Budgeting Wisely, Investing Carefully
Twenty-four-year-old Molly Laurain is investing liberally in her human capital. She has a full time job at a New York City construction management firm, is licensed to sell real estate in New York and Illinois, and is taking classes to prepare for the Graduate Management Admission Tests — and a possible graduate degree in real estate development. For added value — and just plain fun — she takes improv classes, which help her with public speaking, remembering names, and, in general, figuring out what comes next, on stage and in life.
But like many 20-somethings learning how to navigate the demands of career and life, she’d like a little advice on saving and investing. Three months ago she got something that’s rare these days — a raise — and began ramping up her savings to around $250 a month. Her employer does not offer a 401(k). Two years ago, her father gave her $1,000 to fund a Roth IRA, which she invested in a balanced mutual fund; it’s now worth about $2,300.
“I pretty much only put money in when I get money unexpectedly — like a gift, or a raise,” she acknowledges. She had been using her regular savings account, which now holds about $2,000, to pay taxes, and considers it a bulwark against “unexpected emergencies, like losing a job.” For “short-medium” savings she uses Smartypig; every month $255 is automatically deposited into an account that pays about 2 percent interest. Knowing that she can access the money without penalty gave her the confidence to put more of her savings into it. (Smartypig is an online bank with a social networking component; the funds are held at West Bank, a 126-year-old, FDIC-insured community savings bank in Des Moines, Iowa.) With Smartypig, consumers set up an account with a specific savings goal, calculate how much they’ll need to contribute monthly to reach it, and allow an automatic transfer from their checking accounts. You can enable the account to accept additional contributions from friends and family members who want to help. “Since it’s not directly linked with my bank account,” she notes, “it’s harder to dip into it.” She says she changes her goal all the time, and now just likes having a cushion.
Given the uncertainty of her income if she chooses go to grad school, Laurain needs to stay flexible. Certified Financial Planner Gary Schatsky sketched out a couple of financial strategies to help Laurain — or anyone in her situation — prepare for the future while giving her the freedom to change her plan.
Delay Retirement Contributions (for Now)
This year, with Laurain having her highest earnings ever, Schatsky would typically recommend making a tax-deductible IRA contribution. “But if she’s going back to school, and needing a lot of cash, a deductible contribution raises inaccessibility issues,” he points out. With a Roth IRA, however, “she can pull out the principal without penalty.” That said, he advises that money growing tax-free in a 401(k), Roth IRA, or regular IRA should be “the last dollars you touch.” Why? Saving earlier beats saving longer: A 20-year-old saving $250 biweekly at 7 percent will have $1,003,000 by age 65 — without adding a penny after age 30. A 35-year-old, on the other hand, who puts away the same amount and gets the same return will end up with $979,000 at 65, despite having invested three times as much.
Ramp Up Savings and Rein In Spending
Laurain has a total of more than $12,000 between checking and savings. That’s okay, “as long as she continues to earn money and save,” Schatsky allows. “Let’s imagine she’s not going back to school — she barely has a nice emergency amount of cash there.” Ideally he’d advocate she save $5,000 to $8,000 a year in some combination of savings and tax-deferred vehicles. No matter what she decides, increased savings and lowered spending needs to be part of the picture, says Schatsky. “She’s making more than she did in 2008, and saving less. I understand she’ s just beginning to taste what a wage increase can bring, but she’s got to bring this in check.”
Diversify Today; Diversify Further Tomorrow
Schatsky says the Vanguard STAR mutual fund, a fund of other Vanguard mutual funds, is an acceptable choice for now. It’s a low-cost fund that gives her instant diversity. But in a perfect world? Once she accumulates about $10,000 in her IRA, he’d add an international fund and replace the STAR fund with a low-cost index of the total U.S. stock market.
Molly’s Response
“I know I need to save more. I don’t have to get Starbucks coffee for $3 every day, I can get it on the street. But it’s good to have a target for how much of my salary I should be saving. It’s like having a personal trainer tell you to ‘do 50 sit-ups and 40 pull-ups every day, and you’ll look great.’ Taking advice from an expert, you have more motivation.”
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