The wind fell. Now what?
January 3, 2012 12:00 PM   Subscribe

I got a large bonus this year which will probably never be repeated. After taxes, it was 26K. I don't have any immediate needs (no medical issues, etc), and I know next to nothing about investing. Given this economy, what should I do with it? Stocks? Bonds? Saving account? IRA?

Some notes:

- I wanted to max out my 401K but someone screwed up (maybe me) and that didn't happen. So it's too late for that. I could, of course, buy an IRA. This would be attractive to me if it meant a tax break. Can one deduct all of what one puts in an IRA? Some of it? None of it?

- I have already donated a sizable amount to charity and would prefer to be selfish with this windfall.

- I am not a gambler. I am willing to gamble for pragmatic reasons (and I realize that all investing involves risk), but I'm completely uninterested in gambling for the sake of a thrill.

- I am okay with the money being tied up for a while, but I'd like to be able to get at at least some of it in case of an emergency, even if that means taking a loss.

- I'm 45, American, and I earn a middle-class salary, though I live in NYC, so you should adjust accordingly. I don't own a car or property (I rent an apartment) and I have no kids and no plans to ever have any. I have no significant debts.

- My credit rating isn't terrific due to some past mistakes. I am not looking for a way to correct it. It will correct itself over time. I just add this detail in case it's important.
posted by anonymous to Work & Money (18 answers total) 7 users marked this as a favorite
Do you never want to buy? I would put the money toward a down payment on an apartment, but that' me (also live in NYC).
posted by sweetkid at 12:03 PM on January 3, 2012

It's not too late to max out your 401k for 2012. And you mentioned your credit rating... do you have any credit card debt? If so, pay that all off immediately.
posted by Grither at 12:04 PM on January 3, 2012

If you actually want to, this is a great way to get your hands on a co-op or condo. Of course, unlike other places in the country, owning an apartment here isn't inherently better than renting -- you'd be surprised what monthly maintenance fees don't cover -- so don't buy a place just to buy a place.
posted by griphus at 12:12 PM on January 3, 2012

Can one deduct all of what one puts in an IRA?

You already paid taxes on that income, get a Roth IRA.
posted by empath at 12:14 PM on January 3, 2012 [9 favorites]

IRA donations are tax-deductible, and you have until April 15 to make a contribution. The only problem is, you can't put any more than $5,000 into the IRA in the course of a year.

But, that would take care of $5 grand. As for the rest, I'd split it up between

a) A savings account for emergencies (you know the whole "whatever it would cost to live on for three months) thing,
b) A savings account for next year's IRA contribution, and
c) A savings account for mad money.
posted by EmpressCallipygos at 12:16 PM on January 3, 2012 [1 favorite]

1) Pay off all your existing debt. That's a guaranteed rate of return of your current interest rate for whatever period the debt was going to exist, at absolutely zero risk. Got 15 years left on your mortgage at 5%? That's a far, far better zero-risk "investment" than anything you can buy on the market right now, where you'd be ecstatic to see 2-3%.

2) Once that's done, start a slush fund. The old saw is that you should have 6 months of salary on hand at any given time. These days, 8-12 months is looking like the better number. Why have this? Because life is expensive, generally speaking, but it isn't expensive all at once. Some things you pay every month. But some things you pay every six months, or every five years, or maybe just the once. Some of those things can be really expensive, e.g. sticking a new engine in a car, spending a day in the hospital (even with insurance!), paying legal fees for an estate dispute, whatever. Not to mention the possibility of being unemployed for a few months. So yeah, stick it in a savings account or maybe buy a CD or something, but have it basically liquid and in a zero-risk account.

3) Once that's done, and I'd be shocked and quite impressed if there's any money left over once you've taken care of those two things, then start looking into actual investment options, as discussed here. Yes, money you invest in your 401(k) now is better than money you invest next year, but having to tap into your 401(k) or just borrow the money because you don't have a big enough reserve can be really expensive.
posted by valkyryn at 12:32 PM on January 3, 2012 [8 favorites]

Pay off the debt, open a Roth IRA and stuff it in. Roth has the advantage that the principle you put in is (generally) always available for you to withdraw. So you can think of it as a mini-emergency account, but one which will earn tax-free interest. What you do with it inside that account depends on your needs: if you have no emergency fund, stick some in semi-liquid things like CDs; if you have a good cushion already but are short on retirement planning, invest in some broad index funds for the long haul; if you're good on both of those fronts, set it up as savings for a longish-term goal (taking some continuing education classes in 2018, buying a house in 2016, whatever).
posted by introp at 12:47 PM on January 3, 2012

If you are interested in a semi-liquid way to store money for emergencies, you might try a CD ladder.

Obviously, rates are lower. And you'd want to make the 'rungs' closer together (say, 3 months). You can use google to find a bank with high-rate CDs that is right for you.

Ladder calculator
posted by the man of twists and turns at 12:48 PM on January 3, 2012

Given this economy, what should I do with it? Stocks? Bonds? Saving account? IRA?

The general answer is that you should have a decent amount of cash (an emergency fund) for the short term and a mix of stocks and bonds for the long term. The emergency fund should probably be in a normal savings account, which you will make virtually no money on because the interest rates are extremely low right now, but is completely safe. The stocks and bonds should probably be in a retirement account, you are already trying to max out your 401k which is definitely a good thing and you should probably open an IRA if you want to invest more than that. As for what to invest in, I am personally a big fan of low cost index funds, something like the Vanguard Target Retirement 2030 Fund would probably be the best bang for your buck in terms of being able to get everything in one fund and not having to worry about the details.

I'm 45, American, and I earn a middle-class salary, though I live in NYC, so you should adjust accordingly. I don't own a car or property (I rent an apartment) and I have no kids and no plans to ever have any. I have no significant debts.

It sounds like overall you are in very good shape financially so there is not really an obvious immediate need you have to cover. The main things you didn't mention which would be relevant would be if you have an adequate emergency fund saved up and how much you have saved for retirement already. Depending on those two factors it might make sense to be more aggressive in building up your retirement savings (such as maxing out both 2011 and 2012's IRA contributions with the money) or more conservative by making sure that you have enough cash on hand to avoid getting into debt if unexpected expenses or losses of income end up happening.

I am okay with the money being tied up for a while, but I'd like to be able to get at at least some of it in case of an emergency, even if that means taking a loss.

The problem with this is that most of the time you have to make a choice between long term and short term. If you go with stock investments, not only is the actual value of your investment going to fluctuate in unforeseeable ways in the short term, but most of the tax-efficient ways of investing (i.e. retirement accounts) don't allow you to remove funds without significant penalties. One option you could look into is a Roth IRA, you can put post-tax money into a Roth IRA and withdraw the contributions at any time. So you can use it as a sort of emergency fund of last resort (above your actual emergency fund which would just be a normal savings account) even though the main point is for long term investing. Overall if you are more conservative it's totally fine to have a relatively large amount of money in cash rather than being tied up in investments, the main thing that will most likely determine your long term financial health is how much you spend rather than how well your investments perform, so don't discount the positives of having money in the bank that isn't giving you a big return.
posted by burnmp3s at 12:58 PM on January 3, 2012 [1 favorite]

You lose the ability to fully deduct IRA contributions from your income above about $58,000, and the ability to deduct anything at all above $68,000 (both of those are for single/non-married individuals, see here for married folks). There are no income limits for deducting contributions to your 401k, so going forward you could just jack up your contribution to max out for the next two years--using your windfall to make up the difference in your take-home income--and accomplish the same thing. Of course, this only helps you with your taxes for 2012 and 2013, and not for 2011 when you actually received the windfall.

The limits for a Roth IRA are higher (around $110,000 for a single person), so that's probably still an option, but you don't get a tax break in the short term. One nice thing about a Roth IRA is that you can always pull your initial contribution out without penalty for any reason (not earnings on that contribution, though) so if you want to start an emergency fund but also save for retirement you could stick $5,000 in a Roth IRA and invest in something safe to accomplish both things at once. If you don't end up needing to touch your emergency fund, yay! You have a nice little egg for retirement that you can pull out tax-free once you're 65 or so. If you do need it, you can pull it out and you're not any worse off than you would have been not opening a Roth IRA, so long as you open it somewhere with minimal or no fees.
posted by iminurmefi at 1:05 PM on January 3, 2012 [1 favorite]

Index funds.
Index funds.
Index funds.
posted by Cool Papa Bell at 1:50 PM on January 3, 2012

There are some nice New York State municipals out there. They're at 5%, which sounds low but keep in mind you don't pay any taxes on the gain.

No state has defaulted on its debts since 1841, so it's fairly secure.
posted by Tell Me No Lies at 2:10 PM on January 3, 2012 [2 favorites]

Assuming you don't have a Roth IRA already, I'd open one and put in the maximum annual contribution for 2011 ($5k), and then 2012 ($5k) -- you can still contribute to 2011 until March or so.

Then I'd take the rest and invest it passively via index funds or a blended fund (one that has equities and bonds) with very low expenses. You should think hard about your time horizon and risk tolerance while choosing a fund; risk vs. reward is always the underlying tradeoff in any investment, and nobody can tell you what you're comfortable with. Regardless, Vanguard is my strong recommendation, and they have a lot of funds to choose from.

Every year I would withdraw out of it enough to fully fund your Roth IRA, unless you can manage to fund it from other income sources. At 45, you still have 25-30 years to let that money grow, tax-free, in the Roth ... it's a deal you shouldn't pass up if you possibly can.

Buying property is also a reasonable thing to do, although I would only do that if you actually want to live in the place you are buying; as an investment, property is notoriously illiquid on top of being highly leveraged, and it's questionable whether it will outperform equities (it traditionally, in the 20th century, has not) over the long run. The numbers only look good, at least to me, when you use it to eliminate your own rent, and don't feel like you're giving anything up by moving from rental into owned property. And also the rent/buy numbers are very different in various parts of the country; buying may be a no-brainer in some places but insane in others, so take everyone's anecdotes (mine included) with a grain of salt.
posted by Kadin2048 at 2:11 PM on January 3, 2012

The Motley Fool is a good resource. (I'm referring to what's available for free on the site, I've never paid for any of the variety of services/info they offer. I ignore whatever I see in those little gray sponsorship boxes.) They offer sound advice in simple language.

You might specifically be interested in this part.
posted by Wretch729 at 2:13 PM on January 3, 2012 [2 favorites]

Also please excuse my obnoxious pedantry but "windfall" refers to fruit or wood blown down by the wind, and thus easily accessible. The wind itself doesn't fall.
posted by Wretch729 at 2:16 PM on January 3, 2012 [1 favorite]

I wanted to max out my 401K but someone screwed up (maybe me) and that didn't happen. So it's too late for that.

No, its too late for the 2011 tax year. There's nothing stopping you from cranking it up NOW out of your IMPENDING income, however, and replacing the out-of-pocket reduction with this pile of cash you have.

Well, nothing except your own willpower to do it and to not spend out the 26k in other ways rather than limiting it to actual living expenses. But you could increase your 401k withholdings to 100% for as long as you can and live off that bonus money.

If I had your life I'd probably do that with 20k of it (which should actually net you more like 25k in retirement savings since you're surely paying at least a 20% marginal tax rate) and Have Fun with the other 6k. Buy something entirely frivolous you'd never otherwise buy, assuming you can do that and not feel bad about it. Or buy something you would buy but spent way more than you would otherwise.
posted by phearlez at 2:24 PM on January 3, 2012

I like index funds, after maxing out 401k and ensuring you have 6mos emergency money stored up. However, another wild and crazy idea: depending on your lease, see if you can re-negotiate your rent by paying cash in advance for a discount (for the year). You tie up the money now, but think about having your rent paid for the next year and your income then going into savings, etc.
posted by getmetoSF at 5:49 PM on January 3, 2012

The limits for a Roth IRA are higher (around $110,000 for a single person), so that's probably still an option..

Although note that even if you are over the limit you can still contribute to a Roth IRA if you first deposit in a regular IRA and then transfer it to a Roth. This is best done only if you have zero pretax monies in an existing IRA though (i.e. no taxable basis). This is known as a back door IRA which explains it in detail.
posted by NailsTheCat at 8:26 AM on January 4, 2012

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