Woo! It has been a whirlwind month for me which is why you haven’t seen many posts. You probably know that Jews don’t celebrate Christmas but you might not have realized we have our own holiday season. The fall is when we have 4 distinct holidays and since our holidays aren’t federal holidays, I end up taking 3 days off work and some people take 7 days off in 4 weeks. I was writing a lot of sub plans and constantly playing catch up on grading and checkin in with students. This Tuesday marks the end of the fall holiday season and life is starting to normalize again. This coupled with a new job with an intense work schedule got me way behind on my writing.
This morning I woke up, went to yoga in one of my favorite parts of town and am now writing in my favorite coffee shop. I will be writing a net worth post later this week for October but there are a few highlights that relate to this post I want to bring up. I have almost maxed out my Roth IRA, an incredibly exciting prospect because I just opened the IRA this year. I feel proud of this accomplishment since a year ago this time I was still trying to understand if the Roth was the right investment for me at all since I had gotten some sketchy investment advice telling me not to open a Roth. Incase you aren’t familiar with this common term “max out,” it means there are limits imposed by law as to what you can invest in one year in certain account types and you “max out” when you put that total maximum in. For a Roth IRA the maximum you can put in during one calendar year is $5,500. I have $254 more to add to reach that marker. I also set a goal last month to get $10,000 into my taxable investing account and am going to start attacking that after I max out my Roth for 2018.
Now onto today’s content. Sometimes people ask me questions about investing, or people tell me to talk to their friends about investing. What I have realized is that many of these people are in the same position I was just 2 years ago. The phrase “you don’t know what you don’t know” is never more applicable than investing for a regular person. So I decided to type up the main points of consideration when you first start investing or want to do a check up on your portfolio.
Three Questions to Ask When You Invest
There are sort of three main prongs of investing after you learn about investing in the stock market itself. I have a few posts about how to think about it (here, here, and here) and I also want to direct you to JL Collins The Stock Series that explains why you should invest in a Total Stock Market Index Fund and its partner a Total Bond Market Fund. The main take away is that so long as you believe in the American Economy and its ability to succeed overall, investing in a Total Stock Market Fund does not carry risk. It always goes up over the long term (as in 10 – 100 year timelines). Investments are always made for the long term. We’re not considering how to get rich quickly. We’re talking about getting rich the boring, careful, and slower way.
The three main things you want to consider when you get started are
- What are your goals?
- What is the cost to you to make this investment?
- What is your Volatility Tolerance?
The goals you have for yourself will determine what accounts you should open and where to focus. Availability, in some cases, will also dictate which accounts you have. If you have a goal to save for retirement at essentially age 60 or later you will pick from the bucket of different retirement accounts. If you want money for before ager 60, you’ll pick a different account. If you want to save up a cache of cash, you just need a simple savings account. But for achieving long term goals you have these choices…
- Taxable Brokerage Account – this is a post-tax account, so you save in it from your take home pay. Then when you sell your investments, you’ll likely have to pay a tax on capital gains. Capital Gains taxes are more favorable than income taxes so don’t dismiss the fact that you have to pay tax on the growth. You’d use this account if you are saving for anything that would occur before age 59 1/2. I am coming to personally value this type of account more and more over time. You can easily liquidate this type of investment account. You can open a taxable account at any brokerage firm. I use Schwab for many reasons. Other people like Vanguard, Fidelity, or Betterment. Investment cap: none.
- Roth IRA – another post-tax account but it’s for retirement. The tax advantage is that all of your investment growth is tax free! You can’t access that growth until you are 59 1/2 but no taxes will be levied once you withdraw the money at that age. Pretty nifty! I am in the 12% tax bracket and am 28 years old so I am heavily valuing this account at least for the foreseeable future. By the time I am 60 years old, the $6,500 I have put in there so far will likely grow to $76,000 (assuming 8% growth). So $70,000 I never have to pay taxes on sounds amazing to me. Investment cap: $5,500 yearly, $6,500 if you’re over 50.
- Traditional IRA – pre-tax retirement account that you open on your own. Your money will grow tax free until you start withdrawing it after age 59 1/2 and you’ll pay tax only when you take the money out of the account. This lowers how much of your income you have to pay taxes on. My mom started using this later in her life because she and my dad’s income was getting too high for their comfort level. They wanted to pay less in taxes. What’s cool about both IRA’s is that you can contribute to it during tax season for the previous year. So from January – April of 2019, you can go back and contribute for this year of 2018. It helps if you realize you made more money in 2018 and want to lower your tax liability. Investment cap: $5,500 yearly, $6,500 if you’re over 50. WARNING: you can only put $5,500 into IRAs whether you have one or both types. So the total you put into your Roth IRA and Traditional IRA cannot exceed $5,500 or $6,500.
- 401(k) or 403(b) – pre-tax retirement account that is facilitated through your employer and contributions will come right off your paycheck. This lowers how much of your income you have to pay taxes on. You’ll pay taxes on the money once you take it out in retirement after age 59 1/2. Often companies offer a “match” meaning they reward you for investing by giving you an equal amount. My mom had a 401(k) match of 3% of her salary. Some people get 5% and some are lucky enough to get more. Basically, the company will pay you more money if you decide to invest, so open this kind of account if they will match you! I wrote an article about a lot of sketchy stuff going on in many 403(b)’s so watch out and do your research before just opening this account. I currently do not invest in my 403(b) and plan to roll it into an IRA when I stop working at my current employer. Investment cap: $18,500 yearly, $24,500 if you are over 50.
- 457(b) – this is a unique pre-tax account available to state government employes. It can be used for retirement certainly, but the money can be accessed before age 59 1/2. The requirement for accessing the money is that you must separate from service (quit, retire, or be fired… doesn’t matter as long as you don’t work there anymore!). This account can be used in conjunction with a 403(b) and/or a pension. You will pay the tax on the funds when you withdraw them after you stop working at your employer. I use this as a backup emergency fund. I contribute $200 each paycheck. Investment cap: $18,500 yearly, $24,500 if you are over 50. You can invest $18,500 here and $18,500 to your 403(b) if you have that much available!
- SEP IRA, SIMPLE IRA, Solo 401(k) – pre-tax accounts used for self-employed people. Same rules as their counterparts named above.
The Cost To You: Fees
The fees you have to pay are the most important feature to consider once you decide your investing goals. Investing isn’t free like checking or savings accounts. But it doesn’t have to be expensive! Investment fees have the potential to erode your account value over a long time.
For index funds, companies general want to compete with the inventor of index funds, Vanguard, so they keep fees low. And if you’ve read up on total stock market index funds, you know you want to invest in them because they are awesome. Schwab has a low barrier to entry: you only need $100 to get started. Their Total Stock Market index has a fee of just 0.03%. If you are paying a 1% investment fee, it is time to consider moving your money.
Here is why fees as a percent are incredibly important to understand. While 1% seems like such a small number, it is NOT. Say the blend of stocks and bonds I am invested in gains an average of 8% a year and I contribute $200 every month consistently. And say the management fee is 1%; the average returns drops from 8% to 7%. So let’s compare this over 35 years because that is how long I’m supposed to work as a teacher in Ohio in order to retire.
At 8%, the Dave Ramsey Investment Calculator shows us that my retirement portfolio would grow to be $446,685.
Now if I have to pay a 1% fee, every single year, my return would drop to 7% and my portfolio grows to merely $354,992. That’s not a terrible portfolio size, but I’ve lost $91,693 to fees! I don’t know about you, but $91,693 is a lot of money to use and I could find lots of ways to spend that money in retirement. In college I traveled to Italy for 2 weeks on about $3,000. $91,693 is about 30 trips to Europe I could take.
Fees matter a lot. There is no reason to be paying 1% in investment fees so please investigate this before you open an account or look now and consider making some changes if you are paying this much. Don’t let companies profit off your ignorance. Knowledge is power.
Usually this feature of investing is referred to as “risk tolerance.” Essentially this is asking how comfortable are you with the ups and downs of the stock market. If you’ve ever paid attention to the news, you know the economy takes turns all the time and the stock market can take a dive or even crash. The news tends to report about the drops more but from 2009 to 2017, we were on a historic bull run, meaning the market was generally going up and up and up and it was fantastic.
The reason I have stopped using the term “risk tolerance” is because after listening to an episode of the Mad Fientist and combining it with my knowledge from JL Collins, I know that when I invest in total stock market index funds, there is no risk… for the long term. “Risk” refers to not actually knowing the outcome of something. Risk is when you roll the dice at a craps table and you leave the outcome to a random event. Investing in the American Economy is not risky because we aren’t rolling any dice. We aren’t leaving the outcome up to a random event. These companies that comprise the stock market are filled with hard working people who are trying to turn a profit, trying to help people, trying to be efficient. They aren’t rolling dice to make decisions. The total stock market goes up over the long term. Don’t believe me? Believe Warren Buffet instead, who elegantly states:
“Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a fly epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”Warren Buffet
So if the stock market rose that much in a century, why didn’t everyone make money? People try to time the market. Don’t bother. Pursue other interests and passions. Know the market will do its thing and you just want to check in every so often. You don’t need the money right now. If you do, it should be in a savings account not in the market.
The stock market will inevitably go down, and it will inevitably go up. The question is about how well can you stomach when the market goes down. Will you get scared and not be able to sleep at night? Are you likely to sell your investments if the market drops? In February of 2018, the market took a little dive. I remember my taxable account being at $1503 near the end of January, the highest it had ever been. I had made like $300something. I had only started investing a year earlier and was wary of how things worked. Then it dropped over $120 in two days. Seemed scary. Like maybe it would drop more. And it did. But luckily I had really internalized what JL Collins says about the total stock market index. I knew the dive that we took in February 2018 is just part of the process.
If those dips and dives the market takes make you uncomfortable, you will want to take a more conservative approach and pad your portfolio with bond index funds. Maybe you want to be 50/50 stocks to bonds (but hopefully not if you are very young). Common conservative portfolios are 60/40 or 70/30. I am 90/10 and inching my way closer to 95/5. All new investments I make are in stock funds not bonds. As I become more knowledgable about the stock market and investments, I am less interested in bonds because I am in the accumulation phase of my investing career.
Make choices that work for you
Make choices that work for you but just be aware of all of your options and how investments work. These are what I consider to be the three main concerns when you are investing. Set goals and then use investment vehicles to achieve them; don’t overpay for investment products, and pick the appropriate stock to bond ratio that will allow you to sleep at night. What else do you consider or have concerns about? Leave me a comment below.