Friday, December 11, 2009

College Graduate, First Job -- How to get started saving and investing?

You've graduated, started working, and understand the importance of saving and investing for your future.  What are the very first steps to take?

First, of course, you need to SAVE!  You must manage your spending so that you can save a significant portion of your income -- at least 10%, and more if possible.  Yes, we all want to enjoy life when we're young, but we also don't want to live in poverty when we're old.  There are always ways to cut back on your spending.  Things that are considered necessities these days didn't even exist 20 years ago (cell phones, cable TV, etc.).  Going out for food, drinks and movies are all things that are optional.  I'm not saying not to do these things, just to realize that every dollar that you spend today could be 4, 6 or 8 dollars when you retire if you save and invest it instead of spending it.  Finding balance is the key.  If you can't give up enough current consumption to save a significant portion of your income, then please stop reading now (there are many books to help you with this problem).

Assuming you have the discipline to spend less than you earn, there are two things to work on first: building your short term cash reserves, and contributing to a tax deferred account for retirement.  I almost hate to say it, but if you have parents or other resources you could fall back on in an emergency, then I'd recommend working on both (you don't want to have to rely on your parents, so I'm sure you'll want to build your cash reserves even if you do have alternatives).  If you don't have any fallback resources, then you should focus solely on building your cash reserves first.

For your cash reserves, open a rewards checking account, as discussed in my last article.  Perhaps your current bank or credit union offers one, and it'll be very easy to open one.  The credit union my kids and I use happens to offer a rewards checking account paying about 3.5%, and although this isn't the best rate available, it only takes a few clicks on the website to convert your existing account to a rewards checking account.  Otherwise, go to the web site referenced in my last article, and find the account that offers the highest rate with the least hassle of opening the account and the easiest criteria to meet (e.g., 10 debit card purchases instead of 12).  This advice may change when rates rise significantly, but as of now, this is the best place to park your short term cash reserves (IF you're willing to take the simple steps to meet the criteria).

For your tax advantaged retirement account, it's likely that you won't be able to start contributing to your employer's 401(k) plan until you've worked there for some time, usually 1 year.  I'll assume that's the case, and write another article on 401(k) plan strategies later.  That leaves IRAs for your tax advantaged retirement contributions when you're just getting started.

Assuming that you've built up your cash reserves to your target level (as discussed in my previous article), or that you have alternatives for emergency cash needs and can start contributing to your IRA now, you need to decide between a traditional IRA, a Roth IRA, or a combination of both.  Then you need to decide where to open your account.  Discussing the traditional vs. Roth IRA is an entire article in itself, so I won't get into a lot of detail here, but will suggest that you do both, and split your contributions between them.

The traditional IRA gives you tax savings in the current year (increases your take home pay), and the Roth IRA will give you tax savings in the future.  I recommend doing both, since no one knows what their tax rate will be in retirement (and therefore how much the future tax benefit of a Roth IRA will be), and it's hard to give up the current tax savings of a traditional IRA.  However, once you're eligible to start contributing to a 401(k), you may want to just contribute to a Roth IRA, since you'll get the current tax savings from the 401(k).

Although I'd like to see you eventually investing with Vanguard, for reasons I've gone into in previous articles, their minimum investment of $3000 for most funds makes it difficult when you're just getting started.  Now that Schwab has a few good low cost index funds with $100 minimums, and a few good Exchange Traded Funds (ETFs) that you can purchase with no commissions (I'll explain more about ETFs later), I'd recommend that you open your first IRA accounts with Schwab.  Go to, and open a traditional and Roth IRA account, or go into the local Schwab office and do it.  Next, you have to decide which funds or ETFs to invest in.

To do this really knowledgeably, we need to get into asset allocation theory (which we will do in future articles), but for now, if you want to keep it simple, invest 50%-70% in the Schwab Total Stock Market Index Fund and 30%-50% in the Schwab International Index fund.  I provide ranges, because there's no clear evidence about the best way to split your investments between US and international (Total Stock Market is the total US stock market).  The most common advice is to limit your international exposure to 20-30%, but there are good arguments to have it as high as 50%.  If you want to go more along with the crowd, go with 70% Total Stock and 30% International.  If you want to match your investments more to the global economy, increase your international percentage to as much as 50%.  If you want to keep the math simple, go with 50% Total Stock and 50% International, and make your additional contributions to keep the Total Stock value approximately equal to the International value (i.e., contribute more to whichever fund has not performed as well recently).  This is a form of rebalancing, which we'll discuss in future articles.

To be very specific, you could open a traditional IRA and a Roth IRA at Schwab, and invest a minimum of $100 in the Schwab Total Stock Market Index fund in one, and a minimum of $100 in the Schwab International Index Fund in the other.  Then, out of each paycheck, invest in each fund so that the values remain approximately equal.  Or, invest in both funds in both the traditional and roth IRAs, so that you keep the Roth and Traditional values approximately equal as well as the Total Stock and International approximately equal.

Once the size of you portfolio has increased, I'd advise adding some small cap and value funds or ETFs to the mix, but I wouldn't worry about that when you're just getting started.

1 comment:

  1. Very clear! Thanks for the articulate advice Dad! So you can just go online to Schwabb and open an account that way? I didn't know it would be that easy.
    I would really love a follow-up article on traditional vs roth IRA accounts.
    Additionally, you mentioned a future article on 401k intriguing subject!