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.
You might choose the Target Retirement 2040 Fund or if you want to be more aggressive (more risk, possibly higher return), you could choose the Target Retirement 2045 Fund.
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?
Article comments
I’m not sure if your list was meant to be in order of priority but, if so, I’d definitely switch things up. Having an “emergency” fund of 3-6 months (maybe more) living expenses is the single most important component of financial fitness. There are some Vanguard bond funds offering good yields right now that can provide a nice balance with their stock index finds.
The only thing I would add, would be the use of a Muni-Bond fund that would provide the liquidity he seems to want, with some additional returns. Concurrently, the Muni-Bond Fund would help out in NJ which like NY is a high tax state.
Everyone is running to the Roth thing – if this guy is a business owner with a teacher in NJ (Teachers in the northeast are usually paid more than one would think) it is likely he wouldn’t qualify. Rather, if the commenters, you, or your buddy love the Roth idea he can start a Roth 401(k) through his solely owned business.
Just some thoughts.
Flexo –
Yes, I have my girls’ accounts in the NJBEST plan (the aged based plan since I set it up when they were a few months old before I really knew anything about them). I still think that the fees for the S&P 500 option are totally ridiculous at .85% (NY’s is still high at .55% but better than NJ). When I was mentioning the tax benefit I actually wasn’t even thinking about it being tax free upon redemption. I was actually thinking about the state tax deduction or credit on your tax return when you contribute to it – NJ doesn’t offer that. They do have a tuition credit of up to $1500 if you go to a NJ college but in actuality, the odds of my daughters going to a NJ school for college are almost zero. I can’t imagine either of them falling in love with Rutgers! HA HA! Princeton maybe, but not Rutgers.
I’d alter the 401(k) & Roth IRA suggestions. One should contribute to a 401(k) to get any company match. When you’re getting the full match in your 401(k) then put your money into a Roth IRA since you won’t pay taxes on that upon withdrawl. After maxing out your match and your Roth IRA, go back to the 401(k) until you’re saving enough for retirement.
Nice article. I have to say thought, you should MAX out your ROTH IRA before you open any other IRA’s. The ROTH is the best thing you can do with your $5k. You will have way more money in there in the future than you will have put in, thus not paying as much tax.
Depending on where in NJ, I recommend the $martChecking account from Provident Bank. 5.01% on up to $25,000 and 1.25% (or close to that) thereafter, plus reimbursed ATM fees each month. All if you meet the following requirements:
-10 POS transactions with the debit card (I have found that selecting Credit or Debit/ATM doesn’t make a difference, they both count in the tally)
-1 ACH/Direct Deposit per month (since wife is a schoolteacher, shouldn’t be an issue)
-Must receive electronic statement, no paper statement (easy enough).
I realize this doesn’t address all of the questions but (a) you need a checking account anyway, (b) 5% on $25k is better than 2% on $25k, (c) you can put excess money elsewhere and (d) you’re supporting and getting the customer service of a local bank. I’ve been quite satisfied with the bank so far — I’ve had the account since the beginning of the year. Details also available online:
http://www.providentnj.com
Just an FYI…I am a NJ resident and the 529 plan has no tax benefits and is not very good. I have my daughters college money in it right now but the fees are over 1% and I am doing some research as to where to roll it over. Somewhere that offers a vanguard plan where the expenses are lower and the investments are better.
Lynn: Do you invest in the NJBEST 529 plan? The earnings in this account are free from federal and state (New Jersey) taxes for New Jersey residents. Source
You can get your management expenses under 1% if you invest in the NJBEST S&P 500 portfolio, but in general you’re right about the fees. Vanguard has cheaper options, but you’re going to find that in general, 529 accounts are slightly more expensive than the corresponding or underlying mutual funds.
Why the 401(k) first over a Roth IRA? Or do you think taxes will be lower in the future?
Either way, very good recommendations!
I would make sure he knows about about market fluctuations etc. remind him it’s not a good idea to check his balance a lot. If he’s always had his money in relatively safe and reliable investment vehicles ht might ‘think’ he’s ok with short term losses/risks for longer term gains, but I’ve seen that change quickly for people that get ni the habit of checking their balances on a regular basis.
-MBirchmeier
Fidelity is also a good option for low cost funds, but I am partial to Vanguard as well. Be careful with those Target retirement funds. One fund company’s idea of asset allocation for a target 2040 can be completely different than another’s. I won’t go looking for them, but a number of blogs have touched this subject.
With the targets, check what the fund’s balance of stocks and bonds is compared to other target funds of the same date. Because risk doesn’t bother me very much at this age (I’m young), the Target 2050 has a good balance for me. But even then, once they do a 2060 I’ll probably move my funds there even though I’ll retire before then. This is because I handle most of my asset allocation on my own.
As for further advice for the friend, be sure to check out the wive’s 403(b). Some state plans are good, others are very bad. As always consider talking to a financial professional before making any decisions. And by professional, I mean a fee only planner that can be found on the NAPFA website.