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Failing to contribute the maximum amount to this retirement plan is simply giving up on free money; by doubling his current contribution of three percent, Chris would actually be tripling the amount added to the 401(k) each year due to the employer's matching policy. This account is also earning an estimated eight percent annually, not far behind the 9.5% the stock market is expected to earn, and the money in the 401(k) remain far more liquid with the ability to borrow up to 50% of the value at any given time, and at a rate lower than a mortgage and significantly lower than a secure personal loan (though funds must be repaid within five years). This strategy will build both short- and long-term growth to a much higher level without impacting the ability to have an emergency fund or purchase a home.
As the Nicholsons have short-term goals that are focused on stability, including the emergency fund and the purchase of a home, an aggressive growth strategy through increased investment in the stock market, even in mutual funds, is not recommended. The spreadsheet is currently optimized for contributions to the 401(k) maxing out at six percent and with the rest devoted to savings; though more substantial contributions to the 401(k) would lead to faster growth due to the interest earnings of the account (Chris is allowed to contribute up to 20% of his earnings each year) this would not be as liquid as the savings account due to the required repayment of borrowed funds within five years; while it makes sense to consider the 401(k) as a part of the Nicholsons' emergency fund, it would not be wise to use this money as a substantial portion of the down payment on their home, and thus maximizing savings contributions are recommended.
As shown in the spreadsheet, this will allow the Nicholsons to put a 20% down payment on their home as early as the end of 2010, with the use of some 401(k) funds, or by the end of 2011 using just over half of their savings account without touching their 401(k) and leaving their emergency fund fully funded (house price and thus down payments are adjusted annually for inflation). If the Nicholsons purchase their home at the end of 2011 with the price estimates given and twenty-percent down, the monthly mortgage payments for a 30-year mortgage at eight percent interest will only be $660 -- $110 higher than their current rent payments, Property taxes will add an additional $100 to their monthly payments, however the tax deductions for mortgage interest payments made will all but certainly offset this. A 15-year mortgage at 7.5% interest will lead to monthly payments of $834 with less of a tax incentive, and would not be recommended at current (and expected future) income levels.
After the home purchase is made, contributions to the savings account should be reduced and somewhat more aggressive retirement investing should occur. The Nicholsons should consider opening an IRA in addition to the 401(k) Chris has, as this will give them greater freedom in selecting investments and earning a rate of return closer to the market rate than the 401(k). A Roth IRA might be beneficial due to the fact that the Nicholsons will have relatively low tax liability over the next decade regardless; though the tax deductions to a traditional IRA would be beneficial in the short-term, the tax-free growth of a Roth IRA would be even more beneficial in the long-term, and again the Nicholsons seem very security-minded. Additional investments in their mutual fund and in the stock market could also be considered when the house is purchases; additional mortgage payments are also a possibility and would increase security, but would produce a lower rate of return over the long-term.
Assuming that both Chris and Faith retain their current employment until retirement, their salaries should increase substantially and provide room for many luxuries as well as abundant savings for post-retirement living expenses and even travel. Securing a home (that can later be sold) for little more than the monthly rent payment makes good fiscal sense, and after that aggressive investment in growth stocks both trhough the market and in an…[continue]
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