How Should Successful Young Couple Invest?


Dear Dr. Don, I pay an additional $300 a month on my mortgage principal, but I am unsure if this is the best use of these funds. We're a young couple: I'm 25, and my wife is 23. Our combined income is $82,000 before taxes. We recently purchased our first home for $215,000 with a conventional 30-year mortgage. We used most of our savings for the 20% down payment.

We are now trying to aggressively reboost our savings; we have $6,500 in savings and $5,800 in bonds. We contribute 3% and 5% to our 401(k)s respectively. We just set up an automatic monthly withdrawal of $1,000 to our bond account and $417 to a new individual retirement account we've established. I'm trying to figure out the best use of our "extra" investment money.

Thanks, -- Mitch Motivated

Dear Mitch, If your employers offer matching contributions to your 401(k) plans and you're each not contributing up to the limits of the match, then that's the first place to put your "extra" investment money after establishing an emergency fund. You want to set aside savings equal to roughly three to six months' worth of living expenses.

If you're contributing to a traditional IRA, you should at least consider opening a Roth IRA and contributing to that instead. I'm recommending the Roth IRA because with it you contribute after-tax dollars, and qualified distributions are tax-free in retirement. It also gives you a measure of tax diversification when compared to your 401(k) plans.

If you decide on the Roth IRA, then you can do a conversion to move the funds from the traditional IRA to the Roth if that makes financial sense. How the money is invested in the traditional IRA can influence your decision, as can the annual account expenses. Talk with your tax adviser if you can't decide whether a Roth IRA is right for you.

I don't think you should be making additional principal payments on your mortgage at this point in your careers. Increasing your retirement savings in your 20s gives that money more than 40 years to grow. Not everyone in their 20s has the money available to increase retirement savings. You do, so take advantage of it either through the traditional/Roth IRA or your 401(k) plans.

I'm a little concerned with how big a percentage of your investment portfolio is allocated toward investing in bonds. You didn't name the fund, but interest rates are far more likely to increase than they are to continue to decline. As interest rates head higher, bond prices will go lower. That said, there's a solid argument for having some of your investment portfolio allocated to bonds.

Adding $12,000 per year to your bond allocation through an automatic investment plan, or AIP, has the advantage of dollar-cost averaging your bond investment over time in this expected rising-rate environment. Dollar-cost averaging has you investing the same amount of money each time; what varies is how much of the investment you buy. So if you invest $1,000 a month in a bond fund, the number of shares you purchase each month will vary based on the mutual fund's share price.

Where's the rest of your money being invested? Even though you have roughly a quarter-million-dollar investment in real estate, you still would want investment exposure to the stock market in your retirement portfolio.

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