What should I do with my extra money now that I'm done paying off my student loans?
I'm 25 years old and I am on track to pay off my student loans in the next few months. I have about $9,000 in a high-yield savings account (1.85 percent) and $4,500 in my 401(k), to which I am currently contributing $4,200 per year.
Once I am done paying off my loans I expect to have an extra $1,500 left over after my expenses for each month. I am going to need to buy a newer car in the next year or so and also want to start saving for a down payment on a house. At the same time, I know its extremely important to invest into retirement and even better the younger I am. What is the best way to balance my excess income between current and future needs, and where should I be investing the most into retirement (Roth IRA, Roth 401(k), 401(k), etc.)?
Great job in paying off your student loans, that is a great feeling! $1,500 in left over expenses each month is spectacular.
After reading your current situation, here are a few ideas I had:
1. Investing for retirement starts with your 401k. What does your employer match? The typical rule is to contribute what the employer matches and if that equals 10-15% of your pay, you are saving enough for retirement. If your contributions + your employers match does not equal the 10-15% threshold of your income, you could simply open a ROTH IRA and contribute the remainder.
2. How does your credit look? The auto industry is facing some of the lowest interest rates in a long time. Couple that with Tariffs and maybe a slowing economy, you might be able to get a car loan for very cheap(0-2%) with perfect credit. Perfect credit (750+ score) is a great tool to use on your financial journey. You could easily absorb a new car payment in your cash flow, and just invest the rest and you'll come out ahead.
3. For the down payment, when are you looking to buy? General advice will say to save at least 20% for the downpayment, but if you're not looking to stay in the house for the entire loan term, you could lower the 20% or skip it all together. If this goal is 3 years or less, I would stay away from investing and just use a money market account or CDs to get a little interest and to be sure the money is available when needed.
4. For an emergency savings account, you want at a minimum, 3 months of expenses. Before investing, make sure you fund this account first so you don't have to sell or withdraw at an inopportune time.
Any cash flow left over after meeting those goals above, you can simply open a Brokage account online with any custodian and save and invest there. This money will be available anytime you want, you'll just have to pay short or long term capital gains tax, or a loss can be used on your taxes.
Hope this helps straighten out your situation!
Chance Butler - Intelligent Investor
It’s great that you’re almost done paying off your student loans! Usually, we recommend paying off your credit card debt and student loans as you approach your 30s, so you’re already ahead of the game. Now, it’s important for you to make sure you have enough cash on hand to cover any emergencies. We suggest saving enough cash to cover 3-6 months of expenses before you start investing. This will cover your expenses in the unfortunate event of a true emergency, like a medical expense where you have big bills to cover or a job loss where you need to pay rent, but don’t have income coming in.
After establishing your emergency fund, any extra income should go towards retirement.
You’re already familiar with 401(k) plans since you’ve been contributing, but make sure that if your company offers a “match” program, you’re contributing as much as you possibly can to maximize contributions. The 401(k) match is typically a large part of any employee equity package, so you want to make the most of it. If the Roth option is available, you should determine if it makes sense for you. After-tax contributions to a Roth 401(k) takes more out of your paycheck on the front end than a pre-tax contribution to a traditional 401(k), so it might hit your budget a little harder in the short term, however, when you’re ready to withdraw the funds in retirement, your earnings aren’t taxed. Simply put, when you take one dollar out of your account, you get to keep that whole dollar. Since you’re young and at the beginning of your career, it’s likely that you will become wealthier over time and taxes will be higher when you retire, so in that case, it’s better to pay them now.
Congratulations on paying off your student loans. That is HUGE! Now the fun begins. All planning is specific to the individual, but I think information on basic financial planning targets could be beneficial.
- Cash (Emergency Fund) - 3 to 6 months of living expenses
- Insurance Coverage - Life and Long Term Disability
- Retirement - Maximize Employer Match
I would concentrate on building up your cash to an amount that equals 3 to 6 times your monthly living expense amount. A high-yield savings account is a perfect place for these dollars. The living expense number used for your calculation should include all spending that is not consider taxes or savings. Next, I would focus on reviewing your insurance coverage. If you have dependents, you could look at having term life insurance. Maybe start with a 20 year term policy with a death benefit of about 10 times your salary. Your employer likely provides some Disability Insurance. You should review that coverage and consider filling any gaps with supplemental Long Term Disability coverage. Don't worry about short term disability coverage. Finally, I would recommend that you contribute to your 401k a percentage that gives you the full match from your employer. Remember, the employer match is a 100% investment return.
After those targets are achieved, you should move your focus to maximizing retirement funding. I would lean toward Roth 401k contributions. If you want the option to retire before your peers, I would recommend you contribute around 15% of your gross earnings. If you are willing to extend your retirement target to age 65 or 67, then you can reduce that target to about 10%. Any remaining surplus should go towards additional cash savings for your down payment. If you plan to purchase in the next 5 years, stay in cash savings. If your time horizon on the purchase is a little longer you could invest conservatively in a brokerage account. Betterment or Wealthfront are good options to consider.
I would encourage that you work with a financial planner to develop a game plan that is specific to you. Hope this helps!
Congratulations on paying off the student debt and on the wisdom to plan what you want to do next with the extra income.
Regarding the $1,500 per month, I always recommend splitting efforts between multiple goals. In your case, you might consider putting some money toward each of your three goals (a new car, a home, and retirement). The exact numbers to save to each will depend on your personal circumstances, your overall budget, the other goals you have, and your timeframes for buying the car and the house.
Similarly, the choice between the IRA and the 401(k) and between the traditional and Roth option will depend on many individual factors. You will want to look at the investment options and fees in your 401(k) to determine the attractiveness of investing there verses an IRA. For choosing between the Roth and Traditional, you will need to look at your current tax bracket, the level of income you are on track to having in retirement, the taxation of other sources of retirement income, and other key factors. Generally, the Roth ends up being better for most 25-year-olds I do this analysis for, but you may be a rare case. Heck, you are definitely a rare 25-year-old considering your current strong financial position.
Another option to consider is to get a fiduciary and fee-only financial advisor to help you with these decisions and many others. Make sure the advisor doesn't just offer investment advising/management. An advisor who earns their fee will offer career development/mentoring, help with buying a home and other major purchases, advice on ways to get better/cheaper insurance (not just life insurance), guidance on maximizing your employee benefits beyond the 401(k), multi-year tax planning, and much more.
Dear What Should I Do With Extra Money Now that I am Done Paying Off Student Loans,
Bravo to You- it is Rare Indeed for someone 25 to achieve such a goal. Take a moment to applaud yourself!
After paying off of student loans, the purchase of a vehicle and saving for a home loom in the not too distant future. Take time to map out a strategy to accumulate savings for each of those "buckets". At the same time, accumulate monies in an Emergency Fund comprising at least but hopefully one year annual salary. Plan to make all of this automatic so that you need not monthly give thought to the task at hand. Using systems such as "Mint" and or "Personal Capital" you can map out a strategy and watch your savings grow.
Allocate as much of your savings to the max you are allowed to retirement accounts. You are presently allocating $4,200 annually. Keep this allocation until either your income increases and or you have a side hustle where you can allocate more to such funds.
You questioned which funds are the best for your investment. The better question is within each "basket" whether Roth IRA, Roth 401K, 401K will you place your monies to gain the best return for you over time. For this question you will require reading, learning, being mentored from a top tier financial mentor-collaborator who knows your situation and your financial roadmap. This is an exciting and challenging course ahead but if done with as much focus as you possess now, you are on track to reach financial independence!
Tunnel Vision Approach
Whatever you vividly imagine, you can achieve! Set your intentions today to accomplish a lofty goal of saving, no matter how much debt at the start of your unique financial equation. Acknowledge the road is tough, dedicate yourself now to mastery of your goal.
Your mindset will change dramatically as you acquire drive and ambition to accomplish the goal to get rid of debt. Acknowledge monies required in an emergency fund; one full year of funds to equal what it costs to pay your bills for a year. Tragedies do happen, be ready, prepared, understand that when a tragedy arises, the last thing you want to think about is "oh no, there is no resources to allow yourself to grieve, to take time, to pay bills, to cover expenses, to care for yourself, for health, to travel somewhere necessary when the time comes". Once you get accustomed to this mindset, believe me things get easier.
Cut, Cut, Cut
Line item by line item, no matter how tedious, look at each thing you spend each and every day. It was not until I started at square one, looking at each bill that could I get to the bottom of spending. For each and every dollar spent, review is this as a necessary line item in your budget, can it be eliminated without major disruption to your lifestyle. How can you accommodate for change that will happen without this expense, benefits?
The first things slashed, daily latte run, ordering out at work and a very expensive gym membership at a resort. Crazy, who would imagine my life would have gotten to the point I would deprive myself literally of long term savings and emergency money for fleeting pleasures at the risk of long term happiness and freedom to pay Starbucks $100 or more each week for lattes, to get Indian food $100 each week, and to work out paying a membership fee of $450 each month not to consider the initiation fee. So far, that totals $1250 of spending cuts, now for the wake up call, keep the internal competition going!!!
Sink or Swim- Budget for Life
Utilize software to keep your budget stimulating; Personal Capital and Mint are resources. Even though my expenses are directly funneled through my debit account, I was reluctant at first to see the big picture. I hemmed and hawed avoiding numbers not wanting to see school debt, subscription debt, purchase debt. Reward yourself for taking the debt in, analyze spending, dedicate yourself to the change required to move from here to financial recovery. There are countless before you and I who are accomplishing the goal of financial independence. Reward yourself in fun ways, exercise, walk, hike!
Automate The Process
Automate 20% movement of your money from your pay check deposited directly into a long term 403B account. 403B money cannot be touched until retirement at a time when your earnings and therefore your tax levied upon withdrawal is lower than today. Understand fully what you are investing in, the 403B is a basket, know where the money is going each month, what are the monthly gains, what are the stocks that comprise each fund rather than blindly taking money from yourself into the abis.
Automate another 20% of your available funds to enrich a pay off account. This account is best automated with after tax dollars for ultimate flexibility to move monies in and out of the fund without penalty of paying off bills in large chunks without any consequence of a tax consequence. The goal here is to look at the interest rate charged on loans and start reducing the amount owed and therefore the long term interest rates accumulated when you take out such debt.
The remaining 60% is divided dedicating 40% to your existing bills. For example, for someone who earns $1000000 annually hypothetically, $20000 annually should go to 403B, $20000 should go to long term debt, of the remaining $60000, $40000 should pay off bills annually and the remaining $20000 annually should go to an IRA and or an Emergency Fund.
Create a Side Hustle
The side hustle, "fun money" dedicated to additionally paying down massive debt or money not otherwise available in your budget for improvements, self interests and fun. There is nothing wrong with an occasional night out with friends or family. Alternatively this becomes the additional money to pay down debt. You can become your own self made entrepreneur in this space. Many do amazingly well with an Air BNB account, renting out a room, driving for Uber, creating a Udemy Course. The sky is the limit!
Investing and Compound Savings
Caution, Caution, Caution, Caution, Knowledge is Power! First obtain strong and sound and fundamental education about the markets, choose to trust someone to teach and mentor understanding about individual stock selection, acknowledge there is fluxuation in the markets, there are no guarantees to an investment horizon, acknowledge the long term effort to your roadmap involves some degree of volatility on a continual basis, this is the nature of a healthy and dynamic stock market. Become empowered starting now.
Though Blue Chip Stocks are understood to have less risk than their internet counterpart, there is no steadfast rule that one group of stocks is safer than any other group of stocks. Best way to find and invest in stocks is to study the Business, understand the fundamentals of the company, is it sound, are there earnings, is the vision for the company long term? Prior to investing one must carefully digest each company's fundamentals and not be drawn to trends or fads. Take the time to understand all of this and your portfolio may be less likely to fluxuate however at any given time the market may fool all of us! Beware, be careful, be knowledgeable.
Your goals are based on your time horizon, your goals, risk tolerance, life expectations. Before you learn to invest in the markets, purchase your first home or make any commitment with lasting and long term consequences, make certain you start with a money consciousness transcending all you will do. This is a multiple step process involving learning about money, learning about savings strategies, learning and gaining insight about you, your family and how money was cared for growing up. Then trust in yourself and mentors around you who pave the way to empowered growth.
Gain insight from the books you read about investing, not only the patterns and styles of investing also the individuals who invested and how they profited during their tenure as investors in the marketplace both in the stock market, real estate and investing in themselves and their ability to become the controling factor of their personal and long term success- self made entrepreneur. Start a money diary, meet with like individuals.
Learn from great of the greats, Market Wizards, Warren Buffett, George Soros including business moguls Steve Jobs, Oprah Winfrey and Karl Icon. Tesla did not just become a great company nor did Apple. It took dedication, determination and mind set to lead the way to greatness. Then it took dedicated action period. Understand Investment strategies, savings strategies, trading mentality. Be humble, patient and focus on the long term. This is a life commitment to grow savvy and smart long term. I call it the "tunnel vision approach.
The platforms available to you are diverse including among the many (not in order of importance or worth) E-Trade, Interactive Brokers, Fidelity, Morgan Stanley, Sink or Swim. There are many professing to teach and mentor money consciousness, in the end and at the end of the day the proof is in the pudding- you control. Believe me, the more you think, act and talk about money and savings the more you will attract to your life the things that make financial independence possible and freedom over your life.
I run a small group for millennials, college students and eager investors to empower a mindset of saving and the automation of finances. I teach very basic strategies about how to watch and how to understand the markets, setting up a dummy account, moving forward knowing risk tolerance. My goal- mentor caution, care diligence long term. It is fabulous to start now. If you begin with 100 per month or whatever it is you can afford in cash and never allow anything to stand in your way, investing cash on a regular and systematic basis, the power of compounding over the years and over time will allow you to amass a great fortune that will place you in a position of attaining financial independence.
Stay on track. Stay focused. Save for the Long Term as This is Where Money is Made.
Be Empowered and Emotionally Grounded prior to Investing in the Markets.
Jan Attard, MBA, RIA
J. Oliver Maxwell, LLC
Tunnel Vision, a focused life (Book)