Going for growth
Where to put $5,000? Once you've been investing for a few years, your next five grand can fill any gaps in your portfolio - if other responsibilities don't have dibs on the money.
NEW YORK (MONEY Magazine) - You've picked up a lot over the past decade: a house, kids, a good job and, chances are, a few mutual funds. At this stage, life sets some of your priorities, but you have flexibility on others.
Assuming that you've already got an emergency fund and your credit-card balance is under control, ask yourself:
Four questions to get you started:
1. Do you have a will? You could live another half-century. Or not. If you have a family, there's no excuse for you not to have a will and the other essentials of a basic estate plan, including guardians for young children. If you don't, skip directly to "Put Family First" below. Steer your $5,000 there - and you'll have change left over.
2. Are you saving for your kids' education? You can never start socking it away soon enough for this six-figure monster, and you can use all the help you can get. The best form of help is the tax-advantaged savings plan known as a 529. Assuming that you've got a will and you're maxing out on your 401(k) - and you are, aren't you? - then a 529, in-state or out, gets your five grand. See "Save for College" below.
3. Are you dying to remodel? Face it: Renovating is more of an expenditure than an investment, since few home makeovers recoup their costs. Still, some projects repay better than others, and one can actually be done for only a little over $5,000 - adding a deck. Go to "Romance the Home" below.
4 Do you have more than $10,000 in funds? If so, and none of the other goals on this page take precedence, you're ready to use your next $5,000 to start building a diversified mix of funds. A portfolio is the basis of any long-term strategy and the best way to keep your money growing while minimizing risks. Click here to see "6 funds for growing."
What you can do:
Put family first Best use of $5k: Get a will - now.
The more you have at stake, the more you need to protect your family with a will and two other key legal documents: a durable power of attorney (for managing money if you're incapacitated) and forms that let someone handle crucial medical decisions. A lawyer can prepare all three for $1,000 or less.
Romance the Home Best use of $5k: Add a deck.
Kitchen and bath remodels tend to have the highest payback ratio, but decks come close. A typical deck might return 87 percent of its costs when you resell. And it's one home project you can do for a small sum.
Save for College Best $5k choice: Your state's 529 plan (if your state offers a tax break and low-cost plan) alternative: Michigan's or Utah's 529.
With a state 529 college savings plan, your savings grow tax deferred; withdrawals for educational costs are federally tax-free too, at least until 2010. If proposed legislation extending 529s' tax status is not passed, earnings withdrawn after that will be taxed at your child's rate.
But the potential tax savings are worth the risk. Not every state's plan deserves your money, though. Use your local plan if you can deduct the savings on your state tax return; the plan is no-load; and annual expenses are less than 1 percent. If not, choose the low-cost 529 from either Utah or Michigan. Utah Educational Savings Plan (800-418-2551) Michigan Education Savings Program (877-861-6377).
Tough call: Prepay the mortgage or invest?
Who wants to feel beholden to a bank for decades? Why not put $5,000 toward your mortgage and be debt-free faster?
Why prepay: You'll pay less interest over the life of the loan, cutting the total cost of your house. Paying an extra $5,000 in year five of a $200,000 30-year loan with a fixed rate of 6.5 percent saves you $19,700. If you lose your job or retire, you'll be happy to have one fewer monthly bill.
Why invest: Today the rate on a 30-year fixed-rate mortgage is still a low 6.5 percent, and in effect that's what you earn by prepaying. That's good, but far less than the historic 10 percent average annual return for stocks.
But wait. Because you can write off mortgage interest, the money you borrow is even cheaper. If you're in the 25 percent tax bracket and you itemize, your effective interest rate is 4.9 percent.
Bottom line: Stocks win. Odds are that your investment returns will outpace your cost of borrowing. The best argument for prepaying your mortgage is psychological: Perhaps you will sleep better at night knowing you have one fewer bill to pay each month.
Out of the box idea: Fund a Roth Once you're saving enough in your 401(k) to get the company match, sign up for a Roth IRA. You can put in as much as $4,000 a year. You'll pay tax on the money you save in a Roth, but what you withdraw is tax-free, a major plus if your tax rate is higher later. So if you think your taxes can only go up from here, open a Roth IRA.
Worried that you haven't saved enough for retirement? MONEY Magazine is looking for people between the ages of 50 and 60 who have saved less than $50,000 in their 401(k), IRAs and other retirement accounts and are interested in sharing their story and getting some financial advice about their situation. Please e-mail: firstname.lastname@example.org.