Reader Question: How Can My Money Earn More for Me?
A reader and friend is looking for some basic financial advice. It just so happens that April is National Financial Literacy Month, so the timing is perfect because I am in a sharing mood. I get to share his situation and my suggestions with Consumerism Commentary readers, and readers have the option of offering their own thoughts.
I’m neither a financial adviser nor a financial planner, but I thought I could help by sharing my philosophy, my approach, and what will, I hope, pay off for me in the long run. Here is a little about my friend: He owns his own business and his wife is a public high school teacher. They are both 33 years old, living in New Jersey. Right now, most of their money is in a high-yield online savings account. First, he asked me how he could earn more on that money and I suggested switching to a bank offering a higher interest rate and we touched on certificates of deposit, but he is looking for more.
So I asked him what his goals are and what kind of money we were talking about. He wants to save for retirement and for his child’s education, and he would like all his money to be earning more in general.
Here was most of my response. If you have anything to add or change, please feel free to leave a comment at the bottom of this article. Don’t consider this financial advice. If you take action on my suggestions, you do so at your own risk.
Email begins here:
For retirement, you should be putting some money into an Individual 401(k). Since you work for yourself, you don’t have an employer offering you a 401(k), so you can just set one up for yourself.
You can invest up to $16,500 in that account in 2009. The 401(k) is the best option for retirement if you don’t do anything else. You should only invest money in this account that you’re 98% sure you won’t need until you’re 59 1/2. You can borrow from it before then if you need to, but if you don’t pay yourself back, you’ll owe penalties. Since this is a long way off, you should choose a stock index fund like VTSMX.
If you invest in an index like VTSMX, you would have to change your allocation as you get close to retirement to move away from stocks and more towards bonds. Bonds have a lower return (over the long term — they can beat stocks over the short term) but are safer, stocks are riskier but can provide a higher return. A “lifecycle” or Target Retirement Fund changes the allocation between stocks and bonds automatically as you get older. So if you invest in a lifecycle fund now, it will be mostly stocks, but as you get older, it will gradually shift towards bonds. This will help you preserve your money and you’ll be less exposed to stock market crashes and recessions when you’re getting closer to making a withdrawal.
I’m not sure what your wife’s options are, but she probably has a pension which will help out in retirement and she probably has an option for a retirement contribution plan such as a 403(b), basically a “non-profit” 401(k).
The next priority would be education for your daughter or any other future kids you decide to have. The most popular option here is a 529 Account. Again there are low-cost options with Vanguard. But if you’re pretty sure your kids will go to school in New Jersey, you can invest in a New Jersey state 529 plan because you’ll save on taxes. If you invest in a 529, you must withdraw the money for education expenses only. If you withdraw it for some other purpose, you’ll owe taxes.
The next priority would be everything else you want to save for. Make sure you have enough in an emergency fund to cover your expenses for a few months in case you’re not working and Ali loses her job. If your mortgage interest rate is high, you might want to pay that off faster because that will save you money down the road. Otherwise use that money to invest in a regular investment account. I would suggest stocks (VTSMX) even for your non-retirement investing because they’ve taken a beating recently, and while they might go down a little in the short term, they should recover nicely (unless the United States economy is fundamentally flawed, but I don’t think it is).
I’m suggesting Vanguard because they generally have the least expensive investment options. There are no account maintenance fees if you agree to email delivery of statements (rather than paper) and the funds’ expenses are lower than just about every other company. And low expenses means you keep more of your own money, which is good when you have lots of time for it to grow.
Most of Vanguard’s funds require an initial $3,000 investment. So when you set them up, you’d have to start with at least that much in your 401(k), your 529, and your regular investment account — that’s $3,000 initial investment (or more if you wish) in each of those. But after that you can set up automatic investments or just leave it alone for the rest of the year.
Don’t be seduced by investing directly in individual stocks. That’s like gambling. Stick to broad non-managed index funds like VTSMX because it will spread your risk around and it’s proven to beat stockpickers’ performance over the long term.
If you’ve maxed out your 401(k) and want to invest more for retirement, consider a Roth IRA and a SEP IRA.
End of email.
Do you agree or disagree with my suggestions? What did I leave out of this message?