Alright, the time has come. I’m on the cusp of being 21 and I have some income I’d like to begin setting aside for the future years. My calculus teacher in high school swears Roth IRAs are the way to go. But that was four years ago, is that still the way to go?
As a single person looking to invest, I know lots of corporations offer to set these up for you, will this cause a problem for me in some way? Who should I sign with? A broker house?
I’m really… unintelligent about finances outside of a normal balance the checkbook and such.
And Admins, I felt this was IMHO, but I see it could also be a GQ, sorry if I flipped the coin and landed on the wrong side.
I haven’t set up a Roth IRA myself (I put all my money into a 401(k) through work), but I have no doubt it’s easy. Look at the webpages of sites like Fidelity, Charles-Schwab, etc. It’s definitely a good idea to put money into a Roth IRA now, if you can. Every extra year of compound interest you get adds up to a lot of money.
Incidentally, the difference between Roth IRAs and 401(k), besides the limits to how much you can put in and the possibility that your employer will match your contributions in a 401(k) is that you put money you’ve paid taxes on into the Roth, but when you take it out it’s tax-free. 401(k) contributions are not taxed, but when you retire, that money will be counted as taxable income when you withdraw it. If your tax rate is about the same now as when you retire, there’s really no difference between the two (unless I’m doing the math wrong) – the advantage of the 401(k) is if you are in a higher tax bracket while you’re working, and will be in a lower one when you retire.
If your company offers a 401k and matches your contribution to any extent start that right away. It’s pretty much the easiest way to get started – your company should offer information to help you understand how it works – they deduct the $$ out of your paycheck each month so its pretty painless.
The money taken out of your check is not taxed (until the very distant date when you withdraw it, but it is still a tax advantage overall). Neither is the money your company puts in as part of a “match.” So let’s say you make $28,000. Over the course of a year you put $1200 into your 401k. Come taxtime the IRS considers that you made 26,800. Let’s say your company matches at 30%. They put in $400 to your 401k that the IRS also ignores in the here and now. So you really made 28,400, but the IRS taxes you on $26,800. This is a Good Thing.
Usually 401ks offer a variety of mutual funds and you can choose a couple to begin with. Choose a couple different “kinds” for example, one that contains only small companies (“Small cap”), one that contains only big companies (“Large cap”) and one that contains only international companies. There’s all sorts to choose from (your employer should provide you with lots of information). Just make sure you have several different “flavors.”
When you leave your job, you can roll any accumulated 401k funds into an IRA without paying any penalty (as long as you never “cash out” your 401k – it has to be an institution to institution transfer).
A Couple of Caveats:
Some companies make you wait a specified period of time in order to “vest” your 401k. What that means is that if you leave before that time is up, you lose what you put in. That Sucks! Make extra sure before you start what the rules for vesting are.
Don’t invest in your company’s own stock in a 401k. What happens if the company goes under? You’re left with no job AND no equity. Screwed. ::coughEnroncough::
For basic getting-started financial advice for the 20-something person, I like Greed is Good by Jonathan Hoenig.
Now that I’m practically old (29), I have a full-service financial planner. I’ve been doing my 401k since I was 23 and keeping my debt low. My FP said I was “way ahead of the game” for my age group.
The bolded part is incorrect. The only way you can lose what you put is if your fund/stock/whatever tanks. What you put is is always yours.
You can lose all or part of the company matching however. A typical plan might call for 5 years for 100% vesting. At the end of year one you own 20% of the matching and 20% of the gains. Every year you get another 20% until after 5 years it’s all yours. Matching monies put in by the company after 5 years, typically, is yours.
Just a slight correction to what Hello Again said.
You don’t lose what you put in. You lose what the company put in.
30% of $1200 is $360, not $400. The point is still valid, however.
This is completely a matter of opinion. I think the take is not to invest EVERYTHING in the company stock. Diversification seems to be the mantra in investing. Given that, you are probably better off using the company stock purchase plan to invest in the company rather than a 401(k). Only you can make that choice.
I am not a financial advisor, etc. Just another guy about your age also interested in investing.
I highly suggest an IRA, especially if a 401(k) or the like are not available. You’ll want it to be a Roth IRA, since you’re probably not going to be making much now but you should have quite a bit 40 or 50 years from now when you pull it out. The beauty is that you pay the tax on it now when the tax’ll be lower and then nothing when you pull it out. However, do realize that this basically puts your money in a box for the next 40 years. I believe you can take some out early for a first-time home purchase, but everything else will hit you with a penalty. I believe the max amount you can put in an IRA is currently $4000 a year, so I’d suggest funding it as fully as you can every year, preferably to the max. Even if you only did it for a decade, stopping in your early 30s, $40,000 picks up a lot in the next 30 or 40 years. Also note that there are various ways to invest the IRA. Mine is currently just basically a savings account, but that’s because there’s only about $600 in it. The amount is currently too low for moving it out into CDs or stocks.
All the other investing I have is currently in individual stocks and index funds, and is mostly there so that I can use it for startup money when I get out of college. It’s not a lot, but it’ll help pay for a month’s rent or the like.
You are 20 and looking to Invest “for future years” I agree that a Roth is the way to go if you are investing for retirement if that is indeed what you are talking about stop reading now and know I’m a blowhard
OTOH do you think you might need this $$ before you are in your 50’s? For a house? Further Schooling, diapers while you and the SO finish grad school? If so, remember that the IRA, especially the ROTH locks in you in – I would advise you not to do it unless you are doing it for retirement. If you are trying to grow this money for 5-7 years while you get your life direction sorted , there are better options, like mutual funds, than an IRA.
Whatever you do, don’t take the advice you get from strangers on a discussion board as gospel. I doubt you’ll get anyone here to come out and say “I’m a certified financial planner, and this is what you need to do” For that, you need to find your own certified financial planner. Now that that’s out of the way…
When you choose what funds are in your IRA or 401(k) you have three or four primary choices in terms of your willingness to accept risk. Bond indexes are generally, highly stable, low-paying things that you won’t lose your shirt on. Stock indexes are somewhat more risky - if the market tanks, so does that slice of your investment. And then there’s your employer’s stock.
You’re young, so the occasional burp in the stock market won’t ruin your retirement plans. As you get older, you may want to look at sliding more of your investment base to bonds. For the curious, I’m 36, and my 401(k) is set up as 75% stock funds, and 25% company stock. This company’s almost older than money itself, so I don’t expect it to go belly-up any time soon. My stocks portion is divided among a handful of types, so if say, tech stocks dive, only about 10% of my overall investment is affected. Likewise, if big companies like Sears, GM and Chevron all head south, the “large cap” portion is what gets hit. The fancy word for this is “diversification.” Also known as “Not keeping all your eggs in the same basket.”
Oh, and employer matching of 401(k) contributions? That’s a very good thing. Hello Again described the tax advantages nicely. Not only the tax advantage, but it’s free money! Matching is usually limited to some percentage of your gross pay - in my case, it’s 6%. Or, it may be expressed as a percentage of your contribution. I contribute 6% of my gross pay to my 401(k) and that’s matched 100% by my employer. As the taxes go, I’m being taxed at 94% of my pay, but in the end, getting 106% (or so, depending on other tax-affecting factors)
I would say that it’s probably going to depend on how much work you’re willing to do yourself, how much flexibility you want or need, and the like. I use ShareBuilder, which is an online brokerage I’ve been happy with. None of the plans have a minimum amount limit. They have three plans: basic, with no monthly fee with each trade costing $4; standard, with a $12 monthly fee, but your first six trades are free; and advantage, with a $20 monthly fee, but your first 20 trades are free. However, this only applies if you are willing to make purchases on Tuesday and not in real-time. They also have a real-time commission, generally about 10 to 20 dollars, depending on the type of trade and your current plan, which you can change from month to month. Where they get you is that all sales are done in real-time and thus have the higher commission. They can also do IRAs and ESAs.
I would say that they are a good brokerage if you are going to drip investing. That is, put in some amount of money each month into the same funds. I don’t know how they are if you use them as a more classic brokerage, using it to do real-time trades. I would argue, though, that if you’re looking into just depositing money every week, month, etc. that you’d be better off doing it this way than paying higher commissions for real-time trades. I would highly suggest looking around, reading the Motley Fool’s website, and talking to someone who really knows this stuff.
Dude, I wasn’t much older than you when I made one of the better decisions in my life.
I decided I needed to begin investing. Simple enough. Plan for retirement, look to the future, all that good stuff.
The I opened up the phone book and looked under ‘investments’ (or whatever) and found a local Morgan Stanley-Dean Witter office. I spoke to a guy there who was a little older than I was and was starting out. He told me, “I don’t care what you invest now. I don’t care what you HAVE now. I’ll be managing your investments for the long haul. In 20 years we’ll both have some real dough to work with.”
We’re 15 years in and he’s been right. His plan was to lock up young folks who wanted to save and he’d make them money and they’d make his career.
Call a professional. It’s the best thing you can do.
I don’t think you need to work with a broker. I recommend establishing accounts with Vanguard, which is known for its low-cost mutual funds. I said accounts because you should set up a Roth IRA and max it out. If you have additional money to invest, set up an after-tax account.
Since you admit to being unsophisticated about investing, I don’t think you should invest in individual stocks. Instead, invest in mutual funds. And within the universe of mutual funds, stay away from funds with a sales charge or load. (These are the funds that an individual broker will try to sell you, which is why I don’t think you should work with one.) Instead, invest in no-load funds, and Vanguard has among the lowest-cost no-load funds. In particular, you should invest in index funds.
You could just put all of the money in the S&P 500 index fund, which invests in the 500 largest companies, and forget it for a while.
If you feel the need to diversify, you could invest in the Vanguard Target Retirement 2045 Fund. Currently, 90% is invested in various stock market index funds and 10% in a bond index fund. As it gets closer to 2045, the percentage invested in the bond index fund will increase. The idea is that someone decades away from retirement can handle the swings in the value of stock investments, while someone close to retirement should have less volatility in their investments. You could invest in that fund and forget about it for forty years, knowing that the fund managers are taking care of the diversification for you.
Thanks again for the responses, I’ve been doing LOTS of reading on this today, probably more than I should considering other stuff I’ve got on my plate. In any case, I’ve been reading the about.com site suggested, and I’ve been reading fool.com and I’m really trying to figure this all out.
I’ve found I hate being ignorant of this sort of stuff.
So I hope I can allay any fears you all have for my financial well being by my telling you I have no intention of taking any of you as gospel, your comments are fully appreciated and read and noted, but indeed none of you will be my financial advisors unless your name is Greenspan.
And I will indeed probably go the professional route, but I just need to learn more about this all. I don’t dive in blind. And as the about.com site said, “Investing without doing your homework is no better than gambling.” Though that applies more to stocks and such, I really liked that phrase.
No one has said this yet because it almost goes without saying (or should) but if you have any consumer debt (especially credit cards, or high-interest car loans, etc.) your very first investment should be in eliminating that debt. Next build up traditional savings of about 3 months salary as an emergency cushion for car repairs, brief unemployment, etc etc. Then think about long-term savings and investments.
Sorry about my math errors! I was in a rush and simply took 1/3 instead of 30% :smack: (<stern voice>let this be a lesson to you young man…</stern voice>) Also for the somewhat misleading info re: vesting. But the general points do stand: 1)401k accounts offer groovy tax advantages 2)look into the restrictions before you start so you know exactly what you need to do to receive 100% of what you and your employer put in. (some companies – like the one I work for – have plans that vest immediately so this point would be moot) 3)Hi, Opal , don’t forget to diversify across asset classes!
In the case of a 401k, you do not need to have a brokerage, financial planner, etc. to begin. Typically the employer has selected a brokerage to run the program, and you automatically get an account as an employee. If/when you need to roll it over (because you leave your job), any number of institutions – from brokerages to mid-sized banks – can run an IRA (you don’t need to use the same institution your employer chose).
Soon you too will find yourself cursing the Capital Gains tax.
First, stay away from Motley Fool. They’re full of shit.
Read “A Random Walk Down Wall Street.” The author has an axe to grind (he is, or was, on the Vanguard board), but he knows what he’s talking about.
You can’t beat the market. Don’t even try. Stick with low-load index funds.
At your age, you’re going to go through a number of downturns in the market before you retire. My thinking is that you should invest in index funds, but you may also want cash on hand that you can put into the market when it (inevitably) crashes. There’s an opportunity cost to this, and trying to time the market is about as tough as trying to beat it, but when the market tanks you can give it your best shot. It feels really nice to be able to invest when everybody who’s fully invested in stocks is locked in.
Finally, pay no attention to me. I’m a computer progammer, not an investment advisor.
You do know that this is precisely what Motley Fool recommends, right?
The advice you (the OP) are getting is generally good. If you get a job with a 401(k), max that out - the benefits are similar to those of a traditional IRA taxwise, but the contribution limits are higher.
Roths are still a good deal and I actually converted all of my traditional IRAs to Roths back when you could spread the tax hit over four years. The question is at what point might you become ineligible to contribute. This is probably not a serious risk for a recent college graduate not named “Bush” or “Kennedy,” but might be something to consider down the line. For example, if you’re planning to go to law, business, or medical school, you might very well wind up in an income bracket that makes you ineligible to contribute to a Roth. Better to sock some $$ in there now and let it grow longer tax-free so that you can still enjoy the benefits of the Roth system even when you can’t actively contribute to it.
Traditional IRAs are still useful, particularly when you change jobs (as you almost certainly will). You can roll your 401(k) balance into a traditional IRA rather than keep it at your old employer. I generally recommend doing so every time you change jobs, if for no other reason than to avoid dealing with whoever is managing the money at your old employer.
Index funds are a good idea. You might also start up a money market for a cash reserve.
Above all, when investing in stocks, mutual funds, etc., DO NOT check the balances and values every day and DO NOT freak out when your investments decline in value. It happens, but you need to invest for the long term. Resist the temptation to try and rejigger things so that your investments are always growing all the time. By all means, get out of bad investments, but don’t think that an investment is bad just because it’s not growing 8% each month.
I disagree with Kelly. The Motley Fool is a great site. They’ve become fairly annoying because of pop-ups and much of their site now requires registration. However, their basic idea of doing it yourself by buying index funds and letting the money grow is excellent advice.
You’re teacher was right. Roth IRA’s are an excellent way to go. Part of Bush’s tax cuts was an increase in Roth’s from a maxmum contribution of $3,000 per year to $5,000 per year. It was a gradual increase, and will start working it’s way in next year. After 2008 it will continue to be adjusted up for inflation.
Anyway, the max right now is $3000 per year. That’s only $250 per month, and you can invest less if you want. Since your young, you will get a TON of compounding interest. (That’s when your money makes money, then that money your money made makes it’s own money, etc.) If you invest in an index fund of stocks that makes the average long term return one would expect of 12% you could retire at age 65 with 3.6 million dollars! Keep in mind, with a roth, that money is all tax free. You don’t have to uninvest it gradually because of tax worries. You can spend it all on strippers before you’re 70 if you like!
If you wait until you are 30 before you do this, using all of the same numbers ($3000 a year at 12% interest until age 65) you would only have 1.1 Million dollars. Big difference that extra decade makes.
They give a good summary of info without getting too technical. If you qualify for a Roth, then it’s really a great way to invest since you can grow interest without having to pay a tax on it.
Which, adjusted for inflation (assuming 3% a year) will be worth $942,451 in todays dollars. (I’m sure you know this, but I always get a small shock when I account for inflation. :))
One thing that hasn’t been mentioned yet: 401(k)'s and an IRA (either a traditional or a Roth, but not both) aren’t mutually exclusive, i.e., if your employer offers a 401(k), you can put money into that and also open an IRA. It’s common to contribute just enough to your 401(k) to meet your employer’s matching limit (if any), then to max out an IRA (which you have more control over), then to go back to the 401(k). Ideally, max both of them out!
As for specific broker recommendations, I’m a Vanguard fan. They have a variety of good (low-cost) index funds, great customer service, and a good web interface. I keep my IRA and my emergency fund with them.
And I second Hello Again about paying off high-interest consumer debt first, if you carry any.
You’re correct about inflation. Thinking about how, by the time I retire, a simple house will cost probably over a million dollars usually just motivates me to save and invest that much more.
Good point about the merits of doing both. I always put in at least 5% to my companies 401(k) plan. That way I get the full matching funds. Not doing this is like turning down a 5% raise. I also max out my Roth IRA every year because that’s the much better deal of the two, IMO. Also, you can roll over funds from a 401K to an IRA. When I left my last job I did this. The only thing that sucks is you must pay taxes on all the money you are rolling over. That’s OK, though, because it’s better to pay taxes on a few thousand dollars now than a few million dollars later!
I’m in the Vanguard Russel index fund. It tracks every single stock listed on the NYSE. Talk about diversification! I’m also in other index funds that track the S&P 500 and a spider that tracks the NASDAQ. (Not just the QQQ’s, but the whole NASDAQ.) I, almost literally, own everything!
