It’s another Q&A Edition of Optimal Finance Daily: Episode 1461. Today's theme is about how to start investing in your 20s.
And I’m your host and personal finance enthusiast, Diania Merriam. We are going to change it up today and address some audience questions on the show. But quick disclaimer, just like all the content shared here, this is for informational and entertainment purposes only… or “infotainment” if you will. I’m not a certified financial planner, and encourage you to take my opinions with a grain of salt.
That being said, if you want to send a question in to be answered here on the show, just send a message to finance AT oldpodcast.com
But for now let’s get to today’s questions and start optimizing your life!
Personal Finance Question 1: “How Do I Start Investing in Today's Economy?”
Our first question comes from a Bianca who wrote:
“I am 22 and have some extra money I’d like to start investing. I always hear this is the way to become wealthy and stable into retirement. I just downloaded E-Trade and made a brokerage account. I’ve also been listening to Optimal Finance Daily to educate myself on how the stock market works.
I feel like I’ve got the gist of it, but I still feel stuck on where to start when it comes to actually buying the stocks and choosing the right ones. Especially in the odd COVID market we’re in, where does one put their money in today’s economy?”
DIANIA MERRIAM: Thanks so much for asking this question Bianca, and kudos to you for thinking about this stuff at 22 years old! So many of us, myself included, wish we would have been thinking about investing at your age. When it comes to investing, one of the most important factors is time in the market, so investing early and often is a winning strategy.
Get Comfortable with Investing
The first thing I would recommend is to read The Simple Path to Wealth by JL Collins — this is the book that got me comfortable with investing and gives some very specific direction that I can’t cover in a 10 minute podcast. I’m a big advocate for passive investing in low fee total market index funds vs. choosing individual stocks, especially when you’re first starting out.
Research shows that over time, active investors don't perform any better than passive investors. I've also decided to be passive so I don't have to spend much time on my investments! I pretty much set it up and automate everything and I barely think about it anymore.
Evaluating Your Emergency Fund
Bianca let me know that she has a $4k emergency fund, so my first question on that front is: are you comfortable with the size of your emergency fund? I'm not sure how many months that $4k will cover for you. It's typically recommended to have 3-6 months of expenses in an emergency fund. I chose to have a year in cash on hand for a number of reasons, but even if you're continuing to build up your cash reserves, time in the market is one the most important part of building wealth so you should also start investing even as you continue to build up your emergency fund.
Evaluating Retirement Funds
I like to think about investment accounts or vehicles as buckets, and the actual stocks and bonds you’re choosing is like water in those buckets. So you have tax advantaged buckets primarily used for retirement savings — that would be your 401k, IRAs, HSA, and if you’re self employed SEP IRA or Solo 401ks. Then there is an after tax brokerage bucket, these have no tax advantages and Bianca shared with me that this is where she’s currently investing some money, about $20k.
Bianca also let me know that her employer doesn’t offer a 401k and she has not opened an IRA. When it comes to wealth building, it’s typically advised to focus on investing in retirement vehicles first as these have the most tax advantages which allows your money to grow and compound faster.
There is a limit to how much you can contribute each year (so for example as a single young person, that would be $6k in an IRA), and once that annual window closes, you lost your chance to contribute. So you might consider prioritizing a $6k annual contribution to a Roth IRA before you put anymore into that after tax brokerage you opened up with E-trade.
If I were you, I’d probably start with that extra money you have on hand to invest and put it in the IRA. And then every year, fully fund the IRA, and consider pulling from that after tax brokerage to do so.
Roth, Traditional IRA, or Both?
When you open the IRA, you’ll need to decide if you want to do a Roth IRA, Traditional IRA, or both. I don’t have information on your income, but I suspect you're probably in a low tax bracket right now, it might make sense to contribute to a Roth IRA and pay the taxes now so that you can use the money tax free later (when you'll likely be in a higher tax bracket).
A traditional IRA works like a 401k in that you would be putting the money in tax free and paying tax on it later. It would lower your taxable income now, which depending on your tax bracket, may be appealing so something else to consider here. The beauty of IRAs is that you can go open this on your own — it isn’t tied to your employer at all.
Which Investments to Choose?
You specifically asked about which investments to choose, or the “water” in the buckets if you’re still following my example from early. And in any of these “buckets” you can choose the same or similar investments.
For example, I have a Roth IRA AND an after tax brokerage with Vanguard. They are 2 separate accounts but they are both invested in Vanguard's total market low fee index fund (VTSAX). I don't play the game of picking and choosing different investments, I just put it all in this one index fund.
Since you're young and have plenty of time to ride the market rollercoaster, you might consider being 100% invested in stocks and no bonds at this point. The added benefit here is that you won't have to worry about rebalancing your portfolio each year to maintain a certain stock to bond asset allocation.
The Simple Path to Wealth book will help you set this all up yourself, or you could consider a service like Betterment or Wealthfront which makes the process slightly easier for a pretty low fee (around .25%). And if you decide to you do it yourself and invest in the low fee index funds, you'll pay closer to .04% on fees.
I hope that helps and happy investing Bianca!
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Question 2: “How Do You Prioritize When It Comes to Money Management?”
Our next question comes from Mitchell who says:
“There are so many great ideas proposed on this podcast, and it’s easy to hear all this different advice and think, ‘That’s so great, I’ll do that!'
But in reality, trying to focus on 17 separate financial goals is inefficient and might lead to none of them being accomplished. However, it seems like some are better to start earlier than others in their implementation.
So my question is: is there a good way of diagnosing your current financial position and linking it to the stage or tactic that might be most beneficial? For instance, I’m a numbers guy and the concept of calculating loss recognition in investing to prevent capital gains taxes is like a puzzle box I’m stoked about. But $2,000 invested at age 24 doesn’t warrant this kind of strategizing.
Is there a better way of thinking about what to optimize first when it comes to money management?”
DIANIA MERRIAM: Thanks for this great question Mitchell, and I’m stoked that you’re so eager to optimize your finances! The tricky thing about listening to a podcast that that offers general considerations around money is that it might not all apply to you, or it might not apply to you just yet.
Personal finance is so personal, but the more you learn, the more you’ll build up a level of discernment when you hear something that may or may not be relevant.
You’re right in that focusing on 17 goals is inefficient, and so my question is: are these your goals, or are they goals you hear mentioned by others and assume you should be replicating? I think getting very clear on what you want, will help you come up with financial goals that are unique to you. And focusing on one at a time will help you narrow in on the strategies and tactics.
So for example, my first financial goal was to get out of debt and I was laser focused on this for 11 months. Then I focused on fully funding my retirement vehicles and building up my emergency fund. After that I focused on buying a house and self funding my business. And now, I’m focused on reaching financial independence while I experiment with self employment.
By focusing on one goal at a time, which will typically start with debt freedom, move to shorter term goals like buying a house or funding a dream, and end with ultimately reaching financial independence, you can bring some focus to your efforts. And you also open up space to allow your goals to shift and change.
For example, I had a goal to reach FI by 40, and that has since shifted to reach FI when I reach FI and take time to work for myself. So I’d encourage you, Mitchell, to take a look at where you are now financially, and come up with one goal that you can focus on that would create a little bit more freedom and options in your life.
How to Start Investing: Sign-Off
Well I hope you enjoyed another Q&A edition of Optimal Finance Daily. If you have a question you’d like addressed on the show, go ahead and send it over to finance AT oldpodcast.com
I hope you have a great rest of your day, and I’ll see you tomorrow, where I’ll be back narrating your favorite authors, and where your optimal life awaits!