How to start a nest egg?

May 4, 2009 5:57 PM

Now that I have a little extra money, how should I start saving it? (I don't have a 401(k)) For instance, what's an IRA and why should I care? Or what about this thread talks about high-yield savings? Or this one about index funds? While I *am* young, I'm mostly concerned with creating a nest egg, not playing the stock market (read: I'm more interested in low-risk that will hopefully allow me to afford a family and eventually retire). Thanks!
posted by marclar to work & money (18 comments total)

everything I read says start with a Roth IRA. so I did through ShareBuilder. Pretty easy. I then base purchases for it based on info from Motley Fool. Their advice is around long term growth and not "playing the market"
posted by patrad at 6:05 PM on May 4

Take out a copy of Suze Orman's The Money Book for the Young, Fabulous & Broke from the library, get your basics down, then start thinking about index funds and such.
posted by djb at 6:14 PM on May 4

If you're interested in Roth IRAs, and are concerned with guidance (ie., you're like me and you trust expertise over your own opinions), the two best brokerages to go with -- as rated by JD Power and Assoc. -- are Raymond James and Edward Jones.

I recently started a Roth IRA acct. with Edward Jones, with a CFP handling my business and consulting with me, and it's been a great experience so far. I was with Merrill Lynch for a couple of years, talking to a broker who had handled my grandfather's finances (modest), but he really didn't give a sh-- about me because my account was so small -- he just pimped some BlackRock mutuals on me, and because it was my first experience, I didn't know any better.

But the CFP was really the one who guided me to the Roth IRA. Up to $5k a year tax-free is amazing. And I'm no financier, but I agree that index funds are the way to go -- especially if you're getting in right now.
posted by the NATURAL at 6:28 PM on May 4

IRA stands for "Individual Retirement Account." It can actually be almost any type of investment at all (stocks, bonds, mutual funds, all the way to some forms of physical property I believe) but you make the investment through an agent or organization who is authorized to designate it as and manage it as an IRA. The purpose of doing this is that there are special federal tax rules which mean that the IRA will cost you less tax-wise than would a normal investment.

But there are rules that limit how much money you can invest per year across the total of all your IRAs and that prevent you from selling / withdrawing money from the investment before a certain age, and a host of other rules that if you violate can cause it to revert to a normal investment and also incur additional tax penalties.
posted by XMLicious at 6:35 PM on May 4

Everything you need to know about investing in 129 words is still everything you need to know, and still only 129 words.
posted by alms at 6:40 PM on May 4

It's significant to note that someone following those 129 words would still have gotten terrifyingly devastated by the current financial crisis. But there may not have been much of any way to avoid that except luck or owning one of the banks that got bailed out.
posted by XMLicious at 6:53 PM on May 4

I can tell you how I started my nest egg.

I was/am a member of USAA. If you are eligible to join them, I highly recommend it.

Ok, so first I read enough to understand that "IRA" was (in simple terms) a way of earmarking money for retirement. That is, I didn't have to choose between an IRA and an index fund. I could put money in an index fund, and earmark it for my retirement.

I decided that I would put money in a mutual fund. That means, I'm buying a tiny part of stock from a lot of companies. It's safer than buying stock, because it's a combination of many companies.

I found out that I needed to read the prospectus for mutual funds. This is a booklet that tells who the companies are, what fees are charged, and how well the mutual fund has been doing. I was told to look at the 10-year history to get a good idea of how well it's doing.

So, I called up USAA and asked them to send me one prospectus for each of their mutual funds. A few days later, I got them in the mail. Truthfully, I just skimmed them. USAA had also sent me a form. If I filled out the form, and mailed a check with it, I'd have an IRA!

I sent in the full amount that I could for the tax year. This changes sometime, but at that time it was $2000. I put about $1000 in one mutual fund, and $1000 in another mutual fund (but, it's one IRA, remember, because it's an earmark). I continued this for several years, and each year picked different ones because I wanted to "diversify".

After several years, I started to really love index funds. They were cheaper, and doing better on average (some years better, some years worse -- but on the whole a little better). An index fund is a type of mutual fund, and can be earmarked as an IRA. An index fund is cheap because nobody is "buying and selling". Instead, it has a little bit of each company (because it's a mutual fund), but the companies are on an index. For example, the S&P 500 index fund is made up only of the top 500 companies on Standard and Poor.

Fast forward a few more years, and I realized that I could save more that just what I was allowed to earmark as an IRA. So, I put money in a money market account. This is a bit like a checking account, but you earn more money with it. After that, I started moving money from checking to the mutual fund, and from the mutual fund to other mutual funds (outside an IRA, after I've finished putting in my IRA allotment).

The best investment I ever got came from my dad. Essentially, it's this: Save a little every year, starting when you are young. You will put in fewer dollars, and have more for retirement, if you start young and continue to do it every year. Time is the key.
posted by Houstonian at 7:12 PM on May 4 [2 favorites has favorites]

(Why can we not edit! Of course, I started moving money from checking, to the money market account, to mutual funds.)
posted by Houstonian at 7:16 PM on May 4

If you're interested in Roth IRAs, and are concerned with guidance (ie., you're like me and you trust expertise over your own opinions), the two best brokerages to go with -- as rated by JD Power and Assoc. -- are Raymond James and Edward Jones.

Although if you're willing to learn some expertise of your own and grow to trust your own opinions, paying the costs of a full-service broker like EJ will come to rankle a little.

Particularly if the advice you're paying dearly for is "buy index funds in a Roth IRA".

The cheap-and-cheerful approach: head over to Vanguard, open a Roth IRA, and choose the age-appropriate Target Retirement fund. You'll need $3K up-front to meet the minimum balance requirement, but after that you can set up automatic deductions from your checking account to fund it up to the IRS maximum.

It's not perfect -- people may quibble over Vanguard's choices on stock/bond allocation etc -- but it's good enough and it's dead simple. 'Cause as Houstonian's dad says: the key is to start.

(Although if your employer offers a 401(k) with employer matching that you're not participating in: do that first. No sense in leaving free money on the table.)

Suze Orman is OK if you like her tone; and Andrew Tobias's The Only Investment Guide You'll Ever Need is sensible and easy going if you're just starting out.
posted by We had a deal, Kyle at 7:43 PM on May 4

Oh, and:

For instance, what's an IRA and why should I care?

It's a tax-advantaged way of saving for retirement. You should care because (a) saving for retirement is good, and (b) paying more taxes than you need to is bad.
posted by We had a deal, Kyle at 7:54 PM on May 4

I just read I Will Teach You To Be Rich by Ramit Sethi, which is mostly geared toward 20-something singles, of which I am not, but I did learn a lot. There is a lot of information about how to save your money and when it's ok to splurge. Also different types of investments (IRAs, index funds, lifestyle fund, etc), and practical stuff like how to get credit card companies to lower your APR, or getting the best deal on a new car. I've also read the Suze Orman mentioned above, but for some reason Sethi's book spoke to me more.
posted by dogmom at 8:11 PM on May 4

Seconding We had a deal, Kyle's suggestion to open an IRA at Vanguard and buy the appropriate Target Retirement Fund. This is the easiest way to get started and overcome anxiety about information overload.
posted by DavidNYC at 9:59 PM on May 4

Ramit wrote a good assuming-you-know-nothing piece about retirement accounts. A few years old, so a few of the IRS limits have changed, but the basics are still sound.

(I have found I Will Teach You To Be Rich to be more like I Will Tell You How Great I Am these days -- such is book promotion -- but there's a lot of good stuff in his archives.)
posted by We had a deal, Kyle at 10:04 PM on May 4

Retirement accounts are simple math.

$100 +5% per year over 30 years = $432, minus 30% taxes = $333

$100 +3% per year (5% minus taxes) over 30 years = $281

If you don't want to try to beat the market, then just meet the market - get a no-load index fund (like the ones from Vanguard). All it'll try to do is match the S&P 500.

About the risk thing - more risk when you're younger (more reward too), less risk when you're older - so you don't lose the nest egg in a crash.

All this stuff is really well known & a few prospectuses from nearly any brokerage firm will give you the basics.
posted by MesoFilter at 10:53 PM on May 4

I'm going to recommend The Simple Dollar and Get Rich Slowly, both of which are fantastic personal finance blogs geared toward laypeople. Both have good, solid articles on investing and net worth which should get you started.

Good luck!
posted by Tamanna at 4:01 AM on May 5 [1 favorite has favorites]

The cheap-and-cheerful approach: head over to Vanguard, open a Roth IRA, and choose the age-appropriate Target Retirement fund. You'll need $3K up-front to meet the minimum balance requirement, but after that you can set up automatic deductions from your checking account to fund it up to the IRS maximum.

One little trick with Vanguard is that the STAR fund only has a $1000 minimum. If you don't have $3k, that fund is good enough until you do.
posted by smackfu at 6:08 AM on May 5

For instance, what's an IRA and why should I care?

As others have said above, an IRA is basically just a normal investment account that has special rules to let it grow without you having to pay taxes on the earnings every year. If you earn interest in a savings account or sell stock for a profit outside of a special retirement account, you'll lose some of those gains in taxes. Due to the way that compound interest works, small losses to taxes every year can really add up over a lifetime in savings, so making sure you take advantage of retirement accounts is important.

Although you should do more research about each type of account and pay attention to special exceptions that might apply to you, here's a quick rundown of Roth IRAs vs Traditional IRAs/401(k)s:

Traditional IRA or 401(k)
- Contributions are tax deductible. This effectively means that you can take a portion of your pre-tax paycheck and put it in your account directly without paying taxes.
- Withdrawals are taxed. This means when you start spending the money in retirement, it will be treated as income and you'll have to pay taxes on it.
- There are penalties for withdrawing funds before you reach retirement age.
- For 401(k)s, often employers will give you matching contributions up to a certain percentage of your pay, which often makes it by far the best investment option up to the point where the matching cuts off.

Roth IRA
- Contributions are not tax deductible. This means that you are taking money that you have already paid taxes on and putting it into your account.
- Withdrawals are tax-free. You've already paid taxes on the money you're investing, so it won't be taxed as income again at any point.
- There are penalties for withdrawing earnings before you reach retirement age, except in certain cases like buying your first home. Also, you can withdrawal your contributions at any time without penalty.
- There are more strict requirements in terms of how much your can invest and what kind of income you can have in order to contribute to a Roth IRA.

While I *am* young, I'm mostly concerned with creating a nest egg, not playing the stock market (read: I'm more interested in low-risk that will hopefully allow me to afford a family and eventually retire)

You can invest in pretty much anything in an IRA, although most people have a mix of stocks (including mutual funds or index funds), bonds, and cash. In your particular case, you should have mostly stocks, because they have a high risk (or variance), they are also the most likely to have earned the most money by the time you retire.

I agree that it's not a good idea to try to "play the market," especially if you don't have the time or desire to learn every detail of the market and make better guesses about what's worth investing in than the professionals can. A good way to look at the stock market is that it's a slot machine in reverse. Instead of putting in coins to try to win the jackpot, you're the one who owns the machine. The payouts are more or less random, and in any given day you might have to pay out more than you take in, but in the long run the odds are in your favor. Your biggest risk in the long run is that it will cost so much to maintain the machine (i.e. pay your brokerage account fees, trading fees, taxes) that your profit takes a hit. So opening a cheap IRA account and contributing to a low-cost index fund is a good idea, because it's like setting up a slot machine at somebody else's casino without having to do anything other than wait for the money to come in.
posted by burnmp3s at 7:09 AM on May 5

Thanks, everyone -- excellent feedback. I discovered that I *can* do a 401(k) through Freelancer's Union, of which I'm a member. So I'm opting for that and finding out if I can put pre-tax dollars in there.

Otherwise, I like the Vanguard idea, and I'm now subscribed to Get Rich Slowly . .

Excellent answers; I really appreciate it :)
posted by marclar at 7:06 AM on May 6