Once you have a budget and start following it, and have some kind of emergency fund, it's time to invest it. This is key, because there's no other way, from my understanding, that you can have enough to retire on unless you invest in something. That's always been kind of scary, dark, murky waters to wade into, but the more I learned about it it's not that scary. So here's what I've learned, but mostly this is what the financial planner said. If you have tips or I left something out/got it wrong, or you have a question, feel free to throw it out there!
- The Baha'i National Center has a 503(b), which is the nonprofit equivalent of a 401(k). These are retirement investment accounts. And usually the employer contributes some percentage. Sometimes you have to contribrute a set amount and then the employer matches it. One of the pluses is that it's taken out of your paycheck pre-tax, so that lowers your taxable income, which is a good thing. If your employer contributes, do what you have to to get that because it's free money.
- But from what I've heard, IRAs (Individual Retirement Account) are where it's at. Bob, the financial planner, said to max these out before you max out your 401(k) because the return is higher. There are two kinds--Traditional and Roth. With each one you can contribute $3000 a year. The difference between the two is that with the Traditional your yearly contribution is tax deductible, but with the Roth it's not, so what you contribute is taxed. But, with the Roth when you start to use that money for your retirement you can withdraw it tax free, whereas with the Traditional all your withdrawals during your retirement are taxed. So for us we're going to get a Roth, so that when we retire we can start using all this money we've invested tax free. I just read in Kiplinger's Personal Finance today that there are 3 places to get an IRA--a bank, mutual funds investor, or a brokerage firm. We're going to start ours with a bank because the minimum is a lot lower. With Chase, I think, there's no minimum to open an IRA. Eventually what we're going to do is roll it over, or transfer the funds, to a mutual fund. The brokerage firm is for more experienced investors who want to manage their investments a lot more closely.
- Here's what I know about investing. Mutual funds are when a large group of people pool their money to buy a large number of investments, whether its stocks or bonds. Stocks, and someone correct me if I'm wrong, are when you own parts of a company. They're typically more high risk but the return can also be higher. Bonds are lower risk but the return is lower. Here's the amazing part, where the math comes in. Bob explained that the stock market is ruled by the law of averages. That's why since 1802 stocks have had a 7% return on your investment. 1802!! And they've had an 11% return since 1926! That's including the Great Depression. So there are two key things here. One, investing should be considered a long term thing. And this is why it's best, sometimes, the less you know. There's a slew of articles and professionals who say that once you make your investment don't touch it. Bob, who's going to be retiring with a ton of money, mostly based off of investments, only changes his investments once a year. See, in my mind to invest meant following the stock market everyday, watching the littel ticker on the bottom of news stations. But actually, the people that make the most money are the ones who do nothing! There's even been studies done of investors. The ones who make the most are the ones who both know and do the least. The ones who make the least amount of money are the ones who know what each of their stocks are doing from day to day and are always trying to predict the next Microsoft or Dell. The thing is it's almost impossible to predict what's going to make money. To accurately predict how an individual stock is going to do you have to account for political situations, weather conditions, whether the company is going to be investigated by the gov't, war/terrorism, and public favor/fashion/needs. So that's the second thing-invest in mutual funds, indexes if at all possible. With mutual funds you're buying a large, diverse number of stocks spread across several industries. And with indexes, you're basically investing in the entire stock market. The analogy I read is that with buying an individual stock you're choosing one piece of hay out of a haystack and betting that it's value will increase. With an index you're buying the whole hay stack, knowing that for the past 100 years it's value has increased 11%. One other things about investing.
- Look for no-load investments. That just means watch out for how much you're being charged to be invested in a mutual fund. Even if a company charges 1%, that adds up quick.
- So here's what we're doing. Two companies, T. Rowe Price and Vanguard, are mutual fund investors. They do two very cool things. One, since they're on the internet, they charge the lowest out of any company. We're going with Vanguard because their 500 Index Fund, which has had a 10% return for each of the last 10 years, and which is based on the performance of the 500 largest companies in the US, charges only .18%, instead of the 1%+ that a lot of other companies charge. Also, they have retirement packages. I'm hoping to retire when I'm 65, in 2040. I can buy a 2040 Retirement plan, and not even think about it until 2040. The company will manage all of the investments, even balancing out what it's invested in. Since I'm young I can afford to have most of the investments in high risk/high return mutual funds and less in bonds. But as I grow older I'll want that ratio to change to include more stable, less risky funds. Vanguard will do that for me.
- Another key to investing is something called dollar cost averaging, which is very simple. All that means is that you invest the same amount every month. Instead of buying stocks in one lump sum, you contribute say $25 a month. Hopefully that'll grow as our income grows, but that's a good start. Here's the benefit--when stocks are dropping you start buying more at a lower price; when stocks are increasing in value you're still buying but fewer of them. And with the law of averages you'll end up making money both ways. Bob gave the example of his mutual fund investments after 9/11. With his monthly investment he was buying up a lot of stock at really low prices, knowing that the value would increase. So for example, let's say he bought a bunch of stocks that were $2 a piece, down from $10. Even if the value goes up to $4 he's made a 100% return on his investment. When the prices went up he was making a lot of money because the investment company was able to sell off all the really cheap stocks he just bought, and he'd stopped buying the pricier stocks. And then he just reinvested whatever he was making.
- What about real estate? It doesn't make sense for us right now. To really make money on the investment, unless you live somewhere where real estate is booming, you need to live someplace for more than 3 years. Otherwise you're losing money because of the fees and taxes. Plus we can't afford the upkeep. If we stretch and buy a house right now and the furnace breaks, that's it. We'll just have to invest in a lot of sweaters.
- I'm also hoping to meet with a financial planner. We want to meet with one once--that's it. And we're looking for one that's fee only. Meaning they won't push investments that they'll make a commission off of. Mostly I just want to run our plan by them and see what they think.
- I've also got a subscription to Kiplinger's Personal Finance. It's a magazine that for $12 a year for 12 issues will tell us just about everything we need to know for people in our situation.