I have a little money. Help me save it.
September 1, 2012 1:50 PM   Subscribe

I'm about to have, for the very first time in my life, total personal savings of $10 thousand. How should I save it?

I have no idea whether $10 thousand is good or bad or normal or whatever, I don't really know what other people have saved. I just assume no one has any money anymore.

I know nothing of IRAs and mutual funds and so forth.

My goals:

1. I'd like to be sure that I don't lose any of the money to the whims of a more aggressive investment portfolio.

2. I'd like to be able to direct deposit a portion of my paycheck into my chosen savings account.

3. If there's an emergency, and it's a costly one, I'd like to be able to get at this money for a marginal fee. Otherwise I'd prefer to just let it grow.

4. I'd like to avoid monthly or yearly fees.

5. Ultimately I suppose this money is for retirement.

Some relevant facts:

1. I am 30.

2. I have about $70 thousand in student loans, for about $800 a month.

3. I am currently saving between $1,000 and $1,400 per month, depending on the month. In the future it will be more like $500 to $900. (My rent is going to go up next year when I move out of my cheap sublet apartment.)

Anyway, that's my situation. What should I do? I suppose I'd be willing to split the savings and do a more aggressive investment with part of it, or have a more stable CD for part of it.
posted by kensington314 to Work & Money (20 answers total) 44 users marked this as a favorite
The first thing you should do is get the money into a tax-advantaged account - either a (Roth or Traditional) 401(k) or IRA, as appropriate. Roth accounts have a particular advantage for you, as your principle can be taken out, tax free, at any time if you need it.

Vanguard is my preferred broker, since it provides many avenues to avoid paying fees and provides a fairly simple interface. There is no reason you should be paying money for a brokerage to keep your savings even if you pick someone else.

I am of the opinion, as are many people, that a six month emergency fund is one of the most important things to have before considering any longer term investments. This should be kept in a very low risk fund. Once a six month fund has been accumulated, you can consider higher risk/longer term investments. For what it's worth, I keep my emergency fund in tax-free municipal bonds.
posted by saeculorum at 2:02 PM on September 1, 2012 [2 favorites]

What I would do:

1. Plop enough money to cover 6 months worth of living expenses into a "high interest" savings account. These days they only pay out about .8% APY but I think the ease of access is worth whatever tiny amount more you would get going with a low-risk mutual fund or something.

2. Start an IRA with Vanguard, either their Target Retirement 2045 or 2050. The minimum initial investment is $1000 and you can set up automatic monthly deposits for however much you want going forward.
posted by ghharr at 2:10 PM on September 1, 2012 [2 favorites]

Response by poster: Thanks, saeculorum. I suppose the emergency fund concept is what I'm getting at with wanting to have access to it in an expensive emergency. Can you explain to me the advantage of municipal bonds?
posted by kensington314 at 2:11 PM on September 1, 2012

for #2 - in the past when I was able to save, I set up an automatic transfer that took a certain amount out of my chequing acct and put it into my mutual fund. So, say I was getting paid $1400 every second Friday, on the Monday after that $500 was automatically saved for me.

It's way easier to save money when you don't feel like you have it to spend in the first place!
posted by mannequito at 2:16 PM on September 1, 2012

It's my opinion that an emergency fund should not be easy to access (it's for emergencies, after all!). Short term expenses can generally be paid with credit card instead. I've never heard of a scenario where someone needs to pay $10k in the matter of a day or so that you could access a high rate savings account but not a week or so which a brokerage account would require. In your scenario, I think you should be considering the entirety of the $10k as an emergency fund, as it is barely sufficient to pay six months of rent at $1400/month plus food. I understand it seems like more than you'd ever need, but it's surprisingly expensive to live. You should be assuming that the emergency fund covers everything you need to buy in six months and that you would otherwise have zero income. Personally, I extend my emergency fund to about a year's of expenses, but I have a job that is not easily replaced should I lose it.

To be quite honest, I use tax-free municipal bonds primarily because I don't like having to figure out capital gains taxes every year. Secondarily, the return is much greater than a high-yield savings account. However, many financial commentators suggest high-yield savings because it is easier and more familiar to set up a high-yield savings account than a brokerage account. Personally, I am of the opinion that starting "real" savings with "the big guys" should be done at the start as a way to become familiar with long-term investment.

A note here is that Vanguard supports automatic transfers into any account you have, which I recommend for getting you in the habit of regularly saving money. Although it is great that you have a pile of money accumulated, regularly saving money will be better in the end, both because it encourages you to save money, and because you get the money into an account earning interest sooner.
posted by saeculorum at 2:22 PM on September 1, 2012

How much interest are you paying on your student loans? You might end up with more money in the long term if you pay the loans off faster.
posted by DoubleLune at 2:23 PM on September 1, 2012 [3 favorites]

The most important thing, which you've already started doing, is defining what you want the money for. Then you can decide what the right place to put it is.

First some definitions:

Investment Account (Taxable Account): A standard account, not tied to retirement, or any other specific tax-related status. Your money here is the same as money in a normal bank account (its even insured typically, although through a different entity than bank accounts). It's called 'taxable' to note that it's not treated specially in the tax code, the way retirement accounts are.

Retirement Accounts: Act as wrappers around other investments. You don't invest in your IRA, you invest in a stock inside of your IRA (and the IRA wrapper changes how taxes are applied). There are a few different versions, the big ones being:

* IRA - Individual Retirement Account
* 401k - Company sponsored retirement account.

Both retirement account
* Traditional - You don't pay taxes on the money now (ie, when you put in $1000, the income you pay taxes on at the end of the year goes down by $1000). But when you're retired, you pay full taxes on the money you withdraw. The idea is that when you're older, your tax rate goes down, and it ends up beneficial for you.
* Roth - You pay taxes now on the money you put in. But then you don't pay taxes on that money when you withdraw it.

Specific Investments:
* Mutual Funds: A bunch of stocks bundled together and sliced up and sold as a whole. You pay a small fee for the ability to own a huge number of stocks at once, at a reasonable price)
* Index Fund - A mutual fund that picks which stocks go into it via a set of rules. Such as "S&P 500" which is the largest 500 companies in the US. The rules can get complicated, but the key is that they aren't human driven (and such, not to the whims of a money manager)

Regarding your specific ideas/questions:

#1 - Agreed, you don't want an aggressive investment strategy. But you may need several distinct strategies. Your emergency fund strategy will be much more conservative than your retirement strategy (ie, you may need the money tomorrow vs. you may need that money in 40 years).

#2 - Sure, that's easy enough with most any strategy. CDs at banks are about the only one that can't be added to over time.

#3 - This money should be in a "taxable" account. Any retirement account will have fairly large penalties for early withdrawl (ie, before you're retired). So you want this money accessible as your Emergency Fund. Honestly, don't worry about this money growing. It's there to save you from getting screwed by fate (which often leads to expensive loans if not prepared). When your car breaks down, and it's time for a new one, you pay the cash you've been socking away, instead of taking on a loan That's how this money ends up growing, not directly in accounts.

Suggestion for your emergency fund: A savings account at a bank that isn't your normal checking one. I suggest a separate bank only for psychology purposes. If you don't see the money, it's easy to forget it exists, and just let it grow, without being tempted to spend it.

#4 - Any mutual fund will incur fees. But I suggest them anyway, the key is to lower fees to a bare minimum. There's the idea of diversification, which is worth paying for. If you own one stock (no ongoing fee), and that company goes out of business, you get screwed. If you own a mutual fund, which holds hundreds of stocks, and one company goes under, then whatever, the others are fine.

Your bank accounts should be no-fee, and you certainly have enough now to get over any account minimums that may be lurking.

#5 - Retirement.

Once you have your emergency fund setup, then:

Open an IRA with Vanguard. Inside that IRA, put it into a portfolio that looks similar to the first "Coffeehouse portfolio" here: http://www.bogleheads.org/wiki/Lazy_Portfolios It matches much of what I've been talking about. Low Fees, Diversified across US and International, Stocks, and Bonds. Vanguard will easily let you setup a monthly deposit that just goes and buys as much as it can in those 3 things.

Your actual actionable plan:

1) Open a new bank savings account. Plop your $10k there, and sleep tight at night that you can't be blindsided by a big expense. Save up a few more grand there to make yourself feel more stable. 6 Months expenses is an amazing thing to have saved.

2) Open an IRA plan with Vanguard, setup a basic no-nonsense portfolio like the one I linked. Note that an IRA maxes out at $5k per year (might change each year, just check), so deposit your $416 each month.

3) Open a Taxable account when you're happy with your emergency fund, and want to get more of a return out of your money now. Still put money in the same boring Vanguard mutual funds, but realize that you're saving for your freedom. See a fairly aggressive blog about this idea, about a guy who saved up a ton of money and retired super-early. (http://www.mrmoneymustache.com/) His money is invested in mutual funds in a taxable account, and he spends his dividends as his main income. Combine that with a low price lifestyle, and you can retire really early and just do what you'd like (not giving up work, but not being tied to work as a way to eat).

I hope that helped a bit, I typed a lot there, rather quickly, and would love to answer more questions here, or over private message. I am a guy who's in step #3 now, along with paying down a mortgage. Contact me if you want to continue talking.
posted by cschneid at 2:50 PM on September 1, 2012 [12 favorites]

Disclaimer: I am a huge advocate of Roth IRAs/401(k)s and think they are possibly the most under appreciated government benefit available.

This is why you should be considering a Roth IRA and/or Roth 401(k): You are allotted a certain amount of money every year to put into a 401(k) and IRA (this year, it is $5k in an IRA, $17k in a 401(k)). This amount of money "disappears" every year if you do not use it. As a result, you should be filling up your Roth IRA and 401(k) as much as possible before moving to a taxable account. When/if the time comes that you can invest more than your yearly maximum in a Roth 401(k)/IRA, you can start keeping your Roth 401(k)/IRA in aggressive, retirement-oriented funds (this way, you use the tax advantage and avoid paying yearly taxes on the accounts) and start keeping your taxable accounts in conservative accounts (which typically have low tax rates, or no taxes in the case of tax-free bonds).

Roth IRAs/Roth 401(k)s allow you to remove principle (the money you put in) at any time, tax free, without any penalty. As such, they are ideal for storing an emergency fund for investors like you that are not ready to max out their IRA/401(k). If you need to spend your emergency fund, you just withdraw it from the IRA/401(k) exactly the same as if you had a taxable count. If you do not need to spend your emergency account, you can keep it in the IRA/401(k) and accrue the tax-advantaged nature of the account. If you keep your emergency fund in a taxable account, you don't get this advantage.

If you have to use a Traditional 401(k) or Traditional IRA, you can't use this strategy, as you will be tax-penalized if you have to withdraw your emergency fund.

So, the progression would be:
  1. Put your $10k emergency fund into a Roth IRA/401(k) and start investing as much as possible into the IRA/401(k) up until the maximum each year.
  2. Once you start maxing out your Roth IRA/401(k), you should start moving your low-tax investments (ie, bonds, typically for short term use) out of your IRA/401(k) and into taxable accounts, and start putting high-tax investments (ie, stocks, typically for retirement) into your IRA/401(k).
  3. Once your income becomes sufficiently high that you think your tax rate might be higher than you have at retirement, you should then consider switching investments to Traditional IRA/401(k) accounts

posted by saeculorum at 3:12 PM on September 1, 2012

I was about to wax poetic about employer-matching 401(k)s and Roth IRAs, but you know what? You need emergency cash, and I think you need more of it than you currently have.

I would go with an interest bearing savings account (something like ING, or a money-market account through your bank).

Watch your expenses and keep saving aggressively.
posted by moammargaret at 3:27 PM on September 1, 2012

Index funds, index funds, index funds.
posted by Cool Papa Bell at 4:12 PM on September 1, 2012

It depends on your risk tolerance, how much liquid cash you want to maintain, and what's your investing time frame.

But a few general suggestions:

1. Stay away from actively managed mutual funds and instead invest in passively managed index funds.

2. Find diversified index funds with the lowest fees (total expense ratio), such as a total market index at Vanguard or Fidelity (Fidelity has very low fees for some funds in order to be competitive with Vanguard). You can also invest in low cost diversified bond funds as well. Don't buy individual stocks unless you really want to take on a ton of risk.

3. Consider investing in TIPS (Treasury Inflation Protected Securities), which you can do directly online.

4. If you must get help from an investment advisor, never pay a percentage of your assets but instead just pay a fixed fee.

5. If you can afford it, set up automatic investments every month from your bank account. If you don't do that, you will probably tend to procrastinate in investing. It's one of the smartest things I ever did myself, and always better late than never.

6. If you do a 401(k), try to do a self-directed brokerage account where you can invest in low cost index funds because otherwise you might be paying high fees that are opaque and not apparent.

7. Be careful with any money you put in a money market account because it's my understanding they are not always insured in the way bank savings accounts are FDIC insured.

By being smart and being disciplined in investing regularly and consistently, and not worrying about every market up and down, you can steadily build up your assets.

For an interesting read about the investment industry I suggest a book called "The Big Investment Lie".
posted by Dansaman at 5:11 PM on September 1, 2012

Oh and if this is for retirement savings, always max out on IRA before doing non-retirement investing. If you have a 401(k), you can still do an IRA. It won't be tax deductible, but it will still grow tax deferred.
posted by Dansaman at 5:14 PM on September 1, 2012

For whatever portion of the $10,000 that you decide to set aside for emergency expenses, put it somewhere safe.

Some type of FDIC-insured savings account would be a good bet. Online, both EmigrantDirect and INGDirect have a relatively long history of rates somewhat higher than brick and mortar banks, and I've had good experiences with both. This is probably the best option to start with.

A more complicated alternative is to start off with most of your emergency savings in a savings account account like one mentioned above, and gradually roll your savings into I-Bonds offered by the US Treasury. That is what I have done. This way my cash is immune to inflation, although honestly that's likely not going to be a problem for the next decade or so. If you go this route, gradually roll in the money because I-Bonds are illiquid for the first year you own them. Even after that they're also a little trickier to crack into than an online savings account. This can be a benefit or a hindrance, depending on your point of view.

FDIC-insured CD's would also keep your money safe and rather accessible too. Opening them up and keeping track of when they come due is kind of a pain though. The penalty for early withdrawals from CD's vary (read the fine print), but it's often just a few months of interest. Not a big deal if you are facing a real emergency.

Many money market funds may lose you money right now, since their fees haven't changed, yet interest rates are quite low. There are also a lot of bond mutual funds out there marketed as safe places to stash cash, but excepting very few, they can have all sorts of lousy assets in them (cough, subprime MBS). Do not reach for yield (a higher interest rate) with this part of your money. If you need it for an emergency, you want it to be there regardless of what the markets are doing.
posted by eelgrassman at 9:59 PM on September 1, 2012

What is the interest rate on your student loans? Paying down the principal on them is a guaranteed return essentially equivalent to the rate. If it's 2%, go ahead and save for retirement, but if it's 8%, I would pay them down faster (while keeping an emergency fund).
posted by benbenson at 6:07 AM on September 2, 2012

Response by poster: Thanks for the great advice, folks.

Cschneid, I may take you up on your offer to take this off this thread. I know nothing about this stuff.

Saeculorum, you've noted two options here for my emergency fund: municipal bonds and tax-advantage IRAs. What would you say is the best for someone in my position? I'm partial to the notion of municipal bonds, because they seem safe and, well, I like the idea that part of my civic life has to do with Ames, Iowa owing me some money. But the IRAs seem potentially easier and more flexible?

Also, to BenBenson and DoubleLune, about $30 thousand of my student loans are between 2.87% and 3.2%, and another $27 thousand are at the appalling rate of 6.8%. After I sock away my emergency fund and get this little project out of the way, I may actually look into securing $20 thousand or so loan at 4%+ from a credit union, to reduce some of that student loan interest. Not sure if that's realistic though.
posted by kensington314 at 12:03 PM on September 2, 2012

Response by poster: All this advice is really great and has really opened my eyes to my options here. I'm wondering if I shouldn't just divert like $800 of my savings into a more aggressive student loan repayment, and then just build my emergency fund with the rest, until I've paid down the more 6.8% student loans.
posted by kensington314 at 12:17 PM on September 2, 2012 [2 favorites]

Refinancing that 6.8% student loan debt at 4% saves you just over $800 over the next year (albeit continually less as the loan amortizes). That's real money; I think you should definitely be looking at that if you can refinance/consolidate at 4%.

IRAs (and 401(k)s) are not investments themselves, they are vehicles for investments. In other words, although there will likely be some brokerage-induced restrictions (more so with 401(k)s than IRAs), you can more or less invest in whatever you want with a IRA/401(k), be it a stocks, bonds, or mutual funds. In other words, you do not invest in an IRA/401(k), you use an IRA/401(k) to invest in some particular sort of investment. My Roth IRA contains a mixture of an international growth fund, a large cap growth fund, and a whole-stock market index fund. I'm just using that as an example; I would think it inappropriate for you to immediately start investing in such things without learning more about investment in general (also, I am a fairly aggressive investor with tolerance for risk).

If you can only open a Traditional IRA/401(k), you should keep your emergency fund in a taxable account - ie, not a Traditional IRA/401(k) - either in a high yield savings account (as many financial commentators suggest) or very low-risk bonds (like municipal bonds, as I do). The reason you should not use a Traditional IRA/401(k) for your emergency fund is you will be penalized with both income tax and an additional 10% tax penalty if you have to use the emergency fund.

If you can open a Roth IRA/401(k), I think it is the appropriate vehicle for your emergency fund for the reasons I've stated - primarily, if you end up needing your emergency fund, a Roth IRA/401(k) is equivalent to any other account you can open, but if you end up not needing your emergency fund, the fund can grow tax-free. It's almost always to your advantage to maximize the amount of tax-free/tax-advantaged investment that the government allows you.
posted by saeculorum at 10:15 PM on September 2, 2012

another $27 thousand are at the appalling rate of 6.8%.

Goodness Look into refinancing that. If you can't, put whatever remaining money you have after establishing an emergency fund (which would help prevent you from running up 20% credit card debts) directly into those loans.
posted by alidarbac at 10:25 PM on September 2, 2012 [1 favorite]

kensington314: "All this advice is really great and has really opened my eyes to my options here. I'm wondering if I shouldn't just divert like $800 of my savings into a more aggressive student loan repayment, and then just build my emergency fund with the rest, until I've paid down the more 6.8% student loans"

If you can convince a credit union to refinance your student loans to 4 percent, have at it. I don't think they'll bite, but let me know if they do and what you needed to do to convince them to underwrite it. You're paying 153 dollars a month in interest on that 27k. If you can't refinance, you might want to consider paying it down with most of the 10k in savings. This is the common advice I give to people with fixed rate federal student loans, as they're all at 6.8 percent and that's too damn high. You'll need to ear mark the extra payments for the 6.8 percent loans, and the lenders don't make this easy.

Roth IRAs are nice, but perhaps a bit overpromoted above. AFAIK, you cannot pull money out of a Roth 401k, only Roth IRAs. And they're subject to income limits, of the kind that people who can make 800 dollar student loan payments and still save an extra 1k+ on top of that may bump into. Finally, while I'm guilty of raiding my Roth IRA for rent, this means I can also tell you it's a phenomenally bad idea to treat it as an emergency fund. Losing your job because of the same economic downturn that's hit your portfolio is a shitty 1-2 combo nobody should set themselves up for. And it'll take you a couple days to unwind your position and transfer it to a retail bank you can access. And ironically, saeculorum neglected to mention the number one reason to grab a Roth IRA: you can pull up to 10k of earnings out early penalty/tax free for a first time home buy.

On investing goal number one (don't lose money), there's something of a paradox you should be made aware of. Modern portfolio theory (most relevant part*) demonstrates that as long as you can find persistent negative correlations among investment options, you can improve your return or reduce risk beyond going 100 percent safest, boring assets. Stocks and bonds, as demonstrated in the above video are one such pair. Also note that in the simple case, investing in the risk free asset class is the safest (most reliable) bet. Paying off student loans is your risk free investment. About 5 percent adjusting for taxation (assuming your top tax bracket is 25 percent).

tl;dr: Rapidly pay down your pricey student loans, then consider opening a Roth IRA and 401k/403b/457

*This whole course is pretty awesome, so if you find yourself stuck in an airplane or something, having it loaded up on your ipod isn't a bad move.
posted by pwnguin at 1:13 AM on September 3, 2012

AFAIK, you cannot pull money out of a Roth 401k, only Roth IRAs.

You can, but you can't pull out contributions first (tax-free) like you can with a Roth IRA. With a Roth 401(k), you have to pull out contributions and earnings proportionally to the ratio of contributions/earnings. In other words, if you have a Roth IRA with 20% earnings and 80% contributions and a Roth 401(k) with the same mixture, withdrawals (up until all contributions are exhausted) are 0% taxable with the IRA and 20% taxable with the 401(k). This is, at the very least, better than a taxable account, where 100% of your earnings are taxable.

And they're subject to income limits, of the kind that people who can make 800 dollar student loan payments and still save an extra 1k+ on top of that may bump into.

Roth 401(k)s have no income maximum (until the "highly compensated employee" criteria is met, which can never happen below $100k), and the income max for Roth IRAs is higher than you might think - $110k for a single person, $173k for a married couple (phasing out above those incomes). Even beyond those rates for IRAs, there are ways to get around the limits. I make less than the limits, and max out my Roth IRA and Traditional 401(k) each year.

I am currently trying to convince my employer to allow a Roth 401(k) option, to show my interest in them.

I am done evangelizing here; feel free to contact me outside the thread if you want more information.

posted by saeculorum at 6:42 AM on September 3, 2012

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