Find the Right Spot for Your Extra Cash
A young executive needs answers to three questions.
Mark Bologna is one of the last people you'd imagine would lose sleep over his finances. A senior federal executive, Mark, 36, has already accumulated $250,000 in his thrift savings plan, the government's version of a 401(k). He and his girlfriend own a condominium in northern Virginia, and he just finished reconstructing a small house in his hometown of New Orleans. Once it's rented, Mark expects to net several hundred dollars a month.
Still, Mark confesses to late-night angst about being too careless with his cash. "I let $35,000 sit around and missed this whole bull market," he says. Not quite; his thrift-plan balance is invested 100% in stocks, divided among large-company, small-company and foreign-stock index funds. Mark also owns $25,000 worth of Berkshire Hathaway shares, which he calls a "foundation" because Berkshire is so diversified. What's vexing Mark is the roughly $60,000 he has in the bank and in money-market funds. "I have to take advantage of my ability to save," he says.
In truth, money funds, which currently yield about 5%, aren't so bad. But Mark thinks he can do better. To do that, he needs to get three questions answered. First, how much cash should he keep totally liquid? Second, where should he put the rest? Third, how quickly should he act?
Everyone needs cash in reserve. Mark should keep $10,000 in the bank or in a money fund, and he should invest the rest of the money.
His income is too high to contribute to a Roth IRA or to deduct his contributions to a traditional IRA. So most of Mark's investments will be in regular taxable accounts, which may be better than an IRA for after-tax earnings. Take his Berkshire Hathaway stock. If it appreciated 12% a year over the next 20 years, it would be worth almost $250,000. If the maximum federal tax on long-term capital gains is still 15% in 20 years, Mark would owe Uncle Sam no more than $33,000 or so. But if he were to withdraw $250,000 from the thrift plan (or from an IRA), the funds would be treated as ordinary income and suffer a much deeper tax bite. Even if legislators were to raise the capital-gains rate, it's unlikely they would push it as high as regular tax brackets.
So, Mark should direct the $50,000 into long-term growth investments that complement his index accounts. He is light on stocks of smaller U.S. companies, as well as on emerging-markets stocks. Among the funds in the Kiplinger 25, he should consider Champlain Small Company, Vanguard Selected Value and T. Rowe Price Emerging Markets Stock (see The 25 Best Mutual Funds). And if he wants to dampen risk a bit by adding a bond fund to the mix, the thrift plan's F fund, which tracks the broad Lehman Brothers bond index, is a no-brainer.
Pros often suggest investing a lump sum in dribs and drabs over a year or so to benefit from averaging. But Mark is already averaging with the $1,700 a month he invests in his retirement accounts. There's no reason to hold back the new money. As David Mendels, of New York's Creative Financial Concepts, says, "Jump in with everything and hope for the best."
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