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One of the best thing about this blog is the chance to help ACTUAL READERS with ACTUAL PROBLEMS instead of just hypothesizing about financial matters. Today’s reader sent me a question, and after reading it a few times, I was in complete awe of how awesome she is! I wanted to share her situation with you, not only to show that millennial are lazy, entitled jerks, but also to inspire those who may be starting college, or just out and are trying to get their bearings in life, including what to do with their money.
Plus, I want YOUR input on this question! I have some suggestions, but I’d like to hear from YOU on what you think Laura should do in this situation. So, without further ado, here’s her email:
I need some financial advice! I’m 23 years old and have a full-time job. I held part-time jobs all through college and have been a compulsive saver my whole life. I have 6 months of expenses saved in an emergency fund, and I’m contributing 8% of my gross income to my company’s retirement plan (a Roth account). I’ve got quite a bit of extra money between my savings and a CD that just came due (over 15k) and I’m just not sure what to do next. I still have about $9500 in student loans to pay down, at very low interest rates.
-start contributing more to my Roth account (through work)?
-start a separate retirement account on my own, through my insurance company?
-pay off all $9500 of my student loans?
-put this money aside to eventually pay for my future wedding or buy a home?
-treat myself to a killer vacation?
-give myself a little extra spending money each month?
-do something else with my money that I’m not familiar with (like investing)?
I know I’m fortunate to be in this position, I just don’t know how to proceed. Everything I’ve found online is about how to save for that 6 month emergency fund…. but there’s nothing out there on what to do next. Any suggestions are welcome!
First Things First
Laura, I just want to commend you on your aptitude for putting yourself in such an advantageous situation financially. What you have done thus far is nothing short of remarkable, especially this day in age when things like “working during college” are not even encouraged! So THANK YOU for setting an awesome example for the readers here! I honestly hope to raise my kids to have the same drive and “get r’ done” attitude that you have, and give them the joy of working hard to put themselves in a similar situation.
I’ve got a really simple philosophy on retirement investing, and it falls in line with many of the popular finances gurus out there. It goes like this:
- Invest up to your company’s retirement match (if they have one)
- Max out a Roth or Traditional IRA
- Invest any excess back into your company’s retirement account
Since I’m a tax guy, I like the idea of putting most of your retirement money in tax-advantaged accounts. I also like the idea of balancing out your tax situation with regards to your investing. Since you stated that your work has you on a Roth plan (I’m assuming 401k), after hitting the company match, I would opt for a Traditional IRA to max out (2013 max is $5,500). The reason for this, is that you get some tax savings form the traditional IRA right now, and you’ll get tax savings on the Roth IRA later. Once you’ve maxed out the Traditional IRA, then go back to your work’s Roth 401k and max it out (when you have the money to do so).
Extra Cash From CD
As you probably know, interest rates are abysmal for savings accounts and CD’s right now, so I DO NOT recommend throwing that $15k back into another CD. And since your emergency fund is in place, you don’t need any more cash reserves. So we’re left with a few choices with what to do with that money that you have diligently earned and saved. I’ll put them in order, from the most HIGHLY recommend to the LEAST recommended (in my opinion):
1. Start a separate retirement account on my own, through my insurance company? I DO recommend starting a Traditional IRA, but PLEASE do NOT do it through your insurance company. They specialize in insurance, a necessary evil to protect you “just in case.” They should not be handling your financial future through investing. I would connect with a company like Vanguard who can get you set up with an IRA, and help you invest in low-cost index funds for your retirement. I just moved all my money over there for my Roth IRA, and am excited to be working with them, as they are a non-profit company (you know, not here to siphon tens of thousands out of my retirement account over time to grow their empire). You can max out the IRA this year ($5,500), as I assume your company is not matching more than the 8% you are currently investing through them.
2. Treat myself to a killer vacation? With about $10k left, I say grab $2k of that and have yourself a week-long vacation wherever you want to go (within reason, of course). Heck, if you find a cheap condo on vbro.com or airbnb.com, you might be able to stretch it out even longer! Now, for me, I use credit card rewards to fund my vacations, and I suggest doing that if you can. Or at least start with one card to get a round-trip airline ticket to get the flights taken care of. Up to you, and if you don’t care for the credit card game, just use your cash without guilt, BECAUSE YOU’VE FREAKING EARNED IT!
3. Put this money aside to eventually pay for my future wedding or buy a home? Now we’re getting to some of the good stuff. It sounds like you do have some long-term goals in mind that are going to require a decent sum of money to accomplish. Here’s how I like to approach these things (let’s use buying a home as an example). Figure out some basic details about where you want to live, what style of house, and start searching for some actual houses on the market that you would want to buy. You can then get a ballpark range for how much the house will cost. Then take 20% of that for a down payment (so you can avoid PMI), and that’s your goal.
You then reverse engineer that goal by saying “I want a house in 3 years. I need $40,000. So that’s 36 months away. I’ll need to save just over $1,000 a month to hit that goal, but I can help myself by saving this extra $8,000 I have toward that goal. Now I only need $32,000, and that’s about $900 a month.” You see how that works? You set a number and a date, then divide by number of months, and you have your monthly goal. Adding the extra $8,000 you have left will help reach the goal much easier or quicker. It all comes down to your priorities at that point, and I’ll touch on that later
4. Pay off all $9500 of my student loans? Honestly, the “right answer” is to have these paid off before you buy a home. Getting a home while debt free is probably the best thing you can do. BUT, having said that, we didn’t do this. We bought a house and STILL have student loans, because it was a priority. Yes, I’m paying SL interest, yes, it sucks. But sometimes finances have some gray area, and we chose the home route.
Based on the latest market, our home has now outgained the interest paid in value, so I feel comfortable saying you can save for a home while the loans are still here, as it is an investment. Especially if they’re fixed rate loans in the low 4% or less range. Houses are a great value right now, I don’t think anyone would argue that. Just make sure you only buy what you can afford, and I would suggest to be more conservative that we were when purchasing (maybe like no more than 30% of take home for mortgage would be a good rule of thumb).
On the other hand, if you want to kick those pesky loans to the curb, the yes, make it happen!
5. Give myself a little extra spending money each month? I would say that spending cash is something best derived from your monthly income, not boosted to extra saved cash. Spending cash is a recurring expense, so if you feel the need for more, I would say you should work it into your budget, and cut something else out that maybe you don’t care about as much.
6. Start contributing more to my Roth account (through work)? Since you’re most likely already up to the company match, I would put a hold on investing any more here until you max out a Traditional IRA. See above commentary.
7. Do something else with my money that I’m not familiar with (like investing)? You can invest it, but with the retirement options above, and some goals that are less than 5 years away (possibly), I wouldn’t risk this capital until you’re comfortable letting is stay invested for the long term.
Figure Out Your Priorities And Goals
Of course, everything I just wrote out is all subjective, being filtered through my brain and injected with my opinions. BUT, your priorities and goals could be different than mine! Which is why I always suggest writing out your priorities, and THEN you can set a list of goals, in order of importance to you. Heck, maybe a wedding is the most important thing on the list, and you’d rather save $10k for that over a house down payment. Then do that! Or maybe you need even more security, and want to dump a majority of it into retirement accounts to ensure you are FLIPPIN’ SET in 20 years. Then make it happen!
I just wanted to give you my (very uneducated) opinion on what I would do with the cash, and some things to think about with each option. I can’t tell you exactly what to do, because it’s up to you. But since you’ve already made some amazingly wise choices at such a young age, I have full confidence that you are going to set yourself up very nicely here. And hey, this is just my opinion, but I also have awesome readers that want to help too. So feel free to come back and read through the comments to see what others think. Maybe I’m just a crazy old cook (I’m 27, after all) who is completely out of touch and is giving out TERRIBLE advice that you should run from. Who knows?!
All I know is that I’m glad you stopped by, am astonished at how awesome you are with your money, and wish you the best in whatever you choose to do. Heck, come back and let us know! 🙂
Comments: What do you think Laura should do in this situation? Should she kill the debt and get on with her life? Or should she blow it all on a sick 4-week vacation to the Bahamas? Or maybe she should have it all cashed out in $1 bills, fill a swimming pool and swim in it like Scrooge McDuck?