Where should I invest some extra cash?
My wife and I have some accumulated cash (about $100,000) sitting in a very low interest rate savings account at a local credit union. We to put that money to work, and we are interested in investing it for the future - retirement, kid's education, etc. We both have 401(k) plans sponsored by our employers, and we are not currently "maxing out" our contributions. Also, we are planning on setting up a Roth IRA and a regular brokerage account. The Roth IRA will be used as a savings vehicle for when our kid goes to college in 15 years. Not so much interested in the 529 Plan. Does this sound like a good strategy, or are there other investments that we should be considering to help our money grow?
It is great you are thinking about the future and you are asking a good question. When thinking about growing your assets, you have to consider the risk tolerance you have for the capital you are allocating. With respect to the specific vehicles you mentioned, a Roth IRA is a great one because your assets grow tax free, versus a traditional (Regular IRA) one which grows tax deferred. On the issue of 401K plans, it is usually a very good idea to max out your contributions, especially if you get a matching contribution from your employer. Of course, that also depends on your tax situation. Regarding the kinds of investments you should be considering, typically stocks (equities) have the highest returns over any kind of long time frame. A low cost way to obtain the market return is to invest in indexes, there are plenty of funds which offer indexes like the S&P 500 or Dow or Nasdaq with minimal fees. From a diversification standpoint, you probably want to spread your capital out with exposure to various asset classes. A good rule of thumb is the younger you are, the more exposure to equities you want, and as you get older, the more you lower that exposure. So at 20, you might be looking at 80-90% in stocks, the rest in cash and bonds. As you move to 50, split it half and half. Other asset classes to look at would be emerging market equities, emerging market bonds, corporate bonds, real estate (real estate investment trusts), small business loans, small business equity, venture capital, hedge funds, or some form of private equity. You can get exposure to these other asset classes with a little research into each area. I hope this helped answer your question.
Yale Bock, CFA
President, Y H & C Investments
I think you are on the right path. Here's a few recommendations:
1) I would hold on to 3 months-worth of expenses in a cash account. The rest can be invested in a low-turnover conservative portfolio of assets. The goal is to reduce short-term capital gains and volatility. When you need some cash, you would be able to sell some of the assets while being tax efficient. Stocks and ETFs work great for this purpose.
2) I recommend that my clients end up with a 1/3 of taxable assets (401k, IRA,...) 1/3 in Roth and a 1/3 in after-tax investments at retirement. This will help you become tax-efficient in retirement and maintain flexibility before retirement. Depending on when you will retire and by using conservative growth assumptions, try to figure out how much you need to put away in each of these types of accounts. This will help you figure out if you need to max out your 401k or not.
3) Depending on your income and if you have any IRA assets, you might not be able to contribute into a Roth IRA. If your income is higher than $184k, but you DO NOT have any IRA money, use the Back-Door Roth contribution strategy. The idea of using a Roth account for college planning is a great. However, you might not be able to use it...
I hope this helps.
Yes, you can historically do much better with extra cash than the low interest rate of a savings account. While you may want to max any employer matching contributions and a Roth IRA, you can also establish an individual (taxable) account. A great way to go is a balanced ETF portfolio that can be allocated based on your goals and time horizon.
Hi! What a great situation you and your family are in! Way to go. Your little one must be about 3 years old…I envy you these days. Our kids are 26 and 29, and we’d give anything to go back to the days when they were little and to do it all over again. Happily, we do get to talk with and see them often.
I wanted to add to advisor Kristi Stewart’s advice about thinking about a 529 Plan for your son or daughter’s education savings - even if you do live in a state with income taxes. The cool deal on the 529 plan is that the money in it will grow un-taxed. It’s kind of like an education Roth IRA…you put in after-tax money, so you’re not getting a tax break this year by contributing, but over the years as it grows, the earnings will never be taxed as long as they are used for qualified education expenses. That’s an awesome tax deal and might be a place to put some of that $100,000.
You can learn more about the 529 Plan at our Investopedia tutorial. Best wishes to you and your family!
In this artificially low interest rate environment, savings accounts, CDs, etc.. do not even keep up with inflation, but I think you have already figured that out. You can thank the Central Banks including our Fed for this. You can take the $100k to fund your brokerage account and begin to invest in a combination of stocks & bonds.
You could use Exchange Traded Funds (ETFs) for easy diversification if you like, or a combination of individual stocks & ETFs. For the bond portion, I would use bond ETFs for easy diversification & access. If rates begin to rise in earnest, you could easily exit the ETF whereas individual bonds would be more difficult to exit without the spread widening on you. At these levels though, I would want a sell discipline or exit strategy just in case the market changes character significantly. Not short term trading but mid to long term technical indicators.for a major reversal.
You are also correct that 529 Plans are not that great due to their limitations. Roths are very flexible and a good idea. But by the time the kids get to college, you may find you like the advantages of the Roths & take monies for college out of the taxable brokerage account. Especially if you keep adding to it incrementally.
Regarding maxing out your 401ks, you do want balance - outside, accessible assets versus long term retirement assets. A good balance would be 40-60 or somewhere in that range. This will leave you flexible to invest in other assets classes not normally offered in 401ks.
Hope this helps and best of luck, Dan Stewart CFA®