20saver

This is the seventh installment of my review of Suze Orman’s The Money Book for the Young, Fabulous & Broke. The previous installment, Retirement Rules, covered the basics of 401(k)s and Roth IRAs.

“You will never truly be powerful in life until you are powerful with your own money” (page 220). What better way to be powerful with your money than to learn how to invest it! Orman is adamant about the fact that, in most cases, you don’t need a financial adviser to invest. Besides, most advisers get paid by commission so they have a selfish motive behind pitching certain plans and options. Let’s buckle down and become acquainted with the basics of investing.

First of all, Orman reminds us that saving is for short term goals while investing is for long term goals. You can’t risk the possible loss of value if you put your money in investments for short term goals. You won’t have time for the value to rebound before you need to withdraw your money. Investments are perfect for funding your retirement accounts; however, since you can let the money ride out the peaks and valleys and be in great shape when you finally need the money in 40 years.

Your options for funding your 401(k) and Roth IRA include mutual funds, stocks, and bonds. Mutual funds are premade packages of diverse stocks. Stocks are shares of a company. You usually only have the option to choose stocks of your own company for a 401(k), but you can choose any stocks for a Roth if it’s set up with a brokerage firm. Bondsare essentially loans you give to corporations or the government. They agree to pay you interest on your money until the bond matures and the principal is returned to you. Bonds are one of the most conservative investing choices available. Orman recommends waiting until you’re much closer to retirement to contribute any money towards them since bond returns aren’t very high. The key to investing is diversifying your money so that you’re taking the least amount of risk. Orman loves and highly recommends mutual funds for this reason.

There are different kinds of mutual funds:
Growth funds: earnings/profits are fast growing
Value funds: the share price is lower than the true value. Investors are waiting for the value to be recognized so they can increase their earnings.
Blend funds: both growth and value stocks are in the same fund
Small cap funds: smaller company stocks where big gains are possible
Mid cap funds: middle sized, faster growing companies that are more stable
Large cap funds: big, established companies that are the least risky
Actively managed funds: a money manager figures out the best investments for the fund
Unmanaged funds: also known as index funds, there is no manager, but instead investments are based on the existing market index (the market index is a number of stocks that represent a slice of the market, such as the Dow Jones)

Unmanaged or index funds have consistently outperformed actively managed funds. A big reason for this is that they have less fees, offering a larger net return for the investor. Orman believes that index funds are the best bet for 20somethings as they are simple and well diversified.

A few things to look for in a fund:
Expense ratio: the annual fees to cover the operating costs. Look for a low ratio in order to get the best returns. The average ratio for an actively managed fund is much higher than an index fund.
Long term performance of fund: how well it has done over the past 3, 5, or 10 years
Fund category: how the fund rates compared to its peers (large cap value, small cap growth, etc.)
Load: the sales commission used to pay the financial adviser. Orman urges never to buy a mutual fund with a load. To find out if a fund is loaded, call up the fund’s customer service and ask.

If you’re confused about which options are available within your 401(k), give HR a call. That’s what they are there for.

Orman explains that consistently contributing small amounts to a fund over time is key to investing success due to the wonders of dollar cost averaging. The price of funds changes over time: when a fund price is lower per share, you buy more funds with the money you contribute; when a fund price is higher per share, you buy less funds with the money you contribute. Buying more shares at a lower cost with steady, small amounts is better than putting all of your money into the market in a one time lump sum because you are taking advantaging of dollar cost averaging, allowing you to buy more shares in the long run. More shares mean higher profits when the price per share rebounds.

Orman offers one last piece of advice: the easiest one stop shopping for funds is a total stock market index fund. It’s the simplest and most diversified option available.

I have absolutely zero experience with investing as I’m yet to have a 401(k) or Roth. One day, and hopefully soon, I will be able to get some experience with mutual funds. I’m planning on sitting down with Jake to see about changing his 401(k) to better match what Orman recommends. Right now, he has a cookie cutter plan that isn’t offering the best returns. I’m really glad that I read this chapter as I knew very little about investing. Now I’m ready to jump in with both feet whenever I can get my hands on a retirement plan.

Next up for my Money Book for YF&B review is how to get the best deal when buying a car.

This is the sixth installment of my review of Suze Orman’s The Money Book for the Young, Fabulous & Broke. The previous installment, Save Up, covered ways you can save money.

The whole reason behind Orman writing chapter 6, “Retirement Rules,” is that 20somethings cannot safely rely on social security to take care of us when we retire. There is very little chance that the system will still be running when we reach that point in our lives and, even if it is, the amount we will get from it will not be enough to live off of. In short, we must fund our own retirement. Luckily, we have the power of compound interest on our side because of the sheer amount of time we have until we retire.

There are two basic flavors of retirement accounts: 401(k)s and Roth IRAs.

Here’s a nice trivia fact: the name 401(k) comes from the part of the federal tax code that deals with these plans. The contributions you make into your account are taken out of your paycheck and invested into mutual funds, stocks, and or bonds. There are limits to the amount of money you can put into your 401(k) every year. For 2008, the federally imposed limit is $15,500, but your employer could have a lower limit. Give HR a call and check it out.

The neat thing about 401(k)s is that your employer probably offers a company match where they match a certain percentage of your contributions up to a specific amount. This is free money! Do not pass up this opportunity! Any plan where you get a company match is top priority. Orman is very clear on this point: you must enroll and invest enough in your 401(k) to get the maximum company match each and every year.

There is such a thing as a vesting schedule that applies to your company match (not your contributions). Each year, a little more of the company match becomes yours- typically 20-25% a year until it is all yours- in order to ensure that your employer is not wasting their money on an employee who won’t be sticking around with the company for very long. Therefore, skip contributing to a 401(k) if you are not planning on staying long enough with the company to collect the match.

The money put into your 401(k) is taken out of your paycheck pretax. Another term for this is tax deferred. You pay the taxes when you take the money out of your account when you are at least 59 1/2. The amount you pay in taxes is based on your income tax bracket at the time you withdraw the money. If you make a withdrawal before you turn 59 1/2, you not only owe tax, but must also pay a 10% early withdrawal penalty.

Unlike a 401(k), a Roth IRA is completely separate from any employer. You must set up an account yourself. In a Roth IRA, the money you put in has already been taxed and will not be taxed again when you take it out (unless your account is less that 5 years old or you’re under 59 1/2 when you withdraw your earnings). Orman highly recommends concentrating on a Roth if you can’t get a company match or if you’ve already gotten the maximum company match.

Orman is absolutely wild about Roth IRAs because, when you make withdrawals in 40 years, your tax rate will be higher since you will more than likely be making more money than you do right now. So it makes much more sense to be taxed now with a Roth IRA then later with a 401(k).

Just like a 401(k), the money you contribute to a Roth is invested in mutual funds, stocks, and or bonds and there is a limit to the amount you can contribute to your Roth IRA every year. For 2008, it’s $5,000. You must also make less than $101,000 if single or $159,000 if married. You can withdraw your contributions anytime without penalty or taxes from a Roth, but your earnings can only be taken out tax- and penalty-free once you hit 59 1/2. In this way, a Roth can double as an emergency cash fund. Orman recommends opening up a Roth account with either a discount brokerage or a no load mutual fund company because of their lower fees.

Another advantage to having a Roth IRA is that you can withdraw your earnings penalty-free, up to $10,000, to use for the down payment on your first house. Again, your account must be more than 5 years old in order to cash in the waived taxes and fees. For a 401(k), you can also use your earnings for a down payment, but you must pay the taxes even though the 10% fee will be waived. 

Since I don’t have a full time job, I do not have any sort of 401(k) account. I would absolutely love to have a Roth IRA and plan to open up an account once I can afford to set aside the minimum balance and monthly transfer requirements, not to mention any fees I’ll need to pay on the account. Once I do get a full time job, I plan on maxing out the company match. Jake has a 401(k) through his employer, but they do not offer a match, instead they just give a plain percentage regardless of if you personally contribute any money or not. He’s currently contributing 3%, but I’m hoping that he’ll be able to set up a Roth soon and contribute that money to the Roth instead.

Next up for my Money Book for YF&B review is investing principles.

This is the fifth installment of my review of Suze Orman’s The Money Book for the Young, Fabulous & Broke. The previous installment, Making the Grade on Student Debt, covered paying back student loans.

One of the strongest statements Orman makes in her fifth chapter, “Save Up” is the following: “Success is not solely about making more money. It is about knowing where the money you make is going.” But Orman doesn’t go the traditional budget route, she instead suggests some reasonable changes her readers can make in order to free up some cash to deposit into an emergency savings fund, build up a Roth IRA, or pay off debts. Here are her suggestions:

Stop getting an income tax refund. It’s great to get a big, fat refund back every year, except for the fact that the government was holding that money for a whole year interest free! Change your withholding so less money is taken out of your paycheck, thus increasing your take home pay. The key here is not to have so little taken out that you owe money. Find the right balance by calling up your human resources department.

Do not have a life insurance plan if you don’t have any dependents.

Raise your car insurance deductible, thus lowering your annual premium. If you go for a low deductible and make multiple claims, your insurer will raise your premium anyway or outright cancel your policy. If need be, Orman recommends charging any deductibles on a low interest credit card.

Get rid of your land line if you have a cell phone.

Take a gander at your bank statements. Look for any errors, ATM fees, or bounced checks. Switch banks if there are too many fees.

Balance your checkbook. Do not guesstimate about having enough money for the checks your write or the withdrawals you make. Know that you have the money, everytime.

Check your credit card statements for errors. If anything doesn’t look right, give your credit card company and or the business you patronized a call and get the scoop.

The following are small changes that affect your lifestyle more, but are still completely doable:

-Wait an extra week or two to get your next haircut/manicure
-Use the dry cleaner less often
-Drink more economically- go for a glass of beer or wine instead of the $10 martinis. You can also change to a different bar that offers cheaper drinks.
-Pack lunches at least a few times a week
-Use public transportation if you live in a metropolitan area
-Cut down on expensive sport equipment by buying used or off season
-Go out to the movies less
-Get a roommate to help pay for rent and utilities
-Don’t live in a trendy neighborhood where rent is sky high
-Keep your car for a couple of extra years instead of getting a new one as soon as you pay off your current car

Orman recommends paying off your credit card before focusing on saving if the interest rate on your credit card is more than the interest rate on your savings account.

Be sure to either set up an emergency savings fund that will cover six to eight months of expenses or to have a credit card with a credit limit that will cover the same (if you’re too strapped for the emergency fund).

When debating over contributing to your 401(k) or your savings account, Orman says go for the 401(k) before the savings account if your company matches your contributions.

One last bit of wisdom Orman shares: savings is for short term goals (up to about 5 years), investing is for long term savings goals (beyond 5 years). Sock your money away accordingly.

I already do a good many of Orman’s savings suggestions, plus a bunch of my own. After reading this chapter, I plan on looking into my tax withholding to see if I can find the right balance so Uncle Sam isn’t holding so much of my money and changing my car insurance deductibles so my rate isn’t as high. I also want to go over these points with Jake to see if there’s anything that he’s willing to change in order to save some money- fingers crossed! 

Next up for my Money Book for YF&B review is planning for retirement.