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It’s been a long time since we had an Ask the Readers around here. Time to remedy that situation! Jeff recently wrote with a question about saving. The lucky dog has saved so much that he doesn’t know what to do next!
Two years ago I started getting smart about my finances and in the time since, I’ve been able to put away enough money to max out my Roth IRA. I’m a grad student on a teaching-assistant income. As such, I don’t have a huge amount of cash lying around after I’ve maxed out the IRA, but I also don’t have a 401(k) — or, in my case, a 403(b) — to put that extra cash into.
So here’s my question: What’s the best thing to do with extra cash once the tax-shelters are maxed out? Just invest in the same type of mutual funds as I already have within my IRA? What if I’ve got a wedding or a house in the not-too-distant future (say, 2-4 years)? Any pointers on this would be greatly appreciated!
Jeff should be congratulated for maxing out his IRA. That’s awesome! Saving that $5,000 a year puts him far ahead of most Americans. In my opinion, he has three options, two of which he mentioned, and one he didn’t. My personal preference is to put things in this order:
- Debt reduction. If Jeff is carrying any high-interest debt — and he probably isn’t or he’d have mentioned it — attacking that is probably the best move.
- Targeted savings. If Jeff thinks he might be getting married and/or buying a house in the next few years, he could open named accounts at ING Direct (or another online bank) to focus his saving. Interest rates suck right now, but they’re bound to improve in time.
- Additional investing. A reasonable argument could be made that the market is in the middle of a bull run, and that it’ll keep climbing for a while. If Jeff thinks this is the case, he might be better off putting his money into a regular investment account.
Thought the stock market is attractive, it’s not nearly as attractive as it was a year ago. Besides, the stock market really isn’t a great place to save for short-term goals. You could argue that it’s been fairly low recently so your chances of seeing a drop are lower, but they’re still there. If you’ll need cash for a wedding or a house in a few years, Jeff should make sure he understands the risk involved before putting short-term money into the market.
If I were in Jeff’s shoes, I’d save the extra market investing for after I’d met my other savings goals. I’d keep maxing out the IRA every year, and put any extra money toward targeted savings. If he does invest, should he stick to his current mutual funds? That really depends on what those are.
What would you do if you were in Jeff’s shoes? Should he be focusing on his short-term goals? Or is he better off opening an investment account? How do you prioritize your saving strategy if you’ve already maxed out your IRA?
This article is about Ask the Readers, Choices, Investing, Retirement, Savings Friday, 8th January 2010 (by J.D. Roth)
January 8th, 2010 at 5:37 am
For the wedding savings, I’d say stay out of the stock market. Stick to CDs or high-yield savings.
As to long-term savings beyond tax-sheltered accounts, I just answered a reader question on that topic earlier this week.
Essentially it boils down to:
1. Make smart asset location decisions.
2. Choose tax-efficient funds.
January 8th, 2010 at 5:44 am
I’d redirect the addtional money to a high yield online savings account to start saving for a house or duplex.
After I would get the 20% down payment saved up ( also to avoid PMI insurance), I’d buy (or try to buy) a deal on duplex, if he plans to staying in the area.
January 8th, 2010 at 5:44 am
+1 to Mike’s comments. The rule I’ve always heard is never to have any money you anticipate needing in the next 5 years put into the stock market.
January 8th, 2010 at 6:01 am
One thing Jeff could do to get ahead of the curve is save up and put aside that additional $5000 for his 2011 Roth contribution. This way, he can deposit it in early January 2011 and maximize the earnings throughout the year.
I imagine he has already maxed out his Roth for 2009, but if he hasn’t, he has until when he files his taxes to do so (correct me if I am wrong).
January 8th, 2010 at 6:02 am
Emergency fund is not mentioned. Should have been first on the list before Roth max. Put it in high yielding savings account.
Then debt, then targeted savings, then could do Traditional IRA.
He could put money for 2009 & 2010 in Traditional IRA ($6500 for each year) and then convert to Roth IRA in 2010 and just pay the tax.
January 8th, 2010 at 6:05 am
Great job in saving the dough, Jeff. I think that the Roth is a good choice for you. My wife and I keep our short term savings in a checking account at the credit union. I only pays about 3% right now and there are hurdles but I sure enjoy getting cash from the bank each month, instead of paying.
January 8th, 2010 at 6:13 am
If Jeff is a grad student, I assume he might have some student loan debt or credit card debt. As such I’d put extra money towards debt, after that I’d put it towards emergency savings (he doesn’t mention if he has any) or targeted savings and that money should stay pretty liquid, i.c. CD, money market or savings. After that I’d focus on extra investments for retirement.
January 8th, 2010 at 6:14 am
First, I would reward myself. It is important to not loose site that Getting Rich Slowly shouldn’t be about a hording or greedy mentality. If Jeff has already done the basics (pay off debt, emergency funds, retirement investments, targeted savings) then the next thing to do is reward yourself (within reason) and celebrate.
Then, I would look at other areas such as diversification, review tax implications (as Mike recommended), and safety nets (insurance, annuities).
Lastly, I am currently evaluating my situation where I am concerned that my retirement tax bracket may not be lower than my current tax bracket. This has potential impacts to our retirement “liveability”, so I am looking at alternative vehicles to ensure that changing tax laws will have less of an impact on me if/when they happen.
Congratulations Jeff and others that are in this situation.
January 8th, 2010 at 6:16 am
Very impressive to save much at all on grad-student pay!
How big is the emergency fund? It might make sense to bulk that up as much as you can. Medical emergencies and funding bumps do occur, even in grad school. It might also give you the flexibility to avoid teaching for a semester, if that makes sense for you.
You might also consider a portion of your emergency fund as your opportunity fund for during and after grad school. It would be sad to choose a practical option over a dream opportunity for research or a career because you didn’t have a few thousand dollars for a plane ticket, for example.
As many previous posters have suggested, keep your emergency fund in accessible-enough low-risk cash equivalents. In other words, if you’re going to lock it up in CDs, do a CD ladder. If you’re going into low-risk bonds, do a bond fund. And so forth.
January 8th, 2010 at 6:48 am
Don’t forget about generosity. Giving to causes you feel strongly about helps them and gives you a different perspective about the meaning and purpose of money. It is a tool and nothing more.
January 8th, 2010 at 6:53 am
Jeff needs to blow the doors off of it. If he has the discipline to max out his IRA on a grad student salary, he needs to spend some money on wine, women, and song in the European capital of his choice. May I suggest Lisbon?
Of course, if the IRA is the only thing he’s invested in and he hasn’t tackled any of the things that were mentioned, he should address those first. I suspect Jeff’s financial house is in order and therefore he deserves a reward.
If Jeff weren’t in grad school, I wouldn’t tell him to travel. Generally, graduate students are unsupervised and they have much fewer responsibilities than people with day jobs. Furthermore, if Jeff is a TA, he probably isn’t doing much when class isn’t in session so its completely plausible that he could take off for 10 days and nobody would mind (or notice). As an added bonus, Jeff might be able to get the university or his advisor to cover some of his travel expenses if he is going to a conference or giving a presentation. Once he’s abroad, he can take a quick side trip for a few days to another country. I’ve employed this strategy many times.
Based on my own experience, one doesn’t get a better opportunity to travel than graduate school. Sure, you aren’t going to stay in the Hotel Meurice; but the older you get the less likely you are going to tolerate staying in a 10 Euro/night hostel in Barcelona eating street food all day. Additionally, the older you get the less likely you are to spend a late night drinking bottles of wine with those cute 22 year old Argentinean and Greek girls who are also staying at that 10 Euro hostel.
If Jeff has his finances together now, he needs to consider the fact that he can’t buy back his 20s once he’s cashing out his IRA in his 60s.
January 8th, 2010 at 7:17 am
I’ve been through grad school and (without knowing more about his situation), I would suggest that he needs to have a good emergency fund. I’ve known many students who ran out of funding (be it TA, RA, or scholarship) before completing their degrees. If it turns out that he completes the degree on time, so much the better, because after graduation many students move to another city with jobs in the area of expertise. Obviously there can be a lot of expenses associated with that.
And after that, of course, is the usual life things that come up as you establish yourself in a career, marry, have kids, etc.
So anyway, the short answer would be to save it somewhere that will preserve the capital and keep it moderately liquid. From my own life experience, I could see him needing it in the next few years, so definitely not the stock market.
January 8th, 2010 at 7:19 am
I think he meant a 403b, a special investment account for people earning income from a public education institutions or some other types of non-profits. I teach and don’t use them because traditionally they can have higher fees and expenses than a Roth. I wouldn’t invest there unless some type of match is offered.
He also didn’t mention if the college he is working for is withholding a portion of his salary for retirement. I have 13% of my salary withheld each month and the state matches 13% and we also invest in a Roth. We also do some emergency savings and savings for our children and upcoming events. After that we have fun with the rest. So, I’m with Joshua. Start thinking about making some memories with the money.
January 8th, 2010 at 7:25 am
I like Joshua’s answer! So true.
But, if Jeff is saving for 2-4 year plans, might I suggest a tax free muni bond fund. It will most likely pay better than the pitiful savings and CD rates and the risk is pretty low.
An example would be: T. Rowe Price Tax-Free Shrt-Interm (PRFSX).
January 8th, 2010 at 7:28 am
It all depends on his entire financial situation. It’s hard for anyone to say anything useful about it, although some good suggestions will probably come from this post. (I know I will be checking back for some good suggestions)
January 8th, 2010 at 7:38 am
I’m with the emergency fund crowd Jeff doesn’t mention one, but if he doesn’t have enough socked away to last him a few months, now would be a good time for it. (This could also give him a nice cushion if he ends up having to take contract positions immediately after graduation instead of getting a full-time job right away — not unheard of in academia, although the likelihood depends on his field.)
After that, I agree that short-term savings are important, especially if he knows he wants a house or wedding in the forseeable future. A CD ladder (which it’s easy to build through ING) is another good choice for this, because he has an idea when he’ll need the money.
January 8th, 2010 at 7:45 am
I like Lesley’s suggestion - having a cushion fr post grad school is a really good idea. Many people I know are so tapped out right after grad school, moving to take a job ends up on credit cards (and they spend some years paying that off).
January 8th, 2010 at 8:06 am
Pay off debt, build an emergency stash, setup a retirement plan, invest additional money in markets per investment plan.
January 8th, 2010 at 8:07 am
LOL- I am betting the “reward yourself” people are in debt!
The reward is the wedding and house. Short term rewards are not near as good as long term rewards unless you REALLY need them.
I put our money into a savings and wait for investing days- like today. We “reward” ourselves with travel- but budget it in long term.
Having a house, two cars, a motorcycle, boat, barn, tools and no debt in retirement is reward with planning- it is our life! (And we saw 22 countries and all fifty states along the way.)
BTW- we also continue to work and save at the back end. We like our community!
January 8th, 2010 at 8:10 am
Nice move @4, to save for next year’s Roth as well - that’s just super smart.
I’d vote for targeted savings. It’s an amazing feeling to look at my ING accounts with nearing $20 grand and dream about the country property I’m going to buy when the time is right.
January 8th, 2010 at 8:11 am
1. debt reduction
2. short term savings - anything you might need in 3-5 years - CDs or bank accounts. Unfortunately rates are low, but the stock market is not the place to be. I watch/read a lot of stock market stuff and the consensus seems to be that we’ll either be flat for a couple of years or could have a currency problem that takes our economy back down again. Very few think things will just keep climbing back up, up, up. At most I’d take 10% and invest - but be aware you could lose that or decrease it very easily.
3. Money beyond debt reduction and short term needs should be invested. Low cost index funds are a good way to go (I like Vanguard). You can also do your homework and invest in individual companies that are run well and pay a dividend that is above the going rate of your bank accounts. There are good companies out there with secure dividends - think PEP, PFE, MMM, NUE - but be aware that right now all of these companies are trading high - they’ve had runs. Have a list of companies you’ve researched and would like to buy - watch their prices and when they go low on weakness, buy them. If you don’t feel comfortable with doing your own stock research stick with low cost index funds.
January 8th, 2010 at 8:17 am
Joshua’s suggestion (11) is my favorite, but someone might as well present a new argument. Two years ago, I was a graduate student with a similar situation and decided to invest heavily in stocks. I realize it was a lot of luck, but I made a killing and bought a house with the spoils this week. Here’s why I think Jeff should consider it.
This is a counterargument assuming he has a decent emergency fund and his financial house is generally in order.
1. He’s (probably) young and able to assume more risk
2. Capital gains taxes are low. As a graduate student, I was sitting in the 15% marginal tax bracket meaning my capital gains taxes on stocks held over a year was…zero! Jeff loves investing in his Roth, but for lower income individuals, CG taxes are lower anyway. That’s set to change with new government, but only to 10%. Fear of these taxes can sometimes get in the way of making good investments.
3. Stocks are still pretty cheap. Two to 4 years is a pretty decent time horizon…the odds of a major loss of capital are pretty low. If you get nervous close to when you need the money, sell and sit in cash.
4. The market demands he takes risk. With intrest rates sitting at 1% (and taxed as ordinary income), inflation will eat his pricipal.
Those are my arguments…I know this site tends to be conservative when it comes to markets, but Jeff should look at the upside of what to do given his special situation and market conditions. Best of luck!
January 8th, 2010 at 8:20 am
I’m a year or two ahead of Jeff. I was a grad student who was able to max out my Roth IRA each year, who started searching for a job about a year ago and was able to move into the ‘real world’ in August. Jeff, my biggest advice would be to save up a SUBSTANTIAL loss-of-income fund (6-12 months of expenses, possibly in CDs) by the time you anticipate graduating. (I consider loss-of-income different from an emergency fund, but that’s a story for another day.) Academic hiring is cyclical - if you don’t have a job in August, you’ll likely be waiting until the next August. You don’t know what the market will be like when you finish, so plan ahead! You can always redirect those funds to a house, etc. later. But keep the money liquid until you have a signed contact - even if you’re offered a job in November, many are ‘contingent on funds’ - and I’ve known people to have their offers retracted as late as May - meaning they’ve missed the prime application time (fall) for finding a new job.
My story: Between planned savings, a modest inheritance, and the generosity of family members (my sister would let me rent a room from her for cheap (probably free if I asked - but my pride wouldn’t let me if there was any way I could avoid it!)), I had a viable plan for supporting myself that for that uncertain year, if necessary. This meant that while I still felt a lot of pressure to get a job (I finally got a great one in July!), I wasn’t desperate. Finishing your degree and looking for a job is stressful enough - don’t add worry about how you will support yourself if you DON’T get a job to the mix.
Oh, and being able to support yourself for that critical year gives you the freedom to say ‘no’ if you are offered a job you truly don’t think you could live with. Don’t underestimate the freedom that comes with knowing you don’t HAVE to be trapped!
Good luck!
January 8th, 2010 at 8:21 am
@John Shilling #4:
1. You have until April 15th of 2010 to make contributions for 2009 regardless of when you file your taxes. If you’re contributing to a Roth, it won’t make a difference on your taxes since you can’t write it off. If you’re contributing to a Traditional, you would want to file an amended return.
2. Contributing all $5000 in January might not be your best bet. Assuming you’re investing in stocks and bonds, the market is going to have fluctuations during the year and you may be better off contributing in chunks throughout the year to dollar cost average. Unless your IRA is in CDs, that is, then your method is certainly the best.
January 8th, 2010 at 8:23 am
He doesn’t mention an emergency fund. I would make sure I had 6 months living expenses before saving for a down payment or wedding. I certainly wouldn’t go into debt for a wedding either–either keep it simple or pay cash.
After getting burned by putting part of our emergency/car fund into mutual funds instead of money market or high yield savings, I must insist any short term goal must be kept in something liquid. We lost almost $2K in the first few months we put the money in the fund. Had our car died at that time, we’d have had to settle for much less car. I learned my lesson. Stocks are for my long-term retirement, NOT short term goals!!
January 8th, 2010 at 8:28 am
This is what I would do in this scenario:
1. Pay off all debts
2. Establish a good emergency fund - High yield savings, CDs
3. Save for house or other short term goals - High yield savings, CDs
4. Since the Roth is maxed and he doesnt have a 401k option I’d invest in a traditional IRA or buy mutual funds. For mutual funds, assuming he would be strting with a small initial sum of money, I’d just buy a all-in-one fund that meets his risk tolerance such as a Target date fund. Simple, easy, rebalances itself as you age.
January 8th, 2010 at 8:34 am
This is what I would do (because this is what I did, am doing):
Like J.D. said, pay off debt first.
After that, it’s all home down payment savings.
I don’t actually max out an IRA (or a 401k for that matter). My current plan is to put $500/month towards my 401k, and then another $1250/month towards a down payment on a home. Up until recently, I was focusing that $1250/month on paying off my car, but that’s done now.
I the home savings is advice that’s often overlooked by older writers who have younger audiences. Twenty percent down, which is still the recommended amount, on a $250k house, which is not particularly expensive in most places and is really cheap in some, is still $50,000.
Why does no one ever mention the $50k you’re going to have to save if you want to own your own home? Why should a 25-year-old who’s about to start a family prioritize retirement savings over this? I think it deserves more coverage.
Personally, I live in an expensive part of the country (coastal California), and I’m trying to save $100k as a down payment for a home, and so I don’t max out my 401k.
January 8th, 2010 at 8:50 am
We also maxed out our IRA Roths in graduate school. We put the extra money in CDs at first (interest rates were high and we didn’t know what to do), then in the stock market (QQQQ and DIA) after we gained a little more confidence and some extra money, then back in a CD when it looked like graduate school was coming to an end and we wanted to have a safe down payment.
We did what Tyler said… saved $50K, put 20% down. Actually needed a little more because of closing costs and moving costs that took a while to be reimbursed (and we still have a room with no furniture in it). Even if you don’t plan to buy a house right away, it is nice having a cushion for all of those up front expenses… especially when there’s 3 months between your last paycheck/moving expenses and your first real paycheck/reimbursements.
The general heuristic: short-term expenses that you need safe keep in CDs, bonds, and money market accounts. Long-term (~5 years) or when you have more leeway for risk keep in index funds. Only buy real estate when you think you will be staying put for at least 5 years or are willing/able to take risk on prices going down.
And, I have to say, in my now extensive experience as a guest, weddings under 5K tend to be a lot more fun for the guests than weddings over 20K. Just saying.
The nice thing about non-retirement savings is that you can do whatever you want with them.
I do disagree with Tyler about saving for a house before maxing your 401(k). In fact, I’m surprised he can’t do both given what he’s posted about his income/frugality… 100K seems small comparatively. While it is true that for far too many retirees the primary or only form of retirement savings is the house, if you have enough discipline to put 5K/year to a ROTH on a TA stipend, you can save for both retirement and a house on your real salary. 401(k) limits are just not high enough to not take advantage of the entire thing, especially if you don’t have access to a defined benefit pension. On top of that, while you’re in graduate school you can’t contribute to a tax deferred plan other than the IRA, so you’ll be starting late once you graduate and are employed. Of course, NOW you don’t have access to that kind of tax advantage, so you just want to know where to put general savings.
Btw, you can contribute to this NEXT year’s Roth now too if you haven’t yet.
p.s. Agree with #5 Emergency fund! Savings account or ladder CDs. This is for when the student office messes up your paycheck, or you have transportation problems, or reimbursements come slowly etc. (You’ll have to fund most of your job market interviews and get reimbursed, for example.)
January 8th, 2010 at 9:00 am
I believe there are tax-sheltered bonds you can invest in - for states and municipalities?
January 8th, 2010 at 9:01 am
OR “TIPS” which are inflation-protected bonds
January 8th, 2010 at 9:08 am
Assuming debts or cleared and savings are in place…
What about CD ladders? I know they don’t generate the greatest interest…but they are safe and you’re money will be there in a couple years.
Invest in social lending…a little risk, but higher return. I haven’t used Lending Club for this yet so I’d be interested to hear from others that have…is this really a viable option?
If you use ING create sub-accounts for future house and marriage.
Keep up the good work!
January 8th, 2010 at 9:13 am
I love blind assumptions that people who are able to enjoy life today are in debt.
It is possible to live and save at the same time. I used to be of the mindset stash all our money now and enjoy it later. But I realized something. I want to enjoy life both now and later and we’ve figured out how to do it, without being in debt.
In my area estate sales and auctions are published in the paper after someones death. If you were to attend one of these event you would see people’s life possessions being auctioned off at deeply discounted prices and complete strangers pillage through belongings seeing what they are going to take home with them. The possessions people have worked their entire lives for are carted off in cardboard boxes by strangers who brag about the bargain they got over cheap coffee and stale cigarette smoke at the coffee shop the next day. After taking an estate planning class last year and learning that most people who inherit money blow through it in less than eight months and the typical question asked to trustees isn’t “How can I best use the money?”, but “How fast can I get the money?” I’ve decided to enjoy life (and I can do it without being in debt).
I’m trying to treat my life and income like a week at the fair. I’ve arrive each night and have tickets in hand ready to use them. I am surveying the rides that will bring me the most enjoyment and will spend the entire week enjoying the atmosphere, the rides, the food, the experience. I’m not going to wait until the last night when all rides are half price waiting for a perfect time to spend my money and try to burn through them all before the fair closes. Knowing fate, I’ll have waited until the last few hours of the fair to get that “killer deal” and the rain clouds will settle over the midway and I’ll be left with a handful of tickets that are worthless!
January 8th, 2010 at 9:20 am
I’m guessing Jeff has no debt to pay off. I’d also be willing to bet he has some sort of emergency fund. If nothing else, the ROTH IRA can act as a sort of worst case emergency fund too. After five years, he can withdraw the principal tax and penalty free. Any income is tax deferred until he meets the normal withrdrawl requirements.
So, what other investment choices are there in this situation. What is the goal for this money? More retirement savings? Extra emergency savings? Down payment on a house? Dream vacation? I’m not sure, but I’d like some liquidity while I figure this out?
I think it is still important to have some kind of goal, because it will affect your choices.
Some ideas:
Micro loans: Do some social good as well as invest. Check out http://www.kiva.org among others. Loans can be for as little as $25.
Laddered CDs: Compare rates to savings accounts, which are more liquid. If the money can be only somewhat liquid, you could ladder in 6 month increments over two years.
Tax exempt or tax free bonds or bond funds: I’m wary of funds unless they are low cost index funds. I’d be inclined to shop for individual state or municipal bonds and look for some tax savings.
Some other ideas:
Fund a parent’s or a family member’s ROTH - Make it a gift and fund their ROTH. All the income tax savings as before. And if they don’t need it, well…you just might get that money back tax free.
Donate to a worthy cause - because life isn’t all about money and there may be a tax break.
January 8th, 2010 at 9:23 am
One thing that nobody has mentioned is that you should ABSOLUTELY NOT put money in the exact same investment in a taxable account and an IRA. The reason is that doing so may cause you to get hit with the “wash sale” rule when you sell the investments in the taxable account, if you also bought some of that investment in the IRA (including via automatic dividend reinvestment.) It’s fine to have similar investments (say, an index fund based on the Dow US Total Stock Market Index in the IRA, and one based on the Wilshire 5000 in the taxable account). It’s questionable to have two funds that track the same index.
January 8th, 2010 at 9:42 am
A couple clarifications in reply to various comments above:
1. Contributions made to a Roth can be withdrawn tax-free, penalty-free at any time. No need to wait 5 years. (Though there is an exception for amounts converted from a traditional IRA to a Roth IRA.) It’s the earnings in the Roth that have hoops you have to jump through.
2. After maxing out a Roth in a given year, you cannot contribute to a traditional IRA.
January 8th, 2010 at 9:56 am
If you’re thinking about getting married, either save up for some premarital counseling, or find a pastor or someone who will counsel you for free. Financial incompatibility wrecks a lot of marriages.
If you can’t find a job in your field, try to do some kind of a sabbatical year for yourself.
January 8th, 2010 at 10:02 am
What was with me an the exclamation points last night? Look how many I included in this post! And I generally hate them! I must have been very excited!
January 8th, 2010 at 10:13 am
To the recurring theme of an emergency fund, very good point. I’ve got a good 5-6 month’s set aside in an ING account. But to TosaJen, I like your advice about saving up for expected, but not-as-common, expenditures, too. I’ll be going on the job-market before long, and that will involve a bit of traveling around, not to mention the move, itself. So I’ll definitely set up some dedicated savings accounts for that.
To John Schilling, who suggested saving up for 2011’s fund, I happened to fall into that this year and it worked out well. I sat on all the dormant money I had after maxing out my 2009 IRA, and as the year rolled over I was able to put it towards 2010. But doing that for next year, but on purpose, is a good idea.
I’m still pouring through the comments, but great stuff so far!
January 8th, 2010 at 10:24 am
I don’t think you need to seek out ways to spend money to be happy. You can be happy and content with what you have and ways to spend it will present themselves later. We are programmed to want an increasing standard of living as life goes on, so there is absolutely nothing wrong with saving a larger percentage of one’s income while young and spending more later.
Another point: The poster doesn’t say what he is in graduate school for… but I would personally not save for travel because during my graduate career and after I have had many chances to get that travel partially or fully reimbursed by my work for conferences or giving talks. In fact, I’ve had so much travel this year that I’m pretty burned out on it (as much as I enjoyed the trip to Europe this year and the resorts across the Southwest). Why spend money to go to Lisbon when someone will pay you to go to Madrid, especially when you’re on a TA salary?
It is true that you don’t want to die miserable and wealthy, but that doesn’t mean you have to go to the opposite extreme early. Saving while you’re young gives you a lot more options later when you’re in a position to enjoy them. As a graduate student, living it up generally means going out to eat or drink, buying theater tickets, or upgrading to a nicer apartment… take small pleasures now while they still mean a lot. If you’re happy with your life now, there’s no need to seek ways to spend your money. There will be more money in the future, and if there isn’t it is nicer to have a cushion (and the ability to eat meat if you want) than to have memories you can’t afford to repeat.
January 8th, 2010 at 10:48 am
Not much info to work with, but if it looks like a home purchase is in your future I’d save for that. If it doesn’t happen or your priorities change you can reallocate later.
My wife and I did something similar 4 years ago to what Tyler is doing - cut back on retirement to plow as much as possible into our downpayment fund so we could do it right - 20% down. We bought the house in July. We’ve considered continuing that path by aggressively paying down our mortgage to get a guaranteed 5% on our money.
January 8th, 2010 at 10:54 am
Jeff, nice work on building up a 6-month EF & maxing out your Roth, that’s no easy task. However, I am assuming that you will have some school loans to contend with after graduation. If this case you are going to have your hands full savings up for an engagement ring, wedding, down payment and school loans.
The number of upcoming expenses you are about to face is going to increase dramatically. For short term savings don’t even think about the stock market, it’s too risky. Plan on setting up a high yield savings account or you could ladder cd’s for slightly better interest. The low interest rates are frustrating, but it’s better safe than sorry.
January 8th, 2010 at 11:11 am
I love how somebody thought Tyler K’s 100K down-payment fund “wasn’t that much.” He wants to buy in this lifetime, and 100K is 20% of 500K. He’s still going to be working after he buys that property.
I’m “only” planning on 75K - for 20% down and move-in upgrades on a targeted 300K property - but let me assure you, if you are also paying down debt (as we are) and paying high costs of living (as we are), it’s a real stretch to do both.
“Maxing out” is $16,500, or $1375/mo. That’s only going to be possible once the down payment is fully funded. IMO, having a paid-for residence at retirement does so much to reduce income needs *in* retirement, that the 401(k)is a less urgent focus. For now, I contribute enough to qualify for the company match.
Re: Jeff’s question: I’m with the save for loss of income people. A year’s worth of living expenses saved up will take a real load of anxiety off if he doesn’t find a job right away, and if he DOES, it’s a great wedding/house (or world travel) fund. Win/win.
January 8th, 2010 at 11:39 am
I agree with most of the advice given here. If he needs the money in 2-4 years, the stock market probably isn’t the safest place to put his money. But if he is willing to take the risk, then he can go that route.
Like others have mentioned, there’s no mention of an emergency fund. The general rule of thumb would be to build enough cash reserves to cover six months worth of living expenses.
If he does have the emergency fund in place, then CD’s could be an option. I’ve seen rates at 3% for a 4-year CD that are out there now. And if he’s willing to jump through a few hoops, reward checking accounts are offering about 4% currently.
Regarding John’s comment(#4), I like the idea of saving ahead for next year’s IRA contribution. But rather than depositing the entire $5,000 early on in January, how about investing it throughout the year (dollar cost average) to ride out the market ups and downs?
January 8th, 2010 at 11:44 am
@42. Wasn’t that much FOR TYLER. He makes considerably more than I do, has been in the worforce longer, and has reported that his fixed expenses, even in Santa Clara, are pretty low. It just seems odd that he can’t both max out retirement and save 100K for a down payment in a short amount of time. Maybe he just doesn’t like the options in the 401(k) plan, but that would be a preference, not a constraint.
January 8th, 2010 at 12:11 pm
Since his employer doesn’t offer a 401k/403b, can’t he open his own IRA and deduct the contributions?
January 8th, 2010 at 12:13 pm
I’m not going to say what “Jeff” should do because there is too little information to go on. I can say that I was in a similar situation (grad school, the sciences, which are well funded and does not come with loans when living below your means) and I saved all my money in a simple bank account. The reason was due to the high likelihood of an international career which makes retirement accounts a hassle (imagine having them in three different countries). Since I spent all my time in my office, I managed to save a lot of money, relatively speaking around 75%-80%. This was due to a lifestyle choice. My other colleagues had apartments instead of a dorm room and went out to restaurants all the time so not everyone chooses the same way. Later I took my savings and invested them in stocks to provide a living income although initially that money was for a house (not just down payment but the full payment). I think my former grad school colleagues are still working for a living and enjoying life when they’re not at their jobs. So it depends on what you want. If you want to use it for a wedding party or a house, save it in cash.
January 8th, 2010 at 12:31 pm
The emergency fund really depends on the field. There are some where people get jobs right out of grad school with good salaries, some where people struggle along as post-docs for a couple years and may or may not wind up with a real job, some where a large percentage of graduates are never going to be able to work in their field because supply exceeds demand. If he’s already got someone lined up for the wedding and will need to find a job in a place where that person has or can find a job, that also has an effect on how long the search is likely to take and whether he’s likely to have to settle for a lower-paying job than ideal. But Joshua does have a point. In Jeff’s future career, money is likely to be easier to come by than time.
January 8th, 2010 at 1:17 pm
I don’t have specific advice for Jeff: It looks like it’s all been said. I would like to ask why so many people think that 20% is the maximum that should be put down on a home, and that more $$ available as downpayment automatically = more expensive home? Best advice I can give anyone is don’t buy all the house you can possibly afford. Don’t be a slave to your home. Buy a conservative home and be able to afford dinner out, tickets to a sporting event, the ballet, or whatever trips your trigger occasionally. Much more fun than being imprisoned at home because you can’t afford to go out. BTW: Smaller home = less furniture to buy, less to clean, lower utilities, lower taxes, etc. etc. etc.
January 8th, 2010 at 1:35 pm
This is a great post, and the comments have been excellent as well.
I concur strongly with Chett. Jan, it’s rude and false to assume that anyone that wants to enjoy life today is in debt. In fact quite the opposite - I would argue that the whole point of getting to the final stage of personal finance (as JD describes it) is to be able to enjoy the here and now without having to go into debt. As Chett described so bleakly, you can’t take it with you. Once you’ve done the responsible things with your money (e.g. the things that so many have outlined above), it’s important to find a balance that allows you to enjoy what you’ve earned (and share it with others). Remember what Dave Ramsey says: if you’re willing to live like no one else today, one day you can live like no one else. Not everyone arrives at “one day” at age 65; for Jeff, he may be there already - good for him!
January 8th, 2010 at 1:45 pm
I’d contribute some money to dig wells for people who are dying for lack of clean water. Or buy some bednets for children in malaria-infested countries. Thousands of children die each day because of very easily preventable diseases. Perhaps it is time to consider helping them.
January 8th, 2010 at 1:52 pm
@Jaime -
If you want to persuade others to share your point of view, try a little honey, sugar.
January 8th, 2010 at 2:21 pm
@Debi:
I completely agree with the advice regarding purchasing a conservative home. Buy a super affordable house you can live with, then do just that. Live.
January 8th, 2010 at 3:11 pm
I think the best thing to do is to start your own business. You can increase your income and decrease your taxes.
January 8th, 2010 at 4:17 pm
Wow… 53 replies already… I can’t read them all..but I agree with the few I did make it thru… meaning it would depend on the rest of the situation. Debt reduction, Emerg Funds, should be first. Saving for next years contribution early is a big bonus. That way future money can be targeted to a Wedding/House/Vehicle paid for with cash.
If all that stuff gets taken care of … starting some kind of side business is a BIG bonus. It’s on my 5 year plan.
January 8th, 2010 at 4:28 pm
One thing that came to my mind was opening a college savings fund to start saving for his future child’s education.
Many of them do offer various tax advantages. I am not sure if that is up your alley, but it is something to consider.
Best,
Tomas
January 8th, 2010 at 4:49 pm
If I were Jeff I would start a CD ladder going to save for short term expenses at slightly higher interest rates.
January 8th, 2010 at 4:58 pm
@Lise (#56)
I love the idea of a CD ladder. I think that’s the best idea yet. It gives Jeff some flexibility, while also allowing him to chase higher interest rates. (Which, admittedly, are still pretty low right now.)
January 8th, 2010 at 5:29 pm
Eliminate high-interest debt, go to the casino and have some fun.
John DeFlumeri Jr
January 8th, 2010 at 5:36 pm
WRT CD ladders, slightly is the operating word. Perhaps even miniscule. I think all CD rates up to several years out are below the inflation rate. What is the point of locking in negative return rates?
January 8th, 2010 at 6:00 pm
A high interest checking account–you can find some earning as much as 4%
January 8th, 2010 at 6:38 pm
JR: Why not ask for more details before posting these questions? Waste of time otherwise.
January 8th, 2010 at 6:51 pm
Assuming he is serious about a wedding and without additional details…
1) Emergency funds first
2) Save for wedding
3) Invest with anything beyond
January 8th, 2010 at 7:42 pm
@Nicole:
Trying not to overdo the details too much, my expenses look roughly like this:
Out of my (pre-tax) base salary, roughly 20% goes directly towards my 401k and house savings. Over 30% goes to taxes. 17% goes to rent.
That means about 70% of my base income is accounted for with just those things, and there are other, shorter-term smaller things I save for, like vacations. I put about 5% of my base salary towards vacations, about 8% is my wife’s allowance, 2% is medical insurance.
That leaves 15% of my base salary for everything else, like food and clothes and gas.
Could I max out a 401k *and* keep putting $1250/month towards the house down payment? Probably, but it would definitely require me to start skimping in other areas to the tune of nearly $1000/month, which would make things tight. I’d probably have to cut out vacations, or tighten my wife’s allowance, and I’d have to give up on new equipment for my hobbies (surfing and cycling).
It’s possible, but it’d require more sacrifice than I’m willing to make right now. Just because I’m not saving as much as is possible doesn’t mean I’m not saving enough.
Also, none of this includes less-predicatble forms of payment, like annual bonuses and stock awards. Those come in big chunks and are handled differently. I expect most of those to go towards the house down payment fund in the next couple years, because at $1250/month, it’ll take almost 7 years to amass that $100k goal, and that’s longer than I want to spend. In reality, including all my bonuses and stuff, I expect to put between $30k and $50k in to the house down payment fund in 2010.
Not that anyone needed that level of detail on my finances.
January 8th, 2010 at 8:35 pm
@60 Heh, yeah, good luck finding that 4% interest rate nowadays.
I opened an HSBC savings account a year ago at 3.4% (I think), 4 cuts later, it’s down to 1.45% (then again, inflation is really low right now, so it’s still serving its purpose).
January 8th, 2010 at 10:30 pm
After the emergency fund is secure and he’s spent a little money on himself (you have to live it up a little bit), I would consider a regular taxable (single account). Instead of mutual funds, I would lean more towards ETF’s. Primarily, they should give him less of tax burden (which I know isn’t much since he’s in school, but every little bit counts)since most ETF’s have lower portfolio turnover and therefore should pay less capital gain distributions at the end of the year. This will become more economically viable as he ages and the account and his income grows.
If he does lean more towards bonds (funds or ETF’s) be careful to not get any too long term. When interest start to spike, he may see an unexpected drop in principal. Stick to short term to intermediate bonds, at longest.
January 9th, 2010 at 6:23 am
For any short-term goals he may want to check out http://www.smartypig.com as they are offering 2.01% interest which is higher than ING and others. They also specialize in compartments for your saving goals. Just a thought.
January 9th, 2010 at 9:10 am
Assuming that Jeff has no debt and is in a PhD program:
It’s a good thing he’s got 5-6 months of expenses set aside, but I might suggest he bulk that up even more, actually. Given what the job market in academia is like in many fields right now, a hefty emergency fund seems absolutely crucial to me. If, like many grad students, after graduation Jeff winds up moving from visiting to visiting position for a couple of years before finding a tenure-track job, this will generate lots of moving expenses, not all (or much) of which will be paid for. If, even worse, he winds up having to cobble several adjunct teaching gigs together for a year or two to make ends meet, he may not even have health insurance, in which case an EF is doubly important. 5-6 months worth of current expenses will work for a while if he can stay where he is now while he’s looking for a tenure-track position, but in case he can’t, it’s better to have as much set aside as possible.
Once Jeff has a tenure-track job, his EF target should shift to cover 5-6 months of his new expenses. Then start saving for down payment/ wedding.
January 9th, 2010 at 11:48 am
I did this while I was in school. I’d max out my Roth and put it in something with very low volatility (usually a short-term US Treasury index fund). Then if I needed the money, I could tap it without having to worry about taxes, penalties, or the money not being there.
Once I knew for sure that I wouldn’t need the money, I moved it into other, higher-risk investments.
Found more info here:
http://www.rothirarules.net
January 9th, 2010 at 12:12 pm
@66 Miraj, I checked out SmartyPig and started an account. I was annoyed, however, that you can’t set up automated deposits from two separate accounts for one goal. I have checking accounts at two different banks, and I wanted to put in money from each checking account, but one has to be done manually each month.
January 9th, 2010 at 1:07 pm
I like the advice to live it up a little, although if Jeff is thinking wedding, he probably has a lady in his life (or a gent!) and may not be interested in the hot Greek coeds per se. I also think that charitable giving is an awesome thing to do with your money that can give you what money can so rarely buy - a sense of purpose and connection to others.
As someone who spent 3 months job searching out of grad school and then ended up having a nightmare job, quitting, and spending ANOTHER 3 months job searching, I also would urge him to set aside a big chunk of money that he can access to last him longer than he thinks he’ll need.
And to the comment that people who recommend having fun with your money are in debt, that’s a jealous and bitter attitude and not very helpful now, is it?
January 9th, 2010 at 4:20 pm
Hey J.D.– I searched and discovered that while Your Money and Your Brain by Jason Zweig has been mentioned quite a bit here in the 2 years since it came out, you’ve never reviewed it. How ’bout it?
Matt
January 9th, 2010 at 4:32 pm
Exchange your USD for EUROs , Swiss Francs and maybe Yens.
January 9th, 2010 at 4:47 pm
@Handworn (#71)
Sounds like a good idea. I referred to Zweig’s book heavily during the writing of a few chapters of my own. It’s good stuff, and I ought to give it a complete read and review — you’re right.
It might take me a couple of months to get to it, but I’ll make a point of doing so…
January 9th, 2010 at 7:11 pm
Jeff sounds like he is in a good position. If he has some short term savings needs, then he should put aside a portion of his extra funds to meet those goals. However, he needs to evaluate the posibility his of retiring early. I think 59.5 is the earliest you can take money from an IRA, so if he plans to retire before that age then he will need some retirement money aside that is NOT in an IRA or 401-K. I like bonds for this purpose (non-taxable ones are best, save the taxable bonds for your IRA). Since a bond mutual fund is also a conservative investment, once it gets large enough, it can even do double duty as a higher-yielding source of emergency funds. I max my IRA, and ever since I reached my goal for my emergency fund (which consists of 2 savings accounts and 6 CDs), any new savings I acquire have been put into a bond fund. Once I have about 25-30K in that fund, I then plan to reduce my traditional emergency fund by about 50%.
January 9th, 2010 at 9:33 pm
For starters I would check out reallocating his Roth IRA (if not already done) to more small cap and small cap value funds such as Vanguard’s excellent small cap or small cap value indexs, and emerging markets and international funds (again from Vanguard if available). The Roth IRA is non taxable and these sorts of potentially rewarding funds are not tax-efficient, thus perfect for the Roth IRA if long term gains are sought.
And then I would take any money that can be saved beyond the Roth IRA and start building the taxed investment account using the same service (vanguard for vanguard, fidelity for fidelity, etc). I would invest using more tax-efficient index funds like vanguard total stock index or 500 index (it is tax efficient because these are large cap stocks). You can also buy treasury bills on your own or invest in short and intermediate bond fund. In any case, you want to buy and hold outside of your Roth IRA as well, and think of your Roth plus your taxed investment account as one meta-portfolio, made up of different parts but leading to a better outcome overall. I recommend using a couple of books to learn more about this type of strategy: William Bernstein’s The Four Pillars of Investing and Bill Schultheis’ The NEW Coffee House Investor. Good luck and never stop learning!
Shane
January 9th, 2010 at 10:12 pm
@ Chett and Sarah
Not jealous or bitter. I believe there is a balance. I don’t believe you should just go out and blow money when you hit goals. Since I have traveled more than most, own my home, raised my kids
and enjoy my job AND am without debt— jealousy does not come into play. I do see so many go right back into debt with the premature celebration ball. Did I hit a nerve?
Completing grad school is not landing that six figure job it could have been in the past. I have several nephews who are struggling. The only ones who are in the military or pharmacists.
I like the laddered CD’s. One credit union in my area is offering a one year 3.6% CD. I looked on line and found a good company offering a corporate bond for about the same amount. They are out there- you just have to search.(I do miss the days of much higher CD rates- but they will be back:>)
January 10th, 2010 at 7:16 am
@69 Shiela, Hmm I am sorry I didn’t realize that, but you could provide feedback to them as they are trying to improve their service. I only have one checking account so I didn’t notice that issue. My suggestion is for you to create two separate goals for each account and you could merge it manually once the goal expires and you withdraw the cash. I still think it’s a great deal @ 2.01%. Would be interested if anyone has a better deal (interest rate wise) with 0 hoops to jump around and that is not temporary?
January 10th, 2010 at 3:47 pm
I’m wondering what kind of health insurance he has. I ended up having to get my own right out of grad school, as I ended up in a different state where the company who administered my policy couldn’t operate. I ended up with a high-deductable/HSA plan, and needed to quickly max out the 3000 contribution limit for a single person. This wasn’t horribly difficult to do, but putting aside 3000 in the eventuality of needing to do this isn’t an awful idea. As it was tax deductable, this was my number one priority. Once he does that, I suggest looking at municipal bond funds, or investing. I’d lean more towards the muni funds because of the tax benefits they provide.
January 11th, 2010 at 3:12 pm
1) From the little I know about it, I wouldn’t suggest it, but I’d like to hear what others have to say about it. Is it ever a good idea to put money the extra into a whole/universal life policy?
2) If Jeff is interested, he could start saving up to buy and manage rental property.
January 12th, 2010 at 12:12 pm
sigh…
if you’re going to buy a large amount of cd’s, or bond funds, you should buy them in your IRA account, and keep stock index funds in your non-taxable account. it sounds counter-inuitive at first, but it can really add up. interest from the cd’s and bonds are taxable as ordinary income, which for most people is higher than the long term capital gains, or qualified dividend rate. so what if you want to use the cash or bond fund in your IRA? sell your stock index funds in your taxable account, and at the same time rebalance your roth IRA. for example, if you have 10k of vanguard 500 in a taxable account, and 20k in your roth IRA consisting of 10k in money market funds and 10k of vanguard 500. you need 10k of cash. you sell the vanguard 500 in your taxable account, and the same day, you rebalance your IRA to be 20k of vanguard 500 and $0 of money market fund. you pay the long term capital gains tax on the taxable account and no taxes on the stuff in your roth IRA.
so point is, if you want to keep money for short term goals, you can buy stock funds in your non taxable account and then buy more stable funds in your Roth IRA, and it will be more tax efficient that way. (assuming you keep the stock fund in your taxable account longer than 1 year)
January 12th, 2010 at 4:09 pm
Personally, I tithe first, then still have money to max out the IRAs… so I’d consider that always, giving some of the money and your time to help others. It feels good, and I think God honors it.
Financial planner, $250+, might be a great call to help you.
Yes, debt payoff is the best guaranteed return, and emotionally hard to beat!
If debt is paid off (and not deferred, student loans being what they are…) you might try other things.
Practically, when trying to decide where to park the same money, having looked at 529 Plans (and I’d mention that if you haven’t thought about it…) for just a good parking place, that would justify the return… after that it was tough looking around for something that would be accessible, but also return something with a limited amount of risk…
I found 18% return this last year in a high yield (read Junk…) Vanguard Muni-bond fund (571 issues, meant even if a particular city defaulted… there would be income, yield was 4-5%, and was tax exempt/free… so imagine I’m looking at CD’s which pay only 2%, and you get nothing usually if you pull it out to soon, vs. keep it for a year, need it, free withdrawal anytime, and earn (past performance no indication of future) 4-5% without taxes — in your bracket, perhaps only 1%, say 6% in real terms… now, it could also have gone down. Not nearly as risky as stocks (we learned that) or Corporate junk bonds… 40%!
However, as some have pointed out, if you take a loss and want to use the money that’s left to pay into a Roth, you had better understand the wash rules. Likewise, as some have pointed out, using a different mix outside the Roth from what you have in makes sense.
My logic was — security, security, security, it was Nov 2008, and I wanted to get some kind of return, even if the fund had lost money that year — and it had as part of the general flight of money to US treasuries… however, outside of taxes, what did it offer — better/wiser heads at Vanguard doing the picking vs. buying a single issue myself… too much work. Overtime, the particular fund’s returns had not been spectacular, but steady, and way more than any fixed rate security would return… little more risk… but would they default when now with the government bailing out and stimulating everywhere… and interest rates lower than the yield, ability to raise taxes, etc.
18% return is wonderful, but at the same time, the International ETF and directed ETF I purchased returned in some cases 73% — it was a weird year.
Don’t chase returns, but consider the big picture… what do you need the money for — if it’s past the 6-9 month expenses fund, then you really have freedom.
If you can hold it for a year, the taxes become not your normal rate, but 15%, but also realize the ETF or mutual fund can pass on expenses to you… Capital gains, something that one can ignore in the IRA land.
So, with any thing you plan to do, spend some of the money and your time learning more about how what ever investment works, and then be thankful you have the chance to plug more money into the game.
Dave Ramsey & other courses come to mind, if you’ve not already taken them…
I could also mention sector funds, etc. but here’s the thing, past performance is no indication of future returns… let that seep into your brain, and then find out if you’ve done the rest
1. give
2. debt
3. secure return (for smallest part)
4. risky but greater chance of better return
I just looked at it as a parking location which I wouldn’t have to worry about the yield being taxed… but if I had taken more risk… I could have paid the taxes and had a better return… however, there is also the ability to deduct losses on taxes yearly, sell, and move the investment into something else… painful, but a choice.
Note I don’t suggest an individual stock… we played that game as well… my son’s pick did much better than mine, he was up 25% (notice about the same as a market index…) my pick stayed flat! My wife got to pick two and they still didn’t do as well as the index, and the commissions are going to further reduce the benefits vs. buying a mutual fund — if one has $3000 to start, or perhaps something like sharebuilder.
Go back and look at your needs, the 3-5 years from now need, vs. sooner, 1-2 years, and go from there.
There are many, many more exotic things, but what I’ve seen for someone like yourself, is your time spent trying to decide, watch, manage, etc. isn’t likely to be justified for the size of the account. Find something that’s easy to contribute too — and the more autopilot adding you can do (CDs don’t lend themselves to this…) the better.
Thx.