Part III: Non-Retirement Investment
In part I and part II, I talked mostly about saving for your retirement. Saving for retirement gives some great tax benefits. Therefore, everyone should participate in it. However, you cannot access your retirement savings until you retire except in some special cases. There are also limits on how much you can contribute ($5000 max for IRA for example). Once you contribute to your 401k, and max out your IRA account (remember for a couple, you get to save $5000 each, but you’ll have to open two separate account) and still want to save or invest, you’ll have to go with a non-retirement account. There are two ways of investing in non-retirement account. You can stick with mutual funds or you can open a brokerage account and invest in individual stocks.
Individual Investment Account
Vanguard calls a non-retirement mutual fund account as Individual Investment account, and that’s how I’ll refer to all non-retirement mutual fund accounts. Basically, in this account, you buy mutual funds with your after-tax money. There is no limit on how much you can invest and when to withdraw from this account, but you’ll have to pay taxes on your earnings whenever you make profits. Unlike IRA accounts, you do not have to earn income to open this account, you just need money! So people who don’t work but have saved money, this is probably the best option they have. For example, students who don’t have earned income but have saved some money, you open this account, buy a stock index fund, such as S&P500 index, and you don’t have to worry about it! Whenever you want to invest more, just transfer money from your linked account (as little as $50) and it’ll buy more, even a fraction of share. There is no transaction fee, or account maintenance fees, at least not at Vanguard. Other companies may have annual fees and stuffs, so make sure to do your own research if you want to go with a different company.
I am surprised how many young people do not know what a mutual fund is. A mutual fund buys many companies. Take a look at this Vanguard S&P500 index fund (VFINX). This fund buys all the stocks listed in S&P500. So if you own this mutual fund, you own all 500 companies! Here’s a list of top 10 companies that this fund holds.
As you can see, Exxon Mobile is 4.16% of this fund. What this means is if you invest $1000 in this fund, you’ll invest $41.6 in Exxon Mobile, $23.8 in GE, $19.7 in Microsoft, and so on. So instead of buying individual company, by buying this fund you buy small percent of all of them. You can of course try and buy these companies directly yourself, but $1000 will only buy you may be 12 stocks of Exxon right now, and you won’t get to buy GE or Microsoft because you used up all your money. By buying a mutual fund, you also lower your risk of loosing money because not all of 500 companies are going to go down in a single day. So instead of paying commission on every single transaction, you buy one fund and there is no commission! At the end of the day, the price of the fund changes according to the changes in these companies stock price. As simple as that. Don’t be discouraged by the YTD Return %, I am writing this post in one of the worst period of the stock market, so they are all down. However, over long term, S&P 500 has returned around 10% annually!
If you want to invest in specific sector, for example oil and energy, there are mutual fund that only hold such sector specific companies also. There are mutual funds that hold international companies, Asia and pacific specific companies, many many other specific companies. So if you want to invest in international market, you just buy those mutual funds.
Please note that, investing in 401k and IRA account is just like investing in Individual Investment account. The only difference is how the accounts are treated. You can buy the same mutual funds in your 401k, IRA and regular investment accounts, though you may want to diversify. More on that on part IV.
Finally, if you want to be more involved in investing, you can open up a brokerage account. Not everyone needs a brokerage account because most people are passive investors and they should stick with mutual funds and let the pros do the investing for them. Investing in individual stocks in risky ((just look at our investment in Wamu!). It is also very time consuming, because you’ll have follow the financial information of the company, their growth potentials, competition etc. Imagine doing that for 10 companies! But, individual stocks also have potential of big gain, if you know what you are doing (or get lucky).
So, if you want to buy individual stocks yourself, you’ll need a brokerage account, and if you are enrolled in ESPP, you probably have one already. Brokerage account I use is Zecco. I also have an ETrade account that came with my ESPP, but I don’t use it for anything else because they charge huge commissions. With a minimum balance of $2500, Zecco gives you 10 free trades per month, which is more than what you’ll need if you are a long-term investor and not a day-trader. If you want to open a Zecco account, please contact us, so that we can refer you. That way we’ll get some money to cover hosting for this site!
I am a firm believer of mutual funds and think that most of your retirement and non-retirement investment should be in low cost mutual funds. You can set aside small amount of moeny every month and invest in individual stocks, but do not get carried away and gamble with your retirement savings!
I have listed all different ways you can save or invest, and have told you how I think you should prioritiz your contribution among different accounts. I want to summarize what I have said so far in this series.
For people who are working and have earned income:
- If your employer has any kind of match, contribute enough to get the maximum match. If ROTH 401k is offered, sign-up for that one. This should be your first priority. Also, participate in ESPP if your employer has one.
- Max out your IRA contribution. If you qualify, you should have a ROTH IRA instead of a traditional IRA. If your employer does not have a 401k match, this should be your first priority also.
- Invest whatever you can in Individual Investment account. Remember, you’ll need to save some cash and keep it in high-yield saving accounts for some unexpected expenses. So don’t invest everything.
- Brokerage account
- After doing all of the above, if you still think you will have money leftover and employer offers a ROTH 401k, you should increase your contribution percent on step 1 of this list to whatever you want.
For people who do not have any earned income but have money:
- The only options you have is the non-retirement investment. You should open a Individual Investment account and invest as much as you can. You could also open a brokerage account and buy stocks, but as I have said before, mutual fund is probably best.
The best way of doing this is by investing in all of your account every month or each pay check. Especially on point 4 above, I am not suggeting your change your contribution percentage after you have contributed $5000 in your IRA. You’ll have to plan ahead in the begining of the year and decide how much you want to contribute to each account per month. For example, you’ll have to contribute roughly $415 per month to get to $5000 in one year. Calculate all your other expenses, such as student loans, car payments, rent etc. Decide how much per-month you should save in cash (and keep it in a high-yield saving account). Then you’ll have an idea of how much would be still left for you to invest in a non-retirement account. If you think you’ll still have money left after doing all of the above, then you can sign up to contribute more on your 401k.
On the fourth and final part of this series, I’ll talk about asset allocation and what type of funds you should buy.