AboutJohn D Smith, CFP Expertise I can answer detailed questions regarding mutual fund investing, retirement planning, education planning and related financial planning/investment issues. I have a B.S. degree in Financial Planning & Counseling. I am also a Certified Financial Planner (CFP) and have performed fee only investment management and financial planning services for the past 11 years.
Question QUESTION: I am 36 years young. I have been investing for the past 10
years primarily in no-load mutual funds (mostly from T. Rowe
Price) and are diversified. I have other investments too. I
always keep an eye on my portfolio and analyze it frequently
but at the same time I am a long term investor. On an
average my investment generates 10% to 15% yearly. I also
have IRA and 403B. I don't have any debt except mortgage and
that too is manageable (My philosophy on purchases is that
if I can not pay by cash at that instant then I won't buy. I
consider credit card to be only of a convenience and I use
it as such. I divide things in "must have" and "nice to
have" categories. I lead a simple life.). I keep a 6 month
reserve of cash which is generally in Money Market and short
term CDs. The yearly invested amount, let's say, is around
$15,000 to $20,000 every year. I intend to keep this going
every year and keep increasing the amount. I am not eligible
for IRA contribution tax break and I am not eligible for
Roth IRA. Given this scenario, is it really that worthwhile
to max 403B and IRA? I realize they have the benefits of
savings on taxes on dividends every year and in case of 403B
the taxable amount itself is reduced. But I get locked in
till 60 years of age. If I diligently invest every year then
does it matter whether I invest in regular funds and take
the tax hit now at the current tax bracket rate but keep the
flexibility of cashing when I want or sock it in retirement
plans hoping to pay less tax later as the tax bracket will
be lower? In the end does it really make that much of a
difference?
ANSWER: Hi. With the advent of extremely tax efficient vehicles such as ETF's, the tax free growth of 401k plans aren't as compelling as they once were. However, the up front tax advantages that comes with pre-tax contributions is meaningful. Whether or not it is "meaningful enough" depends somewhat on what your tax bracket is during the contribution years vs during the years when you take withdrawals. With that being said, the actual benefit of maxing out a 401k depends on each persons scneario not only now but in the future as well. Regardless, automatic 401k contributions does intill a savings discipline which most people lack. One final thought; for those who have tax deferred accts such as 401k's and IRA's in addition to taxable savings accounts, there is the idea of asset placement which involves putting certain investments in each type of account and managing the mix as "one" vs separate accounts. There is proven benefits to this. Although this isn't a straight forward answer, I hope it helps.
---------- FOLLOW-UP ----------
QUESTION: John, thank you very much for the reply. I do have one more
follow up question to ask, in reply to your question. I am
in the 25-30% tax bracket. I am a regular and diligent
investor and I have been investing since I was 25. Therefore
lack of discipline will not apply in my case. I also monitor
and analyze my investments regularly. Given this additional
information do you think I should go completely with ETF or
divide between ETF and 403b, apart from my other regular
funds and investments? Thank you
Answer Hi. Since you sound like you have a fairly good understanding of investments, I will share the following concept with you to think about. You can invest in both and start to consider asset placement strategies. What I mean by this is investing the 403b and personal accounts based on their different tax characteristics. Typically, this means putting lower returning and tax inefficient investments (i.e. bonds and equities such as REIT's, emerging markets or high turnover mutual funds) in your tax qualified accounts and putting the high returning and more tax efficient investments (i.e. ETF's or other index type funds) in your taxable accounts. The idea behind this is to improve long term after-tax performance and there are plenty of compelling studies that show this makes a difference. If you Google "asset placement investing" you will come up with references to this strategy. You can also go to About.com for a further explanation. I hope this helps!
