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My Story

Finance was never my strong suit, but I was really good at saving money. Over the past several years, I've learned that saving money isn't the best path to financial freedom. It's how you manage your money and where you invest it.

I grew up poor 🥺, 6 family members in a 1 bedroom/1 bathroom apartment. I was taught to get a good education so that I don't have to do hard labor for a living. Investing in your 401k, maintaining a savings, and relying on social security benefit, was my path to retirement at the age of 65 👴🏻. If I had a salary of $30K after graduating from college, then I would be very fortunate. Several years after graduating from college, I invested $10K in a high yielding savings account and made $20/month. I thought I was brilliant 😄 for making money off of my savings. Little did I know, that was just a drop of water in the ocean 💧🌊.

My life changed when I got laid off 🔪👨🏻‍💻 in 2016. I started thinking about excelling my career and also looked into investments. In 2018, I quit my job to focus on my career advancement and the stint lasted for a year. I took on a roommate to help with the monthly payments and relied on my savings to pay my bills. Despite being in deficit every month, my total asset was actually net positive during the time I wasn't working! And that's largely due to great investments 📈!

The Formula

Mutual fund yields more income than a savings account. The US stock market will go up and down, but I (as much as most investors) hypothesize that the US market 🇺🇸 will eventually rise over the long term 📈. Like anything else, rewards come with risk. The higher the reward, the higher the risk. Mutual fund are fees cost 1-2% 🤮, which is steep!

Here comes Index Funds 🦸🏻‍♀️. Index funds are unmanaged, thus, fees could be as low as 0.03% ✅! The gains are about ~10% on average. If you invested $10K into Index Funds for an entire year, that's $1K in gains with a total investment of $11K. And since the fees are so low, it's basically negligible. That sounds a whole lot better than $20/month! By next year, with $11K invested and an expected gain of 10%, you will then have a gain of $1,100 🤑. That $100 was a result from your gains the first year. Welcome to compound interest where you earn money off of your gains. Compound interest works very well over long periods of time.

Imagine if you invested $10K into Index Funds in 2021 over the course of 10 years, how much money would you have at the end?

Let's take another example. 3 investors who took different approaches to retirement saving, assume annual rate of return is 5%.

  • Jasmine invests $300/month @age=25, Jasmine invested $144,000 over 40 years.
  • Aladdin invests $300/month @age=35, Aladdin invested $108,000 over 30 years.
  • Lam invests $600/month @age=40, Lam invested $180,000 over 25 years.

Lam invested the most money but falls behind Jasmine because she invested 15 years before he did. Why? The answer is compound interest. The moral of the story is, don't be a Lam 👎🏻 and invest later in the game. The earlier you invest, the more your investments multiply.

Investment Types

Investing in Index Funds is great. However, taxes will chip away your gains. If you invest, held onto it for less than a year, sell it, then you will get taxed on short term capital gains, which is your ordinary income tax. However, if you hold on to it for at least a year and then sell it, you will get taxed on long term capital gains 💡which is much less!

When you get a pay check, you get taxed. When you invest that money into a mutual fund and then sell it, you get taxed. This is double taxation! Different types of investments can avoid the double tax if you invest carefully 👍🏼.

There are many types of investments/expenses to take advantage of tax:

  • 401K/403b - Company sponsor retirement investment
  • IRA - Your personal individual retirement account
  • HSA/FSA - Health insurance with tax savings/investment capability
  • Commuter benefits - pretax on work commute expense
  • 529 - Tax advantage investment for educational expense
  • Brokerage Account - There is no tax savings here, but you can invest in mutual funds.

401K

As defined via investopedia.com, a 401(k) plan is a company-sponsored retirement account to which employees can contribute income, while employers may match contributions. You can choose between a traditional 401k vs a Roth 401k, pre-tax vs post-tax respectively.

With a traditional plan, money is withdrawn from your paycheck BEFORE tax and is invested into your 401K account. When you withdraw money from your pre-tax account after the age of 59 ½, you will get taxed based on your ordinary income tax rate.

With a Roth plan, money is withdrawn from your paycheck AFTER tax and is invested into your 401K account. When you withdraw money from your post-tax account after the age of 59 ½, you will NOT get taxed. Thus, you earn interests tax-free!

Let's run through some numbers to see the difference. Lam makes $50,000, 22% tax bracket. He makes $2083.33 per pay period. He invests 5% into his 401K.

Traditional

  • 401K Contribution: $104.17 (2083.33 * 5%)
  • Taxable income: $1979.16 (2083.33 - 104.17)
  • Tax Paid: $435.42 (1979.16 * 22%)
  • Net Income: $1543.74 (1979.16 - 435.43)

Roth

  • 401K Contribution: $104.17 (2083.33 * 5%)
  • Taxable income: $2083.33
  • Tax Paid: $458.33 (2083.33 * 22%)
  • Net Income: $1520.83 (2083.33 - 458.33 - 104.17)

Here we see, you get less money per paycheck with a Roth. But all of the interests you earned will be tax free! Which plan should you choose? It depends on what you think will be your taxable income by the time you retire and what the tax laws 👨🏻‍⚖️ will be by the time you retire (which is a mystery).

401K (based on 2023):

  • Max Contribution is $22,500, for age 50 and above is $30,000
  • Withdrawal age: 59 ½
  • Withdrawal penalty: 10% on top of potential tax
  • Required Minimum Distributions (RMD): Age 72

IRA

investopedia.com defined IRA (individual retirement account) as an account used to save for retirement. You can choose between a traditional IRA vs a Roth IRA, pre-tax vs post-tax respectively.

With a traditional IRA, your taxable income income is decreased by the amount you invested in this plan. When you withdraw money from your pre-tax account after the age of 59 ½, you will get taxed based on your ordinary income tax rate.

With a Roth IRA, because you are not deducting the invested amount from your taxable income, your money grows tax free. There is no RMD, so you can withdraw money whenever you want! For 2022, if your income exceeds the $129,000, then the amount you can invest is prorated. If you make more than $144,000, then you are not eligible to invest in this plan. However, if you are married, then your taxable income limit is increased to $204,000 - $214,000 (prorated range).

Brokerage Account

If you want to participate in mutual funds, you will have to open a brokerage account. There are no tax benefits in this type of investment. This is a great option if you have extra money laying around. Here are some popular financial institutions 🏦 you can use: Vanguard, Fidelity, Charles Schwab, Wealthfront, Betterment, Etrade, and many others.

Example:

  1. Lam invested $10,000 into a brokerage account..
  2. 3 months later, his account gained interests and is now at $10,500.
  3. Lam withdraws $10,500 and pays short term capital gains tax on $500.

Which funds to choose?

Each fund has a portfolio summary which includes the asset mix (stocks included in this fund), dividends if any, historical returns, and fees. If the fund is managed by experts (called actively managed), the fees are likely to be higher. They key thing is to look for fees! High fees may consume the majority of your gains. Also, just because a fund has performed well over the last X years doesn't mean it will perform well within the next year.

I'm a big fan of any funds that include S&P 500 index, which contain stocks of major companies like Apple, Facebook, Google, Johnson & Johnson. This index has done well over the course of its lifetime and is shown to always kick back despite coming from a bears market. This is my opinion and you should still do your homework on which funds to invest in.

HSA vs FSA

When it comes to health insurance, which plan should you choose, PPO, HMO, HDHP, etc? Why are we talking about health insurance when the topic of this blog is about finance? Because certain plans take advantage of tax and even has investment options! So which plan to choose - it depends on how often you think you will visit the medical office.

If you are very healthy 💪🏻 and don't have a track record of injuries, then a high deductible plan would make sense. This is where HSA comes into play. You have the option to invest money into an account where money can be used to pay for qualified medical expenses like co-pay, over the counter medicine, and even medical bills. Any amount over $1,000 in the account can be invested into the market. There is no use it or lose it rule. For 2023, the max HSA contribution is $3850.

If you plan to visit the doctor often, then a low deductible plan would make sense. And if you plan to incur substantial medical expense 🤕, then you can also contribute money into an FSA account in addition to your plan. The money contributed to the FSA account can be used to pay for qualified medical expenses. However, it is a use it or lose it account for the fiscal year. For 2023, the max FSA contribution is $3050.

529

Are you planning to spend money towards education 🧑🏻‍🏫 or want to save up money for college funds 🎓 for your children? Take advantage of the 529 plan, a tax-advantaged savings plan designed to help pay for education. Different states have rules/fees. For the state of Illinois, you can deduct the amount from your taxable income. However, there are no tax benefits for Federal. If the money is used to pay for qualifying educational expenses, then it will be withdrawn tax free!

If you plan to have children 👪, you can still open a 529 account under your name, invest money into the account, and then transfer your account to your child once they are born.

Investment Strategy

What I should do with my money first 💸: pay off my debt, save, or invest? Here is my rule of thumb:

  1. Pay off your high interest rate debt first e.g. credit card (order can change depending on the interest rate)
  2. Contribute enough into your 401K/403b to get the full company match
  3. Max out your HSA contribution
  4. Max out your IRA contribution
  5. Max out your 401K/403b contribution
  6. Contribute whatever you can in a brokerage account
  7. Pay the minimum for any debt where its interest rate < market’s return rate
  8. Don't forget to have some rainy day money in your savings account

Here is an example I found in a blog written by Brent Lacey (2020):

Example 1

  • Lam makes $2,083 per pay period.
  • Company matches up to 5% for 401K contribution.
  • Lam has a balance on his credit card for $1,000 at 12% interest rate and a minimum payment of $100.
  • Market return is 8%.
  • Lam has student loans of $400, 2% interest rate, and minimum payment of $50.
  • Where should Lam invest his money?
  1. $1,000 -> credit card
  2. $104.15 -> 401K (5% which gets the full match)
  3. $50 -> student loans
  4. Do something with the remaining money

Example 2

  • Lam has an extra $200,000 to invest.
  • Lam has a mortgage balance of $200,000 with an interest rate of 3%.
  • His monthly mortgage payment is $1,600 and have 30 years remaining.
  • His current brokerage account has an average rate of return of 8%.
  • Should Lam pay off his mortgage?
  1. Continue with the monthly mortgage payment of $1,600.
  2. Invest that $200,000 into a brokerage account

8% - 3% = ~5% profit + compound interest over 30 years. The rates aren't exactly apples to apples, but it is a quick high level comparison to determine which route is more favorable over time.

Conclusion

Recap: 401K/IRA - you get taxed once. Brokerage account - you get taxed twice.

When should I start investing? Yesterday.

I want to time the market when it’s low. They say “buy low sell high”. Should I wait for it? It’s pure gambling to time it. By not investing now, you lose out on the potential gains and the dividends that comes with it.

They say stocks/bonds ratio is 70/30. What ratio should I follow? It’s up to you on your risk tolerance and financial plan.

Resources

Disclaimer

⚠️ The contents discussed in this blog is my personal opinion and experience and is not intended for you to make a big financial decision. I am not a financial advisor. Please do your own research and/or consult a financial advisor.

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