The first step to setting out my investing plan for the year is to calculate how much I plan to contribute to my investments, which requires choosing investment vehicles.
- I am going to max out my Traditional 401(k) since it saves me a good amount on income taxes. $17,500 in pre-tax income instead of post-tax saves $4,900 in the 28% federal income tax bracket, which is not a small amount.
- Maxing out my 401(k) is more than enough to get the maximum match from my employer.
- I could also contribute part of the IRA contribution limit ($5,000) to a Roth IRA for 2012. I won’t know for sure how much I will be able to contribute until I do a full run of my income taxes with all the tax forms.
- I could also contribute the remainder of the 2012 IRA contribution limit to a non-deductible Traditional IRA and the full 2013 contribution limit ($5,500) to a non-deductible Traditional IRA.
- I could buy up to $10,000 in i-bonds through Treasury Direct.
- I could buy index funds in my regular, taxable investing account at Vanguard.
I’ve decided to go with #1, #2, and #3 for this year. Any remaining savings for the year will go towards the mortgage principal. I will re-evaluate this plan again for 2014.
Why do I not want to use the non-deductible Traditional IRA? Its gains are taxed as ordinary income rather than capital gains like they would be in a taxable account. It could make sense to defer taxes on fixed income investments, but for now, I have plenty of tax-advantaged room to cover than between my 401(k) and my Roth IRA and I could always buy i-bonds in taxable to gain some more fixed income room. Buying total stock index funds in taxable is pretty tax efficient, so I would rather do that over opening and maintaining a Traditional IRA with non-deductible contributions. It could make sense to use the non-deductible Traditional IRA if I was to convert its funds to my Roth IRA within a year or two. At some point, I could end up working somewhere with high fees in the 401(k) plan and wanting to roll over my current 401(k) to a Rollover IRA instead of into the new plan, which would leave me with both non-deductible and deductible Traditional IRA contributions. So for now, I’m going to keep things simple and not make non-deductible contributions. As above, I will re-evaluate this plan for 2014 and may retroactively make a non-deductible Traditional IRA contribution for the 2013 tax year.
Why do I not want to buy i-bonds? I don’t have a need for that much fixed income room yet. My current fixed income allocation is ~1/4 of my investment portfolio. I like their tax-deferred nature, but the current composite rate is 1.76%, which is still less than my mortgage.
Why do I not want to add more funds to my taxable account? I would rather pay down the mortgage than invest in a non-tax-advantaged account this year. I will, of course, re-visit this decision again next year.
Monthly 401(k) Contributions
I have a simple little spreadsheet that takes the following formula to tell me how much to set my monthly contributions at:
- H3 = annual base pay (gross)
- J2 = Yearly max to the 401(k) – $17,000 for 2012
- I2 = ROUNDUP(J2/H3,2) = the % that I should contribute monthly from my paycheck to max out the 401(k) over the course of the year, e.g. if it is XX.3%, I will set it to XX+1%.
I updated my 401(k) contribution % back in December, so it is already set for the year!
Roth IRA Contribution
I set aside my estimated Roth IRA contribution with my January RSU vest. It is in a savings account and once I’m sure of the final amount, I will ACH it off to my Roth IRA at Vanguard. I will pull any extra funds necessary to max out my Roth IRA from my general savings account.
2) Asset Allocation
Now for the fun part: figuring out which index funds should get all of this money. To do that, I calculate what my portfolio will look like at the end of 2013 if the market makes no changes and what the “ideal” portfolio would be.
As of writing this post, my investments portfolio is worth ~$77,400. I estimate adding $20,700 to the portfolio this year, including my 401(k) contributions, my employer match, and my Roth IRA contribution, putting an estimated end of year balance at $98,100.
My target asset allocation at the end of 2013 will be:
- 31% S&P 500 Index
- 7% Extended Market Index
- 37% International Stocks
- 25% Fixed Income
Based on this, let’s calculate my ideal portfolio at the end of 2013 and compare it to where my portfolio is now:
I keep the Extended Market index fund in my Roth IRA. The amount that needs to go into it by the end of the year is more than my contribution amount. I also have Total International Stock Index fund in my Roth IRA, so I will re-balance by putting 100% of my Roth IRA contribution into the Extended Market Index fund and by exchanging the difference from the Total International Stock index fund into the Extended Market Index fund. That will even things out and then I won’t look at the Roth IRA again until January/February 2014.
The remaining amounts will go into my 401(k). I subtracted my employer match off of the targeted amount for the S&P 500 index fund since it goes into something I count as that for my asset allocation calculations and then came up with the following split for my 401(k) contributions:
- 27% Vanguard 500 Index fund
- 38% Vanguard Total International Stock Index Fund
- 35% Vanguard Retirement Savings Trust
Since this is all the contributions I plan on making for 2013, I should just be able to set and forget this for the rest of the year. I’ll check in on what things look like perhaps in early to mid July, but it looks like this year will be pretty simple for investment contributions!
Readers, have you set your 2013 investment plan? How does it look?