Get-started savings plan
Facing an abundance of financial advice out there, one puzzled young saver asks our expert how to simplify things.
NEW YORK (Money) -- Question: I'm a 24-year-old woman looking to start a saving plan. I've cleared all my debt and have started an emergency fund, but I'm unsure how to proceed from there. I've read so many books and articles that I'm more confused than when I started.
I tried talking to a financial adviser, but she told me to come back when I have $10,000. I'm so worried about doing it all wrong that I'm tempted to just open an IRA at my bank and leave the rest of my money in CDs. Can you point me in the right direction? - Ruth, Post Mills, Vermont
Answer: Sure, happy to help.
The first thing I want you to do is take a deep breath and relax. You're putting too much pressure on yourself. Believe me, this isn't rocket science. You don't have to be precise down to the second decimal point to get good results.
If you follow a few simple principles you should be able to build some financial security for yourself fairly easily. And you already seem to have a good head start given that you've pared down your debt, started an emergency fund and have already begun to save.
As for worrying about doing it all wrong, well, I've got news for you. You're going to make mistakes. We all do. But as long as they're not huge blunders you'll do just fine. Those blunders include not saving at all or following the herd into whatever investment has had a recent hot streak (and thus is at greater risk of cooling off).
So resist that urge to go down to the bank and dump all your cash in CDs, and instead follow my simple three-step Starting Out plan:
1. Sign up for your retirement savings plan at work
This is the single most important thing you can do to start building long-term financial security. If your company offers a 401(k) or similar tax-deferred savings plan, sign up for it ASAP.
The money you contribute and the investment earnings on that money isn't taxed until you withdraw it. So in addition to improving your financial prospects long-term you also get a nifty little tax break now. Most likely, your employer will also match a portion of what you put in with a 50 percent match of the first 6 percent you put in being the most common arrangement.
Best of all, signing up for an employer's plan makes regular saving so easy. You don't have to write out a check each month; the money goes right from your paycheck into your account before you get your hands on it.
So put as much into the 401(k) as your plan will allow, or as much as you can afford. At the very least, try to contribute enough to get the maximum match from your employer. If your employer's plan has an automatic contribution-increase feature, sign up for that too.
If your employer doesn't offer a 401(k) or similar plan, then contribute as much as you can to an IRA. You can do either a traditional IRA - in which case your contribution may be tax deductible. Or you can do a Roth IRA. Your contributions to a Roth aren't deductible, but you can pull your money out of a Roth tax-free. For reasons too complicated to get into here, you're probably better off doing a Roth when you're young, although it's not as if you're going to sabotage yourself if you do a deductible IRA.
The most important thing, though, is to put money into some form of tax-advantaged savings vehicle. By the way, most mutual fund companies have an automatic investing option that will move money directly from your checking account into your fund account. Like payroll deduction, this is a great way to make saving easy, convenient and more likely to happen.
2. Invest smart, but keep it simple.
Yes, it is possible to do both. In fact, the fancier people try to get about their investing strategy, the more likely they are to mess things up.
You want to put most of your savings into stock mutual funds, since they have the best shot at high long-term returns. On the other hand, it's always wise to hedge your bets a bit. So you'll also want to keep a small part of your stash in bond funds, which can also add a bit of stability just to keep things from getting too wild.
The easiest way to get a mix of stock and bond funds that works for you is to buy what's known as a target retirement fund. Essentially, these funds are mini portfolios themselves in that they own a mix of stocks and bonds.
You just buy a fund with a date that roughly corresponds to the date you think you'll retire - say, 2050 or so - and you'll get a blend of stocks and bonds that's appropriate for someone your age (probably 80% to 90% stocks and 10% to 20% bonds). What's really neat about these funds, though, is that they gradually shift more assets into bonds each year so the fund becomes more conservative as you age.
If a target fund isn't an option in your 401(k), then you might go with an asset allocation fund, which is similar to a target fund except the stocks-bonds mix remains roughly the same over time. If you choose an asset allocation fund, go with one that describes its strategy as "growth" or even "aggressive growth."
If your 401(k) doesn't offer a target or asset allocation fund, then put 70% to 80% of your money in a broadly diversified large-stock fund (a large-company index fund, if possible) and the rest in a broadly diversified bond fund (again, an index fund if possible).
3. Resist the urge to tinker.
Once you've got money flowing into your 401(k) or IRA, you may get the urge to "make improvements." Perhaps you'll hear of other types of funds that are doing well. Or a friend may talk about how well his or her investments are delivering smokin' gains. This is the time when you've got to dare to be dull - that is, just stick to your nice little mix of stocks and bonds and don't try to do anything fancy.
Believe me, simpler works out better in the long run.
Nonetheless, it is a good idea to "rebalance" your holdings every year or so by selling shares of funds that have done well and putting the proceeds into ones that have lagged to bring your mix of stocks and bonds back to the appropriate proportions. (You don't even have to do this if you're in a target or asset allocation fund; the fund does it for you.)
But unless something drastic has happened - like your funds have performed horribly compared with their peers over the course of a few years - that sort of minor maintenance is about all you need to do.
Those three steps should get you started. Is there you more you can do? Sure, although frankly I don't think there's a whole lot more that will dramatically improve your results (other than trying to save even more than what you stash in tax-deferred plans).
I've purposely refrained from giving you lots of links to previous columns of mine and other sources that can provide more detail on various issues I broached above. I did this because you said your head was already spinning from too much information.
But once you've gotten started investing and you've recovered from information overload, I do think it would be a good idea to learn some more about the right way to go about saving and investing, if only to reinforce what I've already said.
So when you feel ready, I recommend you check out our Money 101 library, which has 23 lessons on everything from setting priorities to making a budget to the basics of investing to planning for retirement. They're easy to read and, dare I say it, even border on enjoyable.
So if you take on one lesson a week I can almost guarantee that in less than six months, you'll have an excellent grasp on the fundamentals of personal finance - and a clear head to boot.