There is an awful lot of misinformation out there about investing, much of it propagated by people who stand to benefit from leading others astray. Detangling all of it will take time and while I intend to do that on this blog eventually, I want to start with a simple, basic strategy that a lot of people can follow. This strategy will outperform most of the “experts” over time and at a much lower cost than what they will charge you. As a general side note, please remember this; very few people in the media are impartial anymore. Don’t act on any financial advice that is given out publicly without evaluating who the source is and what he or she may have to gain from disseminating it.
Cash is king and that is where you should start. If you don’t have enough on hand to deal with life when it happens to you, it is going to cost you dearly. For example, you can’t pull money out of your 401k very easily (or cheaply) to deal with sudden medical expenses. It is better to have enough cash saved up before sacrificing liquidity in favor of potentially higher returns. A lot of people will tell you to have six months to a year of expenses on hand. I think that is a decent place to start but also that it is a little more nuanced than that. Think about your personal situation. How many incomes are in your household and how many total people? If there are more mouths to feed than sources of income doing so, your cash needs are greater. Conversely, if you have a household of two working partners and no dependents, you can probably get by with somewhat less cash, particularly if your incomes are relatively similar. No matter what you do, keep in mind that the basis for your calculations should be your expenses, not your income. And if you don’t know at least approximately what your monthly expenses are, then you need to go back and start there.
Once you are comfortable with your cash position, you can start investing. I recommend a 401k if your employer offers one. Of course, not all 401k offerings are the same. A good one will include at least some level of employer matching, at least a handful of low cost (expense ratio of no more than .5% and preferably lower) investment options, and a reasonable vesting schedule. Sadly, my current employer fails on that last point with a ridiculous six years to 100%! But I digress. You can put a maximum of $19k a year into a 401k and it will lower your taxable income accordingly. But assuming your MAGI (modified adjusted gross income) is less than $122k, you can also put up to $6k a year into a Roth IRA.
But start by contributing at least enough to your 401k to get the employer match. A typical one seems to be 50% of the first 6% of your salary (in other words, 3% if you contribute 6). From there, you can determine where to go with the excess. In general, a 401k reduces your tax liability today while a Roth IRA reduces your tax liability in retirement. Since your tax rate is very likely lower today than it will be years down the road, there is a solid argument to be made for putting $6k into your Roth IRA and then going back to finish maxing out your 401k. But I would start with some combination of these two, again taking the phase outs based on your income under consideration in the case of the Roth IRA.
What should you invest in with your 401k and Roth IRA money? This is an easy one. Go for low cost index funds that mirror your objectives. If you’re young and you have a long time until you plan to retire, you can afford to be risky so you can go with a heavier stock to bond ratio – as high as 100/0 even. If you’re getting older, you will likely want to move towards the other end of the spectrum. It’s all a matter of risk tolerance but remember, more risk typically produces more reward.
Regardless of the risk you want to take on, this next point is the most important of all on investment choices. Do not let anyone bleed your retirement savings year after year. Actively managed funds almost never outperform index funds over the long term and they are much more expensive. A fee of over .5% will eat up a ton of your money over time. If Vanguard options are available to you, there is a good reason they are the largest mutual fund company on earth. Their funds are the gold standard in providing low cost funds with competitive returns. You would be hard pressed to go wrong if you’re looking at anything of theirs.
What if you’re making less than $122k a year (roughly 90% of people are below that level) and you are already maxing out both your 401k and your Roth IRA or you’re making more than that and doing all you can with those two avenues? First, pat yourself on the back because if you stay on that course and make decent investment decisions, your retirement is more secure than that of almost anyone you know. Now, prepare to have a little fun. With that $25k a year going into your long term retirement funding, you can afford to get aggressive with any excess if you want to. In my case, I do some more conventional stuff and I’ve also started a side business investing in real estate. In your case, the world is your oyster. This is where you may want to talk to a professional if you aren’t sure. I work with both attorneys and a CPA with my business. If you work with a financial advisor/planner, make sure they are fee only. If not, they’re likely to put you in the investments that are most profitable to them while your interests wind up more of a secondary consideration. But you can also just stick with more conventional investment choices like the ones I mentioned for your 401k and Roth IRA if you prefer.
I do want to stress one point, however. Unless you have a fairly large amount available to invest, say at least mid five figures, I would stay away from individual stocks. With less than mid five figures, you simply don’t have enough to be able to diversify adequately. The less diversified you are, the more you are gambling. And consider this; almost no one in the history of mankind has picked stocks well enough to beat the market consistently over time. Do you think you will be one of the handful of counter examples? If not, your best bet is probably to stick to mutual funds for stock market investing.
I think this is enough for now. I kept it very basic because with investing, as with so many things, getting started is most important. And if people feel overwhelmed, it tends to push them in exactly the opposite direction. As always on my posts, if you have any questions, feel free to comment below or email me at email@example.com.