Ask the grumpies: Getting started with money

Mel asks:

What books do you recommend for someone who is looking to understand the basics of investing for retirement and how much money a person should hold in their savings account for emergencies? Or to that end, also understanding which comes first: having savings you can reach for at a moment’s notice or putting money into a retirement plan? I’m looking for that sort of information in a book form.

I have a fairly (I think?) healthy relationship with money, carry no debt beyond the mortgage, and feel the word that best describes me is “careful.” So I don’t really need to understand budgeting or how to pay off debt, but I do want to make sure that we’ve saved enough for retirement, saved enough for college (and aren’t going to be locked out of applying for certain loans because we have too much in a savings account vs. moved over into a retirement account — is that even a thing?), and saved enough for emergencies.

I’m looking for big picture books to understand how the various plans work as well as books to avoid because they contain terrible advice.

A good primer on all things personal finance is JD Roth’s book, Your Money:  The Missing Manual.  The numbers will be out of date (you can now save $19K annually in a 401k and 6K annually in an IRA), and we now know that you can legally do a Backdoor Roth, but it is really good at explaining the basics.  Like the difference between an investment (ex. a specific stock fund) and the bucket you save an investment in (ex. a 401k).  It also summarizes many of the best ideas from the best personal finance books.

How much a person should hold in their savings account for emergencies isn’t something there’s 100% agreement on.  In general, most people agree that you should have at minimum around 1K (give or take, probably more given inflation) to cover small emergencies.  After that people tend to think in terms of months of expenses– you need 1 month of regular expenses in case your work has a billing mistake.  You need 3 months of expenses to cover things like car problems or a short-layoff.  You need 6 months of expenses to cover a lengthier spell of unemployment.  Some people will argue a year of expenses, but that’s a luxury.  Other factors are also important like how stable your industry is– if there’s more uncertainty, you need a larger emergency fund, if you are hard to fire then you need a smaller emergency fund.  If you have dual incomes and a spouse can increase hours or cover expenses you might need less.  If you own rental properties you might need more to cover tenant absences or large repairs.  Some people will keep part of their emergency fund in something safe like savings, but keep the bulk of it in an investment that could be tapped in an emergency without penalty, for example the contribution part of an IRA Roth or taxable accounts (or a 457 plan for government employees).  All Your Worth by Elizabeth Warren (yes, that Elizabeth Warren) and Amelia Warren Tyagi does an excellent job helping you think through what your monthly expenses are and how emergencies might affect them.

All Your Worth also does a great job in providing heuristics about how much you really can afford to spend given your income.  It provides great guidelines for what percent to put in required spending vs. optional spending vs. savings to provide stability in when there are emergencies.  It’s a really great read and a smart book.  As a note– one thing people often get wrong about her balanced money formula is that they think that they *must* spend what she says to spend and save only what she says to save, which isn’t true– if you read carefully, the spending amount is an upper bound and the savings amount is a lower bound.  She does note that if you are unhappy with your spending and you are saving the recommended amount then you can loosen up, but you don’t have to, especially if you’re considering early retirement.

Once you understand these big picture ideas, you can do one of two things.  You can read the Bogleheads Guide to Investing, or you can just figure out the cheapest target-date fund that your savings provider provides (ex. my work provides Fidelity so I use that for my 403b, outside of work the cheapest is usually Vanguard which I use for my backdoor Roth and taxable investments).  With the target date fund you can just pick a single date (when you plan to retire) and set and forget and it will take care of all the rebalancing and diversification and so on for you.  Easy peasy AND it matches the market, unlike the majority of active managers (who get out-performed by the market).

Here’s a couple of advanced posts on diversification of your overall personal portfolio (not just your retirement investments).  Here’s an ordering strategy of how you could choose to use your money.

In terms of college savings and financial aid, you definitely want to read this series of posts from Forbes Magazine.  Here’s one of our many posts discussing retirement vs college savings.  The short version is that depending on what schools your kids are considering and how much money you make (say, under 300K/year) then you are likely to want to shove as much money into retirement vehicles as possible.  (If I had to go back, I’d funnel some of our 529 money into 403b and 457 accounts, but I didn’t know we’d be as high income as we are now and I didn’t know that financial aid at fancy schools went so high up the income distribution.)

In email conversation you also mentioned that as a freelancer you wanted to know more about ways for self-employed people to save for retirement.  If anybody has book recommendations, that would be great.  I found a couple useful web articles on the topic.   You also mentioned you’d be interested in finding out more about how to tap into retirement money without penalty before age 59.5.  For that there’s something called substantially equal payments that you can use in some cases.  You can also always take money out with the 10% penalty.  Or take the principal out of a Roth (or 457 if you leave that employer).

In terms of what books to avoid:  Dave Ramsey is awesome for debt payment, but he is absolute garbage for investing.  Do not follow his advice for investing.

Grumpy Nation– What books do you and don’t you recommend for Mel?  Any web resources?  How should she get started?  Any advice specific to freelancers?

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Ask the grumpies: How do you approach diversification?

Ali asks:

We are good savers but I fear not great investors (i.e., I have a good bit just sitting in the bank now because I don’t know what to do). How do you approach diversification?

Disclaimer:  We are not professional anything except academics.  Consult with a fee-only financial planner with fiduciary responsibility and/or do your own research prior to making major decisions about your money.

If you don’t know what to do and your money is just sitting in savings, the easiest thing to do is to pick out a retirement date (or house purchase date or whatever) and buy some of Vanguard’s target date fund for that year.  It will take care of diversification for you both right now and over time and you’re done.  (You can also mimic it on your own by purchasing the major indices in it.  Mimicking it will save you some money early on (far from the target date) when there’s not much movement because you’re not actually doing much rebalancing early on– you’re mostly in stocks.  It is still better just to buy the target date than to leave it in the bank trying to figure out how to mimic.)

Here’s #1’s original post about how she decided on percents in her retirement account.  They’re probably a bit conservative (too bond-heavy) for when she was younger, but are more appropriate now.  But #1 wasn’t trying to optimize– diversification isn’t about optimization, it’s about getting decent returns while still staying safe.  In fact,  diversification will always return lower than some subset of undiversified portfolios (it will do better than another subset though!).

Let’s step back a little bit an think about why we diversify.

Diversification is all about moderating risks.  We put some money in stocks, which are high risk/high return and some money in bonds which are lower risk/lower return because bonds keep their value in downturns while stocks are likely to lose value (but stocks shoot up high in up-turns while bonds… keep their value).  We keep some money in cash in the bank because it keeps its value and can be drawn on quickly in an emergency.  In general, we want money that we will draw on decades from now to be in stocks and money we will draw on within the next 5 years in something more accessible like cash or bonds.  The closer you get to your target date, be it retirement or buying a house or starting college payments, the more safe and accessible you want your money to be (with some disclaimers for college savings as where those are put can affect financial aid).

More advanced asset allocation will have you thinking about blue chips vs. tech stocks or emerging markets and international markets.  But the thing is, if you’re at the point where you’re not sure what to do with your money, you can just ignore these.  International stock indices tend to have higher fees.  If you get a broad-based index fund it will already include blue chips and tech stocks.  If you get a target-date fund, it will most likely include emerging markets and international markets in addition to bonds.

Diversification can also hide money from creditors like colleges or debt collectors.  Your primary residence has certain safety threshholds depending on where you live, but it can also be taken away if you use it to secure debt (as with a mortgage).  Your retirement savings is often protected.  Trusts and companies are other ways of protecting assets.

So… I recommend some thought exercises.

1.  Do you have an emergency fund that can cover reasonable emergencies (ex. water heater explosions, a delayed reimbursement, etc.) until your next paycheck?  That should be your first priority.

2.  Are you investing up to the match in your employment retirement account?  If you have low-fee options, put it in a target-date fund.  If you don’t, then compare the fees for the different index funds and pick a broad-based fund (if all things are equal, try to get one that matches the total market or the Russell 5000, but if the cheapest fund is the S&P 500 get that, and it’ll be ok).  For additional retirement savings it’s all about your employer fees and whether you qualify for an IRA and if you want to do a backdoor IRA.

3.  What are you doing about housing?  How much of your house is your net worth?  Do you want to buy a house in the future?  If you already own a house, how accessible is the money in case of an emergency (ex. having to move and the house not selling right away)?  For many people, the house is their main form of retirement saving besides Social Security, but in terms of diversification, this is not a great idea.  On average real estate goes up at the rate of the markets, but that’s the average– owning a single home doesn’t give you the average (it is the opposite of diversification).  If your housing market drops, you could lose a lot of savings (of course, it can go the other direction as well– we have friends in California who bought in 2008 and have gained a million dollars on paper since then).  So try not to invest so much in a house that having the market crash could devastate you.  Note though that whether or not you think it is ok to foreclose should also guide how much you’re willing to have in housing mortgage debt vs. equity (vs. renting).  In general, we do not recommend home-ownership unless you can put 20% down– yes lots of people manage ok putting less down, but lots of people were also put in bad situations having to short-sell or foreclose during the last housing crisis.  Basically, think about the worse case scenario and what would happen.

4.  When do you need the money that’s sitting in your bank account wanting to be invested?  If it’s less than 5 years, you can leave it there, or put it in cd ladders.  If it’s more than that, think about your time horizon–   are you investing for college?  Use a 529 (put it in one of their target-date funds).  Are you investing for retirement?  Use a target-date fund (or read some bogleheads forum about people in your situation).  Are you planning on buying a house in 8 years? Put it in a taxable mixture of stocks and bonds (what mix?  depends on how flexible your plans are given the vagaries of the market– to be honest, we just put it in the S&P 500 and cds as we got closer.)

Always do a mental run about what you expect on average to happen and what will happen in a reasonable worst case scenario (ex. 2008 stock market drop plus job loss, keeping in mind that the stock market increased before the drop, so it’s not like it’s 40% off what you put in, but 40% off what you put in plus your gains– the longer you’ve had it in the market, the more money you still have even after the drop).

Because a lot of diversification is about avoiding the low lows even if you miss out on the high highs.

And about acknowledging that long-run risk is different than short-run risk.  In the long-run, stocks will go up more than bonds or savings.  In the short-run, stocks are risky.

Satisficing will get you pretty close to optimizing risk vs. return.  A Vanguard target date fund is probably good enough, and it’s definitely better for long-term investing than just leaving money in a low interest savings account.

Here’s some next stage financial advice. Resources for asset allocation.

Grumpy Nation, how do you approach diversification?

Reminder: Check your retirement (and other stock) accounts!

My sister had 12K that was just sitting in the IRA she opened in college (and thinks she contributed to a couple/few times after getting her first job) making no interest in her etrade cash– it had been sitting there in cash for TWELVE YEARS.  (Her other two stocks in that account were etrade and paypal that she bought in college.  I’m pretty sure I didn’t advise her on that– I was telling everyone my age and younger to buy QQQ!  I understood both that tech was important *and* that broad-based funds (in this case a technology ETF) are the best.  I assume that was advice from our father.)  I put in a order right off to buy Vanguard’s 2060 target date fund with that cash (we chose 2060 because she has a defined benefit pension that has vested, so she can afford to be riskier with retirement savings).  Because if you’re going to set and forget…

Then she put in another 11.5K for 2018 and 2019 and is going to follow the steps to set up a backdoor Roth even though she thinks it’s sketchy.

She also has 30% of her 401(k) portfolio invested in company stock.  She’s been meaning to sell it off for a while, but with one thing and another over a decade has passed and here we are.  She’s not sure if she’s going to sell it all on Monday (the company value is currently coming out of a low point) or if she’s going to set up automatic quarterly sales.  I recommended the quarterly sales (there’s still more of this stock coming in!), and found the number for her to call in an email the retirement provider had sent to her this year saying she had too much invested in company stock, but I also said that if that’s too hard to set up to satisfice and just sell what she’s got.

I’m not a saint either– When I checked at tax time, I had over 1K sitting in my own etrade cash account (taxable) because one of the stocks my father had bought when he was managing my stuff got bought by another company and rather than me getting the other company, I ended up with just the cash.  Which sat there for a few months because I don’t pay attention to that account.  And for some reason last quarter all our QQQ etrade accounts stopped DRIPping (maybe there was a name change again?  It looks like it has lost a Q.) — there was enough in each account to buy one share, but with a $6.95 commission, so I put the money into VFINX instead.  Luckily I do look at these accounts once a year around tax time…  Etrade’s cash account doesn’t even make reasonable interest like Vanguard’s money market fund does!

The other thing we needed to change on my sister’s IRA account was her beneficiary– she’d listed our father, but she’s fairly sure that her niblings have a higher probability of being alive when she’s gone, so now that over a decade has passed and there is a younger generation that didn’t exist when she set up the account, she switched those over too.

To sum:

  1.  Take a look at your accounts to make sure you’re still invested in what you think you’re invested in.  (I’m not even talking about something complicated like rebalancing!)  Sometimes companies merge or die or your dividends stop dripping and you end up with a bunch of cash where you thought you were getting market returns.
  2.  Make sure the people you have listed as beneficiaries are still alive and are still the people you think should be inheriting.  If you’ve had additional kids since listing a beneficiary, make sure you’re not just listing the oldest!

When was the last time you checked your stocks?  Do you know who you’ve listed as beneficiaries?

Ask the grumpies: IRA with Vanguard or TIAA-CREF?

Steph asks:

I’ve managed to swing one month of actual wages this year (my salary is usually all a stipend/fellowship), which means I can put some money in an IRA! I have an existing IRA with Vanguard, but the 1 month job will also let me put money directly into an IRA at TIAA Cref. I won’t quite make enough to hit the yearly max, even pre-tax, and there’s no matching. I’m leaning Vanguard – do you have any suggestions?

Disclaimer:  We are not professional anything except academics– do your own research and/or consult actual professionals before making important monetary decisions.

You are correct to prefer Vanguard.

Vanguard has better fees for IRAs than does TIAA-Cref.  Vanguard is pretty nice to work with.  You already have an existing IRA with Vanguard, so you’ve already done the hard part of getting it set up.

The nice thing about TIAA-Cref is that they will send a person to hold your hand if you need help with something.  But this is just a basic IRA and you’ve already got one.  The TIAA-Cref option is better for people who just aren’t going to get an IRA unless they get help from someone in person.  Which isn’t you.

Finally, depending on how much money you have invested and how you have it invested (we presume low cost broad-based index funds), Vanguard has even lower fees for its admiral funds.  If putting more money in allows you to hit the threshold, then you’ll be paying an even smaller percentage in fees than you were before.

So… I don’t see any downside for keeping with Vanguard or any upside for putting an IRA into TIAA-Cref.

 

Ask the grumpies: how to find an HSA provider

FF asks:

Do you have any thoughts/advice on choosing an HSA provider?

I already have the ACA plan figured out. I first check whether my doctors are in-network. Next, I come up with a detailed list of what I expect to need based primarily on my expenses for the current year. I then calculate what I would pay for the entire year under each plan I’m considering, taking into account both premiums and OOP expenses (including before/after deductibles and copays). This can get very complicated. I also calculate the worst-case scenario (total premiums plus OOP max). This year, for the plans I was considering, the answer was the same for both the expected and maximum scenarios. Plus the HDHP + HSA will have further tax advantages.

What I’m concerned about now is the Health Savings Account, which is not offered via the ACA, but separately through financial institutions if you have a compatible health plan. So far, the most useful information I’ve found is from Consumer Reports: https://www.consumerreports.org/health-savings-accounts/how-to-choose-a-health-savings-account/

People who have high deductible health care plans (HDHP) are allowed to put money into a Health Savings Account (HSA) which functions basically as a super-charged IRA that can only be spent for medical purchases.  By supercharged, we mean the money isn’t taxed going in and the earnings aren’t taxed going out.  It’s pretty amazing.  (Note that these are different than Flexible Savings Plans, which are sometimes called Health Spending Accounts just to be really confusing– these have to be used up each year or the money goes back to the employer, just like a dependent daycare account.)  By IRA, we mean an individual retirement account that functions as a tax-advantaged bucket for retirement savings.  (FF already knows all this.)

Back when I last looked at HSA, there weren’t a whole lot of options– you basically went with what your employer offered you because that was what was available, and most employers offering HDHP also put money into the HSA themselves because that money came with tax benefits for them.  Having outside HSA didn’t make a lot of sense because there was no market for them.

Today there’s a market for HSA outside of individual employers, which means that there are a lot more options for HSA.  Many places that you can stash an IRA will also let you do an HSA.  What you should be looking for in an HSA is similar to what you should be looking for in an IRA provider, with a few additional wrinkles.

First off:  If your employer offers an HSA contribution, chances are that’s going to have to go into the HSA account that they have chosen.  According to that consumer reports article FF linked to, you can keep that HSA account open, let the employer money go into it, but then transfer to an outside HSA account if you want.  I have never found it easy to move money from work accounts to outside accounts, but depending on fees, this may eventually be worth it.

Second:  As the consumer reports article notes, you need to know if you’re going to need the money long-term or short term.  If you’re credit-constrained or have high medical expenses, then you will need to use the money right away.  That means you need an HSA account that has things like savings accounts or certificates of deposit for safe money.  If you’re not credit constrained, then it makes sense to just think about this as another retirement account, which means you want something that has access to low cost index funds in the stock market and maybe in the bond market too, depending on what’s available in your other retirement accounts for diversification purposes.  So, if you need short term then make sure the HSA has short term options.  If you need long term, make sure there are long term options.

Third:  Compare fees.  This part is just like with an IRA.  You want the lowest fee funds.  Watch for hidden fees.

So… that’s pretty much all of my thoughts on the topic.  The consumer reports article you linked to looks really good to me.  It’s not saying anything stupid AFAIK and covers everything I thought of.

Grumpeteers who have purchased HDHP for use with your HSA, what do you recommend?

Vanguard Admiral Shares are pretty cool

I wanted to add a little more international exposure to our portfolios (if I’m reading things correctly, the IRA Roth is a great place to put international exposure because there might be higher taxes with international stock gains?  I’m not 100% clear on this– I also read something that said the opposite), so when we recently did backdoor Roths, I put the money into an international index and an international ETF.   The index (VGTSX) has an expense ratio of .18% and the ETF (VXUS) has an expense ratio of .11%.

If I have 10K invested, then I can convert my VGTSX investor shares into  VTIAX admiral shares, which will decrease the expense ratio from .18% to .11% (same as the ETF).   For most of the index funds that have admiral shares at Vanguard, the switch from more expensive investor shares to cheaper admiral shares occurs when the account has more than $10,000 invested in that specific index.  Basically Vanguard gives you a discount on the index if you have a lot invested in them.

My 2017 IRA investment was only $5,500, but it is a new year so I contributed another $5,500, which, if the stock market doesn’t crash, adds up to more than 10K, meaning I should be able to switch to admiral shares to get the lower cost fund.  So that’s what I’ve done.

I’m wasn’t entirely sure where to invest DH’s IRA this year.  He had less invested overall and thus needs less international exposure and already had the lower cost ETF.  (I know that since we’re living in a community property state that I should be looking at our accounts as a complete whole, but since I don’t know what the future will hold, I want to make sure that he’s also protected.)  I will have to see what holdings he currently has one of these days.  I suppose we’re due for one of those financial fitness days sometime so I can go through and readjust our assets etc., but maybe I’ll wait another year.  We’ve got a lot of stuff going on and can afford to put it off, especially since I’m not really sure what asset mix we should be aiming for in the first place.  In the end  I gave him more VXUS.

Do you pay attention to expense ratios?  How do they change your investment patterns?  Any preferences between Index vs ETF?

Switching away from Roth to Traditional retirement savings as a form of protest– even if it is suboptimal monetarily

The general conventional wisdom is that if you think you’ll be in a higher tax bracket now than at retirement, you should put tax-advantaged retirement (IRA/401(k)/403b/457b etc.) money in traditional retirement savings rather than in Roth savings.  That means you don’t pay taxes now, but you pay taxes later.  If you think you’ll be in a lower tax bracket at retirement, you should put your retirement money in Roth because you pay the taxes now, but will not have to pay taxes on the earnings later.

I have assumed that while our income will likely be lower in retirement, our tax brackets have a very good chance of being higher because they’ve been at historical lows and because we didn’t fix Social Security and Medicare when we had the chance, most likely we’ll be paying for big chunks of those out of general revenue (indeed, that’s the argument the last trustee of SS [Trump has not appointed any trustees, which is bad] made at a very depressing talk he gave recently).  So that would imply that for optimizing our wealth, we should do Roths now and pay the taxes now and live large on tax-free earnings later.  Of course, I’m not 100% sure that that’s going to happen or even that the US government will keep its promises about the tax-free status of the Roth vehicle.

So what I’ve been doing, as I tend to do when I have no idea what to do, is I’ve been using a 1/n heuristic.  Half my retirement money goes in traditional.  Half my retirement money goes in Roth.

If the Republicans pass their tax plan, chances are it will make even more monetary sense for me to put money in Roths– pay those taxes now because there’s no point trying to get my AGI down.

And yet… the Republicans are going to dig a huge hole in the national debt with their “no taxing rich people/no spending on investing in our future/spend a lot on the already rich and powerful” plans.  The US government is going to need my money more later when good people are in charge and the Republicans will have to face what they’ve done to the US sooner if they get less tax money now.  So I’m feeling like it will be patriotic to squeeze them now and pay more in taxes several decades down the line.  Even if that means that we end up with a smaller net worth when we die.

So… even though it’s a bit of paperwork for me… I think I’m going to change over all of my retirement savings to traditional.  Because the US government will need that tax money later.  I know it’s only a drop in the bucket for the US, especially given that they want to increase the deficit by well over 1.5 trillion this year alone, but I do what I can.

Of course, Republicans could mandate that all preferred retirement savings be in the form of Roth so they get taxed now instead of later.  And it sounds pretty likely that they’re going to make it so government employees can’t take advantage of both the 403(b) and the 457, which will cut my optional retirement saving in half.  That’s a way to punish high earning government employees (particularly those who don’t get much in the way of direct employer contributions) and a way to get good people to not want to work for the government (so either salaries would have to increase or other benefits would increase).  But I suspect these politicians don’t want competent people working as civil servants.  And they want to punish state and local employees, because why not.

How do you decide between Traditional and Roth options?