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Straight savings vs. 401k or other investment plan

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I'm still stuck on whether I only want to have five grand or so in ING and then start investing all excess in index funds, or if I'd want a full 3 to 6 months worth of income in ING.

After I decide this set amount to be in ING, and once I achieve that amount, should I start investing in a ROTH or index funds? How do I know what should be RETIREMENT money and what shouldn't be?

And obviously I don't have to consider a 401k until I get a real job that provides it. But once that happens, should that and the ROTH be maximized before tossing anything into index funds?

To sum it up, I'm just trying to find the right balance between savings (emergency money), index funds (emergency money + short term savings), and a ROTH and 401k (retirement).
 
Originally posted by: Storm
How do taxes work with a regular brokerage account?

Lets say I open a brokerage account with 10k all in VFINX with dividends re-invested.

The current price of a VFINX is $111.58 for 1 share. With 10k invested I will have about 89.62 shares. Lets say 1 year from now it goes up to $113.25 with dividends re-invested lets say 90.05 shares

$113.25*90.05=10198.1625... Now I have to sell off some shares because I need the money for medical bills. How will my brokerage account be taxed? What will I be paying taxes on...?

For example, I have a 401k, roth ira ( with money invested in vanguard stock index funds like the vfinx) plus a brokerage account with vfinx. Since I have invested in VFINX in my roth ira and brokerage account wouldnt that stunt diversification?
Click to expand...
VFINX is fairly diversified no matter how many shares you own, since it's 500 different stocks.

A good mix is 50-70% VFINX with the rest split between a "small-cap" stocks mutual fund and a "worldwide" mutual fund.

For a normal brokerage account, you pay taxes two times (but only once on each dollar you make):
1. At the end of the year, the brokerage sends you a statement saying how much you made in capital gains and dividends this year, from activity within the mutual fund. For example, Microsoft is in the S&P500, Microsoft pays a dividend, so Vanguard passes the dividend on to you as new VFINX shares. You have to pay taxes on this each year.

2. When you sell shares, you're taxed on the difference between what you paid and what they are worth now. So you sell 10 shares at $125 each, you paid $100 per share, your capital gains are 10x$25=$250. You don't have to pay this until you actually sell something.

Your cost ("basis") for the shares you were given in (1.) is the price when you were given them, so you still only pay taxes in (2.) for the growth in value.

Finally, (1.) is lower in VFINX / S&P500 funds than in other funds that buy and sell stocks, so it's good to put the "small-cap" and "worldwide" stocks in a 401K / 401K rollover (to traditional IRA when you change jobs) / Roth IRA instead of your "unsheltered" regular brokerage account. That way the higher (1.) amounts are in a tax-sheltered account.
 
Originally posted by: archcommus
I'm still stuck on whether I only want to have five grand or so in ING and then start investing all excess in index funds, or if I'd want a full 3 to 6 months worth of income in ING.

To sum it up, I'm just trying to find the right balance between savings (emergency money), index funds (emergency money + short term savings), and a ROTH and 401k (retirement).
Click to expand...
You should be buying index-based mutual funds in your 401k and Roth accounts too, though many 401k accounts don't offer you good choices like VFINX.

Skoorb is starting to convince me that what you should do is save up maybe 2 months + $5,000 in ING, then take the $5,000 over to vanguard.com as a non-Roth "ordinary" brokerage account to use to buy and hold VFINX. It would still be for emergency use, but will grow faster than at ING. *

You can keep adding more money at Vanguard in this account, or add it at ING to save up enough to start a second account at vanguard for your Roth IRA.

( * over years. In any one year a mutual fund might even lose money.)
 
I max out my 401K (can't do Roths, make too much money). That is all in mutual funds.

I keep about 1 month's salary in cash and also save for big expenses like a vacation so the cash is ready when the bill comes. This gives me a decent amount of quick cash to draw on.

Otherwise, I use DRIPS to save for my daughters' education fund. I could use Vanguard's index fund, but I prefer DRIPS. I've already hit a pretty nice dividend level on an annual basis and this is being reinvested. I pay 15% tax on the dividends, but that is better than what I would pay on interest.

The vast majority of investors would be better off buying Index Funds and Vanguard is just about the best in all cases for all indices. I'm actually doing about 1% better than the return on the S&P 500, so I'm happy with my coices, but I'm a financial professional and I have really rigerous criteria before I invest.

Michael
 
Originally posted by: DaveSimmons
Originally posted by: archcommus
I'm still stuck on whether I only want to have five grand or so in ING and then start investing all excess in index funds, or if I'd want a full 3 to 6 months worth of income in ING.

To sum it up, I'm just trying to find the right balance between savings (emergency money), index funds (emergency money + short term savings), and a ROTH and 401k (retirement).
Click to expand...
You should be buying index-based mutual funds in your 401k and Roth accounts too, though many 401k accounts don't offer you good choices like VFINX.

Skoorb is starting to convince me that what you should do is save up maybe 2 months + $5,000 in ING, then take the $5,000 over to vanguard.com as a non-Roth "ordinary" brokerage account to use to buy and hold VFINX. It would still be for emergency use, but will grow faster than at ING. *

You can keep adding more money at Vanguard in this account, or add it at ING to save up enough to start a second account at vanguard for your Roth IRA.

( * over years. In any one year a mutual fund might even lose money.)
Click to expand...
So the plan seems to be to save up in ING, then save up money to start a brokerage account for more quickly growing "emergency money," and then once I've started that and am letting it grow save up another batch and start a Roth IRA to let grow. Then worry about a 401k once I'm employed with a job that offers it.

Got all that right?

Still, I hate risk, and it makes me reluctant to put more into ING and to not even bother with my own brokerage account for emergency money. But I must listen to you all, as you know more than I do. :laugh:
 
Another Q. If I get the kind of job I want I should be able to make at least $2500 this summer, a good portion of which I probably won't spend. Should I put this money in ING and get a higher loan for school? Or should I not worry about increasing my ING savings or investing in an index fund until years from now and put all the money that I can from this summer towards tuition?
 
What are you paying in interest on the school loans?

Paying instead of borrowing earns you whatever that rate is, which is probably higher than what ING is paying. If you have a credit card be sure that you keep it paid off too.

Try to get out of school with savings and with as little debt as possible, but don't give up on having any fun at all to do it. Moderation in all things including saving vs. spending 🙂
 
Well, I know that in the long run I'd be saving money by paying more now and getting less in loans, but I was thinking perhaps it'd be wise to focus on building savings now so that I can start to invest sooner.

However, it's hard to keep the money in the bank when I know I have a good, legitimate use for it right now. So perhaps I'll set a minimum that I will not let ING go below, like $3,000, and then everything I can get in excess of that I will put towards tuition. True, I won't be building up ING beyond three grand, and I really won't get an opportunity to invest until I'm out of college, but perhaps that's just something I have to accept because I have bills NOW. I could be paying at least two to three thousand more in tuition upfront than I would be if I saved most of it instead.

Think that's the smartest way to go about it?
 
Sounds good, maybe a little higher though depending on if you think you'll be moving for your first job, or if people you know at school in your major are needing 2-3 months to find a good job.

Starting the Roth IRA now is tempting though: you can only put in $4K/year, so not using your earned income from 2004 (if you had wages) and 2005 to make contributions for those years is a missed opportunity. Tax-free growth of investments is a good thing.

As long as you're saving some instead of spending it all on beer you're ahead of most students, so don't stress too much about making the perfect investments.
 
It is wise to have an emergency savings plan, what you feel comfortable with. If you have no kids and live with your parents, then 3 months of expenses or salary is a good start. If you have triplets and are a single dad who happens to be a firefighter, load up on insurance and save at least a year. So the amount you want in your emergency savings should vary on your needs. My goal is to have 3 months right now. Later on I imagine I'll want 6 months to 18 months of expenses or salary. The key to doing this is budgeting so you know your inflows and outflows.

If you have the opportunity to put into a 401k that matches dollar contributions, then do it. If not then put the $ into an IRA, roth or traditional based on your tax bracket.

A 401k and IRA are better than a savings account for investing b/c the returns tend to be much higher and are not taxed. Savings accounts are for just that, savings. EIther for an emergency or for something you'll be buying in the short term, like a house. I use the term short term to be within 5 years. 401ks are deducted from your paycheck, IRAs you need to contribute to.

Savings accounts have abysmal returns, the stock market doesn't, so go with the stock market in the form of an IRA or 401k. There is risk with stocks, but if you have 20 plus years before you need the cash then the risk is acceptable to most people. If you don't like risk, then invest in bonds, which can be protected with collateral and in case of bankruptcy often get higher status in liquidation.

I feel an IRA or 401k shouldn't be used as savings since you pay a penalty for dipping into the money and that money should be for the long term, either your retirement, or kids' education, etc... An investment is long term, it is not a savings account. To protect it, if you're a novice and young investor then you should be properly diversified in index funds. Stock and bond index funds exist, if you are risk averse, as you seem to be, then have a large percent of your money in diversified, non-risky bonds makes sense. Just remember bonds are usually taxed at higher tax rates.

You can buy index funds for your IRA from brokers like scottrade, or your mutual fund company like Vanguard. Vanguard is often cheaper. As mentioned, index funds invest in lots of different stocks so you're diversified. For what its worth, some people like superinvestor Warren Buffet think diversification limits absolute returns, and I tend to agree, but diversification is safety in numbers....

Saving is the key, so you might not be making 50% a year on it, but savings will get you to where you want to be. Or at least where I want to be, retired in 25 years on a tropical island 😉

PS how old are you archcommus?
 
Thanks for the summary.

So you mentioned I should look into bonds and well-diversified index funds for my Roth and 401k to keep the risk low. Obviously I cannto start a 401k until I get a "real" job out of college that offers one. But do you think I should start investing in a Roth or other index funds through something like Vanguard while I'm still in college? I *would* like to start early if possible, but like I said, if I earn as much dough as I can in the summer, I will feel compelled to put that towards tuition. So, like I said, perhaps I should just try to keep my ING at a constant three grand or so and put most of what I earn towards tuition, and not think about investing too much until I'm out of college and employed. Any comments on that?

Also, do you agree with Skoorb that for "emergency money," only a few grand should be ING and the rest should be in easy-to-sell-if-needed index funds? Or do you think keeping all of the emergency money (3, 6 months, whatever) in a bank account is a better idea?

I'll be turning 18 in six days. :thumbsup:
 
My opinion:

I would open a Roth, if you qualify. No point in opening a traditional IRA since I assume you're in a pretty low bracket and it would save you very little cash. Go Roth, and then in the future when you retire you can take it out tax free. Remember for an IRA you need earned income, not passive income, meaning usually money you earned from a job. Passive income is like money you earn from apartment rents or interest,etc.... The cutoff date for a Roth for 2004 is April 15th. Believe me the 50 year old you will be glad you opened it.

Look at this compounding article:
link

Read it, but in particular focus at the chart and at column B. You my friend are in column B, your destiny is in your hands. Look at how much more you can make if you contribute for 7 years vs someone who contributes more, IF you start earlier. You can start your way to financial happiness if you start early. I'm not saying don't hang out with your friends, don't party, but do think about the future.

This is a similar link It shows you how much more the stock market can make.

The reason I say invest instead of save that money for tuition is tuition loans are very very low rates, and the interest is tax deductible. There are loans and scholarships for college, but you can't get a loan for retirement! You can use leverage (loans and debt) for your education, but not to pay your bills later on in life.

The only problem I see is that you weren't 18 in tax year 2004, that might mean you can't qualify for the 2004 IRA, check out the IRS publications. I'm not sure off hand, but you would qualify for a Roth in 2005.

Also, I would keep my emergency money in the bank, b/c the market can tank and thats when oftimes you need that money. But thats just me, do your own due diligence and decide.
 
Thanks again for the great information.

You're links definitely convinced me that I need to start investing in a Roth ASAP. Yes, getting $2k/year more in loans than I would have otherwise sort of sucks, but as you said the interest is low and tax-deductible, and hopefully the payments wouldn't be much of a burden after I' out of college. The thing is, I simply cannot believe the numbers in the chart from that first link. How can one person only invest for seven years and the other invest from the age of 26 to 65 and still come out with less money? I realize that those first seven years make a big difference in the compounded interest, but after the person A has been investing for seven years as well, wouldn't it start to catch up very rapidly, and then eventually SURPASS person B because A is STILL contributin $2k/year? Can you explain at all how this happens?

I also partially agree with you that I'd rather have my emergency money in the bank, simply because I know I will not lose any of it. So does that mean I really don't need to worry about doing any investing outside of my Roth and 401k?

Finally, I know that the numbers in those charts are based off of an average growth and return in the stock market of 10% a year. But what if we were all unfortunate enough for a depression to occur? Would I essentially be wasting away all the money I invested over the years? How do you pad yourself from such a catastrophe?
 
You should believe those numbers. I've verified them on my own, and they are right. If you don't believe them, just open up excel and try it out yourself. [If you want to invest, excel is your friend, make nice with it and learn it] Make the 2000 contribution on the first day of the year and grow it at 10% for the year, and then do it again, and again, and again.... In year 26 the investor in column B will have $20,872 while the one in column A who waited will have ZERO. That 7 year jump will mean a huge advantage. It's pretty simple, its just compounding. Yes compounding is that powerful, simple, and it is every investors friend. Albert Einstein supposedly said that compound interest was the greatest wonder of the universe, that's probably apocryphal but the idea is right.

Now the chart assumes 10% growth over the lifetime of the investor. That is optimistic in my opinion, but attainable. But even if you use a lower compounding percentage for both columns, then the investor in column B still wins. Over the last 40 years the S&P 500 (a very broad range of about 500 stocks) has returned 8.3%. Maybe 10% is optimistic, but I'm sure you can at least do that average of 8.3%. Those 40 years include a few recessions including the last one, and the recessions in the 1970s and 1980s. It includes the tech bubble of the 1990s and its crash, the high interest rates of the 70s, the Vietnam war, the OPEC cartel, the cold war. And still 8.3% for the last 40 years.

Thats not to say there is no risk in stocks. There is. So now comes the major conundrum, once you decide to invest where to put it. Deciding to invest is the first skirmish of the war, now you have the rest of the battles to face. You talk about padding yourself from catastrophe. The best way to do that I feel is to hold quality bonds or cash. Another great way to do that is to invest with a "margin of safety." It's a value investor term. At its most basic, it means invest when the price of a stock is close to it's book value. Ie. intel today has a price of $23.46, but a book value of $6.17 (meaning all its plants, buildings, assets, etc... are worth $6.17, so if the company goes bankrupt thats what one of your shares is probably worth). Or you can also dollar cost average your investments. Instead of buying 100 shares now, buy 10 over 10 months to space out the price and to average it.

Right now I feel stocks are overall fully valued at best, and overpriced at worst, I won't put my money into any unless they are value stocks. Oil prices are hurting the market, as is the federal budget and the higher interest rates that will be coming. There appears to be a bubble in real estate as well. But remember that is GOOD for you, it makes stocks fall and it gives you a buying opportunity. I'd love another recession from an investor angle (maybe not because I'd lose my job but thats another story). It's foolish to want the market to do well if you're starting to invest, you want it to tank so you can buy high quality shares at low prices. I like to buy when everyone is crying about how the market is tanking, not when everyone is optimistic. If you want to invest don't flinch at 20% drops! Learn to love them.

As for investing outside the IRA and 401k, I think you should do it, once you max out the 18,000 annual limits of those investment vehicles. OR if you want to invest in something really, really risky then by all means use regular brokerage account so you don't blow your retirement cash.

Do you know where you're going to college? In state or private/out of state? Near home or far? Scholarships or not? Hapy bday and I hope you enjoy college, I know I did.
 
I'm going to Grove City College in Grove City, Pennsylvania. I live in Pennsylvania and it is a private school, only about an hour away, cost a little under $16k/year currently. I am not eligible for federal aid (loans OR grants), but I am eligible for state aid, and I should be receiving a scholarship (who knows how much) from the school, as well, based on need and my academic record. I don't know what other aid I may receive beyond that, though, it worries me thinking about it.

I'm not sure if I ever want to delve into the world of individual stock selection. As I've said I'm not a big risk-taker and I instead to stay that way. Furthermore, regardless of current stock values and any research that I do, I'm not sure that I'd trust myself with purchasing stocks. That's what I like about choosing index funds through something like Vanguard. I'll automatically be investing in the S&P 500 and won't have to worry about micromanagement. I hope to one day be able to invest beyond the max of the Roth and 401k, but obviously that won't be for awhile, so really the only thing I need to worry about anytime soon is the Roth.

So would my best now be to start investing whatever excess money I have in a Roth? I certainly wouldn't have the funds to max it so I wouldn't have to be concerned with any other investing currently.

Think is, despite those incredible numbers, I'm still hesitant. Two grand from one summer of work is a lot of dough for a kid like me, dough that could be accruing minimal interest in my ING account or going towards tuition. VERY important money. The numbers in that chart show impressive results but I'd be so afraid of some downturn in the market ruining it for me. Like I said, that money could have many many important uses in my life right now.
 
OP,

You seem to be extremely ambitious about saving and investing, which is great. However, it looks like you, like myself when I went to college, aren't fortunate enough to have a) loaded parents to pay for everything, or b) scholarships/grants to pay for everything. Here's something you need to realize...you are planning for something (retirement) that is 40+ years away, but it looks like you'll be stretching your financial limits to make it through the next 4 years (perhaps I'm wrong).


[flamesuit]

You don't need to be worrying about 401(k)'s, IRA's and stocks right now. Did you infer earlier that you were thinking of investing money that you would get from a school loan? Believe me, there would be only one place to "invest" that money, and that would be in an envelope back to the lender. The only way I got through school was through ~10k in student loans, a part time job that paid ~$10/hour, and credit cards for books, clothes, etc. Now that I'm 2 years out of college, I still have about 9 years left of $100/month payments to Direct Loans, and I'm still paying down the CC balances. To borrow money to invest doesn't make sense (forgive me if I read one of your earlier posts wrong).

[/flamesuit]

Now, was the debt worth the degree? In my case, yes. I have a good job, and have been contributing 10% of my salary (7% + 3% employer match) to a 401(k) as soon as I got a full time job (here's another kyparrish nugget of knowledge....NETWORK...remember the $10/hour part time job? I now have a full time gig doing something else in the same company). I'm still paying down the debt of college, but it should be more or less GONE in a few years.

Basically, here's my advice: The spending habits you develop before and after college are as important to your financial development as worrying about investing money at age 17. Get through school with as LITTLE debt as possible, then invest as much of your money as you can each month. See Skoorb's post in this thread for great tips on saving (tips that I think I might start doing...the emergency plan of 2 months liquid + 1 month money market + 3 months in CD's formula looks GREAT.
 
Archcommus, you don't have to buy stocks; you sound very risk averse. For someone 18 I recommend a large amount of stocks, but if thats not your personality then its just not.

I think you should put in that $2000 into the Vanguard Total Bond Market Index (VBMFX) with a Roth. In its worst three year return (1992-94) it achieved 4.58%. It's return for the past 10 years has been 6.99%. Decent numbers, with a fair amount of safety. See here: http://finance.yahoo.com/q/pm?s=VBMFX

I was talking about valuations and dollar cost averaging b/c that applies to mutual funds that invest in anything as well.

The market has downturns all the time, its life, accept it and don't panic. Those numbers might be incredible but they are realistic. Don't be upset when the market falls a bit, that happens for bonds and stocks. If I lost money for 5 years straight I wouldn't be upset, I'd probably be happy since I can buy stocks at good values. I have faith that in the long term the markets will give me good returns. Perhaps you need to learn how to have that kind of contrarian attitude and to have faith in our economy.

Your life is ahead of you, 2000 dollars is a large amount for me too! I'm not a millionaire either. But you can afford to invest it in my opinion. Remember you'll make money in the future, but you can only save it in a Roth now.

If you can't accept the idea of ANY risk then I guess you belong at the bank and this thread should just die, but in life you have to accept some risk to get some returns.
 
kyparrish:

No, I was not saying to borrow money to turn around and then invest it. I agree that would be very stupid. What I was doing was debating where I should invest what I earn now or put it towards tuition. On one side of me I agree with what you say, about waiting to invest until I'm older and have more funds, and for now try to acquire as little debt as possble. However, it's hard to do that when I see what could be gained by starting to invest earlier, as astroview's links proved. That is too great of an opportunity to ignore. On the other hand, it just seems wrong to have two thousand in spare money on me and NOT put it towards my tuition. I'm still debating this topic and have not decided yet.

astroview:

I am not COMPLETELY risk adverse, I certainly don't want it to come off that way. I accept the fact that the market has downturns, because I know in the long run it should produce positive results. I also realize that investing and risk is REQUIRED to build up a good stash for retirement. I am not going to try to retire simply on what I have and can build in my ING account. However, I don't want to be stupid, and that's why I'm currently debating this. Your numbers don't lie and are impressive. But, living in the present, it's hard to turn down the opportunity to contribute two thousand dollars towards my tuition, especially after having worked my butt off for it all summer long. Then I consider, if I start to invest right out of college, I won't be putting if off seven years like the chart suggests, I will be putting it off four. Perhaps that is not as bad? Ahh, I don't know. I know you're right, astroview, it's just tough to make myself do it now when tuition looms over me.
 
Student loans are deductible on taxes. Often they are capped too, one number I heard is 8.25% recently, and if your loan is at 8.25% you better believe that the 10 year treasury will be at like 13% and there were be other big troubles going on...

archcommus, look at your budget for school and see if you will be any scholarships and what your parents might be willing to provide for you. If you can swing it, low rate govt loans for school and investing a bit are a good mix I feel. That's just smart, its using leverage. It's how americans buy houses, go to school, and buy cars. Debt used intelligently can help you go far. I know several people who could pay off all their school loans right now, in fact they're not going to b/c they feel they can invest the money better than repaying off a low interest loan that has tax benefits.

I understand delayed gratification is difficult, but it can be a good thing.
 
His numbers are right about that dude investing for 10 years and then stopping. I ran them a couple of years ago too 🙂

It's good to start early. I started initially when I was 19 or something. I put some money in that I had and was unable to contribute to it again, and in fact had to cash some of it out later, down the line, but it instilled in me the lust to have some real, growing investments, and that's stayed with me since.
 
My tuition is a little under $16k. Based on the chart on PHEAA.org, I am expecting about three grand from the state as a grant. I have no idea how much to expect from the school in the form of a need-based scholarship, or what other scholarships I will acquire. IF, and that's a big if, the school happened to give me about as much as the state, and if I got NO other scholarships, that would mean I'd need to pay about $9k for the first year. The big question is, how much am I okay with getting a loan for? Well, average debt for today's students after four years is in the ballpark of $30k. Considering my school costs below average, I think $20k in debt would be an acceptable amount for me after four years. So, I'm thinking as long as I keep it under $5k a year in loans I won't be too upset about it. That means I'd need to pay $4k out of pocket a year. That is $2k a semester. The big question, CAN THIS HAPPEN? Answer is, probably not without my own contribution. So I have to decide, put all the money I earn in the summer towards school and come out with possibly under $20k in debt (maybe), or invest that money and accept loans amounting to the high-20s or more after four years? Obviously option one sounds favorable, but when you consider what I could be gaining from investing and the (hopefully) manageability of student loans, then perhaps it is actually option two which is best, as has been said by astroview and others. Or maybe I'll end splitting it up, maybe a grand into a Roth and a grand towards tuition, really not sure yet.

What do YOU guys think is an acceptable amount of loans to come out with after four years, each year costing around $16-$18k?
 
Also, I just did some reading on FW, my mind went spinning. So many other options were recommeneded for a kid in a similar situation as mine, many even suggested keeping all his money in ING and not even bothering with an IRA because of such low yields currently.
 
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