Beginner Advice For Someone New To Personal Finance, Part 1
September 29, 2008 – 6:07 amI’ve got a friend that has completed his fully funded emergency fund (baby step 3 of Dave Ramsey’s plan), and he and his family (wife + 3 young children) are preparing to start saving for retirement. I would like to help him out by giving him some advice, and I’ve been trying to determine what I can do that is both easy to understand and yet will still be of value to him early in his investing career.
The best option I’ve come up with is to buy him a copy of “The Smartest Investment Book You’ll Ever Read” by Daniel Solin.Of course I wish I could recommend ten or twenty books, but I don’t think my friend is much of a (personal finance) reader, and it’s hard finding one book that covers everything that is important.
In addition to this book I’d like to give him a quick summary of advice that it took me quite a while to learn. Some of these items are covered in the book, and others are not. The goal is to keep it to two typed pages. My first page includes the following, and I’ll post my second page of thoughts later this week.
I’m not a financial advisor, but over the years I’ve learned and read quite a bit on investing and personal finance concepts. Below are a few of the key investment ideas I think you should consider:
1. Investment expenses count. This should become painfully obvious if you read the book. This is why investing in broad-market index funds regularly offers superior returns to funds that are actively managed.
2. Asset allocation is key. Although there is nothing wrong with Dave Ramsey’s recommended asset allocation per se (25% growth funds, 25% aggressive growth funds, 25% growth and income funds, 25% international), many financial planners would recommend including bonds to smooth out returns (like Solin does in the his book). I don’t have a strong stomach during major market downturns, so my bond allocation helps me from freaking out and doing something rash.
3. Most people have a choice in regards to the types of investment accounts they can use for retirement savings. For most people, the investing in accounts in the following order is best:
I. Invest in your company’s 401k at least up to the point where you receive the full company match. If they offer a Roth 401k that would be an even better choice for most young and middle-income investors.
II. Once you have the maximum match, invest in a Roth IRA ($5,000 per year limit for you plus another $5,000 for your spouse max). You have to earn less than ~$156,500 (married filing jointly in 2008) to be eligible for a Roth IRA (in 2008). Your company plan may not have many great investment choices (like low-cost index funds for example), but will have many more choices with your self-directed IRA.
III. If you reach this step you’ve probably contributed as much as you wish too. If not, you could save in after-tax accounts or continue to put money in your 401k or Roth 401k. Having some funds invested in after-tax accounts has some benefits, like flexibility on the use of the funds, and some negatives (like tax exposure).
4. Setup your investments to be automatic. This is easy for you 401k or Roth 401k, but you should set up automatic withdrawals from your checking account if you have Roth IRA(s) as well. After a few months you’ll forget about this money completely.
5. If you’re opening a Roth IRA or are looking to invest some of your retirement funds in after-tax accounts, I highly recommend using Vanguard. Vanguard offers the most index funds, they have the lowest costs in the industry, and they are well respected and stable. The only downside is that most of their mutual funds requires a $3,000 minimum per mutual fund (although you may just need one fund to start). Although this is a lot of money, I think it’s worth saving for a year or two and then opening an account with Vanguard rather than going with a smaller mutual fund company that has higher fees and less choices.
I. The next best option after Vanguard would be to go with Fidelity, and they offer a program called “SimpleStart” that waives the $2,500 minimum if you setup automatic investments of $200 or more per month.
II. A close 3rd choice would be to use T. Rowe Price, and they will let you contribute as little as $50/month automatically if you can’t meet the $1,000 minimum investment to open an IRA.
Thoughts? Did I miss anything?
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