Where Should I Really Be Doing My Investing?

I decided several months ago that I wanted to start investing, so I signed up with Schwab and started contributing automatically each month. It made sense, and I wanted to do SOMETHING, even if it wasn’t perfect.

Well, now I realize that it wasn’t perfect and I want to tweak my plan. I currently contribute to a Roth 401(k) through work but until Sunday, I hadn’t created a Roth IRA.

So my brilliant idea is to use the Roth IRA as an investing account! I can withdraw my contributions at any time (but not the earnings!) and if I want to withdraw the earnings, I’ll be able to take money from other places (reduce my 401(k) contributions for a few paychecks, dip into one of my sub-savings accounts) to make up for the interest I won’t withdraw from the Roth IRA. Essentially, I would keep my investing in a Roth IRA, earn tax free interest there, and withdraw that interest by making smaller 401(k) contributions equivalent to the amount of interest I earned but didn’t withdraw.

I think this is definitely the way to go. Why invest and pay taxes when I can invest and not pay taxes?? It seems like a no-brainer now, why didn’t I consider this as an option earlier?

So I set out to open my Roth IRA. Opening with Vanguard was so easy. It took less than 5 minutes. I had to start with $1,000 in a STAR fund, and I’m going to contribute as much as possible (after making my regular contributions to the emergency fund) until April 15, which is the cutoff date for 2009 contributions. Also, I’m stopping my Roth 401(k) contributions for the time being and using all that money to go toward the Roth IRA. That way I’ll be able to take full advantage of all my Roth options for the 2009 year. After my 2009 contribution window closes, I’ll contribute my regular 401(k) amounts to my 2010 Roth IRA plus the amount of any additional investing I want to do. Once I reach $5,000 of Roth IRA contributions in 2010, I’ll go back to contributing to my Roth 401(k) through work.

So why not just change my investments from Schwab brokerage to Roth IRA and leave the 401(k) alone? For flexibility. No matter what, I’ll always have my Roth IRA contributions to withdraw, penalty-free at any time. With a 401(k), there are rules for when I can withdraw, even the contributions, without penalty, and I wouldn’t qualify. So I’ll max out my Roth IRA contributions first because I see no reason not to.

My goal this year was to contribute $5,000 to my retirement funds, and that is a goal I will keep in mind. Anything above $5,000 will be my investing money, and at the end of the year, will just be my total contributions minus $5,000. Although it will seem like I am putting a lot of money away in retirement accounts this year, I will still have to remember that some of that money, while in a retirement account, will not be used for retirement purposes. But if I’m lucky, I won’t be tempted to withdraw it at all and will continue to take advantage of the tax-free interest I’ll be earning.

3 Responses to Where Should I Really Be Doing My Investing?

  1. mbhunter says:

    “Why invest and pay taxes when I can invest and not pay taxes?”

    Because the rules that govern Roth IRAs can change at any time. It’s more difficult to tighten the noose on non-qualified plans.

  2. FinEngr says:

    So to summarize – you’ll be adding $10k within the next few months, using the Roth for trading, and withdrawing the principal for other vehicles?

    1. Good luck on the goal. I’m always supportive of “more now, less later”. Actually going to write a post along these lines (maybe link back here – will let you know)

    2. This is a strategy that has been discussed before. From what I’ve read, it seems like a mixed-bag of responses.

    3. Only portion I am hesistant on. Even with 10,20,30% gains – your principal accounts for the majority of your position. Removing and amount is like hitting reset on the game of compounding. You’ll then only be earning 10,20,30% on 10,20,30% of the total. Maybe I’m not clear on your plan…

    • Daniel says:

      @FinEngr, I want to contribute $5,000 each year to my retirement funds, at least for the time being. After I reach that limit, I’m going to use the extra space for my own “tax-free” investing. I can do this mostly because I have a Roth 401(k) at work, which means that if I contribute $5,000 to the Roth IRA and $3,000 to the Roth 401(k), I’ll withdraw $3,000 from the Roth IRA (and any interest I gained on it).

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