Equity of $27K. Generates $2K in cash flow.
Property 5 has 25 years left. Equity of $17.5K. generates $1.5K in cash flow.
Total Equity: $224.5K
Total Cash flow: $15.3K
In reality, if you really reinvested all of your money every year, you'd have several more properties. I just used 5 because it was easier to understand and show on a post.
Math does not lie. That employer match is costing you money if you are willing to reinvest all of the cash flow coming off your rentals back into the business.
The danger is in the discipline it takes to pull this off. Don't reinvest the money and you will not do as well using real estate. Use the power of compounding, and you'll be set for life. And that's why it is better for most people to use a 401(k) - they simply can't help but spend the money.