Carl writes in:
I am 21 years old and am still in college earning my degree. As of lately I have begun thinking about my future and what I will do with my money. I understand saving is a crucial part of living a successful financial life, but I am confused on how to attack such an issue. I have decided that I will definitely get a Roth IRA, but outside of that I don’t know what else to do with my money. I want to invest in the stock market in the long term most likely a index fund or a portfolio of low risk companies, would that be a form a saving?
I don’t if i should even bother with an online savings account and just focus on IRA and stocks, or should I have all three?
Carl’s certainly headed in the right direction. He’s clearly aware of the value of spending less than you earn and is interested in figuring out the best way to invest the difference.
However, there’s one big piece of the puzzle that’s missing here: what is Carl saving for? Without having clear goals in mind, it’s incredibly easy to make very poor choices when it comes to saving for the future.
Take the Roth IRA, for example. It’s a great vehicle for saving for retirement because, when you reach retirement age, you can take withdrawals from it without any taxes at all. However, it’s an extremely poor vehicle for saving for goals prior to retirement, since you can only withdraw your contributions.
On the other hand, savings accounts can be a great place to put cash if you intend to spend it in the near future. You don’t have the risk of losing value as you do with the stock market and you’ll earn at least a small return on your money.
Carl needs to spend some time thinking about what his goals are. Is he interested in saving for retirement (based on the Roth IRA mention, I’m guessing he is)? Is he saving for something in the short term - for example, is he considering a home purchase in the next year or two? Does he just want an emergency fund so that he can survive in the event of an inability to find a job after graduation? Or is he interested in long term investing (more than ten years or so) that he can use in his thirties or forties for a major purchase (like, say, a home to raise a family in)?
These different goals are wonderfully matched to different investment vehicles. If you want an emergency fund, you should be putting your cash in a savings account. If you want short term savings for goals in the next few years, you should look at short-term treasury notes, bonds, and certificates of deposit - stable investments that aren’t restricted and won’t lose money. If you’re shooting for long term savings (but not retirement savings), look at stock investments, preferably in index funds. If you’re saving for retirement, a Roth IRA is a great vehicle.
It’s likely that Carl is eyeing multiple goals. It’s also likely that, given his youth, that these goals are more long term in nature, but it is always useful to have an emergency fund on hand for any emergencies. I can say this much: if I were in Carl’s situation, just coming out of college with a strong desire to spend less than I earn, I would fully fund a Roth IRA, build up a few months’ worth of emergency fund, then start investing in index funds for longer-term things, like buying a home in my thirties. However, Carl’s priorities may be different.
The real challenge isn’t the actual investing. The challenge is figuring out your goals and knowing where you’re going with your life.
The Simple Dollar chronicles a man's road to recovery from "total financial meltdown." As author Trent Hamm puts it, "The Simple Dollar is a blog for those of us who need both cents and sense: people fighting debt and bad spending habits while building a financially secure future and still affording a latte or two." We'll post a couple of entries a week, but you can check out his writing daily at www.thesimpledollar.com