Investing 101: Buy Low, Sell High {via The Rich Life}

Investing 101My favorite finance professor in college once gave me the sagest of advice: When it comes to investing, buy low and sell high.

So there you go – that’s it!

Okay, I’m just kidding… kind of.  Let’s talk about that. People get really nervous when it comes to investing. They think to themselves, “I don’t know anything about the market – I can’t invest! That’s for professionals.” And while it’s true that there are plenty of professionals out there to help you (for a nice fee), it’s not true that you can’t do it for yourself. I’m looking at you, Ms. English Major: You’re perfectly capable of doing this for yourself.

Whether you choose to get help or not, investing is a must. It’s the only way your money has the chance to grow significantly. We’re not talking just keeping up with inflation, we’re talking making a return that will give you a healthy and stable financial future.

And yes, there is risk. The greater the risk, the greater the potential reward. That’s life, and that’s also why any money you invest should be money you’re comfortable not seeing for at least a few years – my general rule is five. (For a recap on your option for investing in the short term, revisit this post.) And now, the rules… Continue reading

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When Life Happens: Reassessing Your Budget {via The Rich Life}

When Life Happens Reassessing Your Budget

*Each month I contribute a personal finance column to The Rich Life, an online community for the practice of living a rich life with less stuff. Here is this May’s contribution.

Moving is a funny thing. There’s the excitement – that’s real. And the determination to make the most of it: new friends, new bucket list, new brunch spots… sign me up. Then there’s this cool thing I hear the river does in March, when it turns green to celebrate St. Paddy’s Day, and city-dwellers come out en masse, crossing their fingers for an ease into spring. All right, Chicago, I’m in.

But there’s also the anxiety: Will I make friends? Is rent in the Windy City sky high? What exactly is a “down” jacket?

And, of course, the logistics. Little stuff, like changing your address with the bank, and larger, looming tasks, like packing up your kitchen.

Fortunately, it’s taking care of this logistical stuff that eases my anxiety around all things down jacket. There’s nothing like taking care of what’s in my control to feel like the rest will fall into place, and one of my largest tasks over the next few months will be to accurately reassess my budget.

Budget reassessment is the process of taking a good, hard look at my spending so far this year, project the expenses I expect, and changing my budget if need be. This is an excellent tool for someone undergoing a big change, like me, but really important in general as a way to stay on track.

So, whip out your budget , and let’s get going!  Here’s how:

Where to Stash Your Cash: Long Term {via The Rich Life}

Where to stash your cash long term edition

Hey everyone! As you know, I’ve been contributing monthly to The Rich Life. I want to share that with you, so here’s today’s post! 

We’re finally here – the long term. Remember back in December when I talked about the magic of compound interest, and how it would give us the ability to live the rich life, if only we would hurry up and get to investing? I hope you were picturing yourself, because you’re here, and that time is now.

Most people think of today’s topic – where to put your long-term savings – as the crux of personal finance. And in many ways it is: You’ll certainly have a harder time getting to your worry-free golden years without a 401(k). But you can only do this if you do it right, by first living below your means (something I’ve struggled with), saving cash for an emergency (something I’m still doing), and thinking through your needs.

Got it? Scout’s honor? Okay, then let’s get to it…

When investing for the long term, there are three rules:

Rule #1: Don’t invest money you’d like to see any time soon. By “soon” I mean 5 years minimum, but ideally 10, 20, 30, or 40 years down the road, depending on how old you are. You’re investing for the long term, and you’ll be penalized if you withdraw this money early. If you need cash in the short-term, stick it somewhere else.

Rule #2:Don’t turn down free money (read: employer match). Your employer matches the first six percent of your salary? Then I expect you to be stowing at least six percent of your salary in that plan.

Rule #3: Max out tax-favored accounts before investing in taxed accounts. Long-term savings can be stowed in a tax-favored account, like an IRA or 401(k), or in a brokerage account, which is subject to taxes. Needless to say, take advantage of the tax breaks the government offers in the first two types of accounts before moving onto the third.

There are a few typical places for your long-term savings: namely, a 401(k) or IRA, each coming in both a “Roth” and “traditional” version.

A traditional 401(k) is a retirement account offered only through employers. This is a type of investment account in which you, as the investor, elect to contribute a portion of your paycheck to the account, which (at your discretion) is then invested – either by you or a brokerage firm.* A major perk of 401(k)s is that many employers match all or part of their employees’ contributions. This is free money and it is not to be turned down!

There are two special tax advantages to the traditional 401(k): First, your contributions are made pre-tax, meaning any money you put into the account is deducted from your paycheck before your income is taxed, saving you immediate dough. Second, money within this account can grow tax-free (meaning you can buy and sell stocks to your heart’s content without paying any capital gains tax) until you withdraw it without penalty at age 59 ½. At that point, you would pay income taxes on the distributions you receive as if they were ordinary income. The government sets limits on how much you can contribute to your 401(k), and in 2013 this limit was $17,500.

A less common Roth 401(k) is similar to a traditional 401(k), but the tax incentives are switched. Under a Roth 401(k), rather than using pre-tax money to fund your account, you put in post-tax funds (meaning you had to pay taxes on that income). However, at retirement you’re free to take your distributions tax-free.

Choosing whether to go with a traditional or Roth 401(k) depends on your view of your income tax rate now versus when you plan to withdraw the funds. If you believe your income tax rate will increase as you get older – due either to a bump in your income bracket or legislators raising tax rates – then a Roth is the way to go. If you want to save the tax impact now and believe your tax rate will stay stable or decrease in the future, then a traditional is right for you.

If you don’t have an employer who provides you a 401(k) (or even if you do – you can and should get both types of accounts if possible), you can open an Individual Retirement Account, or IRA, which can be opened through any ordinary brokerage account. I opened one for myself my senior year of college through Charles Schwab.

The IRA – both traditional and Roth – functions exactly like a 401(k), with a few key differences. The tax incentives of an IRA mirror that of a 401(k) – the traditional saving you money now and the Roth saving you money later. Unlike a 401(k), however, anyone with income can contribute to this type of account, making it the most accessible retirement account. Unfortunately, the contribution limit is just $5,500 per year – much lower than the 401(k)’s $17,500 limit. Finally, the Roth IRA is actually restricted based on income – those making over $129k cannot contribute to a Roth IRA.

Finally – and only after you’ve maxed out both of these accounts – you can put as much money as you please into your own brokerage account to invest how you want. Gains on these accounts are subject to hefty capital gains taxes, so only do this as a last option.

Good luck!

*For example, my 401(k) funds are invested under a Fidelity plan I’ve elected out of a few different options based on my risk tolerance. Since I’m young (and have many years ahead of me to recoup losses in the market), I have a high risk tolerance: The plan I elected invests mostly in stocks, rather than “safer” assets like bonds, CDs, etc. Alternatively, I could have elected to manage my savings myself, in which case I would make all the decisions about exactly which stocks to buy, sell, etc. on my own. We’ll get more into investing later.

Where to Stash Your Cash: Short-Term Edition {via The Rich Life}

Editor’s note: I totally back-dated this post. I drafted it up on my way to Honduras, and almost posted, but then vacation/relaxing got in the way (poor me!). 
Where to stash your cash short term editionWhen people ask me why I preach personal finance (…and let’s be honest, I may not get asked this so much as I tend to offer my opinion), I always come back to the basics: Too many of us don’t know what a brokerage account* is.Now, is a brokerage account the end-all be-all to financial literacy? Certainly not. But it’s a pretty great gauge, because if you’re the type of type of person who knows how or why you might open a brokerage account, then you’re likely putting your money in places besides, you know… the hole in your mattress, or (gasp!) a basic savings account.…Scratching your head when I say “brokerage?” Then this article is for you – let’s find you a new place for that cash.To do this, let’s first consider your monetary goals. Are your needs short-term, mid-term, long-term or (most likely) some combination of the three? (For a refresh on this topic, visit February’s article on “How to Allocate Your Savings.”)

Good! Now you’ve got that settled, we’re going to talk about short- and mid-term goals (long-term to be covered in next month’s post!). For these types of goals, the key is this: The sooner you need funds, the safer those funds need to be, and the faster you should be able to access them.

Money is safe when we can predict with certainty its value at the time we need it. Cash is an example of a safe asset. If I sock away $100 in my mattress (or better yet, a basic savings account), then that $100 will still be there a year from now. Compare that to the stock market – a less safe place for my money – and you can see what I mean: The $100 I invest in the stock market today may be gone in a year (though yes, it conversely may have tripled in value). The safer money is, the less return we get for it, but the more assurance it’s there when we need it.

Money is more accessible (a.k.a. liquid) the faster we can get it. The most accessible places for your money give you immediate access to your cash, like your checking account. The least accessible places for your money, like an invested retirement account or worse, a real estate investment, take time to convert the asset into cash you can use.

That said, here are the safest, most liquid places for you to stash your cash:

Checking account – Deposit cash into this account through your local bank. Access it via your debit card or checkbook. Most safe. Most accessible. No return.

How to get started: Open through your local bank.

Savings account – Deposit cash into this account through your local bank and earn a tiny return, so small it may not even compare to inflation. Most safe: Many savings accounts are insured by the FDIC, meaning your money is guaranteed by the government (up to $250k), even in the case your bank fails. Very low return.

How to get started: Open through your local bank.

Certificate of deposit (CD) – A bond, in which you (the purchaser) buy a CD for a price, and at the end of a short, fixed amount of time (called the maturity – usually six months, one year, etc.) you earn that price, as well as a bit of interest, in return. CDs are just as safe as savings accounts but a bit less liquid, as they are intended to be held until maturity. However, they do typically earn a little more of a return than a savings account. Good option for any money you have earmarked for withdrawal in 1-2 years.

How to get started: Purchase through your local bank or brokerage account. “Brokered” CDs can be sold prior to maturity.

Treasury bill / Treasury note (a.k.a. T-bill / T-note) – Bond issued by the government, which – similar to a CD – has a fixed maturity and rate of return. They are regarded as the safest investments, as the government backs them. Again, good option for 1-2 year investments.

How to get started: Purchase directly via http://www.treasurydirect.gov.

Money market fund – A type of investment account that lets you invest money in multiple short-term, low-yield and safe assets, like CDs, commercial paper and T-bills. When you deposit $100 into a money market fund, that $100 will be split into 100 tiny investments into various assets. The idea is that if one asset does poorly, then you lose just $1, but the other $99 will make up for it. (This is called diversification.) These funds typically earn a bit more than savings accounts and are a good idea for short investments (1-3 years).

How to get started: Purchase through your brokerage firm.

High grade commercial bond (a.k.a. commercial paper) – Bond issued by a trustworthy corporation. These are not FDIC-insured and carry a higher risk than T-bills or CDs, but are considered safe assets. These bonds mature in less than 270 days, making them a good short-term investment option.

How to get started: Purchase through your brokerage firm.

*A brokerage account is one you open with a specific type of bank that lets you invest the funds within that account. My Charles Schwab brokerage account lets me do this. So does e*trade.

 

How to Allocate Savings

spending-diet*Each month I contribute a personal finance column to The Rich Life, an online community devoted to the practice of living a rich life with less stuff. Here my February contribution. Find the rest of my series as well as contributions by other women on http://www.therchlfe.com.

Hi Rich Lifers!  And happy February to you!  First, I want to say that I am super inspired by every single one of you who have come out of the woodwork to report that you’ve started to budget.  Whether you’re using Mint, Quicken, the budget we provided here on The Rich Life, or another tool, you’re taking the steps to take control of your finances, and I love it!

So!  Now that you understand the time value of money, and now you’ve made sure to set aside some cash for the future, it’s time to figure out what to do with that cash: It’s time to talk about allocating your savings. 

When I say allocating your savings, I’m talking about big picture.  How much should you be saving for retirement, given your short-term savings needs?  And what about paying down debt?

We have a lot of choices with our money, but the rule we should live by is this: Earn the maximum return possible on every dollar you save. In other words, at the end of the year, you want to ensure that your money was in no better a place than where you chose to put it.

When determining how to allocate your money to earn the maximum return, it’s your job to split your savings among the following choices:
–       pay off debt (high interest or low interest)
–       save for short-term needs (e.g. emergency fund)
–       save for mid-term needs (e.g. down payment on a house)
–       save for long-term needs (e.g. retirement)

I wish there were a formula I could give you to determine this for you, but there’s not.  Factors like how old you are, how much cash you’ve built up and the stability of your income will all determine what your best allocation scheme is, and most likely it will involve contributing to more than one – if not all – of these accounts.

Here are three rules of thumb to guide you in these decisions.


Rule of thumb #1: Pay off high interest debt first.  I’m talking credit cards and in some cases (mine!) student loans.  Your goal is to earn the maximum return on your cash, and while counter-intuitive, sometimes that requires using that cash to pay off debt.  Consider this example:

Marie has $10,000 of savings to allocate, and she has $10,000 in credit card debt at an 18 percent interest rate.  She’s trying to save for retirement, and she wants to know how she should allocate her $10k – should she pay off her debt or invest in the stock market?  Let’s look at the following scenarios:

  • Scenario A: Marie makes the minimum payments of $25/month on her credit card, and allocates the rest of her money ($9,700) to the stock market at a 10% annual return. Here is a breakdown of Marie’s return for the year, under this scenario:

Screen Shot 2014-11-30 at 3.34.50 PMIn this scenario, despite investing almost $10,000 in the stock market and making 10 percent on those gains, Marie lost money, as the interest her credit card charged her was more than her stock market gains.

  • Scenario B: Marie decides to split her savings evenly between her credit card and her stock market investment, allocating $5,000 to her credit card payment and another $5,000 to her retirement fund.  Here is a breakdown of Marie’s return for the year, under this scenario:

Screen Shot 2014-11-30 at 3.39.04 PMIn this scenario, Marie earned $500 from saving on her credit card interest, combined with her stock returns.  However, keeping a $5,000 balance on her credit card still cost Marie $900.

  • Scenario C: Marie allocates all $10,000 to her credit card payment. Here is a breakdown of Marie’s return for the year, under this scenario:
Screen Shot 2014-11-30 at 3.42.00 PM
I hope you can see where this is going.  In this final scenario, Marie was able to earn $1,800 by saving on the interest her credit card would have charged her, had she not paid off that $10,000 balance.  Scenario C was the best place for Marie’s money.
*Note: If you’re asking yourself, “But what if the stock market had a blow-out year, and would have earned Marie a better-than 18 percent return?” then you’d be right to think that Marie’s money would have been better off in the stock market.  However, when making that decision, keep in mind the risk involved.  In this case, Marie knew her credit card company would charge her 18 percent interest, but she didn’t knowhow the market would fare.  Since a better-than-18 percent gain in the stock market was possible but unlikely, the rule of thumb still stands that it’s best to pay high interest debt off before investing in the market.

Rule of thumb #2: Save cash for an emergency.  If you needed $2,000 in a pinch, would you be able to scrounge it up?  Many financial advisors say that you should save between three and nine months’ living expenses in cash, just in case the worse happens.
Yes, that’s a lot of cash.  It is also the kind of investment that earns close to 0 percent return, as these kinds of savings typically sit in low-yield but easily accessible savings accounts.  Determining how much to contribute to this type of account is important, but it’s also a personal decision based on your circumstances.  If you have a stable job and no dependents, contributing as little as 1 percent of your income per month to your emergency fund might be fine.  Don’t trust your employment situation quite as much?  A larger contribution until you reach your goal is a good idea.

Rule of thumb #3: Split the rest of your savings between mid-term needs (like saving for a down-payment on a house) and retirement savings.  Again, there is no set percentage here, but make sure you take care of both these needs.  An expensive house isn’t worth buying if it means you’re eating ramen when you’re 80, but retiring when you don’t have a paid-off house (that has appreciated in value over the last 30 years!) may not be ideal for you either.  Take care of yourself.

I hope you’re able to make some really clear decisions about where to put your savings this year.  Until then, stay tuned for next month’s installment, when we get into the nitty-gritty of investment types.  Hurrah!

Budgeting for the New Year

Budgeting for the New Year

*Each month I contribute a personal finance column to The Rich Life, an online community devoted to the practice of living a rich life with less stuff. Here my January contribution. Find the rest of my series as well as contributions by other women on http://www.therchlfe.com.

It’s January, my favorite time of year.  The cold, the dark, the dieting… just kidding.  But really, it is my favorite time of year for one of my truly favorite activities: making resolutions.  My favorite resolution?  Spending less than my budget.

Remember in December, when we talked about all the wonderful gains you can make over time if you start saving and investing your money now?  Well, budgeting is the first and most crucial step to doing that.  It’s how you make sure you have the extra cash to hoard away, and it’s more importantly how you learn to live below your means.

As unsexy as it may seem, planning for my spending over the next year makes me feel really good.  It’s fun (this is a time to think about big purchases, like my 2014 vacations) and it also makes me feel safe, because I get to plan for both my needs (savings, rent, electricity) and wants (yoga, restaurant-eating, a new bike).  It allows me to make conscious decisions about all of these things, something that wouldn’t happen if I attempted to monitor my spending in the moment.

The rules for budgeting are simple: Know what you make, plan for how you’ll spend less than that over the coming year, and keep track of your progress.  If you fall off the wagon mid-year, use your budget to pick yourself back up!

My budgeting has evolved over the past few years, from nonexistence, to budget tracking (there were no limits attached to my spending, but I knew what it was), to the form it’s in now, a carefully thought-out set of limits for different categories I’ve devised.

While there are some really great online tools you can use to budget – the most common are Mint and Quicken – I’ve found that these forms are a little too passive for me, as I tend to look at the damage at month-end, when I’ve overspent, and feel like there’s nothing I can do about it.  For me, a manual approach in which I check my credit card activity once or twice per week (even daily if I have the time!) and enter that into an Excel workbook helps me see my spending in the moment and adjust accordingly.  In other words, it actually keeps me on track.

With this post you’ll find the budget I’ve created to help you (and me!) get through 2014.  Here are a few pointers to think about as you’re designing your budget:

  • If you’re unsure how much to save, a common rule of thumb is to set aside between 10 and 20 percent of your income for savings.  Last year I was able to save 16 percent and felt like a champion!  This year I’m going for a full 25.
  • When you’re planning your spend for each category, it’s a good idea to leave some income unallocated. The year will bring surprises, so having a sum of money set aside to capture these surprises is important.
  • Some budgeting categories, like food, are best calculated on a monthly basis (taking what you will spend per month and multiplying that by 12), while others are made up of several lump sums throughout the year.  For example, my “fitness” category is the sum of my annual yoga membership plus quarterly fees I’ll pay to use a local swimming pool, plus the $125 I’m likely to spend on new athletic shoes at some point this year.
  • If you’re having trouble budgeting under your income, really think about needs versus wants and your own priorities. (Based on personal experience, I’ve found “clothing” is an easy category to cut down on.)

Be sure to read the instructions tab before you get started.  Happy budgeting!

Click here for my 2014 budgeting template! (Make sure to download as an Excel file.)

Don’t be stupid: Save smart

free-ways-to-get-an-education

*Each month I contribute a personal finance column to The Rich Life, an online community devoted to the practice of living a rich life with less stuff. Here my inaugural contribution. Find the rest of my series as well as contributions by other women on www.therchlfe.com.

I’ve been pretty smart and really stupid with my money.  In 2008, the fall of my senior year of college, I wrote a diatribe in The Daily Texan railing against my university’s lack of personal finance education.  I extolled the virtues of saving, investing, and knowing the difference between a 401(k) and Roth IRA.  I mocked everyone who hadn’t yet started to save, while I busily invested my money in index funds.  And then something funny happened!

I moved to New York, and my dream of maxing out my Roth IRA vanished.  Suddenly bills got the best of me – it’s common thought in NYC that paying a full half of your salary to rent is “okay” – and without even realizing it, I spent the next three years slipping out of my savings mentality and into debt.  It was slow at first, and because I had some built-up cash, I didn’t feel it.  Not until it was too late, and my spending patterns were ingrained.

I wasn’t trying to live the life.  I wasn’t spending my time in the Meat Packing area going to new clubs, nor was I indulging myself at expensive restaurants.  I was buying all the things that felt normal to me – groceries, the occasional meal out, a gym membership, taxis when I was particularly tired – but it wasn’t until a few years later, $3k in debt, that I realized those “normal” things (plus half my pay in rent) were beyond my means.

So here I am, lecturing this simple calling: Please don’t be stupid.

In this series, I’ll talk about ways to avoid being stupid.  These are not get-rich-quick schemes; they are bits of practical advice and ways to understand how to deal with money so you won’t have to worry about money.

In this article, we start with the why: Why is it important to start saving now, pragmatically speaking?  In our next few articles we’ll cover how to save by not spending (read: budgeting), and then we’ll explore what to do with all that cash you’re hoarding (invest!).


The Fundamentals

You should have started saving in high school.  Sorry, I know it’s not fun to be told that you’re late.  I’m with you.  But seriously…

When we talk about saving, the most important factor is actually not how much you save, it’s time. Time is the difference between relying on your social security check at retirement, and not worrying about your social security check. It’s the difference between leaving wealth for your kin and worrying that they’ll have to foot your medical bills.

You’re hearing me talk about retirement for a reason. While we’ll get into the good stuff around saving for shorter-term needs (buying a house!) later, the crux of building financial stability comes in saving for the long term, and doing that now. To understand why, we need to talk about compound returns.

Compound returns happen when your money is invested in a way that earns you a little on top every year. There are a lot of ways to do this – the stock market, high-yield savings accounts, bonds, you name it – but the bottom line is, you are getting a little more cash back at the end of the year than you started with. Compound returns are also the reason it’s important to start saving now. As in, this second.

Consider this example:

Suzie O. started saving $1,000/year right out of college, at age 22.  She invested that $1,000 in an index fund that yielded her 10% per year. At the end of year 1, she had $1,100 ($1,000 * 1.10), and she kept that money invested. In year 2 she added another $1,000, so at the end of year 2, her investment was worth $2,310 ((1,100+1,000)*1.10).  She continued this savings/investing pattern until age 65, when she had built up a whopping $717,905 in wealth. Great job, Suzie!

Screen Shot 2014-11-29 at 1.16.01 PM

Lindsay L. felt like her 20s were for living it up, so she didn’t get on the savings wagon until 10 years later, at age 32. She followed Suzie’s investment strategy – investing $1,000 a year with a 10% return – but when she retired, she had a measly $270,024. Eek!

Screen Shot 2014-11-29 at 1.16.12 PM

If both women saved for over 30 years, why did 10 years make such a difference? Poor Lindsay has less than half of Suzie’s wealth!

The answer, of course, is compounding interest, the beauty of which is that growth is exponential.

Remember what an exponential graph looks like? It has that long, slow flat part at the beginning (your first 10 years of saving), but by the end the graph takes an almost vertical shoot up – the way your investment gains will by the time you’ve built up a sizable chunk of wealth.  The secret is in getting as many of those tail years in as possible.  And how to get more tail years in, without relegating your retirement to age 90?  Start saving now.

And in case you’re still not convinced time isn’t the most important factor for accumulating wealth, let’s consider one last example:

Brad thought he had it all figured out.  He wasn’t able to save until age 32, just like Lindsay. But Brad knew he had lost a few good years, so he decided to invest double what Suzie and Lindsay did. At age 32, he invested $2,000 a year at a 10% return until he retired at age 65… with a measly $540,049.

Screen Shot 2014-11-29 at 1.16.25 PM

Okay, over half a million in savings is not measly, but let’s think about it. Brad put in more money than Suzie – his total investment was $68,000, versus Suzie’s $44,000 – and yet missed her returns by $177,856. What a difference time made!

And there you have it, my friends.  It’s not that simple – there are rates of return and risk tolerances and a plethora of ways to grow your money – and yet, it is that simple.  To live the rich life – the not-worrying-about-money life – give yourself the gift of time by saving and investing now.