Welcome to my blog where I discuss money, investing, politics, and anything else import in the world. I find it surprising that most people in their 30s have very little knowledge or interest in these areas. Of course everyone is interested in money, but very few take the time or have the discipline to properly save and invest it for the future or short term. For those who at least have the interest, I'll write about my experiences and methods of investing, and hopefully give you a head start in investing.

Tuesday, January 15, 2008

Are you ready to begin investing?

Many of my friends and colleagues at work, whether young or old, often ask for help investing, which normally means which fund to pick for the 401(k). Before you even get to the point of picking stocks and funds you need to make sure you are really ready. At least ask the following basic questions:
  • What is my outstanding debt?
  • What is the interest rate on my debt?
  • Do I have an emergency savings fund that is sufficiently funded?
  • Do I have any big purchases or expenses in the next 5 years?
  • How much am I contributing to my 401k or IRA fund?
Mathematically speaking, if you have outstanding debt with an interest rate that, after taxes, is greater than the expected return on your investments, then you should not begin investing. The one exception to that rule is you should still try to fund your 401(k) to the maximum employer matching amount. This is free money that you can never make back. In general, most mortgage rates and car loans are low enough that it make sense to carry them and invest, however, most credit card rates are not. Remember most school loans and mortgages are tax deductible so the effective rate will be less than the actual interest rate (interest rate X (1 - tax rate) gives after tax rate).

An emergency fund equal to your living expenses for at least 6 months should be in a high yielding savings or money market account, like INGdirect or the many similar. This can be built up while paying off debt, but should be in place before you begin to put money at risk.

If you plan to make a large purchase such as a house or car, make sure you are saving down payment money in a high yielding money market at a sufficient rate to get you there by the purchase date.

If you have all that covered and have money left to invest, now is when you have to decide why you are investing. As that will guide you to which is the best vehicle to use, 401(k), IRA, 529 plan, taxable account, etc. My opinion is that first priority is to make sure you will have enough money in retirement. This can be covered in many ways such as pensions, Social Security, or inheritance, to name a few. If it is not already covered, then you should try to max out (or contribute enough to meet your retirement goals) your 401(k), 403(b), IRA, or similar plan before investing for a child's college or investing in a taxable account. The reasoning is that money compounding tax free for retirement is a powerful thing. If you put it off or don't fully fund it your are missing out on many years of growth. Also, you can always get a loan or use a number of methods to pay for college, but you can't get a loan for retirement (Ok, maybe you could do a reverse mortgage, but still not the best plan).

So if you are executing a realistic retirement strategy, next on the priority list would be to invest for your children's education, if applicable. There are a number of tools online to calculate how much you will need and this is a huge topic on its own. I prefer using 529 plans and recommend dumping as much as you can into it early on, up to your tax limits ($60,000 per person for the first 5 years). Again this gives it a chance to grow tax free. The online tools can also estimate how much you need to contribute monthly.

Finally, if you have all the above taken care of, then you would consider investing in taxable accounts. Asset allocation and a range of other topics will follow. I'll get into how I chose to invest in these accounts and hopefully discuss with you your ideas.

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