How should I structure my savings in my lower 20s?
I am a 22-year-old living in New York City and I am in my first career year at a large investment bank. I am trying to decide how to structure my savings and portfolios. I make about $7,000 a month before taxes. My primary expenses are rent (about $1,000 a month), car payment ($500 a month), and finishing off my student debt ($8,000 remaining).
My company matches 5 percent on 401(k) contributions and everyone in my family has suggested that I max out my 401(k). Should I do that, or open an IRA instead? Alternatively, should I just build up my savings as much as possible? Currently, I have about $10,000 split between stocks and crypto, and a few thousand in savings as I frequently move money from my savings account to pay off student debt quickly. How should I be utilizing the extra money I make each month?
Great question, we often help young professionals with their cash flow allocation in similar situations to yours. First, build an emergency fund. A specific account (typically high yield savings account such as Ally bank or Marcus by Goldman Sachs) for a buffer against unexpected expenses or potential loss of income in the future. Typically, 3 months worth of living expenses is a good place to start. You want to hold the emergency fund in cash for safety and liquidity purposes. Set up automatic contributions from your checking account to the high yield savings account the day after you get paid. If you can establish 3 months worth of living expenses in cash in this account over the next 6 months or so that'd be great.
Second, contribute at a minimum 5% to your 401(k) to lock in the match. You may find maxing out your IRA or Roth IRA as a better strategy then contributing more to your 401(k) since you can control cost and have a wider selection of investment options. Any cash flow above that amount could either be allocated towards the 401(k) or invested in a taxable account that would allow you to access sooner than age 591/2 when the retirement accounts no longer have the withdrawal penalty.
Hope that helps.
This is a great question, and it's awesome you're creating a game plan at 22. I wrote an article on prioritizing where you extra money should go on Investopedia here. It was written for medical professionals, but applies to everyone.
First item I would mention is your stock account. I understand the desire to play with crypto currency so you can continue that (although you may want to check out the Robinhood app for its low fees in this area). Your stocks though would be better in a Roth IRA account than in a taxable account. At 22 you have plenty of time for these assets to grow tax free, and it's much more tax efficient to keep them in the Roth than in a taxable account.
Second, given that you're at a large investment bank I would imagine the fees in your 401(k) are relatively low so I wouldn't be too concerned about maxing out your 401(k). Given your current income levels it is likely though that you'll eventually reach an income limit where you won't be able to make Roth IRA contributions. This means two things to you now. 1) If you have excess cash after maxing your 401(k) then put it in a Roth IRA instead of a Traditional IRA, and 2) doing this leaves open the possibility of a Back-Door Roth IRA down the road.
You're doing all the right things now, and go ahead and finish paying off your student debt first. You're almost there and it will help supercharge everything else.
Hope that was helpful, good luck to you!
Matt Ahrens, CIMA®
I am going to answer your question a little differently than what most people consider conventional wisdom. I am basing this on what I wish I had done when younger and assuming that, like myself, you are in a career with a signficant upward income potential but possible periods of volatility.
First, yes, you absolutely want to have an emergency fund. The conventional wisdom on this is to keep the money in "defensive" type strategies. My wife, a few years ago, asked me why our signficant emergency funds were in defensive allocations. She explained that if it was a true emergency fund we really planned to NOT use the funds, so she suggested that we should have the money invested more long term but with liquidity if we needed it. We moved our emergency fund to a diversified stock portfolio (80/20) and have never touched it since. That was good advice.
Next, if you can fund both a Roth IRA and non-IRA investments, of course do both. You should definieltey max out your Roth IRA (or Roth 401k) because the advatnages are so signficant long term. Getting the match is worth it in your employer plan. However, after you have maxed out your company match, I would recommend investing all of it in a 100% diversified portoflio of stocks (you can use an ETF or mutual fund strategy) and building this up over time with consistent savings (not in an IRA.) There are a few reasons for this. 1) Liquid assets won't be penalized if you ever need to access the funds and emergencies do happen. 2) the growth on a tax deferred accout is ultimately taxed as current income, the highest tax instead of capital gains (a Roth IRA is not taxed on the growth after 59 1/2 so this is of course best.) 3) Your ability to leverage or pledge assets or borrow inexpensively through a line of credit for businesses, purchasing real estate or anything else you need to do in life long term depends on your balance sheet and pledgable assets (IRAs usually don't work nor do 401k's.) Of course tax planning is much more comprehensive and depends on lots of factors. But, one of the top secrets of the wealthy is that they have the ability to inexpensively borrow and invest in opportunities without liquidating long term wealth (ownership in stocks/companies). This isn't possible in an IRA.
The conventional wisdom other respondents have provided is correct, however, if I had the ability to advise certain clients over again from 20 years ago, I would have allocated more to non-tax deferred investments.
Congrats on getting a good job and at least you have the most important step right regardless...investing money.
Congratulations on your 1st career at a large investment bank. Here are some thoughts on your cash-flow.
$ 84,000 = Annual Income
$ 18,500 = 401(K) Contribution (take advantage of your company's 5% match)
$ 5,500 = IRA Contribution
$ 15,000 = Taxes (assuming 25% of $60K taxable income)
$ 12,000 = Rent
$ 6,000 = Car (PS: Why do you have a car in NYC? :)
$ 12,000 = Living Expenses (assuming $1000 per month, not including rent & car)
$ 8,000 = Pay-off your Student Debt
$ 7,000 = Emergency Fund (about 3 months of Rent + Car + Living Expenses)
In future years, once you're paid off your student debt, and potentially gotten rid of the car, you might have some leftover income for investments. At that time, we typically suggest you invest in passive long-term ETFs, such as, SPY, VTI, etc. We would need to discuss your risk profile, time horizon and goals before making a more personalized recommendation.
Are you sure that's not a typo? $1,000 for rent in NYC? My impression is that you have to pay $1,500 just to have a cardboard box on the sidewalk. (Just kidding -- but I have to wonder if this is a real question.) And what do you need with a car? It costs more than $500 per month just to park it -- never mind insurance, etc. I lived in NYC for 34 years and never needed a car.
Anyway, let's assume you have cash left over from your take-home pay of a bit over $4,000. Your family is right that you should put away as much as you can into the 401K. The deposits are pretax and an IRA would not be. Also, I am glad you are paying off that debt as fast as you can. It should be gone soon and that will feel good.
Lastly, ditch the crypto. You have a better chance of making money in Vegas. Sure, it was all the rage last year but cryptocurrencies are gambling, not investing. If you want to play, play with money you can afford to lose. Don't play with money you want to save.