Tickle Your Ticker
Many of you have been following the Invest-Along-With-Ashley series, and we have a key update on the situation. As you may recall: - Ashley was eager to start a retirement account—and learned her mom had opened a Roth IRA for her a few years ago.
- Next, Ashley committed to contributing $25 per month into her Roth. Excellent.
The key question now: Where is her money going?
In Ashley's case, her mom's financial planner picked a mutual fund for her Roth IRA (normally, you'd have more than one fund to balance your portfolio). Which fund was it?
Ashley did her homework and learned the fund's ticker symbol: AWSHX
Every investment—be it a stock, bond, mutual fund—is known by its ticker symbol. These codes look funny (Ashley's looks like, "Aw, shucks"), but they are just abbreviations.
Coca Cola Company stock = KO
Walmart Stores stock = WMT
Vanguard 500 Index fund = VFINX
AWSHX stands for the American Funds Washington Mutual fund. To learn more, enter any ticker symbol into any financial site (or Google it). If you go to Morningstar.com, a top research firm, and look at a snapshot of Ashley's Aw, Shucks fund, You'll see a chart of its performance, and you can scroll down to see a list of its holdings. (Remember, a mutual fund holds many stocks and/or other investments.)
Now, it's your turn! Look up the ticker symbol of an investment you own—and tell us what it is, and what you like or don't like about it.
MP owns FFFFX, a Fidelity target date fund.
Amanda owns a few Calvert and Oppenheimer funds, including the Oppenheimer Value Fund - CGRBX.
Retirement Catch Up
Q: I'm 45 and I'm way behind on my retirement savings. What can I do?
A: Plenty! You have about 25 years before you retire (the standard 65 is inching toward 70), so let's make the most of the time you have.
Hint: If this topic makes you anxious…Read. Very. Slowly.
Let's say you have $10,000 in your 401k, your yearly income is $50,000 and you're contributing 3%. That's $1,500 ($50,000 x .03 = $1,500).
In 25 years, at that rate (discounting any company match), you would have about $182,000, assuming an 8% return (i.e. how much your investments will grow per year). We used this calculator.
Increased savings rate:
Starting this month, kick up your savings rate a third of a percent or $150 ($50,000 x .003 = $150). That's about $5 a day. Can you spare $5 a day to feel more secure? We think so.
Taking this incremental approach, ratchet up your savings rate until you are salting away 15% of your income. That will take at least three years, if you increase your savings monthly. But look at the payoff:
... You are now 48, your nest egg is about $20,000, and you're on track to save $542,000.
How can you bump up your savings to 15%, even incrementally, even over six years?
- You're only 45 now, you have time to boost your income.
- If that doesn't seem likely, re-read yesterday's empowering post.
- Start using a budget like this one.
- Inspire yourself. Play around with the calculator above. What if you saved 16%? 20%? Take in a fresh perspective, like this one on a bootcamp for pre-retirees.
How to Open an IRA
When we met Ashley on Monday, she was pacing the floor, worried about her future savings—when suddenly she got the news that her mother had already opened a Roth IRA in her name.
This raised several questions for Ashley, and a particular one for many readers, who asked: How do you open a dang IRA anyway?
Because we don't want you to miss a single step in this invest-along-with-Ashley, here's the answer.
- A common misconception. Many people assume that when they open any sort of IRA or 401k, that this IS the investment. It's an easy mistake to make, because people always say that you "contribute to your IRA or 401k." Not quite.
- To open an IRA, call Fidelity, Vanguard or another low-cost or discount brokerage and tell them that you want to open an IRA or a Roth IRA, if you prefer.
The IRA or 401k is just a vessel: an empty egg carton, a truck with no cargo. You select mutual funds (usually) to put onto your truck or into your egg carton. The money you deposit grows inside these investments.
If you're not sure which mutual funds or investments to pick yet, that's fine. Get started simply by depositing cash into a money market account, in the IRA—which is like a savings account—and later, when you know more, you can transfer that cash to the investments of your choice without incurring a penalty. This is a first step! We won't let your new IRA languish, uninvested. Keep following Ashley's story here on DailyWorth.
Note: If you're calling HR to open your 401k, the rules and options may be quite different, but there is often a money market option you can pick.
The point is to start investing regularly, we hope immediately, so that it becomes second nature.
Helping Ashley Start Her IRA
We recently heard from Ashley, 25, a documentary filmmaker in Seattle: "How do I get started on an IRA? Or a Roth? I want $340,000 in 30 years!"
We offered to help Ashley launch her retirement account, and she agreed to share her saga, as it unfolds, right here.
In addition to that all-important decision to get started, Ashley also had an initial savings goal: $340,000 in 30 years.
To meet that target, Ashley would need to save $3,000 per year, or $250 per month.
There was drama from day one: Unbeknownst to Ashley, her mom had already opened a Roth IRA for her. The Roth was at a bank in Ashley's hometown in Oregon. There was about $400 in the account, in a mutual fund.
Ashley had about 12,000 questions—which is the standard amount. Here are three:
Where exactly is the money? Is it invested in the bank or the Roth IRA?
All retirement accounts (401ks, IRAs, 403bs) are like big, empty trucks. You drive your truck to the loading dock (i.e. bank or brokerage house) and say: "I'd like to put in the following mutual funds and other investments."
You hand over some money; they stack some boxes on your truck. That's your retirement account.
Mom already put one mutual fund in my account. What is it?
You need the ticker symbol to look at the information.
What's that?
Any investment (stocks, bonds, mutual funds, etc.) is abbreviated with a ticker symbol, which resembles the call letters of a radio station: JABAX, FFFFX, WNEW-FM (kidding). You need the ticker to learn about each investment product, and decide which you like or don't.
Tune in next time to find out... What mutual fund did Ashley's mom pick? What is the ticker symbol? Did Brett sleep with Adrianna?
Target Date Mutual Funds
A recent study found that most investors who have target date mutual funds don't understand how they work.
What makes this discovery sort of funny—but not in a good way—is that the point of target date funds (TDFs) is that they were supposed to make the retirement saving process a no-brainer:
Like putting meat and onions in a slow cooker, allowing you to come home to a fully cooked meal.
Here's the idea: You park your money in a TDF, timed to the year you want to retire—say, 2040—set it and forget it. Target date funds have all the ingredients pre-assembled: stocks, bonds, cash, etc. You come back at 65 and, voila!—a fully cooked retirement nest egg.
At least in theory.
According to a study, published by the Employee Benefits Research Institute in November, many people have failed to grasp the one-stop-shopping logic of TDFs. They stuff other funds into their accounts, and end up "with a potentially inferior portfolio."
Given that about 58% of 401k plans at mid-size to large companies rely on TDFs as the default investment choice (i.e. the one you get if you don't pick specific funds)—this is problematic.
We're not endorsing TDFs, which can be flawed and cost more than other mutual funds. But understanding how this popular type of investment works is essential, especially if you own a target-date fund. Do you? It's something to check, as you put your financial house in order.
Doing the Math on a Roth IRA
Now that we're all focused on Saving UP!, I want to address one of the great IRA puzzles: What is the difference between a regular IRA and a Roth? Luckily, it's an easy and fun question to answer.
Let's imagine you have two cars: a Chevy Ira and a Ford Rothie. They are very special cars, designed to gain value over time.
You decide to put $5,000 a year into each one to keep it running smoothly ($5,000 is your limit for 2010 and you stick with it).
That's fine, because you know that in 30 years these cars will be considered valuable antiques. But…because of the contracts you signed for each car, there's a catch!
In 30 years, you can sell your vintage Chevy Ira, but you have to pay taxes on all the money you make. That's because, under a special clause, you were allowed to put in pre-tax dollars—i.e. all those years, you never paid tax on those $5,000 chunks.
Assuming that this whiz-bang car has gained immense value on the antique car market--say, 7% per year--your Chevy Ira is now worth about $340,000.
But because you owe taxes on it, you pocket only about $240,000.
Now, the Ford Rothie is different. You used after-tax money to pay those $5,000 chunks each year. So the tax is already paid. You pocket $340,000.
Obviously, there are some finer financial points to understand, but this covers a key one. For example: You can contribute to both a an IRA and a Roth, but your contribution limit is $5,000 combined for 2009 and 2010. For the purposes of our fable, we allowed $5K in each "car" so you could see how each performed.
Next up: What's a Roth conversion? Is it spiritual? If you are thinking of converting to a Roth, contact us and we'll walk you through it!
Self-Employed Retirement Magic
It's much harder to save when you're self-employed. Nobody in HR is going to coax you out for a power point, some coffee and a few prospectuses—and then set up automatic contributions for you. You have to do it yourself. And you must. And with Daily Worth's growing arsenal of retirement planning strategies, your future security is almost in the bag—as soon as you set up that sweet little retirement account.
A relatively new option you may want to consider is the solo 401k.
Normally, a 401k plan is run by a larger company for its employees. The advantage of a 401k account is that it lets people save a lot more than traditional IRAs (individual retirement account), and many companies offer matching funds.
A solo 401k allows you to sock away $16,500 of your gross income; then you can match yourself, the same way a company would--but for a heftier gain.
»In addition to the $16,500, you can then stash an additional 25% of your gross income (or 20% if you're a sole proprietor), up to a total of $49,000 if you're under 50, $54,000 if you're 50 or older.
Even better, the more you contribute, the more you save in taxes (i.e. you deduct all contributions from your gross profits and only pay tax on the remainder).
These are the current limits for 2009. To learn more, read this nifty breakdown from SmartMoney.
How does that stack up against a SEP IRA, which is another popular self-employed retirement account?
Let's say you earned 80,000 in 2009.
- With a SEP IRA, you could save up to $20,000.
- With a solo 401k, you're able to save up to $36,500.
Here's and a calculator on PensionOnline.com.
A 401k No-No
Dear DailyWorth,
I recently heard that a co-worker used some of his 401k money to pay off a credit card. I am 27, and have $11,000 in credit card debt. Should I do the same?
~ Katie M
Dear Katie,
GACK! NO. And here's why: It will cost you a fortune.
Money you withdraw from your 401k before the age of 59 1/2 is called an early withdrawal, and the IRS doesn't like that. You would pay a 10% penalty, on top of owing state and federal taxes on that money.
(Remember: Your 401k contributions go in tax-free, but you owe taxes whenever you withdraw them.)
Depending on where you live, that means you could lose, say, 30% of your money or more; i.e. that $11,000 would get knocked down to $7,700—possibly less.
Bottom line, you would have to withdraw approximately $16,000 to net the $11,000 you'd need to pay off your card.
But wait, there's more!
IRA vs. 401K - What's the Difference?
Thinking of saving money for your golden years? Good thinking. You’re never too young to start stuffing the coffers. Two popular retirement investment vehicles are the 401K and the traditional IRA (individual retirement account). Simply put, a 401K is a retirement savings plan offered through your employer. An IRA is something you set up yourself with help from your bank or your mutual fund. To 401K or not?
If your company offers a 401K, contribute to it, especially if your employer matches what you put in. Some companies match up to $0.50 for every dollar you put in, for up to 6% of your salary. It’s free money! Don't turn it down. Your own contributions to the plan are taken from your paycheck on a pre-tax basis, which can means more money for you. Eventually, Uncle Sam gets his due, but that’s only when you start withdrawing funds from your 401K, after the years of the interest in your plan growing tax-free. When you do start tapping into the money, you pay income taxes – at your current income tax rate. Think you’ll be pulling in a power salary as a retiree? Probably not. So don’t touch the 401K until you retire and are in a considerably lower income-tax bracket. That said, if you have to borrow from your 401K (say you have a medical emergency), you can. And as long as you pay it all back, there’s no fine, no nasty letter and no robo-calls.
Of course there are a few strings attached, including how much you can sock away every year. For 2009, the limit is $16,500 if you’re 49 or younger, and $22,000 if you’re 50 or older. For 2010, contributions limits will be indexed to inflation. There are rules for getting your hands on the money, too. Touch it before you turn 59 ½, and you’ll be slapped with a penalty if you don't pay it back. Likewise, you need to begin withdrawing before you’re 70 ½. The only caveat with 401Ks is this: Find out what your contributions are being invested in. Even if your investment choices are limited, you should know what they are and be ready to make changes when and where you can. Why? It’s not uncommon for a company to invest a sizable chunk of its 401K plan in its own stock. Then what happens if the company goes down in flames? Think Enron. No pension. No savings. No retirement.
The skinny on IRAs
An Individual Retirement Account, or IRA, is a way for you to save money for retirement that has nothing to do with an employer-sponsored 401K. You set up your own IRA (with a little help from your bank or financial planner) and deposit money into it every year. While you don’t get any matching contributions with an IRA, you usually have more investment choices – things like stocks, bonds, mutual funds and Certificates of Deposit (CDs). If you track your investments and don’t like how they’re performing, you can rearrange them, move more into CDs or bonds or whatever you prefer.
As with a 401K, the amount you contribute to your IRA is deducted from your taxable income, and you don’t pay the piper until you start making withdrawals. Unlike a 401K, however, you can’t borrow from an IRA. (There is a complicated thing you can do, which means opening a new account so you can move money from your IRA to the new account – and then you only have 60 days before you have to re-deposit the money back into the IRA. Unless you have several IRA accounts with plenty of money in each, this rigmarole isn’t worth it.)
Like 401Ks, IRAs impose contribution limits, although they’re much lower. For 2009, if you’re 49 or younger, you’re limited to $5,000; if you’re over 50, you can contribute up to $6,000. For 2010, contribution limits will rise in increments of $500 and will be indexed to inflation. One nice perk about putting money in your IRA: You can do it until tax filing day of the following calendar year. In other words, you have until, April 15, 2010 to sock it away.
The rollover option
Remember Roth IRAs? (DailyWorth featured news about the 2010 conversion option here) Contributions to a Roth IRA are not tax-deductible (you pay taxes on it up-front), but withdrawals are totally tax-free. That’s right. No taxes on earnings. Period. And a Roth IRA isn’t bogged down by as many rules as a traditional IRA. In fact, you may want to roll your IRA into a Roth IRA. If you're thinking about doing it this year, be sure you qualify. For 2009, you can roll your IRA into a Roth IRA if you’re single or filing jointly with your spouse, and your modified adjusted gross income (MAGI) is $100,000 or less. But the rules are changing. As of January 1, 2010, those limits are gone; anyone who has an IRA can convert it to a Roth IRA. If you do convert to a Roth IRA next year, you won’t be taxed for it in 2010. Instead, you can spread the tax hit out over two years, paying half in 2011 and half in 2012. That’s how badly Congress wants your money.
These are just a few of the fundamental ways in which most people save money for retirement these days. The bottom line is: If you have the luxury of an employer-sponsored 401K and opening your own IRA on the side, do both. Whenever you can, stash the cash.