Where to start?

[NME]

Hey everyone,

I'm 22 and recently graduated from college. I have about $25k saved up and I'm saving about $1k each month out of my paycheck after taxes and expenses. However, right now my savings are just sitting in the bank and earning little to no interest. I'm sort of clueless when it comes to investing and would appreciate any help getting started. What are some good investment strategies for someone my age? Are there any helpful books you would recommend?

Thanks for your advice

[zetta]

Books I've found useful, and the main topic covered. I've placed them in the order I would recommend reading them. You can click on my Booknotes catagory in my blog to read my summaries of numbers 1, 2, and 6.

1. All Your Worth (getting your basic financial picture in order so you have money available to invest)
2. The Complete Idiot's Guide to Getting Rich (helps with goal setting)
3. Bogleheads Guide to Investing (explains mutual funds and the indexing strategy)
4. The Intelligent Asset Allocator (how to structure your portfolio)
5. Morningstar Guide to Mutual Funds (how to analyze and pick funds)
6. Common Sense on Mutual Funds by John C. Bogle (highly technical analysis of index investing)

This online book is also good:
Investment Guide

[jIM_Ohio]

12k per year to save...

have you looked into
a) Roth IRA?
b) 401k or other workplace retirement accounts?
c) having an emergency fund?

[disneysteve]

I think you need to start at the beginning.

Do you have any debt such as credit cards, student loans or car loan?
How much of an emergency fund do you need? It should be 6 months worth of expenses.
Are you contributing to an employer-sponsored retirement plan like a 401K or 403b?
Do you have a Roth IRA?

What financial goals do you have, both short-term and long-term? Do you own a home? If not, do you want to, and when? When do you anticipate needing to buy your next car? Are you married? Any children?

Lots of things you need to work through before deciding where and how to invest.

[NME]

I think you need to start at the beginning.

Do you have any debt such as credit cards, student loans or car loan?
How much of an emergency fund do you need? It should be 6 months worth of expenses.
Are you contributing to an employer-sponsored retirement plan like a 401K or 403b?
Do you have a Roth IRA?

What financial goals do you have, both short-term and long-term? Do you own a home? If not, do you want to, and when? When do you anticipate needing to buy your next car? Are you married? Any children?

Lots of things you need to work through before deciding where and how to invest.

Fortunately I don't have any debt, otherwise I would be paying that off first. My expenses are <$2k a month so with the $25k I have saved up I'd keep $12k as an emergency fund and would like to invest the remaining $13k.

I'm about to start contributing to an employer-sponsored 401k (I just became eligible). My employer will match the first 3% of my salary that I contribute so I've elected to contribute 3%. I'm not sure if it's worthwhile to contribute anymore than that. On the one hand I understand that it's tax deferred, but given that I won't really have access to the money until I retire I'm hesitant to invest a lot in the 401k.

I don't have a Roth IRA and to be honest I'm not really sure what that is.

I don't own a home. I'm currently renting with my girlfriend who is attending law school. Eventually I'd like to own instead of rent so one of my goals would be saving for a down payment on a home. I'm not in a rush to own a home though, since I'm splitting rent with my girlfriend. I wouldn't want to have a mortgage that she'd be contributing towards and then break up and have payments that are greater than I'd like to pay/afford on my own.

I won't need a new car for at least another few years, my car is still in relatively good shape. I don't have any children.

I hope this was a little more informative of my financial situation.

[NME]

Books I've found useful, and the main topic covered. I've placed them in the order I would recommend reading them. You can click on my Booknotes catagory in my blog to read my summaries of numbers 1, 2, and 6.

1. All Your Worth (getting your basic financial picture in order so you have money available to invest)
2. The Complete Idiot's Guide to Getting Rich (helps with goal setting)
3. Bogleheads Guide to Investing (explains mutual funds and the indexing strategy)
4. The Intelligent Asset Allocator (how to structure your portfolio)
5. Morningstar Guide to Mutual Funds (how to analyze and pick funds)
6. Common Sense on Mutual Funds by John C. Bogle (highly technical analysis of index investing)

Thanks I will definitely take a look at some of those books.

[cptacek]

A Roth IRA is simply a bucket of money that the government treats differently for tax reasons. You buy mutual funds, individual stocks, bonds, etc., and hold it in a Roth IRA.

It is like if you have two envelopes, and you put a $50 bill in one and 2 $20 bills and a $10 bill in the other. You write "spending money" on one envelope and "gas money" on the other envelope. There is money in each envelope, but you have designated the way you are going to treat the money in that envelope.

With a 401k, the money you put in there, up to $16,500 this year, is taken off your taxable income...you don't pay taxes on it when you earn it. The money your employer contributes isn't taxed either. Hopefully, it grows and grows, and then when you start taking it out when you retire, you start paying taxes on it then.

With a Roth IRA, the limit is $5000 this year, and $6000 next year.
2009 IRA Contribution and Deduction Limits You get paid from your job, and you pay taxes on that money. You open a Roth IRA account and buy $5000 worth of stocks, bonds, mutual funds, etc. That money grows tax free, meaning you don't pay taxes on any dividends it earns throughout the years, not capital gains, nothing. When you start taking it out, you don't pay taxes on it either.

Another cool thing about the Roth IRA is that you can take the contributions out at any time with no tax penalty and you have already paid taxes on it, so it doesn't count as income either. You could send in $100 this month, and decide to take that $100 out next month with no penalty and no tax consequences.

I think that the Roth IRA is the best for young people, though good for older people, too. I view it as the ultimate destination for your retirement money. You are paying probably the lowest tax rate we will see, because of politics, but also because you are young and hopefully make more in the future, which means you will pay more taxes then. We know that taxes are going to go up in 2011 because the tax cuts enacted in 2001 and 2003 will expire. All that money in a Roth IRA isn't effected by tax rates, because you already paid it the year you put it in.

You can put the $5000 in for 2009 up until April 15 of next year, and then $6000 for 2010 until April 15 of 2011. I think that the contribution limits will then go up by $500 increments each year based on inflation (but I've gotten this detail wrong before...Disneysteve?)

I wrote this in 2007, so the limits are different and the tax rates may be different, but the principles are the same as now: Beginning Investing: Cptacek's Personal Finance Blog

[disneysteve]

With a Roth IRA, the limit is $5000 this year, and $6000 next year.

This is incorrect. The contribution limit is not changing for 2010. It will remain at $5,000.

The $6,000 figure is only for people who are age 50 or over.

You are correct that beginning in 2011, the limit will be inflation indexed and will adjust in $500 increments.

[cptacek]

gosh, I was just skimming the page. Sorry!

[disneysteve]

My employer will match the first 3% of my salary that I contribute so I've elected to contribute 3%.

Double check that this is accurate. Dollar for dollar matching exists but is somewhat uncommon. The more common formula is a 50% match so you would put in 6% and they would match 3%. Make sure you are putting in enough to get the full match.

In either case, 3% or 6%, neither is enough to be saving for retirement. You should be shooting for a minimum of 10%. That's where the Roth comes into play.

For a broad, overall formula, many of us like Elizabeth Warren's formula:
50% for needs, 30% for wants, 20% for savings.

As for the savings portion, as I said at least 10% for retirement, ideally 15%, and 5% for other goals like house, car, vacation, etc.

[NME]

I was looking online and found that the Royal Banks of Missouri is offering a checking account that will pay 4.30% APY on a max of $25,000. The bank I currently use is not paying me anything on my checking account and very little (<1% APY) on my savings. Is there a reason I shouldn't switch banks?

The Royal Banks offer requires that I make 10 debit card transactions per month (I'm sure I use my debit card 10 times a month), 1 direct deposit (I will have at least 2 from my employer), and E-statements.

There is no monthly service fee. It does say that the rate my change in the future, but it has been this rate since May.

So is there a reason I shouldn't switch banks since my current bank is basically paying me no interest?

Double check that this is accurate. Dollar for dollar matching exists but is somewhat uncommon. The more common formula is a 50% match so you would put in 6% and they would match 3%. Make sure you are putting in enough to get the full match.

In either case, 3% or 6%, neither is enough to be saving for retirement. You should be shooting for a minimum of 10%. That's where the Roth comes into play.

For a broad, overall formula, many of us like Elizabeth Warren's formula:
50% for needs, 30% for wants, 20% for savings.

As for the savings portion, as I said at least 10% for retirement, ideally 15%, and 5% for other goals like house, car, vacation, etc.

I've double checked it and it is accurate. My employer will match dollar for dollar up to the first 3% of salary contributed. It will take me 5 years to become fully vested in my employer's contributions (20% per year).

I don't really have a problem in terms of income allocation. I'd say right now I'm spending 70% on needs and wants and 30% for savings of my after tax income. I anticipate my salary to at least double within 5-7 years, so I think my proportion saved would go up too. Also, I'm paid bi-weekly so next year I will be paid three times per month in three months. So that third payment will be made up entirely of savings.

What I'm not sure of is how to choose what to invest in with a 401k or Roth IRA. For instance, my 401k offers me about 10 different choices of funds to invest in. I'm not sure how to differentiate between these funds.

[jIM_Ohio]

NME- most important thing is to focus on big picture... many of us are talking retirement, and you are looking for the bank which pays highest interest rate.

You need to step back, and look at why most of the posters here are suggesting long term investments (retirement) by reading up. You might find some threads here which can teach you things, and the books mentioned might help too.

I am self taught in retirement planning- started my own 401k with 6% at advice of my father, then did more homework, increased that investment, opened an IRA and similar. Made some mistakes along the way, and that is OK too.

You need to not worry about savings and focus on a big picture financial plan.

[zetta]

I'm about to start contributing to an employer-sponsored 401k (I just became eligible). My employer will match the first 3% of my salary that I contribute so I've elected to contribute 3%. I'm not sure if it's worthwhile to contribute anymore than that. On the one hand I understand that it's tax deferred, but given that I won't really have access to the money until I retire I'm hesitant to invest a lot in the 401k.

The smartest thing you can do at age 22 is to max out your retirement accounts for the next several years.

Compound interest is very powerful -- someone who contributes $5k to a retirement plan from age 22 to age 30, and then does not put in another dime, will end up with more money at retirement than someone who waits until age 30 to start and then contributes $5k every year from age 30 to 65 (assuming equal returns.)

I began maxing out my 401k at age 22, and as a result my retirement goals were fully funded by my mid-30's. This enabled me to be a SAHM for several years without taking a big hit to our standard of living. My point is that saving more now gives you more flexibility later.

It's fantastic that you are currently saving 30% of your gross income. I would recommend directing half of this (15% of salary) to retirement, and save the other 15% toward a house downpayment. Get the employer match first, then max out a ROTH, then max out your 401k. Each time you get a raise, increase your 401k contribution until it reaches 15%

[Saving_spree]

You can choose Basic Savings Account or Online Savings Account...

[NME]

jIM Ohio- I am focusing on the big picture. However, I would like to take some time to understand what I am doing and develop a strategy in terms of investing in a RothIRA or 401K. The bank question was more of a short-term step.

zetta- I'm going to take a look at some of the books you recommended and hopefully that will give me a better idea on how to pick funds to invest in.

Compound interest is very powerful -- someone who contributes $5k to a retirement plan from age 22 to age 30, and then does not put in another dime, will end up with more money at retirement than someone who waits until age 30 to start and then contributes $5k every year from age 30 to 65 (assuming equal returns.)

This isn't necessarily true, but I get the point about compounding. You'd have to assume at least a 9% return annually for it to be true.


Thanks again everyone for your suggestions and input.