No matter how much or little you earn, if you consistently put away 10% to 15% of your gross income, you can build impressive wealth over time.
But knowing where and how to invest money can be confusing and a little scary. Few of us are taught the ins and outs of investing in school or at home.
In this post, I’ll answer 3 questions from Money Gir l Podcast listeners about setting financial priorities, retirement accounts, and whether it’s a good idea to use “robo-advisors” to make more money.
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Investing Question #1:
Wendy M. says, “My husband is in his 3rd year of medical school and we have taken out a total of $60,000 in student loans. It’s our only debt besides a mortgage and a loan we took for the house down payment from our parents.
I have a job and we have just enough savings to pay his tuition and school expenses for next year. Or should we take an additional $15,000 or $20,000 in student loans if that would allow us to maintain savings and contribute to our IRAs?”
Answer:
If you’re a student or are considering going back to school, you’ll probably need to finance some amount of your education, depending on the degree you want and the school you attend.
I’m a big believer that paying for education is an investment in your future that will pay off. Studies have shown that despite the increasing cost of college and graduate school, the lifetime financial benefit of higher education has never been more valuable.
Having a bachelor’s degree is worth almost $1 million more in lifetime earnings, on average, when compared to only having a high school diploma. Getting a master’s degree is worth an average of $1.3 million more.
And if you’re like Wendy’s husband and go for a professional or doctoral degree, you earn $3 million more than if you didn’t continue your education after high school. In other words, making an investment in your own education pays off for the average person.
Besides the financial benefits of more education, it can be exciting and personally rewarding to study a subject that you love, meet like-minded students, gain more confidence, and have experiences to draw from for the rest of your life.
No matter your professional or personal motivation for getting more education, make sure than you can complete the program on time and justify the price. Taking on too much student loan debt can hurt you, but the right amount can open career doors that make it painless to pay off.
It could take years to see your income grow substantially. Until then, you may feel stretched thin to pay student loans, bills, and invest for the future.
Wendy and her husband are in an excellent financial position because they have what I call good debt, instead of bad debt. Good debt allows you to build wealth by earning more or owning an asset that grows in value. Bad debt, like credit cards and payday loans, typically leaves you with less wealth.
Taking a reasonable amount of student loan debt to earn a medical degree will pay off in higher lifetime earnings. Having an affordable mortgage, especially on a property that appreciates in value over time, is also a wise investment.
Student loans and mortgages also go in the good debt category because their interest rates are relatively low. In addition, some amount of interest paid on both types of loans is tax deductible, which makes them cost even less. In contrast, interest rates on bad debts like credit cards are high and don’t come with any tax advantages.
If you wait to be debt-free to start investing, you might never get started. You’re certain to lose precious time that your investments could be growing.
Since Wendy and her husband don’t have any bad debt straining their finances, I’d recommend that they pay for medical school with an additional student loan instead of draining their savings. Taking away that financial safety net before medical school starts paying off would be too risky.
For instance, if Wendy lost her job or they had a large, unexpected expense, that could throw their finances into a tailspin. Maintaining their savings in the event of an emergency gives them stability. That’s why having cash reserves should be a fundamental part of your financial strategy.
An added advantage of not being cash-strapped that Wendy mentioned is the ability to continue investing for retirement. It’s wise to continue making contributions to an IRA or workplace retirement plan even while you’re paying down debt.
If you wait to be debt-free to start investing, you might never get started. You’re certain to lose precious time that your investments could be growing. Not getting started investing early is the biggest financial mistake you could make. Maintain the habit of investing, even small amounts, at the same time you pay off debt.
I offer lots of detailed advice about managing debt in my book, Money Girl’s Smart Moves to Grow Rich. An important point I cover is that your first financial priority should always be to pay off any dangerous debts like delinquent taxes, overdue child support, or a judgement from a collections agency. In these cases, it does make sense to pause your retirement savings until you get serious bad debts under control.
To sum up, I’d encourage Wendy and her husband to take out additional student loans in reasonable amounts to get through medical school while preserving their emergency savings and contributing to retirement accounts.
See also: A Blueprint to Prioritize Your Personal Finances
Investing Question #2:
Ray G. says, “I'm interested in using a robo-investment service like Wealthfront or Betterment. I've read good things about both, but would love your thoughts on the value of using a robo-investment firm over a traditional firm.”
Answer:
A robo-advisor is an online investment service that uses software to automate the allocation of your money into different funds. They ask questions about your risk tolerance, savings, and time horizon for spending your invested money, and then put your funds into investments for the best growth.
Robo-firms may also have licensed brokers who can give you advice; however, most are technology companies that automate the creation and rebalancing of your portfolio and operate mainly in the digital space.
Dozens of innovative online platforms and smartphone apps have sprung up to make investing more simple, convenient, and an integral part of daily life. Some of the most popular include:
The major benefits of using robo-advisors are low fees and account minimums. They charge a fraction of the cost of traditional firms. Most also give you an elegant and stripped-down user interface that makes creating accounts, setting goals, and monitoring progress a real joy.
Many offer taxable and tax-advantaged retirement accounts, such as a traditional IRA, Roth IRA and SEP-IRA. I’ve been a fan and customer of Betterment since they started almost a decade ago. But I also use traditional investment firms.
If you have a retirement plan at work, such as a 401k, 403b, or 457, that’s the first place I recommend you invest. If you don’t, or are self-employed, a robo-advisor is the perfect way to create a simple investing portfolio.
Traditional firms may offer a wider selection of investment options, but in general, robo-firms offer plenty of mutual funds and exchange-traded funds to choose from. They operate on the idea that you’re more concerned about reaching your goals than you are about digging into the details of specific investments and discussing them with an advisor.
However, a robo-firm may not be for you if you have a high net worth, a complicated tax situation, or are getting close to retirement. You may find that you want more personalized advice in some situations.
Using a financial advisor can be incredibly valuable when you need guidance. They can give you customized recommendations about long-term life decisions like putting a child through college, estate planning, and having enough of the right kinds of insurance.
The crucial aspect to being a successful investor is simple: get started as early as possible and automate it.
And as I mentioned, not all robo-advisors remove the human element completely, so getting more help may still be an option with some of them. So, I think that both robo and traditional firms are valuable. You should choose a firm that you feel comfortable using and that helps you get questions answered when you need it.
The crucial aspect to being a successful investor is simple: get started as early as possible and automate it. Have monthly payments set up to transfer from your checking account into one or more investment accounts.
Making regular investment contributions is more important the choosing a sub-optimal investing firm. You can always change firms, or have multiple firms (like me), but you can’t make up for lost time that you neglected to have money set aside and growing.
See also: Should You Pay Down Debt or Invest?
Investing Question #3:
An anonymous podcast listener says, “I have a 6-month emergency fund and max out both my workplace retirement plan and IRA. What do you think about signing up for a high deductible health plan at work and using an HSA to save more money for retirement?”
Answer:
I’m a big fan of using a health savings account or HSA to cut taxes and save even more for retirement. The trick to using one is that you must first be enrolled in a high deductible health plan.
If you qualify for an HSA, they're available at many banks, credit unions, brokerages, and specialty institutions like HSAbank.com. Most are convenient to use and offer paper checks, a debit card, and online banking.
Contributions to an HSA are tax deductible up to the annual limit, which I’ll cover in a moment. That means you reduce your taxable income and the amount of tax you must pay by funding the account. Additionally, any earnings in the account grow tax free.
You can make tax-deductible contributions at any time, even up to April 15 for the previous tax year. But you’re never required to make any contributions to an HSA.
Plus, a little-known benefit of an HSA is that you can use it to boost retirement savings.
Just like with a retirement account, you should never put money in an HSA that you might need for everyday expenses. You can only use HSA funds to pay for current or future qualified, unreimbursed medical expenses—otherwise withdrawals are subject to a hefty 20% penalty.
When you pay for qualified medical, dental, and vision expenses on a pre-tax basis for you or your family, that’s like getting a 20% to 30% discount on your medical care, depending on your tax rate.
Plus, a little-known benefit of an HSA is that you can use it to boost retirement savings. After your 65th birthday, you're allowed to take distributions to spend any way you like—even on non-medical expenses. So, after you retire, the HSA rules allow you to tap it for any reason without having to pay a penalty.
See also: How to Save Money on Healthcare with an HSA
For 2017 you can contribute up to $3,400 (or up to $4,400 if you’re 55 or older) to an individual plan. If you have a family plan, you can contribute up to $6,750 (or up to $7,750 if you’re 55 or older).
What’s great about an HSA is that you own the account as an individual and control it completely—even when you get your health plan through an employer. You don’t need permission from an employer or the IRS to set up an HSA and it stays with you even if you change jobs or become unemployed.
There’s never a deadline to spend your HSA money. Funds can stay in the account indefinitely and penalty-free until you want to use them, even if you change your insurance company, become uninsured, or are unemployed.
Even though these are great benefits, remember that a high deductible health plan isn’t the right choice for everyone. They work best when you're in relatively good health and aren't likely to spend the full deductible each year.
If you can afford paying the higher deductible, having an HSA can help you build up savings to pay medical bills or to accumulate an additional nest egg to spend after age 65, especially if you’re already maxing out a retirement account like the anonymous listener who asked.
See also: HSA Rules After Leaving a High Deductible Health Plan
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