Cold Feet - Investing for Retirement

[maxtower]

[ QUOTE ]

My recommendations: Right now, I think the most pertinent thing for you to do is to STOP renting. Renting is worse (IMO) than buying a brand new car (depreciating asset) because you're throwing all of that money away.

I've been in my property for a full year now (it took living with the parents for 5 months to build up enough savings) and already it has appreciated 17% (Seattle).


[/ QUOTE ]

This advice is incorrect. Buying a brand new car is easily a worse financial decision. The decision to rent or buy a house depends on a lot of things.
A lot of areas of the country (including Seattle) have experienced great appreciation over the last few years. Buying now would be buying at peak prices. In many markets (not all) you could be exposed to dropping home prices over the next year or two. Best case is that home prices remain flat in some of these places. This has been discussed on the board many times, so I won't go into that more here.
There are other factors to consider. Renting in many areas is actually cheaper than owning. You don't have to worry about maintenance or property taxes when renting. Another reason to rent could be that you plan to move soon. Buying and selling a home is very expensive once you figure in closing costs and realtor costs. You need to plan on living there for several years to make up these costs. If you need to move before then you could be losing money if there isn't enough appreciation.

[mattnxtc]

[ QUOTE ]
[ QUOTE ]
[ QUOTE ]
Can someone tell me what, if anything, I'm missing about the "magic of compound interest?"

[/ QUOTE ]
You're not accounting for paying taxes each year on the portion of your 8% which is subject to taxation (i.e., capital gains, dividends).

So, if that resulted in an average after-tax return of 7% per year in your taxable account, it would grow to ~$290 in the 20 years.

[/ QUOTE ]

Thanks for the response. I should have been more clear. I was intending to compare a Roth IRA with a traditional IRA, so capital gains/dividends wouldn't be an issue.

[/ QUOTE ]

There are pretty big differences between a Roth IRA and and Traditional IRA.

The main difference is that while both are funded with taxed dollars, with a Roth, your captial gains when you withdraw will not be taxed. It is essentially the exact opposite of a 401K plan. Essentially the Roth allows you to make gains that will never be taxed...

[theTourne]

[ QUOTE ]
[ QUOTE ]
[ QUOTE ]
[ QUOTE ]
Can someone tell me what, if anything, I'm missing about the "magic of compound interest?"

[/ QUOTE ]
You're not accounting for paying taxes each year on the portion of your 8% which is subject to taxation (i.e., capital gains, dividends).

So, if that resulted in an average after-tax return of 7% per year in your taxable account, it would grow to ~$290 in the 20 years.

[/ QUOTE ]

Thanks for the response. I should have been more clear. I was intending to compare a Roth IRA with a traditional IRA, so capital gains/dividends wouldn't be an issue.

[/ QUOTE ]

There are pretty big differences between a Roth IRA and and Traditional IRA.

The main difference is that while both are funded with taxed dollars, with a Roth, your captial gains when you withdraw will not be taxed. It is essentially the exact opposite of a 401K plan. Essentially the Roth allows you to make gains that will never be taxed...

[/ QUOTE ]

I understand the tax timing differences, and I assume you meant this, but appreciation in a traditional IRA is taxed as income, not as capital gains.

My point was that (unless I'm missing something) the value of Roth IRA and traditional IRA accounts will be the same at withdrawl (assuming no change in tax bracket). Several people have told me that Roth IRAs are better because the interest/dividends are not taxed (implying that contributing to a Roth IRA will result in more money at retirement), and I don't believe that to be true.

This obviously ignores other differences such as the option to withdraw contributions early, forced withdrawls at a certain age, changes in tax brackets (which most likely favor a traditional IRA), etc.

[IdealFugacity]

i was under the impression that if I am 22, I should plan on being in a higher tax bracket when I'm 60...which is why Roth IRA was better?

[theTourne]

It's definitely possible. I'm not qualified to answer that (as you can probably tell since I asked this question in the first place), but it would depend on what you plan to do during "retirement." If you expect to still be earning income, it would likely be higher than your current salary. If you expect to be doing things like traveling and playing golf instead of earning income when you hit 65, you would be in a lower bracket.

[IdealFugacity]

Got the list of the funds available for 401(k) today. Good stuff, notably VIIIX, VIDMX, and VSCIX, all which seem to be lower ER variations on the Investor share funds I was looking at respectively large cap, int'l, and small cap.

Vanguard said they won't waive the minimum if I set up regular deposits, so if REITs are involved at all when i decide upon my portfolio allocation (reading Random Walk down Wall St and All About Asset Allocation soon as the library processes them into the catalog), my portfolio will be way out of whack for the first few years as I set up Roth IRA in chunks of each fund.

Currently, if I use my first year to invest 9% of salary in 401k (match is only 50% up to 7% i found for a total of 12.5%), and another $3k in Roth (min deposit into REIT. Add another grand if I can put it together, add a few more % pts to REIT listed below), I could end up with a mix of 30% Large-cap, 22% small cap, 33% REIT, and 15% international (w/o accounting for varying rates of return)

Like i said, it'll be out of whack due to the minimum deposit thing, I'll be adding 3-4k a year to one of the 4 categories again in the roth the year after that, repeat for 2 more years to have all 4 available for future investing in as small or large amounts as I like]

that'd be about 16% of my first yr pre-tax income.

Edit: I arrived at the %s by setting up an excel sheet with a desired allocation level, then putting in dollar amounts for how much I'll be putting into 401k and 3k into roth specifically designated to REIT, then using the solver function to minimize differences between desired and real allocation. <3 excel

[TLC]

Unless you are immediately vested in the matched funds, I would advise you to "discount" them somewhat when calculating your overall asset allocation. In other words, since the matched funds represent 28% of your 401(k) and ~18% of your total 1st year contributions, your REIT allocation in your ROTH may prove to be closer to 41% than 33%.

[IdealFugacity]

I am 100% vested immediately. (Match only starts after 1000 hours/6 months)

[MatthewRyan]

[ QUOTE ]
i was under the impression that if I am 22, I should plan on being in a higher tax bracket when I'm 60...which is why Roth IRA was better?

[/ QUOTE ]

yes, its wise to plan for the worst case.

Also, having a ROTH & 401k is tax diversification. Its smart to be prepared for both very high taxes and the (slim) possibility that our country eliminates income tax, or that yours is lower than now.

Also, do not put your short term downpayment money in your equity portfolio expecting it to gain 9%. Short term money should really be in short term bonds or a money market (ING Direct is fine).

[Sand]

[ QUOTE ]
...the (slim) possibility that our country eliminates income tax...


[/ QUOTE ]

There are a lot of things in this world that are uncertain, but there is a less than zero chance this will ever occur. [img]/images/graemlins/grin.gif[/img]