Milestone 6: Invest For Flexibility

Milestone 6: Invest For Flexibility

If you’ve reached Milestone 6 you now have a full emergency fund and a lot more confidence you can weather difficult times, should they come your way.

You’re also putting away 15%-25% of your income into tax-advantaged accounts. This combination of savings stability and steady growth has put you in an excellent position to reach your goals early.

As a result, you should begin saving money in taxable savings accounts to provide more flexibility in how you spend money, when you retire, and how you begin to draw down your next egg.

If you have money left to put to work now, let me begin by congratulating you. You’ve probably arrived at this point as a result of one or more of three things:

You invested in yourself and have a skill set that you convert to solid income;
You play good “defense” and exhibit excellent discipline in your spending;
You have been at this game for a long time and you’re now seeing the results of sticking to your plan.

Regardless of how you got here, you should take a minute to pat yourself on the back.

You’ve reached a level of financial maturity that many never obtain. Not only that, but you’re on a very secure path to financial independence and will have a lot to show for it.

But, as they say, “more money more problems”, right? You’ve been focused for a while now and you have to begin figuring out what to do with the excess.

Ideally, you’ll want something that can provide flexibility while still making good use of your money in some sort of investment.

Perhaps you even want to look into assets that lead to other sources of income?

But how much should you direct to this effort? What if the kids have college down the road or we have mortgage debt remaining?

We’ll try to answer these questions and more in this post.

First, I want to also challenge you to think about finding a solid financial planner at this point.

If you love learning about managing your finances and want to be a money do-it-yourselfer keep up the good work.

However, if you’re nervous about what you don’t know a financial planner can be a world of help and provide confidence that you’re handling things as well as can be managed.

I’m not a licensed financial planner and I don’t do referrals, but if you decide to look for one, I’d find a Certified Financial Planner (CFP).

CFPs have a fiduciary responsibility to act in the best interests of their clients. Otherwise, they risk losing the designation.

As a result, many CFPs are available on a fee-only basis.

So, How Much to Save?

As usual, the answer kind of depends on your situation.

If you’re not saving 25% already, you can finish that up here (though it’s not as efficient as doing so in Milestone 5).
If you’re already saving 25% of your income and you don’t have kids then the answer is whatever you don’t spend or give away.
If you’re already saving 25% of your income and you do have kids and would like to save for their college education, then I’d jump forward to Milestone 7 and come back when you’ve addressed it.

Again, the goal of this step is to provide you with the flexibility to do things like:

Retire early
Start a business
Become a landlord and earn income from real estate
Travel extravagantly
Set up tax-efficient methods for giving
Buy a farm
Pay off remaining debts
Take cooking lessons
Start a blog
Whatever else you can dream up

This is where you can kind of let your hair down a bit and enjoy the fruit of your hard work while continuing to build security for yourself financially.

We’re not trying to be vague, but dreams and goals are highly individualized. Take some time to think about what makes you happy or what challenges you’d enjoy taking on and go do it.

And Where Do I Put These Dreamy Bucks?

There’s an infinite number of ways you can use this money. We’ll hit some of the more popular options, but this list is not meant to be exhaustive.

We also won’t really tell you how these options should be prioritized.

The routes that are highly conservative will do a better job protecting your investment but probably won’t return as much. On the other hand, riskier assets generally come with better returns.

As you look through this list ask yourself some of these questions before choosing a direction:

What is my ultimate goal for this money?
How would I feel if it lost value?
Is there a specific purpose for this money or am I just trying to protect and grow it?
If there is a specific purpose, how long before I’ll need to use the money?
Do I want it to produce income or just grow?
Do I want to be able to liquidate the assets quickly so I can use the cash?
How much effort do I want to put into investing these funds?
Do I prefer more passive investments or do I want to get my hands a bit dirty?
Will more active investments conflict with my other goals?
Is there anything I worry about financially that I’d like to address?

We’ll start on the more conservative end of the spectrum and move up from there. Again, we’re not recommending any particular path, just putting some options in front of you.

T-Bills

Treasury Bills or T-Bills are short-term debts loaned to the U.S. government and backed by the treasury.

T-Bills can have maturities of 4, 8, 13, 17, 26, and 52 weeks.

T-Bills are sold in $100 increments at a discount from their par or face value which means you actually buy them for less than the face value of the bill.

For example, a $100 T-bill might cost the buyer $98. When the T-Bill matures, the owner is paid $100 for the bill they purchased and they net a return of $2.

T-Bills do not pay regular interest payments.

Gains received from T-Bills are not subject to state and local tax but are subject to federal income tax.

T-Bills are sold both through competitive and non-competitive bid processes operated directly by the treasury.

They can also be purchased through secondary markets or in mutual funds, money markets, or ETFs.

T-Bills carry virtually no risk since they are backed by the U.S. government, but they also produce little in the way of interest as a result.

I-Bonds

Long-ignored until inflation began to take off in 2021, I-Bonds are a type of U.S. savings bond that is designed to protect investors from inflation.

The interest rate of I-Bonds is adjusted regularly to keep pace with fluctuations (up or down) in inflation and is composed of both a fixed and an inflation-adjusted rate.

The fixed rate is set at the time of purchase and remains the same for 30 years, which is the maturity period of the bonds.

The inflation rate changes every six months, usually in May and November. The formula for calculating the composite rate is below.

Composite I-Bond Rate = [Fixed Rate + (2 x semi-annual inflation rate) + (fixed rate x semi-annual inflation rate)]

Here’s an example of the composite rate for May 2022 – October 2022:

9.62% = [0.00% + (2 x 4.81%) + (0.00% x 4.81%)]

As I’ve already mentioned, I-Bonds have a 30-year maturity. Once purchased, they cannot be sold for at least one year. There is no exception to this, so don’t use emergency fund dollars for I-Bonds.

If the I-Bonds are sold between 2 and 5 years after they are purchased, the owner must forfeit the prior three month’s interest at the time of sale. If sold after 5 years of ownership, the Bondholder receives the full amount of interest incurred.

I-Bond gains are exempt from state and local taxes, but not federal income tax. However, they can be used to pay for higher education expenses tax-free.

Electronic I-Bonds are available for purchase in $25 increments at TreasuryDirect.gov at an annual maximum purchase per individual of up to $10,000.

You can purchase up to an additional $5,000 in paper I-Bonds in lieu of a tax refund if you so choose. Paper I-Bonds are issued in denominations of $50, $100, $200, $500, and $1,000, depending on the amount you request.

Munis

Municipal Bonds or Munis are debt instruments issued by a state, county, or other local government to finance capital projects like road or building construction.

They’re an attractive consideration for wealthier investors because returns are not subject to any federal taxes and are exempt from most state and local taxes too.

While not as chancy as corporate bonds, munis are not completely without risk.

Munis can be purchased through a dealer like a brokerage or a bank, on an online exchange, or indirectly in a mutual fund or ETF.

ETFs

Exchange Traded Funds or ETFs are a pooled security that acts a lot like a mutual fund except they can be traded on an exchange just like an individual stock.

Generally, an ETF will hold some strategic group of stocks like the S&P500 index, technology stocks, or even groups of bonds to accommodate specific investment strategies.

ETF prices fluctuate during a trading period just like a stock. They can be purchased through any regular investment company like Fidelity, Charles Schwab, or Vanguard and can be owned within 401(k)s, IRAs, or regular taxable investment accounts

ETFs can be a very low-cost option as funds go because many times the administrative costs of operating these funds can be minimal.

If you are interested in holding ETFs in a taxable investment account and wish to avoid taxes on the investment, be sure to look into the dividend yields that are paid out from the underlying securities.

You will owe taxes annually on dividends received in a given tax year.

Mutual Funds

Mutual funds are groups of securities pooled together into some sort of strategic portfolio designed to target certain categories like an index, market sectors, investment types, and even targeted retirement dates.

The Net Asset Value or NAV of a mutual fund is based on the day-to-day performance of the underlying securities. When you buy a mutual fund, you are actually buying a piece of the overall fund portfolio.

Many mutual funds are actively managed by a fund manager or team that seeks to maximize returns for the investors in the fund according to its stated purpose.

Some mutual funds purely track indices and are not actively managed by a strategic manager or team. This usually results in lower expense ratios or costs for mutual fund investors.

Owning mutual funds allows one to spread risk across multiple securities while still providing ample control over any investment strategies you might have for the portfolio.

Anyone can purchase mutual funds through an investment company in a taxable investment account or IRA.

They are also available in most 401(k), 427, and 529 plans. You can technically own mutual funds in a 403(b), but there are significant restrictions on eligibility.

As with ETFs be sure to look into the dividend yields for any mutual funds you are considering. Since you’re on milestone #6 odds are you don’t really need this money in the short term, so picking investments that are tax efficient is important.

Stocks

Stocks are shares of ownership in a company. I’m not going to spend much time here because I don’t think it’s a good idea to own individual stocks in an unqualified/taxable investment/bridge account.

The primary reason is the risk far outweighs the potential reward. Do yourself a favor and buy something safer like mutual funds or ETFs instead.

Real Estate

Real estate can be an excellent investment or an unbelievable headache. Don’t wade into these waters naively.

While many may classify real estate as a passive investment, this may or may not be true based on how the property or properties are managed.

Either way, it’s going to require a good bit of time and effort to evaluate the potential payoff of a given investment.

Returns can be excellent in real estate when leverage (debt) is used to buy and build a real estate portfolio. This is best illustrated through a basic cash-on-cash evaluation.

Cash on cash is the amount of cash returned from a given investment over the amount of cash put into the investment. Let’s look at an example.

Suppose Larry Landlord buys a house for $100,000. He puts 20% down to purchase the house and rents it to a tenant for $1,000/month. Larry pays $500 for the mortgage each month and pockets the rest.

Larry’s cash on cash is $6,000/$20,000 or 30%. The $6,000 from 12 months of $500 net profit and the $20,000 is the total cash he had to relinquish as a down payment on the mortgage. Not a bad return at all.

However, if Larry had paid for the entire value of the home in cash, his return would have been $12,000/$100,000 or 12%. Not bad, but that’s still less than half of the return for the investment using leverage. Powerful indeed!

This is a simplified example and doesn’t include other factors like taxes, maintenance, and depreciation, but hopefully, you get the point. There are many strategies and methods for real estate investing and volumes of information are out there for you to learn more.

One significant downside of real estate is liquidating your assets may take significant time. If you think you may want access to these funds quickly you should consider another investment.

If you want exposure to real estate but don’t want to be a landlord, look into Real Estate Investment Trusts or REITs. They work kind of like a mutual fund, but own portfolios of real estate instead of only stock.

Start a Business or Side Hustle

Another option for improving flexibility and potentially reducing financial risk is to add other streams of income.

The advantages of this are obvious. Multiple income sources allow you to build wealth faster while simultaneously reducing your dependence on any one source of income.

We’ve already covered real estate as an option, but depending on your background and skillset there are a lot of ways to investigate this possibility further.

If you do have an idea let me encourage you to shut out voices of doubt that might convince you to avoid exploring your options.

There is so much information and technology available that make side hustles and other passive income sources very realistic possibilities.

Conclusion

You’re in a good spot if you made it to Milestone #6.

I don’t want to undermine the value of doing things in order, but honestly, once you’re contributing enough to your retirement savings each year (15%-25% depending on your age and savings) Milestones 6-9 can be achieved in a bit of a blended approach.

In full disclosure, we chose to prioritize Milestone #7 ahead of #6 because education is an important value in our family, but it came in its proper place.

Some of you may value having the mortgage gone more than having a bridge account or trips to Italy. That’s fine too.

We’ve arranged the Next Dollar Roadmap for what we perceive as optimal strategies, but it’s not a one size fits all directive. It’s a guide.

At this point in the journey, you should learn to take advantage of the flexibility you’ve built for yourself.

Next stop, Milestone 7: Prefund Kid’s Education Needs.

Investing, Next Dollar Roadmap

Curt

Curt is a financial advisor (Series 65), expert, and coach. He created MartinMoney.com with his wife, Lisa in 2022. By day, he works in supply chain management for a utility in the southeastern United States. By night, he's a busy parent. By late night, he works on this website but wishes he was Batman.

About Us

Hello. We’re Curt and Lisa. We started MartinMoney.com to educate you about personal finance so you can reach your own financial goals. Read more about us here.

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