AAP advice for gurusw

[gurusw]

Gurus:

Here's my dilemma. After my 401K dwindled in 2001, I'm shying from stock market. I also procastinated on buying RE because first I did not have my GC amidst bad job market, & then because of the RE boom.

Now I'm sitting on a lot of cash, and repenting that I should have made investments somewhere. Also I am 33 and it's time I should be buying a house now.

So on that note, how much amount you would recommend towards the house payment? I will be paying at least 20% since I want to avoid PMI. But should I pay upto 40% if I can? or should I be investing that extra 20% elsewhere?

I know that many financial websites advise you to save money for retirement over the years. As the inflation rises every year, the returns on your investment have to be really good so as to beat inflation, and have enough money for retirement. Meanwhile you are stressed with managing your investments, and your equity is rising slowly. After 30 years, your retirement income may not be enough.

I think the more you save for retirement during the pre-retirement years (50 to 60) will be better since even with moderate returns on that savings you can beat inflation for that short period. It's better to put your savings into house purchase now, and build 100% equity asap. Even though the 30yr mortgage is below 6%, and there is tax break on mortgage interest; I think this strategy will work out better as to beat inflation.

What are your thoughts? What is the right strategy?

Note that I'm/will be contributing to 401K so as to exploit the company match. But I am averse to invest any more money, and think all the extra cash should go towards mortgage.

[layman]

Gurus:

Here's my dilemma. After my 401K dwindled in 2001, I'm shying from stock market. I also procastinated on buying RE because first I did not have my GC amidst bad job market, & then because of the RE boom.

Now I'm sitting on a lot of cash, and repenting that I should have made investments somewhere. Also I am 33 and it's time I should be buying a house now.

So on that note, how much amount you would recommend towards the house payment? I will be paying at least 20% since I want to avoid PMI. But should I pay upto 40% if I can? or should I be investing that extra 20% elsewhere?

I know that many financial websites advise you to save money for retirement over the years. As the inflation rises every year, the returns on your investment have to be really good so as to beat inflation, and have enough money for retirement. Meanwhile you are stressed with managing your investments, and your equity is rising slowly. After 30 years, your retirement income may not be enough.

I think the more you save for retirement during the pre-retirement years (50 to 60) will be better since even with moderate returns on that savings you can beat inflation for that short period. It's better to put your savings into house purchase now, and build 100% equity asap. Even though the 30yr mortgage is below 6%, and there is tax break on mortgage interest; I think this strategy will work out better as to beat inflation.

What are your thoughts? What is the right strategy?

Note that I'm/will be contributing to 401K so as to exploit the company match. But I am averse to invest any more money, and think all the extra cash should go towards mortgage.[/quote]
What is your R2I plan? How long are you planning to stay in the house? Check the threads on AAP and investment advices. The best strategy is to decide on your AAP and DCA on to the investments. Stopping 401k, stopping investing in stock market are knee jerk reactions. Top up your 401K investment first because that contribution is tax deferred. After contributing to the 401K, if you are scared of the market, tweak your 401K portfolio to go more conservative with bonds, money market funds etc.

Regarding the house, a sale transaction will result in around 8-10 % expense (6% broker commission + renovation etc). RE has historical appreciation rate of 6% but experts are predicting that we are going to see downturn in the coming years. So, buying a house if you are planning to stay less than 3 yrs is not prudent. If you have long term plan to stay in the house long term, you can buy.

If you feel inflation is going to shoot up, 20% down payment is the smart move. Because you will be locking the rest 80% for a low interest rate. If you are assured that you can generate returns more than the interest rate you get for your loan, 20% down payment is sufficient. Otherwise go with a higher down payment. One data point is that the historical appreciation rate for stocks is around 10% which is more than the interest rate you are mentioning.

[Desi]

If you are buying house with only 20% down, you won't get a HELOC. In any case, both the options you have mentioned are really of buying the car with cash and real question seems to be should you take HELOC to invest - in general the answer is NO. More specifically, it all depends upon the interest rate and terms of the loan rate.

Another important question which you did not ask is - should you be taking a car loan? Sometimes car dealers will offer very attractive rates to sell a car. In such a situation, I would ask for an additional discount on price for paying cash. If your car loan rate is less than 3.75%, then sure, you can take the loan and even money market would still get you a better return after taxes if you are in a total tax bracket of 25% or less. The point is answers are not generic, they all depend on data such as your federal marginal rate, state tax rate, loan rate available for car loan, cash discount offered in lieu of a cash payment.

In most cases however it does not make sense to take car loan or a Heloc loan to invest.

[gurusw]

If I am to become USC, what happens to my NRI account? Am I supposed to close it because I am not Indian anymore?

If I get OCI, can I keep my NRI acct then (even though the acct was in invalid state between the time I was USC, but not OCI).

In case of USC+OCI, I think the RRK limits for 401K withdrawals are invalid since I will be taxed by IRS, and there won't be any tax relief for me. So I'll end up paying penalty+tax just as I would pay if I stay in USA and withdraw 401K money. Is this right? What USC R2I folks are doing with their 401Ks if this is the case.

[gurusw]

If I am to become USC, what happens to my NRI account? Am I supposed to close it because I am not Indian anymore?

If I get OCI, can I keep my NRI acct then (even though the acct was in invalid state between the time I was USC, but not OCI).

In case of USC+OCI, I think the RRK limits for 401K withdrawals are invalid since I will be taxed by IRS, and there won't be any tax relief for me. So I'll end up paying penalty+tax just as I would pay if I stay in USA and withdraw 401K money. Is this right? What USC R2I folks are doing with their 401Ks if this is the case.[/quote]

Bumping up this question in the hope for an answer.

[Desi]

If I am to become USC, what happens to my NRI account? Am I supposed to close it because I am not Indian anymore?[/quote]

The NRI accounts are actually either NRE, FCNR or NRO accounts. A Foreign citizen who is a PIO (person of Indian origin) is an NRI per Indian Income Tax rules. If you take USC, you will still be an NRI and be allowed to continue the NRE, FCNR accounts and / or open new ones.

[QUOTE]If I get OCI, can I keep my NRI acct then (even though the acct was in invalid state between the time I was USC, but not OCI).

Not applicable - you do not need OCI to validate your account holding. Acquiring a foreign citizenship does not affect your account holding.

[QUOTE]
In case of USC+OCI, I think the RRK limits for 401K withdrawals are invalid since I will be taxed by IRS, and there won't be any tax relief for me. So I'll end up paying penalty+tax just as I would pay if I stay in USA and withdraw 401K money. Is this right? What USC R2I folks are doing with their 401Ks if this is the case.


Your 40K should be rolled over to an IRA before you R2I (this is very desirable). Your IRA (or 401K) distributions will be taxed by IRS, no matter where you live and penalty has to be paid if distribution taken before age 59.5 and no exceptions are claimed. If you were to withdraw this money while in USA, you would pay tax at the marginal rate adding it on top of your US salary income plus other income. If you take this same distribution while in India, you hopefully will have little to no US income. Your Indian salary income will get foreign earned income exclusion and any other passive income will be taxable by US. This means that your IRA distribution if taken while in India would be taxed at a lot rate because of low US taxable income. If the distribution is taken while in USA, chances are that you will be paying high marginal taxes because of US salary income.

The GOI will not tax any non Indian source income during RNOR period or if the withdrawal is during NRI status. Once you become ROR, any interest and dividend accruals plus any capital transactions in IRA will come under the puview of the Indian taxation.

[gurusw]

I have Fidelity bond fund FDMMX in taxable acct. This is Fidelity MA muni monet mkt fund. How prudent to hold this considering the bond troubles that are making headlines these days.

[Desi]

I have Fidelity bond fund FDMMX in taxable acct. This is Fidelity MA muni monet mkt fund. How prudent to hold this considering the bond troubles that are making headlines these days.[/quote]

FDMMX is Fidelity MA Municipal Bonds Income Fund.
It is NOT a Municipal Money Market fund.

While the bonds it holds are Massacussets Municipal bonds, not all of the bonds are General Revenue Obligations which are guaranteed by the general reveneue of the state and its taxing authority, which make them safe.

It holds a number of municipal bonds that are guaranteed only by the issuing authority. As to whether these are insured or not, one will have to check the prospectures. Even the insured muni funds have been hit due to downgrades of MBIA, AMBAC and insurers. The holdings shows 74% as AAA rated, which leads me to believe that these are insured Munis.

Just like mututal funds it carries credit risk which is risk of default on principal as well as risk on default on interest payment.

Besides it carries the usual interest rate risk associated with bond funds. In this case the duration is 7 years which is high.

Yes, there are those who think Muni funds are a bargain and should be bought, I see no reason to carry this risk when prime money market or treasury money market (govt reserve funds at Fidelity) give decent returns.

Whether Muni or not, I hate to invest in funds that have duration of 7 years. That is a high interest rate sensitivity.

Personally, I would need a very good reason to invest in this.

In general, Munis have low risk of default, but the risk is there and currently munis are having difficulty raising money.

[gurusw]

Thanks Desi. Is VMFXX (Vang Federal Money Mkt fund) a better place to park my cash then? It's 100% aaa.

I have around 40K in taxable acct which I want to invest in stock market. But I'm going to DCA that amount in next 6-12 mths.

Btw if I want to opt for bond fund for long term (rather than buying bonds directly), which vanguard/fidelity funds do you suggest? (for both taxable & retirement accts)

Thanks for your help.

[Desi]

Thanks Desi. Is VMFXX (Vang Federal Money Mkt fund) a better place to park my cash then? It's 100% aaa. [/quote] Whenever the money is to be kept for short durations, money market is a sound choice. VMFXX is fine. Vanguard also has VMMXX which has a somewhat higher yield where I have some of my own money. The rason for higher yield is that it invest in very short term corporates also, where as the VMFXX invests in treasuries which makes it ultra safe.

Money market funds rarely would fail, but there is always a finite possiblity though very small. The fund companies will go thru a lot to assure the "fixed" price of $1.00. If one has concern about this very small risk the VMFXX is better than VMMXX from that risk perspective and VMFXX may also have state tax breaks.

[QUOTE]I have around 40K in taxable acct which I want to invest in stock market. But I'm going to DCA that amount in next 6-12 mths.

You should define the amount every month and start investing. Yesterday would have been a good day for first installment of the DCA.

[QUOTE]
Btw if I want to opt for bond fund for long term (rather than buying bonds directly), which vanguard/fidelity funds do you suggest? (for both taxable & retirement accts)

I would not advice individual bonds - lack of diversification, marketability and commissions can be high and hidden and not easy to negotiate for onesy, twoesy investor.

Total Bond market - VBMFX is a decent choice.

If the amount of funds are a reasonable size to invest in multiple funds, I prefer dice and slice as follows:

High Yield bond fund VWEHX - 20% (High yields aka junk bond funds have been beated severly recently).

VFIIX - 30% Ginnae Maes

VIPSX - 20% Inflation Protected

VFSTX or VBIIX - 30% (this is short term and intermediate term bond funds).

ETFs for above or equivalent are also available.

I do not like bond funds in taxable accounts.