How Much Should You REALLY Be Investing Each Month?

Key Concepts

Savings Rate: The percentage of income saved and invested for the future.
Financial Order of Operations: A structured approach to financial planning, prioritizing steps like emergency funds, employer matches, and then investing.
Always Be Buying (ABB): An investment strategy that emphasizes consistent purchasing regardless of market conditions.
Pre-tax vs. Roth Contributions: Two methods of contributing to retirement accounts, differing in when taxes are paid.
Marginal Tax Rate: The tax rate applied to the next dollar earned.
Tax Arbitrage: Exploiting differences in tax rates at different times or in different jurisdictions.
Roth Conversion: Converting traditional pre-tax retirement assets into Roth assets.

Savings Rate Recommendation

The video advocates for a savings rate of 25% of income for future investments. This is presented as a more aggressive target compared to older recommendations of 10% or 15%. The rationale for this higher percentage is the understanding that timing matters and that many individuals in America do not begin saving and investing until their 30s.

Inclusions in the 25% Savings Goal:

Contributions to employer-sponsored plans (401ks, 403bs, 457s, SIMPLE IRAs).
IRA contributions.
HSA contributions if invested.
Mandatory pension contributions deducted from pay.
Employer match (subject to income thresholds).
Employee Stock Ownership Plans (ESOPs) or Employee Stock Purchase Plans (ESPPs).
Savings in taxable brokerage accounts specifically earmarked for future financial independence.

The video emphasizes that saving 25% earlier in life provides greater freedom and flexibility in the future.

The Financial Order of Operations

The importance of following a structured "financial order of operations" is highlighted. Within this framework, the employer match is specifically called out as a critical step, described as "free money" and potentially more valuable than paying off high-interest credit card debt. After securing emergency reserves and the employer match, the focus shifts to maximizing tax-advantaged accounts and retirement accounts.

Investment Timing: Always Be Buying (ABB)

When it comes to the question of when to invest, the video strongly advocates for the "Always Be Buying" (ABB) mindset. This strategy is presented as a way to overcome emotional decision-making driven by market fluctuations.

Benefits of ABB:

Removes Emotion: It prevents investors from being swayed by fears of overvaluation or market downturns.
Consistent Growth: By consistently investing, contributions made when the market is up are growing, and contributions made when the market is down are acquiring assets at lower prices.
Win-Win-Win: This approach is described as beneficial regardless of market direction.

The ABB principle is illustrated with practical examples:

Maxing out a Roth IRA ($7,000 annually) by contributing $583 monthly.
Contributing $12,000 annually to a 401k by investing $1,000 monthly.

Pre-tax vs. Roth 401k Contributions

A common dilemma for individuals logging into their 401k accounts is the choice between pre-tax and Roth contributions. The video acknowledges the difficulty in making this decision due to the uncertainty of future tax policy.

The Goal of Roth Contributions:

The primary benefit of Roth contributions is tax-free growth. The video emphasizes the power of compounding growth on these contributions, which can lead to seven-figure accounts that remain tax-free in retirement.

The Pre-tax vs. Roth Decision Framework:

The decision hinges on an individual's marginal tax rate.

Marginal Tax Rate Defined: The tax rate applied to the next dollar earned. In a progressive tax system, this rate increases with higher income.
The Rule of Thumb:
- Combined Marginal Federal and State Tax Rate Below 25%: This suggests a relatively low tax bracket, making Roth contributions a potentially more attractive option for tax-free growth.
- Combined Marginal Federal and State Tax Rate Above 30%: This indicates a high tax bracket. In this scenario, pre-tax contributions are recommended because each dollar contributed pre-tax provides an immediate tax deduction, effectively acting like a 30% (or higher) imputed rate of return.
- Combined Marginal Federal and State Tax Rate Between 25% and 30%: This range requires a more nuanced decision, considering factors like age, future income expectations, and existing account structures.

Tax Arbitrage and High-Income Earners:

For high-income earners who may be in their peak earning years and facing high tax rates, the video offers reassurance. It suggests that there might be opportunities for Roth conversions later in life, especially if their income tax rates drop significantly in retirement (e.g., for those in the FIRE/FINE movement). This highlights the personal nature of financial planning and the potential to optimize tax strategies over time.

Conclusion

The video strongly advocates for a 25% savings rate for future investments, emphasizing the importance of starting early and consistently. It promotes the "Always Be Buying" (ABB) strategy to remove emotional decision-making from investing. For 401k contributions, the choice between pre-tax and Roth should be guided by an individual's marginal tax rate, with lower rates favoring Roth and higher rates favoring pre-tax contributions. Ultimately, personal finance is presented as a personal decision, with strategies needing to be tailored to individual circumstances and goals.