A Few More Random Things About Investing

My Two Rules of Investing post resulted in several good questions from people, both in comments and in email. I’ve got answers which are worth every penny you’re paying for.

How much should I be investing? Oh, goodness, there’s a question with no good answer. It depends on what your current financial situation is, how old you are, and all kinds of other situations. My general recommended approach is this. First, pay off any and all credit card debt, and do so as fast as you can. Then build up some three to six months’ worth of living expenses in a decent savings account. Then move to investing, and save what you can.

The important thing to realize is that any money you use to buy stocks and bonds should be money you won’t need for years. In the last year or so, the New York Stock Exchange lost half of its value. If you needed to sell stocks today to cover some unexpected costs, you’d be in a world of hurt.

Should I invest in an IRA? Absolutely. Any money you’re planning on using for retirement and not touching until then should go into an Individual Retirement Account.

They come in two flavors: traditional IRAs and Roth IRAs. In traditional IRAs, you don’t pay taxes on the money you put in them today, but you do pay taxes when you withdraw the money. In Roth IRAs, you pay taxes now, and later withdraw the money tax free. In financial jargon, traditional IRAs are tax-deferred investments (because you pay the tax later instead of now), while Roth IRAs are tax-exempt investments (because you don’t pay taxes on the money later). The rule of thumb I always see is that, for most everyone, Roth IRAs are better than traditional ones. You’re putting money in your IRA hoping that it’ll grow. With a traditional IRA, you have to pay taxes on those profits. With a Roth IRA, you don’t.

If I just want to invest some money without having to worry too much about it, what should I do? If you can, get a lifestyle fund. For instance Vanguard has a range of all-in-one funds. You pick a lifestyle fund based on when you’re going to retire. Vanguard then adjusts the stock, bond, and cash blend automatically, so you don’t have to rebalance anything. Even better, they use index funds, so the expense ratio is around 0.18%.

The only problem is that you’ve got to have $3,000 to get into one of those funds, and that can be tricky. In that case, you can either sock money away in a savings account until you reach that point, or start with a fund that will let you invest as little as $50 to $100 a month.