What to do with the money I saved?

So, this is one of my favorite topics to discuss and there is no one set way to go. Here I outline what I’d probably do and then discuss some other approaches. The general idea is really simple but each step has a lot of nuances:

Image shows a 4 step guide for putting your money to use
Simple guide on where to put your saved money!

Build a small emergency fund

An emergency fund is one of the most important foundations you can build for your ongoing financial wellbeing. Emergencies that you should be able to cover with the fund vary a lot with your personal situation but common examples would be car repairs, lawyer costs, job loss, sudden housing repairs, dental and miscalculated tax. You may already have insurance in place that will cover those costs for you but even then, the insurance might not come through in time. Often they’ll ask that you pay out of pocket first and then they’ll refund you the expenses so you’ll need some money to bridge the gap. In general credit is a great way to go about such expenses either through “kassekredit” (overdraft facility) or possibly a “prioritetslån” (like an overdraft facility but secured in property and thus lower interest). I still find it prudent to keep some liquid money around in a savings or checking account in case your bank closes your line of credit just as you need the money. This is not unlikely in a job loss scenario where the bank suddenly will have less trust in your ability to pay back the credit.

One way to estimate how big an emergency fund you need is through your monthly expenses. It makes sense that the lower your general expenses the less money you’ll need in case of job loss for instance. What is less obvious is that you’ll probably also need less money for car and house repairs since those tend to scale a bit with the price of the asset which again is often tied to your general expenses. Is monthly expenses an accurate way to judge emergency fund needs though? No not at all. As I mentioned above there are a lot of factors that play into this and I will try to outline some of them:

Need for less emergency funding:

  • A-kasse (unemployment insurance) will greatly limit your need for emergency funds. It gives you an income that you should be able to get by on for 2 years while you either find a new job or adjust your expenses to fit your new situation. Even if you quit your job willingly a one month emergency fund can you through the quarantine period.
  • House and car insurance serve a similar purpose. If you have them then your emergency fund is only needed to get you through the initial payment until you receive compensation.
  • A solid line of credit will also somewhat lower your emergency fund needs as it will be your go to for emergency expenses and will buy you time to come up with a plan.
  • Having another source of income than your job.
  • If you already have a ton of investments that could be liquidated if need be you can also keep a lower emergency fund. I don’t recommend this though as there is a lot of correlation between large layoffs and market crashes.

Need for more emergency funding:

  • Owning a house and/or a car. Repairs will come up at the most inopportune of times.
  • Being self-employed usually carries higher risk of periods of low income.
  • Having children or other dependents increases your minimum expenses. You might be willing to live on rice&beans (or “mariekiks” or “havregrød” ;-)) but you might not want to have your children live on that.

I’m sure there are things that I missed – please list your thoughts in the comments!

Most US sources will cite a need for 3-6 months of expenses in an emergency fund but in general here in Denmark I’d just recommend about 1 months worth of expenses and then possibly adjust a bit per the factors mentioned above. The main reasons are that:

  1. Most people already have membership of an A-kasse and even without that our public safety net is a lot better
  2. We don’t generally have medical expenses near anything in US. Most is paid over taxes and medicine should be manageable in a day to day budget. Dental can be expensive but can usually be planned for over a bit of time.
  3. We don’t have to fear lawsuits much here in Denmark unless doing something stupid.

That said, paying off debt and thus lowering expenses is also a great way to bolster your capacity for dealing with upcoming changes. So, let’s move on!

Pay off expensive debt

Debt has interest. So of course, you’ll have to weigh whether you can gain more by putting your money to work in the market or by paying down your debt. Depending on your assumptions about market growth, inflation and taxation levels at the time of realization AND your risk aversion and your psychological benefits from paying down debt you should be able to find a sharp cutoff point for which debt you’ll want to pay down immediately and which you will just slowly erode with minimum payments. For me any loan at above 3% interest I’d rather just get done with but for you that might be completely different.

Let’s for a moment assume that you have a car debt of 50,000 kr. at 5%. If you invest in the market and have a 6% return over the period where you pay down your debt you may think you’re out ahead (and you are). But behold; those 6% will be taxed at minimum at 15.3% so they only made you 5.1% or less. Your interest is deductible though so you only actually pay around 3.6%. Was it worth then taking the risk in the stock market in this case? Some might say yes since 5.1 is strictly higher than 3.6 but if that debt was paid/investment was made over 1 year the resulting difference would be around 375 kr. Not to say that that isn’t money but I’d much rather have the risk-free return in this case and at the same time free up more cash flow.

If your faith in the market is higher than 6% and/or your loan interest is lower than 5% then the expected gain of investing rather than paying off the loan will obviously be higher. But even if we look at a 4% loan (around 3% after deductions) vs. investing at 8%*0,85 after tax return the previously mentioned difference would only grow to around 850 kr. If you extend the loan period to more than a year or further increase growth assumptions or lower interest on the loan, then this gap will widen of course but at my standard assumption of around 6-7% growth over the next years I think debt over 3% is a decent place to put your money to work near risk free. I say near risk free since a major risk in loan repayment is inflation, but I think that is a whole topic in itself 🙂

3% cutoff should in general mean that you should pay off any consumer or car debt, but can pay minimum payments on student loans and mortgage while you invest.

invest through an aldersopsparing

This will probably be the most controversial point for people seeking FIRE and of course it depends on your exact situation like the others. For those that do not know “Aldersopsparing” it is a form of retirement account that you can utilize for saving for retirement at a slightly tax discount. Normally when you invest in stocks you will pay taxes only when/if you sell a stock for more than you bought it for. The tax rate is then 27% for the first 51700 kr (in 2017) you earn in a given year and then 42% for anything above that limit. In retirement accounts, you instead pay a tax (called PAL-tax) of 15.3% of any value increase in your stocks each year, no matter if you actually sold the stock or not.

It is not obvious if the yearly tax of 15.3% is better than the one-time tax of 27% (if you can keep to the lower one) since the yearly tax dampens compound interest. At 6% yearly over 30 years the PAL-tax wins out even against the 27% one-time tax, but at 8% over 30 years the 27% tax comes out ahead (if you don’t add to your investments). Now of course if you are bound to hit the 42% bracket then the Aldersopsparing is a safe bet but that is not even my main point. The point is that an Aldersopsparing will never be taxed as income again since the money you invest there is your already taxed income and since you pay your yearly PAL-tax on any gains. This means that in retirement when you will inevitably be selling stocks, your Aldersopsparing will not contribute to pushing you up into the 42% tax bracket for stock sales. This is a great benefit in and of itself but of course it comes at the cost of liquidity. You can’t withdraw from an Alderspension before 5 years prior to “Folkepensionsalder” (public retirement age). So, for young people now we are looking at at least age 65 before we can withdraw from this account type.

Is Aldersopsparing then at all compatible with FIRE? I say yes! There is no good way to withdraw it before time (even if you can convince your account holder to release it there will be a 20% penalty tax) but we can use asset secured loans to bridge the gap if need be. I know much can happen between now and when I plan to retire but if interest rates are at all close to current rates then you can borrow whatever gap you have from your standard taxable accounts and up to what you need for living till you can access your money. A 1% loan in your house for consumption in order to leave money in your retirement account will add a bit of risk to your situation, but it has an expected average positive return since expected market growth is a lot higher than 1%. Taking out a prioritetslån at 60% of house value would be around 2% interest (before deductions) currently while a F1 variable interest loan at 40% of house value is just around 1% interest (before deductions) now. The earlier you plan to stop working the less your focus should be on building your funds inside of retirement accounts of course and you should build more equity in a taxable account. But even though I plan to be financially independent at around 50-55 – long before I can withdraw my Alderspension – I still max it ASAP and will only contribute to taxable after I fill this tax advantaged space.

Before I end this section I just want to add another pretty great advantage of retirement accounts. Generally, in Denmark ETF’s are taxed yearly and as “capital income” as opposed to stocks. This is a worst of two worlds situation since it is taxed yearly AND at a rate of between 38% and 42%. But if you keep ETF’s in a retirement account they are only taxed as everything else in a retirement account – namely at the yearly 15.3% PAL-tax. ETF’s generally have fees that are around 10 times lower than Danish investment funds so they are very attractive and can save a lot of money over time but because of the current tax rules can only really be kept in retirement accounts. And if this wasn’t enough then Nordnet has a special fund called Superfonden that you can buy only from a retirement account that has 0% ÅOP (yearly fees) and 0 kr. brokerage fee on buying.

Invest in taxable

I don’t have much to say here. After you pay off your debts and max your Alderspension there aren’t many fancy options left. Just open an ordinary taxable account at a cheap brokerage, choose an investment strategy and get started. There are other retirement account types you can use, but you’ll probably have them through work anyway and in my opinion they are not generally useful. They are paid into with pre-tax income so the idea is that if you earn more now than you will in retirement you might save some taxes. This is all well in theory but in practice having income paid out during retirement will only help cut into your folkepension (public pensions), your boligstøtte (subsidized housing expenses) and possibly other funding. Had you had that retirement money in traditional savings instead you would generally have been better off, but like everything else your mileage may vary.

Other options include:

  • Real-estate investing. I don’t generally believe it to be a very good option in Denmark due to high property taxes and low rent/price ratios (probably because owning a house is almost a given here), but you can make it work due to leverage. Once I get around to doing more research I’ll write a post, but it’s not on my immediate to do list.
  • Crowd lending. It’s growing popular and I see every blogger write about it but I haven’t seen much actual success. I guess in principle you are hoping to get a risk premium (earn more on average due to higher risk) compared to bonds, but I’d rather use bonds for safe investments and stocks for high returns than this. I also think crowd lending will generally be very severely affected by a financial crisis with major unemployment – possibly even more than the stock market.
  • Investing through a business. This used to be a very useful strategy but the tax code has tightened its’ grip around this former loophole. Today the only possible advantage you can gain from doing this is that you can move realized profit from stocks forward and only pay the full taxes on it once you cash it out of the company and into your own accounts. Again, I should do more research but that is the current situation if memory serves.

Other routes?

I had planned to do a short section on what other choices you might want to consider besides what I posted in the initial graphic, but I think I ended up covering a lot of it throughout the post. So instead this will be the place where I ask you what your simple steps for putting your money to work would be. Do you have another way to approach FIRE savings and investments, do you have a vastly different size emergency fund or do you take out 5% loans to invest in leveraged options? Let me know so we can all learn something here 🙂

6 thoughts on “What to do with the money I saved?”

  1. So, on top of your PFA account (normal pension, not kapital) you also have/recommend a Aldersopsparing?
    If so, what is the proportion you save on both accounts?

    1. I max out my aldersopsparing at 29,600 kr a year (2017) from my salary after taxes. Before that my employer pays around 18% of my salary into my PFA account. Since that is above the yearly max (53,500 kr) for ratepension then the last part is put into livrente. So altogether I put 53,500 kr into ratepension (US index and World index), 29,600 into Aldersopsparing (Danish index) and any left over into livrente. I only recommend to use Aldersopsparing though – the others are only because I can’t get the money paid out 🙂 Ratepension is decent, but not really better than just investing outside of retirement accounts and livrente is worse.

  2. Great post! 🙂
    How are you going to acces the money in your aldersopsparing before the age of 65-70? Or do you plan on adding another form of investing or income before the official retirement age?

    1. Thanks!

      The answer is not that straight forward; there are a lot of different aspects. One thing is as you say that I plan to invest some outside the retirement account. Any raises I can get will go there, and in a year when we are through remodeling we will probably have another 5-10k a month we can set aside. This will serve as some of the gap closer until I can access my retirement accounts. The next thing is that if interest rates are close to what they are now it should be easy to borrow money for 10-15 years on favorable terms by offering collateral. If you have a house, then the credit unions and banks have standard rates for the loan and else I’m sure any competent banker at least in the smaller banks will lend you money against your retirement accounts if those are substantial. Our house is set to be paid off over 20 years so I will have it paid off before I’d ever potentially retire. This is more uncertain though so if you are not flexible on your retirement date you might not be able to do this. And then the last important factor for me is that I’m (at least as of now) probably not looking to retire completely. I think I’d want to at least do some consulting or build a business. With hopefully only modest expenses at that point (no kids living at home, house paid off, no daily commute, much lower tax bracket) I think I could cover a large part of that by working 5-10 hours a week and thus minimize the need for a stash a bit.

      But I do certainly think about it and I’ve added a note in my yearly review to project my total retirement savings out to 2052 (when I turn 65). When I find that the projection gives me enough money to last through retirement I’ll have to reconsider. At that point I might stop contributing to the Aldersopsparing and invest solely in taxable depending on my life plans at that time. This is actually what I do for a lot of stuff – I try not to worry too much about the decisions I’ll have to make in the future since by then I should have more information. Right now, I don’t have enough in retirement accounts and they are great tax-wise so I pay into them, and then when I do have enough I’ll do a reassesment 🙂 If one plans to retire mid 30’s or similar, then of course the illiquidity of Aldersopsparing makes it much less attractive (although 30 years of 0 fees and lower taxes is pretty good for a portion of your wealth).

  3. Great blog!

    About Nordnet Superfonden: I am at the moment struggling between the fact that it is free of any costs, but on the other hand it’s risky in geographical terms since you concentrate your investments in Denmark – and furthermore in only 20 stocks. And if we were to go by a global diversification to minimize risk optimally then Danish stocks should really only be 1 % of the portfolio (if even that).

    The alternative is to buy iShare ETFs with about 80 % in their developed world index and 20 % in the emerging world index. Costs in these ETFs are 0.2 % and 0.25 %. I am considering whether the risk minimizing you get with that allocation is worth the small costs vs the free of charge Superfonden.

    What do you think?

    1. Thank you for the kind words.

      I agree that 100% Danish would be a bit risky. The C20 is also heavy in medicine so that’s another way that 100% superfonden would not be well diversified. If you want to invest only in one fund, then a world index is probably a better idea. When that is said 20 companies is still a pretty good diversification and it will probably have a big correlation to the world market since all the companies have a lot of export.

      I’m not an investment expert at all so I also just want a bit of diversification and then just try to max the amount of money I invest. What I’d generally recommend is just getting a broad index like the world index you mention and then use 1-3 other indexes to weight that world index any way you like. Having world as base and then adding some emerging markets is probably a good strategy and the fees you mention look fine. Just be sure to do it inside of a retirement account if you use ETF’s like those you mention!

      I have my company retirement account at PFA invested 50/50 into a world index and a US index. So, when I then add my total investments together I roughly have an asset allocation of:
      33% world
      33% US
      33% Denmark
      I can’t say I have any good arguments for this allocation, except for one! Expenses. The world index and the US index were the cheapest ones to get at PFA and coincidentally the C20 was the cheapest at Nordnet. It rounds out my portfolio to something I think is probably as good as any while keeping my total expense ratio near 0.15%. I don’t have any emerging markets and that might be a bad decision but I’m not sure if there will be a premium on growth to compensate for taking on the extra risk. I hope someone else with insights might comment here, but as I said my plan is just to choose a fairly diversified, fairly cheap asset allocation and then stick to it while adding as much principal as possible!

      I will try to add an expense impact calculator very soon, but I am trying to round out my buy vs rent calculator a bit more first.

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