Your 2021 Guide To Actually Saving Real Money

Hey guys. I know that 2020 was a hard year. And 2021 only seems like a continuation of that trend. It’s easy to throw up our hands or hunker in a ball, suck our filthy, calloused thumbs, and wait. But that’s not the solution.

Despite everything that happened in 2020, the S&P 500 returned over 18%. For those of you with money in the market back in the late February and March, I hope you held your breath and squeezed your butt cheeks while the sky was falling. During that time the S&P 500 fell over 30% from its recent highs, with several pucker-inducing drops of 10%+ per day! For those who stuck to the plan and avoided market timing, you did just fine.

For instance, someone with $1 million dollars invested on January 1, 2020 ended the year with approximately $180,000 in gains for doing nothing other than owning an index fund. That’s real, folks. Of course, we have to pay tribute to the inevitable years this will not be the case (where we could lose just as much as we made), but over time, history shows us that the market returns approximately 7-10% per year, on average.

These are the simple little things that we did every year. The result? We were able to walk away from paid work in our 30s.

Does financial freedom appeal to you?

Here’s how we can set the ball rolling in 2021.

How’s That Emergency Fund?

Easily Increase savings and lower taxes with tax-advantaged accounts.

Pile extra savings in a taxable brokerage account.

Spend money on other stuff in your life.

What do I put in these accounts?

When do I contribute to my investments?

Step 0: How’s That Emergency Fund in 2021?

For far too many, 2020 was a year of painful awareness that unforeseen events can (and do) occur. Those events can drastically reduce or eliminate income, and thereby savings, with little warning. Start the year 2021 by building a solid emergency fund of three-to-six months’ living expenses.

Do you wish you made more money? At risk of being a flippant a-hole, what’s preventing that goal from becoming a reality?

Get a FREE spending and net worth tracking spreadsheet by subscribing to new posts on this website (also free).

Step 1: Your New BFF(s): Tax-Advantaged Accounts

Step 1a: The 401(k) or Similar

It’s incredibly important to focus your efforts first on tax-advantaged accounts, which include IRA’s, 401(k)s, 403(b), or other similar retirement plans.

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An individual can contribute up to $19,500 in a traditional 401(k) in 2021, which is most applicable to many in the private-sector world. These accounts are funded by your employer with either pre-tax (traditional) or post-tax (Roth) dollars from your paycheck. Many companies and organizations offer employer matches, which is free money!

Withdrawing Retirement Funds Early: The Roth Conversion Ladder

Note: For those eyeing a potential early retirement, foregoing Roth contributions and funding a traditional 401(k) with pre-tax dollars will likely expedite the process. Once retired and seated squarely in the 10-12% income tax bracket, the Roth Conversion Ladder allows for early access of retirement funds. This strategy is used to effectively pay little or no taxes on this income.

(Related Post: The Bold and Beautiful Roth Conversion)

Business owners and freelancers should undoubtedly consider a Solo 401(k), which includes a portly $58,000 2021 contribution limit and offers additional flexibility.

The primary goal is to max out your contribution limits to a 401(k) or similar account in 2021.

Why?

Contributions to tax-advantaged plans will lower your taxes. That’s right. Not only are you investing, but you are also lowering your tax obligation, which gives you money to save and invest!

For instance, let’s imagine Joey has $60,000 in income. If Joey maxes out his 401(k), which has a contribution limit of $19,500 in 2021, Joey will now only be taxed on $40,500 of income. Joey gets thousands of dollars back in his pocket. Rad dude!

Joey’s Income: $60,000

(minus)

Joey’s 401(k) contribution: $19,500

= $40,500 in taxable 2021 income

Step 1b: Health Savings Accounts: The Best Retirement Account of All

For those of you holding a high deductible healthcare plan (HDHP), you also have access to a Health Savings Plan (HSA).

Health savings accounts are triple-tax-advantaged retirement accounts! Individuals can contribute up to $3,600 (family up to $7,200) in 2021 with pre-tax income. Those funds can be invested with pre-tax dollars, allowed to grow tax-free, and then can be withdrawn tax-free at any time for qualifying medical expenses. The kicker is that after age 65, these funds can be used for anything: steak dinner, ring pops, or our nursing home room*.

We pay cash for all out-of-pocket medical expenses, invest all of our HSA contributions, and watch that sucker grow like a zucchini in August. All tax-free!

We use Lively (not an affiliate link, I’m just a nice guy). Lively has zero fees, fantastic Vanguard investment options, and a simple, user-friendly interface.

I’m commonly asked my thoughts for our long-term healthcare spending. The answer? Our HSA funds.

Check out this in-depth review of the HSA by the Mad Fientist.

HSA contribution limits for 2021.

*All withdrawals for non-medical spending after age 65 are subject to ordinary income tax, but no penalty. Withdrawals for qualified medical spending are tax-free.

Step 1c: The Roth IRA

There are a variety of Individual Retirement Accounts (IRA) with different tax implications. For most, funding a Roth IRA is going to be the way to go.

Opening and funding a Roth IRA is for many the first account with limitless investing options. In workplace retirement plans or HSAs, fund choices may be limited to less-than-ideal mutual funds laden with high fees. A Roth IRA, particularly through Vanguard, allows the investor to choose any fund that tickles the loins.

Roth IRA Rules and Stipulations:

• Contribution limits: $6000 in 2021
• Those making more than $140,000 (single) or $208,000 (married filing jointly) cannot contribute to a Roth IRA.
• Do you make too much money and want to contribute to a Roth IRA anyway? There’s always the Backdoor Roth. It’s legit.
• Withdrawals: your contributions can be withdrawn anytime, but contributions and earnings can only be taken after age 59 ½ or if funds have “seasoned” for five years like a Jamon Iberico in a musty Spanish cellar. Weird, right? Otherwise, a 10% penalty is applied. Exceptions include first-time home purchases, college expenses, or birth or adoption of small humans. I’d avoid withdrawing from a Roth IRA in wealth-building years at all costs, because then you ain’t buildin’ wealth, brother.
• More on Roth IRA contribution limits and eligibility here

We personally love Vanguard (no affiliation, they’re just great). Open a Roth IRA with Vanguard here.

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Tax-Advantaged Investment Potential

Maxed-out 401(k): $19,500

(plus)

Maxed-out HSA (individual): $3,600

(plus)

Maxed-out Roth IRA (individual): $6,000

= $29,100 invested

Taxable Income Deductions

Maxed-out 401(k): $19,500

(plus)

Maxed-out HSA (individual): $3,600

= $23,100 deducted from taxable income

(plus)

Standard Deduction (individual): $12,550

= $35,650 total income deductions

 Step 2: The Post-Tax Brokerage Account

If you’ve filled all the buckets mentioned above, it’s time to open a post-tax brokerage account. A brokerage account, while not tax-advantaged, does allow the investor full reign over his or her investing options. The world is your oyster in a brokerage account.

Brokerage Account: Funded with post-tax dollars, and only gains are taxed upon withdrawal. Capital gains taxes can be little to nothing if gains are realized when in a low tax bracket (early retirement).

Consider this your savings account, but with investment potential. Any money not first directed to tax-advantaged accounts or used to pay for life expenses can be directed to a brokerage account for investment.

These accounts are funded with post-tax money, so only gains are taxed according to the capital gains tax structure.

Capital Gains Example

For instance, let’s suppose Joey has invested $500,000 into a taxable brokerage that is now worth $800,000. Along with a healthy 401(k), Joey has decided to retire early. These funds have been held for longer than one year, so any gains are considered long-term capital gains.

If Joey wants to sell $40,000 to fund his life in early retirement, he might only realize $10,000 or so dollars in long-term capital gains (LTCG) in 2021, depending on which lot of shares he chooses to sell. Joey is only taxed on the $10,000 (he was already taxed on the money he initially invested, or the cost basis), so the $10,000 falls into the 0% LTCG bracket. In the year Joey chooses to sell a modest amount of these funds, he will pay no further taxes. That’s winning.

We love Vanguard (again, no affiliation). Open a brokerage account with Vanguard here.

Step 3: Everything Else in Your Life

Here’s where life’s expenses fall. Housing, transportation, food, or solar panels for the new rig, as they say.

Where folks generally blow it:

(a) People allot too much money to the “spending category,” finding ways to spend surplus money.

or…

(b) Folks save surplus funds in a traditional savings or checking account where those funds fall behind to the slow but steady forces of inflation. The stuff you buy gets more expensive every year, but your money really isn’t growing in any traditional bank account. That’s losing, my friends.

Debt

Are you paying today’s dollars for choices of your past? Owing money on just about anything beyond an affordable mortgage, an education (that you will use), or perhaps a well-crafted (and reasonably small) business loan is putting your future dollars into a depreciating asset. Your ability to devote dollars to an appreciating asset is hamstringed by diverting funds to paying down debt instead.

The goal here is to optimize your spending. Are you tracking your spending? I really can’t impress upon you enough the power in tracking.

Step 4: What Do I Put in These Accounts?

Asset Allocation

If you are young and can handle the ride, consider going at least 90% stocks on your overall portfolio. Keep 5-8% of bonds, and 2-5% cash, depending on the magnitude of your net worth. This may be too aggressive for you. Understand your personal risk tolerance before making any decision. Conventional wisdom says to keep the majority of bonds in a tax-advantaged account, but it’s complicated.

Funds

For many employer-sponsored plans, you are limited to what is available. For a stock index fund, look for “whole market,” “total market,” or “S&P 500 index” funds. Avoid “growth” or “high yield” funds, which carry more risk and typically higher fees. Target date funds are ok, but you can probably do better. Take a very close look at the expense ratio. The ideal fund will have an expense ratio less than or equal to 0.05%.

Within a Lively HSA, Roth IRA or brokerage account, you typically will have full freedom to choose any fund you like. We invest the vast majority of our money in the Vanguard Total Stock Market Index Fund (VTSAX). Our primary bond fund, the Vanguard Total Bond Market Fund (VBMFX), now forms about 10-15% of our portfolio as we’ve moved into more of a wealth preservation mode. Other than some old investing skeletons in the closet of my tinkering days, that’s it.

It’s this simple: get a broad-based and low-fee stock index fund and a bond index fund. Keep on plugging.

Our Simple Portfolio:

Stocks: VTSAX

Bonds: VBMFX

Cash: One month living expenses held in checking, the rest in a high-yield savings account like CIT Bank.

For more on our investing strategy, check out this post:

Part 1: The CC Family Investing Strategy:

Step 5: When Do I Contribute to My Investments?

The short answer: whenever and as much as you can.

Employer-sponsored plans: 401(k) or HSA contributions are made by your employer and deducted from your paycheck.

Conventional wisdom suggests we ought to front-load our contributions early in the year. It stands to reason that, on average, the market goes up. Investing today probably will buy you more of any given investment than later in the year. That said, be very mindful not to miss any company match. If you max out your 401(k) in February but your employer doesn’t offer a true-up match, you may miss out on thousands of dollars in free money. If a true-up is not offered, contribute as much as possible now, and trickle the rest throughout the year to get the match. You will have to do a little bit of math to figure this out, but you are smart and I believe in you.

Noah at Money Metagame makes a compelling case against front-loading your 401(k).

Use the Robots: Automatic Contributions

For a brokerage account, we set up an automatic contribution each month from our checking account. By spending far less than you make, you know you have a good chunk of money available to invest each month. We defined a set value and set up an automatic contribution to purchase more gooey shares of VTSAX each and every single month. Always and forever. This is called dollar-cost-averaging, and it works.

What’s Going on Doesn’t Matter

In terms of our investing timing, we didn’t care what was going on in the news, we didn’t care if the Capitol was or was not being stormed, we didn’t care if there was a virus in China, and we didn’t care who was president. We purchased shares every single month. If our checking account started getting fatter, we made a lump sum purchase of VTSAX or perhaps bought some bonds, being mindful of our desired asset allocation.

When the market was up, we invested. When the market was down, we invested. Every single month, and every single paycheck. You must keep showing up.

If you are a freelance worker and get inconsistent income, the desire to fall prey to market timing is strong. Be stronger. Invest what you can, whenever you can.

Bottom Line: Set up automatic contributions to regularly invest through all market conditions. If you have surplus funds to invest, get them in the market as soon as possible, avoiding the allure to time the market.

Do All of This in 2021 and You Are Set

Let’s not get too drunk on the “retire early” portion of the equation. Financial independence is for everyone. With a reasonable degree of certainty (nothing is certain), I’m willing to bet that an individual or family who takes these steps year-in and year-out will reach financial independence. How long this takes depends on your income/spending ratio, but more importantly, your grit.

Will you keep these systems in place once the initial zeal wears off? Or, perhaps more importantly, will you stay the course when the market takes its next inevitable dive? Some of you won’t, so it’s better to ask yourself those hard questions now. Pick an asset plan you can live with if the stock tickers are incessantly red. A portfolio of 100% stocks may return some fantastic gains, but it will also tumble fantastically from time to time. Any investment plan not followed is garbage.

I love you guys and I want to watch everyone grow and succeed. This stuff is simple, but it’s not easy. Where will you take action this year?

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