Debt free..... Now what?

[starnz]

Hello, I have a couple questions about my financial situation and would appreciate and feedback provided.

I am 31 yrs old making just under $90k/yr. I have 3 kids, twin 5 yr olds and a 1 month old. I am married and my wife stays home with the kids. I just recently became debt free and I was hoping to get some advice as to how to go about saving short term and long.

As of now, my saving consists of 5%(w/ employer match) of my income going to my 401k and another $200 every 2 weeks going into a separate savings account. I currently have approx. $16k in my 401k and another $2200 in my savings account. I also recently opened an online account with ING and put $1k in it initially with $100 going in every month. I opened this account because it was offering 1.25% interest(not sure if this is a good rate or not but its better then my first savings acct).
I have a home on which I owe $165k @ 4.875% and 26yrs left. I was paying extra on this while also paying it down every two weeks but I canceled that plan recently after I believed myself to be relocating(no longer the case).

I will need to purchase a new vehicle in the next year or so of which I will want to pay cash for, approx $15-$17k. I also budget myself to $300 cash for my wife and I to cover groceries and spending money every 2 weeks. My mortgage and insurance are $1400/mo and bills usually around $600/mo(elect, gas, water, cell, etc). I am also paying $300/mo for preschool for the twins but only until May.

What would be the best way to save for the car purchase? Should I be putting more into my 401k even though there's no match above 5%? Would a Roth IRA be a good choice to max out and if so should I wait until I have the cash for the car first? Thinking longer term, should I be doing anything to prepare for kids college tuition? Should I resume paying accelerated payments on my home?

I know there are a lot of questions and if I'm confusing then I apologize. But again, any feedback or input would be greatly appreciated.

Thanks

[jIM_Ohio]

Congrats on being debt free. Use this accomplishment to do a spot check on your budget and make sure it "aligns" with continuing to be debt free AND also building wealth.

There are two threads you will want to review. If you have questions, post them here- these threads were written by me with some input from others and contain FAQ either I would ask you if you were in this situation, or FAQ you might have on "what steps to take".

http://www.savingadvice.com/forums/investing-banking/50669-questionaire-people-starting-retirement-planning.html

http://www.savingadvice.com/forums/investing-banking/50734-investment-risk-questionaire.html

The main point of those threads is helping you prioritize finances, short term, long term and understanding basic taxes and goal setting. Some food for thought... Here is some simple math for you:

If you want 18k for a car within 12 months, you would need to set aside $1500/mo to accumulate enough money to pay cash for it.

If you want to retire in 39 years (age 70) you should look at your current expenses and multiply them by 25 (if you spend 40k per year, you need $1 M in 401k or other retirement accounts within 39 years).

College for kids- if each kid is going to get 80k over 4 years, you have 13 years (156 months) to save 160k and 17 years (216 months) to save 80k. Simple math suggests that is $512/month for the twins and $185/mo for your 1 month old.


I realize you do not have the cash flow to solve all these problems. That is why I suggest you look at ALL your financial goals (beyond just retirement and the next car) and start thinking about which ones get funding and which ones are delayed or not even considered.

Here is what I would look at specifically:

1) Make sure budget has you spending less than you earn. Get a good feel for budget and look at items which might "go away"- like car payments, mortgage or other liabilities (like diapers and baby food).

1a) if you can make budget so you spend 80% of gross and save 20% of gross, you are on target for a successful financial plan IMO. Focus on the savings rate before you think about 401k-Roth- cash savings or any other investments. That 20% savings rate (or whatever rate you can stomach) will be the single biggest factor to the success of your plan.


2) For that 20% savings rate, try to have 15% going to retirement and 5% going to other needs. I suggest funding longest term goals first, then working backwards to short term goals. For example you put a 12 month timeline and 18k price on your next car. This time is relatively liquid- if you made it 18 months and 20k or 24 months and 10k you could still meet the goals without changing much in the budget, so realize that short term goals come and go. Some goals come and go with more rigid requirements than others- for example college savings will be tough to tell an 18 year old to wait 6 years until you saved up enough for college- so as you look at savings rate, make sure the goals which are furthest away get the most attention. Otherwise the single biggest expense for you (retirement) will keep getting bumped for more pressing short term goals like a replacement car.

3) Put your financial life on a timeline. List the financial accomplishments in the order you might achieve them- retirement, paying off mortgage, replacement car, possibly kids college and anything else you want to accomplish. If you know the cost, put the cost on the timeline.

For example
retire by 70 cost $1 M (use that 25X number I listed above)
pay off mortgage by retirement cost $165k
pay kids college by age 44 cost 240k

and then take each cost and "snowball" them
for example the mortgage is a liability on the timeline- takes up $900/mo and that could clearly fund some other items on list (like kids college).

So if college funding is important to you, could you pay off mortgage in 10 years, then use $900/mo for 3 years to fund kids college?
Or if retirement funding is short because 20% is too high right now, does the $900/mo mortgage make up for that once its paid off?

The timeline and estimated costs of things can be calculated with a simple spreadsheet.

The 25X retirement target is conservative, you might be able to retire on 20X if your savings rate is really high or your expenses are really low or if you have a pension or if your SS benefit is really high (relative to expenses). If you have 25X and cannot retire, something is probably wrong or not mainstream in your situation. 25X is a target, getting the stock market to give you the "exact" amount in your target at an exact year is impossible- the point of the 25X is to create a goal, using some historical data to give us context into your situation. As you get closer to retirement (within 5-10 years) you will likely be adjusting your target because you know more about your retirement (that last sentence is a disclaimer).

The 25X target assumes taxes are not paid yet- so if a Roth IRA is used, its possible 20X or lower could be used. The 25X target has inflation built into the target- as long as your retirement account is 25X of your projected expenses the year you retire, that number implies you withdraw 4% of your account balance each year in retirement, adjusts the withdraw up each year for inflation too, and 90% of the time (in the past) that portfolio would hold up with a 60-40 allocation to stocks and bonds.

For retirement planning, assuming a 7-8% return on retirement accounts before inflation while working is reasonable as you do some projections.


We have both Roth IRAs maxed- self and spouse- at 10k per year
We have 401ks above the minimum- mine is 11% and wife's is 7%. Our savings rate to retirement accounts is between 20-25% and we live on what's left.

In your case I would do the same-
get 500/mo going to each Roth (you and spouse)
401k up to match
set aside some money for the car
build up cash accounts/ emergency funds
make sure you know your financial timeline.

Post here with questions
My responses are long to include as much detail as possible- however I am sure I missed something, assumed something wrong, or made a quick judgement on something- keep reading and ask questions.

Congrats again on being debt free.

**edit**
if 90k income
20% of 90k is 18k per year
15% of 90k is $13,500
meaning put $13,500 each year into retirement accounts
$5000 into your Roth
$4000 into wife's Roth (this is where any new retirement funds go as you get raises and maintain the 15%)
$4500 into 401k (this is 5% you put in now)

5% of 90k is $4500/year
$4500/year ($400/mo) into savings for short term expenses

If you are living on 80% of 90k (72k), best guess is you are spending around $40k-60k per year on food, shelter, clothing, kids, travel etc...).

If 40k of expenses, the 25X retirement target is $1 M
If 60k of expenses, the 25X retirement target is $1.5 M

You need to "define" retirement expenses- as my opinion is the money for a mortgage morphs into other expenses (like travel, vacations or something else). However if a person is really frugal, its possible the 60k of current expenses gets cut in half in retirement. Use current expenses for the target, and if you are frugal, the good news is you will be able to retire a lot sooner than expected.

[watsoninc]

Personally, my next goal would be to have a fully-funded emergency fund with 3 to 6 months worth of expenses. Then, I would work on investing at least 15% (Jim mentioned), and develop a plan for a) investing for the kiddies and b) paying extra on the house. Afterward implementing the plan, I would work on more short-term financial goals (i.e. car). I 100% agree that it is all about your goals. For example, if you plan to fully pay for your kids education, you have a different financial burden than someone who is paying 50%.

Congrats on being debt-free!!!

[Mike75]

Personally, my next goal would be to have a fully-funded emergency fund with 3 to 6 months worth of expenses. Then, I would work on investing at least 15% (Jim mentioned), and develop a plan for a) investing for the kiddies and b) paying extra on the house. Afterward implementing the plan, I would work on more short-term financial goals (i.e. car). I 100% agree that it is all about your goals. For example, if you plan to fully pay for your kids education, you have a different financial burden than someone who is paying 50%.

Congrats on being debt-free!!!

I agree with you completely. Great work on getting rid of the debt, but now you must take every step carefully, so that you don't fall into that trap all over again.

[snshijuptr]

I agree with the Emergency Fund but I also agree with the snowball. Basically you need to list all of your goals, how many months you have to achieve them, how much money you need, and their priority. Then figure out how to maximize your monthly saving percentage. Now you get to do some calculations to maximize returns and meet the most goals. Remeber to think of yourself on the path to reaching all your goals and not as meeting one goal after another.

[bjl584]

I'm assuming that you are talking about consumer debt when you say you are debt free? You mentioned that you owe $165K on a mortgage. Personally I'm not going to consider myself debt free until all of my debts are paid. But, I think that you should focus on the EF for now.