Friday, August 03, 2007

Getting Started with Finances

An old friend asks:
Now that I'm thinking about it, what is a good investment vehicle right now? The stock market is unpredictable (at least to me), and I haven't been working full time long enough to qualify for 401k. I don't think bonds are the way to go because of the low return. I've heard mixed things on mutual funds and real estate is financially out of my league right now. What is a good option?
Here's the short answer:

•Set up a Roth IRA
•Set up your "infrastructure," meaning get a good savings, checking, and brokerage account.
•Work on your budget to make sure you have a plan to spend as little and save as much as possible.
•Invest in index funds, preferably a low-expense ETF, at regular intervals.

The long answer:

He's on to something with the 401k thing. The first thing most people think of is "how do I make the highest percentage return?" when the basics of how your accounts are set up and your budgeting is much more important.

So no 401k, but then set up a Roth IRA. The way it works is even if you make ANY money, you can put up to $4,000 (this year) into an account. Then when you retire, you pay no capital gains taxes (which are 15%). Over the 40 years or so between now and when you will pull it out, the no taxes part makes a huge difference. IRA's and 401k's (especially when your company matches it) are basically just free tax breaks that you're leaving on the table if you don't use.

So that, and set up your "infrastructure." By that I mean have your accounts organized effectively. Maybe you have a high-interest saving account, a checking account, and if you're interested in investing, a brokerage account. Make sure to get the best of breed of each. My personal preference is for simplicity. I use Chase and Fidelity out of habit, but if I were starting today, I might use just a Schwab One Brokerage Account. I hated Schwab when I had it five years ago, but they've changed and this checking and brokerage account is excellent. It even pays 4.25% interest on money in the checking account, more than most other banks. If you had that you wouldn't really need a savings account. (I don't get any money for saying that, don't own the stock, and don't even know anyone that works there, in case you were wondering).

After that, work on your budget. Save as much as you can, make good spending decisions, take on as little debt as possible. Avoid credit cards, though you can use them if you pay off the balance each month and use them just to avoid lugging cash around.

You can try to learn a ton about investments if you want, but for the vast majority of people, they should just put it in an equity index fund (some of the new ETFs have insanely low expenses) at regular intervals and not worry day-to-day! That last part is important, because one of the main rules of investing is that your stomach is more likely to defeat you than your head.

You're right, bonds are too low of a percentage return for our generation. Real estate is not a good idea for you right now, mostly because the economics make it so that in most parts of the country it currently makes more sense to rent than to buy.

Hope that helps. If anyone's curious, I can explain any of these areas more or talk about other personal finance issues. Just email me or message me on Facebook.


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