Need Help Investing

[Schneed10]

Originally Posted by Daseal

Schneed. Few questions here myself. First of all, I'm relatively young (26) so I have my 401K (taking advantage of the max amount of matching) on the most aggressive setting it can go on, last quarter it did pretty well. Considering I haven't worked much, it wasn't a lot of money, but that will change in time. How long would you leave it on aggressive? I was thinking the first 10 years, then pulling it down to moderate.

I know you push stock, but watching my grandmother deal with stock has really turned me off. Cost basis BS, the fact that turning it in can skyrocket your income bracket that year, etc. It's been such a hassle I kind of want to avoid it. If it ends up being the most effective investment vehicle, then so be it -- but it seems like a huge hassle.

Where do you stand on IRAs? I was under the impression that the return from IRAs were quite good and that should be the 2nd thing, after your 401K, that you focus on as a young person saving for the future.

Thanks!

Glad to help. First let's clear up a little confusion. On one hand we're discussing account types, and on the other hand we're talking investments. The basic difference, the account holds your investments. There are different types of accounts which feature different tax advantages, but you can own the same investment in any given type of account. Let's talk about account types first, then get to the investments:

Account Types

A typical 401K and a Traditional IRA have the exact same tax benefits. You put money in tax free, then it's taxed when you take it out upon retirement.

It's just that with a 401K, your money gets deducted from your paycheck pre-tax, and dumped right into the 401K. With the IRA, you're actually taken money from your checking account (after taxes), and investing it. So with the IRA you can deduct it on your tax return, making your refund bigger. But in the end, the refund from such an action equates to the exact amount of taxes you save on an equal contribution to a 401K.

In other words, there's no difference between a 401K and a Traditional IRA.

Now a Roth IRA is different, and better. I advise contributing just enough to your 401K to get the match, and then direct any additional retirement contributions to a Roth IRA. The Roth IRA allows you to put the money in after taxes, so you get no immediate tax benefit. But when you withdraw from it in retirement, you get it all tax-free. With the way the math works on the compounding interest, you're MUCH better off with a Roth. You've got to make under a certain amount of money to qualify for a Roth, I think it's either $75K or $100K.

These retirement accounts (Roth IRA, 401K, and Traditional IRA) are all great for housing stock investments, because they offer tax advantages. If you own stock in a "taxable" or "brokerage" account, like your grandmother did, you miss out on maximizing the tax advantages. So keep that stock in a retirement account, you won't have the same horrendous capital gains hit.

So that's a summary of account types. As for investments (stocks vs bonds vs stock mutual funds vs bond mutual funds), you can own just about any investment in any of these account types.

Investments

For a retirement account (401K, Roth IRA, Traditional IRA), I suggest you stay 100% stocks until you are within 15 years of retirement. So if you expect to retire at 65, stay 100% stock until you're 50. From there, gradually mix in more bonds as you get closer to retirement. Reason: if you look at the S&P 500 over any given 10 year period in its history, it has never lost money. Ten years is enough time to rebound from any recession, so give it 10+ years, it's plenty of time to ride the roller coaster.

In a taxable or brokerage account, keep 6 months of expenses in cash (high-interest savings or money-market). That money HAS to stay very safe, because you may need it at any time. After that, any savings beyond that you can choose to get more aggressive with if you want, but follow these rules of thumb:

- If you think you may need or want to use the money inside of one year, choose money market or high-interest savings.

- If you think you may need or want to use it between 1-3 years, choose municipal bond funds or other government bond funds.

- If funds are needed 3-10 years out, feel free to mix in some corporate bond funds.

As for your grandmom and withdrawing from stock or any other investment vehicle, do it gradually. If you do it all at once, you'll jump in tax brackets and get hit with a big tax bill. In retirement, just take out what you need to support yourself for a six month period. Then when that dries up, withdraw another 6-month chunk.