How do I do this right?
July 7, 2009 9:55 AM   Subscribe

I want to do savings/401k right this time - how do i do that?

After going through layoffs back in February and running through a good bit of my savings – I’ve landed a brand new job that almost doubled my salary – I want to do 401k/savings right this time to save for the future and be prepared for an unexpected/vacation/life events.

The vital stats

Current Salary
- ~70K+bonus
Current Assets:
- Savings ~500 (ING at 1.5%)
- Checking ~4000 (schwab at 1%)
- Rollover IRA (~2000 in a target date (2050) fund)
- Investments (~6000 in various blue chip stocks) – doing ok – back in the black.
- No debts excluding credit cards (with cash back) which I pay off in full every month

Current Expenses:
- Rent 840 a month
- Misc expenses ~500 a month
- Thinking about going back to school part time in the near future – but my company has an education reimbursement program so I’d likely only be on the hook for 1000-2000 a year.

What I’m currently doing:
- Contributing 6% to the company 401k (has a 6% match)
- Transferring random bits of money to my savings account.

My question is what should I be doing? From what I can tell – post expenses, taxes, and payroll contributions I’ll have ~$2000 left over each month. I’m just leaving most of my money in the checking account for now. Should I be moving x percent over to my IRA? Or just savings? Or a combo of both? Any specific tips + general financial best practices would be appreciated. I’m 25, living in NYC, and single.

Thanks all
posted by anonymous to Work & Money (12 answers total) 6 users marked this as a favorite
You are doing more than the vast majority of Americans. Congrats!

I'm unclear if your checking account is your emergency fund, but if not, I would fund that to eventually cover 6 months of living expenses. Absent that, I'd open a Roth IRA.
posted by Twicketface at 10:02 AM on July 7, 2009

You probably want an answer along the lines of x in savings, y in 401k, and 2000-x-y in this other thing, but I'm just here to recommend that once you have a plan, you have the money transfer from your checking account automatically. On the 15th and last day of the month, money is automatically transferred into my IRA, and into my emergency, travel, grad school, and misc savings accounts. Magic!

And I definitely agree with Twicketface's emergency fund suggestion, but absent dependents, I would probably do less than 6 months. Depends on your tolerance for risk, of course.
posted by teragram at 10:12 AM on July 7, 2009

As Twicketface said, you're in a much better position than most people.

By far the most important thing you can do is have a budget, or otherwise stick to a plan to control your spending and live on significantly less than you make every month. At that point you can start worrying about what to do with the money, because unless you get that right your specific investment decisions won't matter much. From your description, it sounds like you are doing this already, so you're already doing the hard part.

Right now, checking and savings interest rates are pretty close together, so having that much in your checking account isn't that big of a deal. If you keep less in there and accidentally bounce a check or automated payment, you will probably lose more in fees than the extra interest you would make by putting it in your savings. Overall your checking/savings is pretty low. You'll want to build that up to whatever you are comfortable living off of if something goes wrong (lose a job, large unexpected expenses, etc.). Six months expenses (not income) is a good target to shoot for to begin with, and you can build up more once you get past that.

The big question mark I see is your (I assume taxed) Investments. Any kind of stocks (including blue chips) are a long term investment, and at 25 there's no reason to be paying taxes on the earnings from those investments every year and cheating yourself out of a significant amount of compound interest over time. I would suggest opening a Roth IRA and transfering your taxed investments to it (up to the yearly contribution limit). You can remove your contributions at any time, and the earnings will compound tax free until you start taking out money in your retirement. I have a Roth IRA at TradeKing, which has cheap trades and no annual fee for IRA accounts. Also, consider bumping up your 401k contributions to a higher ammount if you end up hitting the Roth limits.
posted by burnmp3s at 10:18 AM on July 7, 2009

Nthing Roth IRA.
posted by infinitewindow at 10:22 AM on July 7, 2009

If you keep less in there and accidentally bounce a check or automated payment, you will probably lose more in fees than the extra interest you would make by putting it in your savings.

That is probably true, and may be the end of the story for some, but I end up saving more overall by putting more money in savings accounts, even adding in an occasional bounce, because less money in my checking account means I spend less.

The trick is to find out what works for you: try a few things, see what works. Good luck!
posted by teragram at 10:23 AM on July 7, 2009 [1 favorite]

Well, the obvious question to ask yourself is, what are you saving for?

- Are you looking towards retirement? Sit down with one of the zillion retirement calculators on the web and make some assumptions. At what age would you like to retire? Are you willing to accept higher risks for potentially higher returns? What kind of retirement lifestyle are you shooting for? (World traveller or happy rocking on the front porch?)

- Are you saving towards a house? Education? A new car? Where you put your money matters - once into a Roth IRA, you can only withdraw without penalty for a couple of reasons - first time house buying and retirement. Saving in a Roth IRA won't help you with that European vacation.

Once you figure out some of these things, you can work up a little spreadsheet. I need to have amount X by 2040 in order to retire. I need to have amount Y handy for when I need a new car 5 years from now. Then figure out how much you need to save each month to meet these goals. Whatever you have leftover is what you get to live on.
posted by chrisamiller at 10:35 AM on July 7, 2009

Roth IRA for sure. As for what to invest in, I recommend Unconventional Success by David Swensen. He advocates an asset allocation strategy using index ETFs. ETFs avoid the pitfalls of mutual funds, which he describes in detail. Every three months you rebalance your portfolio to certain percentages, and this ensure that you are always buying low.
posted by diogenes at 10:52 AM on July 7, 2009

These would be my priorities, in order:

1) Get an emergency fund in your savings account. Savings accounts are marginally more safe from basic fraud than checking accounts, and I find I spend less when I have less in my checking account. Aim for 6 months expenses here.
2) Contribute the maximum to a Roth IRA. In 5 years, you can take out contributions from a Roth IRA without penalty which is pretty great (earnings are subject to stricter restrictions).
3) Contribute the maximum to to a 401(k). Start increasing your 6% contribution rate; if you do this gradually you won't notice (especially if it's offset a bit by raises)
posted by 0xFCAF at 10:56 AM on July 7, 2009

I'd pick a percentage to put into your savings (e.g. emergency fund) each month. If you have a big vacation/house/wedding or other expense eventually coming up, I'd have a seperate savings account for that.

Getrichslowly had a post where it recommended (or a guest blogger) no more than 50% for needs, 30% for wants, and 20% for savings.

Personally 30% savings - 10% 401k (or similar), 20% emergency fund/vacation etc fund - was a better goal for me at least my first year after a raise. It's a lot easier to save when you're still used to living on a lower salary.

When you do spend money I'd try to tilt it in the direction of longer-term things you may not to be able to afford later (e.g., now I'm really happy I bought myself a nice dining table; good shoes when my budget had more flexibility. if you're planning on moving that may not be a good item for you, just an example).
posted by ejaned8 at 10:58 AM on July 7, 2009

All of the above is good information. I'd suggest that you don't fall victim to lifestyle inflation. Don't suddenly start living at a much higher level, otherwise you may find yourself short of money. If you can maintain your expenses at the previous salary level, this leaves you able to save very well and still be able to treat yourself as needed.
Take as much out of the salary as you can before you receive it in your back account (for me this means IRA and company stock plan). That way you won't ever miss it or feel the pain of not having it.
Congratulations, this is a great chance to set yourself up for the future.
posted by arcticseal at 11:35 AM on July 7, 2009 [1 favorite]

Realize two things:

1) Spending can always grow to accommodate available money.
2) Your income will probably increase as time goes on.

So, consider flipping the idea around: rather than deciding how much to save, decide how much is reasonable to spend.

Not sure if it's good advice, heh, but it's what I do. I planned my budget initially allowing for 10% saving, 10% tithing, etc. Since then my income has increased 50%. However, since I had a well established weekly budget and standard of living, I've decided to continue on how I did before, greatly increasing my savings rate. I have decided, though, the next time my income increases, I will re-evaluate my budget and maybe allow a bit more each week. If I want to plan for a large purchase, I usually spend less each week to save up for it, although, I suppose I could have a side fund for it that's outside of my budget (as long as saving doesn't drop below 10%!).

Or, on preview, what arcticseal said -- avoid "lifestyle inflation".
posted by losvedir at 12:30 PM on July 7, 2009

Agree with OxFCAF, and here's how those suggestions break down:

CW on emergency funds suggests enough liquid cash to cover six months of expenses. For you, that's a little over $8K. Added to the $4500 you have in savings/checking (no reason not to combine the two, by the way, and I like the Schwab account's features), you can get to $8K in a year if you sock away $300/month.

Next, max out your Roth. Limit is $5,000 this year, which would be $415/month for you, or you can do it when you get your bonus (or tax refund), if you're expecting that much. If you want to do it monthly, I'd open an account with Schwab and set up an automatic monthly buy, transferred from your checking account.

And lastly, try to get your savings rate to 10%, just because. At that point, you'd be banking $11,200/year in your 401(k), plus $5,000 per year in your Roth IRA, and honestly, I think that's enough.
posted by janet lynn at 1:10 PM on July 7, 2009

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