Maximizing your 401(k)

Okay, so you want to invest. You’ve been convinced. After reading blogs like mine and listening to podcasts like those at ChooseFI, you’re finally ready to take the plunge. But how? Where do you start? Do you support this blog by using my Robinhood referral code? No, sadly you do not, because first, we need to talk tax-deferred, and tax deducted.

We can start off slow. Keep it traditional. By that, I mean traditional 401(k) and IRA. These are tax-deferred, which means you don’t pay taxes on them until you take them out (but we’ll go over how to not get taxed on those ever). In 2020 you can contribute up to $19,500 in your 401(k) and another $6,000 ($7,000 if your over 50) into your traditional IRA meaning you can not pay taxes on $25,500 per year, plus your standard deduction ($12,400 for single / $24,800 for married filing joint) and you have $37,900-$50,300 of completely tax-free/deferred. Granted you would only be able to use what you keep out of your 401(k) for now.

To avoid getting too technical here, I’ve deduced another beautiful 5 point list of things you should do to start investing and preparing for early retirement.

Step 1.) What does your life cost?

I recommend taking an hour or 2 and just going over every reoccurring expense you think that you have. include what you estimate eating out and groceries would be. Include gas, rent, utilities, everything. Next, go into all of your accounts, (Mint works okay for this as well) and actually put everything for a roughly 2 month period (the longer the better but a minimum of 2 months) into a spreadsheet. Categorizing it would be good but the big thing is seeing how easy it is to spend WAY more than you should be or need to be. So total your expenses and divide by how many months we are covering to get an average cost of living per month.

Step 2.) Was it worth it?

This one is less heavy lifting, I promise. Look at each purchase and ask yourself, was it worth it? If you invest a dollar today, in 20 years it would be worth $4.32 assuming an 8% return. So was the 10 dollar sandwich worth $43.20? Because that is the opportunity cost of not investing. I can’t tell you what adds value to your life, and maybe the NHL Live package is worth every penny for you, but just take note of what these things are worth to you. Then eliminate what you find to not add value.

Step 3.) Invest a comfortable amount in 401(k)

Our strategy is to invest enough into our 401(k) to where we still have roughly $100-$200 remaining in positive cash flow every month. This means after contributing to our retirement account, and paying every bill that we have, our checking account is at least $100 dollars higher than it was the month prior.

Step 4.) What is your emergency fund?

You need access to money that is readily available. So where is that money? How much is that money? Is it 6 months of expenses sitting in a 0.015% interest accruing checking account? Is it 100 dollars sitting in a piggy bank? We used to have 6 months of expenses in a checking account and moved most of it quickly into Robinhood to purchase VTI (vanguard total stock market tracking ETF) shortly after the stock market started to drop. Now we hold onto roughly 1-2 months of expenses when our account is at its lowest in checking and put everything else in Robinhood if there is excess. To clarify, our (not giving financial advice) strategy is to keep NO LESS THAN 1 month of expenses in our checking. This means once everything is paid, there is still at least 1 month of expenses remaining. This also with Robinhood accessible for withdrawal if we absolutely need it.

Step 5.) Make more money and adjust

When people make more money, they spend more money. Why??? Were you not happy with what you were spending before? Did buying butter when it wasn’t on sale suddenly fill that void in your life? When you make more money, simply adjust your 401(k) contribution to absorb that increase. Easy peasy.

And that’s it! continue to follow these steps and you will end up free from the chains of employment before you know it.

“But CPT CashFlow, I thought I was going to learn about dollar-cost averaging!”

Stay tuned, more is on its way…