When a lot of people hear the word “investing”, some of the things that come to mind are the screaming heads on CNBC going on and on. “GET OUT OF THE MARKET NOW, WE’RE ALL DOOMED”, or maybe “I’M A MILLIONAIRE A HUNDRED TIMES OVER, AND YOU CAN BE TOO IF YOU JUST WATCH MY SHOW!”
It’s intimidating to hear that the financial markets are meant for the strong-willed geniuses, and that everyone else is a chump. But the more I learned about what it actually meant to invest in my own future, the more I learned that it literally pays to be a mindful investor, and being a mindful investor really isn’t that difficult.
Throughout my career, I’ve thrown a little money at my retirement accounts without paying much mind to it. I took my 401(k) up to my company match at my first job with Gannett, tossed a few bucks at my IRA. Then, I took my current job–which doesn’t offer a company match– and picked some arbitrary amount to put into the 401(k) (10%, I think it was). I directed it toward a target date retirement fund and went along my merry way spending most of what was deposited in my account every two weeks.
Then I met Kathleen.
On one of our early dates, the subject of personal finance came up (Thanks, Frugal Portland, for breaking the ice!) and she asked me,”Do you max out your 401(k)?”
“How much is that?” I asked, belying my understanding of this relatively common investment process.
“$17,500.” She knew the number off the top of her head.
“No,” I replied, somewhat sheepishly.
I paused, and then admitted, “I… I don’t know.” I didn’t have a good reason. Because I wanted the money to spend? Because I wasn’t interested in paying less in taxes? The real answer: because investing intimidated me and instant gratification was so much sweeter. Financial media makes investing sound so sophisticated. Once I started learning the mechanics of it, however, I found that smart investing isn’t particularly intimidating once you get beyond the language.
The key to smart investing for the everyday person is to invest in the market as a whole for the long term, rather than trying to outsmart the market by trying to move in and out at the “right time”. A number of great money writers have explored this concept to better satisfaction than I ever could. I suggest you start with JD Roth’s nuts-and-bolts explanation of the simple, passive investing strategy. If that piques your interest, I highly recommend Jim Collins’s Stock Series. Though detailed, it is very easy to understand. Taking the time to read the entire series will calm the inner boogeyman that is scaring you away from investing.
Today, Kathleen and I are diligent about smart investing. Here’s what that means for us:
Low-cost Index Funds
Investing your money costs money. Mutual funds have people who make decisions about what to invest in, and those people are employees who are compensated for this service. The fee for this service is called the “expense ratio” and it is typically expressed as a percentage of your investment. Now, 1.05% doesn’t sound like a lot of money, but in reality it adds up to tens of thousands of dollars over the course of your lifetime. It’s in your best interest to find an inexpensive place where your money can grow.
Vanguard is the pioneer of the low-cost index fund (Jim Collins explains why Vanguard is unique in the financial industry). These funds don’t require a manager to make decisions, so the service fees are minuscule by comparison. The go-to fund for passive investors is Vanguard’s Total Stock Market Index Admiral Fund (VTSAX). The fee for this fund is 0.05%. For perspective, the 1.05% fund costs you 210 times more than VTSAX!
Maxing Out 401(k)
The tax-deferring benefits of the 401(k) are great, especially if your company matches (free money!). A 401(k) can have a huge impact on your year-end taxable income, especially helpful if you’re on the cusp of a two tax brackets. Though $17,500 sounds like a lot to set aside, keep in mind it’s pre-tax. If you contribute nothing, you get closer to $9,000 in cash (depending on your tax situation). After a month or two of paychecks, you won’t even notice the difference in your cash account. (Note: my company uses Fidelity, not Vanguard, to manage my 401(k), so I had to explore a little bit before I found a similar, low-cost index fund.)
Maxing Out IRA
Personally, I have a Roth IRA, which means I’m ineligible for a tax deduction on the max contribution. But the fact that the gains are not taxed makes a Roth mighty attractive. I also have a traditional IRA open, so if Kathleen and my taxable income ever drops below the income deduction limit (which, for a married couple, is $95,000), we can contribute to it and get the tax benefit on the front side, instead. Since I get to choose where my IRA lives, I’m housed over at Vanguard so I can keep the money in low-cost index funds.
I also have cash in another account at Vanguard, the allocation of which looks similar to my Roth IRA. Now, there’s no tax benefit to putting money in this account (in fact, money earned on investments is taxed at the “capital gains” rate), but there’s zero financial upside to keeping the money in a regular old bank. A non-retirement account means you have your extra money working for you, while still having access to any that you might need (Kathleen and I put everything not needed for month-to-month bills into this account).
Nobody knows what the market is going to do in the future. Neither Jim Collins nor Jim Cramer can tell you what’s going to happen. Anybody who tells you they can guarantee you a return is a liar.
It’s possible the health of the economy is solid for the long-term. It’s also possible that you do everything right, sock money away in all the right places, and then things turn upside down just as you’re getting ready to call it a career. Crashes loom large. If you’re extra pessimistic, maybe you think the entire world comes to a grinding halt as we’re thrown into a post-apocalyptic world with roving gangs of bandits (but really, if that happens, then nothing you do will matter).
But the point is this: it depends on your vision for the future. Personally, in the grand scheme of things, I believe the world will be better off 40 years from now, so I’m placing my bet on the world.
Now, this is not the only opinion. There are a slew of personal (and professional) financiers who believe that individuals can routinely beat the market with savvy stock picks, and that fortunes can be willfully built through this process. My oldest friend is one of these people. But he eats, breathes, and sleeps the market. It is fun for him, and his dream is to day trade in retirement. Given his obsessive dedication to the craft, I believe he has a better chance of succeeding than most. But I don’t have that kind of drive, nor do most people. So, for my future, I’m going to stick with this mindful, but simple investment strategy.
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