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.

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9 Comments

  1. Yoon Ha Lee
    on February 23, 2009 at 1:35 pm | Permalink

    Heh. This is very interesting to read, although in our case it is sadly academic. (The short version is we don’t even have a 3-6 mo. emergency fund and one isn’t happening anytime soon, so investing stuff is Right Out.) On the other hand, I want to know about this stuff in case that situation changes someday…

  2. on February 23, 2009 at 2:01 pm | Permalink

    Yeah, a lot of people I know are in y’all’s position. Goodness knows we were back in my grad school days.

  3. Missy
    on February 23, 2009 at 5:10 pm | Permalink

    For those who are interested in getting out of debt, check out Daveramsey.com. There is a lot of good, free information on making a budget, creating a plan for getting out of debt, saving your emergency fund, etc.

  4. on February 23, 2009 at 6:33 pm | Permalink

    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.

    But isn’t it true that if you don’t pay taxes when you put them money in, that leaves you with that much more money that you can invest? The more money you can put into the account, the more you can collect compound interest on, so the more it’ll grow.

  5. on February 23, 2009 at 8:33 pm | Permalink

    Jota: Yes, but you’re essentially rating the risk of taxation costs changing over time. If you think that you’re going to be in a higher tax bracket later on, or that capital gains taxes will rise in the future, then maybe you pay a little tax now rather than a lot later.

  6. on February 23, 2009 at 8:49 pm | Permalink

    Jota: plus you’ve got to actually increase your traditional IRA contributions by the amount you’re saving in tax, which tends to run against human behavior.

  7. Yoon Ha Lee
    on February 24, 2009 at 10:22 am | Permalink

    Misty: What kills me is that I agree with what I’m seeing of the basic philosophy behind that website. We were *doing* these things, approximately: we had an emergency fund; we paid off my grad school loans. Then we had two emergencies in a row, more or less: unplanned pregnancy (hi, lizard!), which would have been deal-with-able if not for the second emergency, which was (if you clump things together) my getting diagnosed bipolar. The hospital &c. fees completely wiped out the emergency fund (MIT grad student health insurance is fine if you are *in Boston* but does not cover a lot of things if you are out of state; naturally, in order to do his research, Joe had to be out of state). In the department of not helping, the being-bipolar has made a full-time job inadvisable at this point in time. We have tried to cut back expenses, and fortunately the only debt left is my unfortunately large college debt (Joe got out of college without debt, lucky guy), and we are managing to squeak by, but it is kind of scary how quickly everything went down the toilet once the various medical fees hit us.

    Anyway, thanks for the link–nifty site.

  8. on February 24, 2009 at 10:48 am | Permalink

    Yoon, that’s the thing that scares me the most. Last I looked, half of all personal bankruptcies were due to medical bills dumping people in a hole that they then couldn’t get out of.

  9. on February 25, 2009 at 7:29 pm | Permalink

    Yeah, I’m with Stephen … which is why I’m for health care reform.