No Debt Plan

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Chris commented on my post, One Simple Step to Retiring with $1,000,000, with a question about Roth IRA minimums.

You say the max is $5,000 is there a minimum? If I can’t afford to do the $416.67 per month, what is the lowest that I can go without any kind of penalty. Or can you go without putting anything in for a year or two, not that you would want to do that. Just curious, I’m not completely familiar with the way the Roth works. Thanks Kevin!

The best answer? It depends.

There could be a few different minimums: minimum to invest in a mutual fund, minimum amount required to open the account with the firm, or minimum amount you can add additional funds to your account with.

There are a multitude of places you can setup your IRA/Roth IRA. A bank, brokerage firm, or directly investing with a mutual fund/investment firm are a few options that come to mind. Each is going to have different requirements of you to open up an account.

For example, we use Vanguard for our Roth IRAs. To invest in Vanguard’s mutual funds — through Vanguard or a brokerage firm — you need $3,000 as a minimum to invest in that mutual fund. The only exception is the Vanguard STAR fund with a minimum of $1,000. Everything else you need $3,000 to get started. However, after that the smallest amount of money you can then add to that fund is $100 if I remember correctly. You don’t have to save up $3,000 at a time unless you want to use multiple funds. We are currently invested in a Target Retirement Fund to get started, so we have no need for another fund right now.

If you setup an account with a bank or brokerage firm you would have an array of options to invest in. Some would have higher minimums than others. Some of the firms may even require you to have a certain amount just to open the account regardless of how much you invest in each mutual fund or stock.

It really does all depend. We have been completely satisfied with Vanguard in the short time we’ve been with them. We didn’t have $3,000 saved up initially, but just set aside money each month until we reached the minimum.

My advice? Just get started today. Do whatever it takes. Set the money aside in an online saving account like ING until you have enough to start investing. Step by step you will get there. Just remember the first step is always the hardest.

Update #2: I also answered a question from the comments below in a different post. It addresses Roth IRA minimums.

Update: Hello StumbleUpon users! Learn more about me or read some more articles. Thanks for all of the up votes! Please leave comments on your thoughts. We had a bit of discussion over at Stumble Upon with some of the reviews, so check those out, too.

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I’ve got a keen interest in learning more about how changing one thing in your life can have a huge impact further down the line. More on that in the future.

The Roth IRA is one of those changes. One simple decision that can truly change your life.

The government allows you as an individual to set aside $5,000 (as of 2008) per year of after-tax money for your retirement. I decided to use the Roth for this example because it eliminates taxing gains on your investment, which makes the example a lot more simple.

So what happens if you start early and set aside just $5,000 per year?

Let’s run the numbers.

Using Excel, you can calculate what amount of money you would end up with based on the following criteria. I’m using myself as an example because, well, I know everything about me.

• Age: 24
• Retirement: 66 (I would rather retire earlier than this, but am willing to work this long)
• Annual Contribution: $5,000 after-tax dollars
• Annual rate of return: This can vary greatly. We’ll stick with a very conservative 7% per year.

You can make changes and run your own calculations with my Roth IRA calculator (in Excel).

Long story short? If you start early, you can retire as a millionaire by just using one investment vehicle. No need for five different accounts with three different brokers. A simple Roth that through whatever investments you chose earns 7% per year, nets you $1.2 million (give or take some due to rounding error). You can see a chart of your cumulative contributions compared to the balance in the account. See how much you are earning at the end without having to put more money in — the beauty of compound interest. (You can click on the chart to see the full size.)

For those who like easy steps:

• Pay off debt, live a debt free life.
• Commit to putting away $5,000 after-tax money into a Roth IRA. That’s $416.67 per month.
• Invest in index funds like Vanguard’s Total Stock Market, Total International Stock Market, and Total Bond Market. Lower fees = higher returns.
• Earn a ‘measly’ 7% return on your investments each year until retirement.
• Retire with $1.2 million.

Want to run your own numbers? I’ve uploaded the handy Excel workbook for you.

Nothing like some pure speculation to get the Monday morning going. What does Ben Bernanke’s portfolio look like? What is he currently invested in?

I wonder if this sort of information is available publicly. A very powerful person in the finance world. What does his portfolio look like?

I did a Google search and the only thing I can find is a CNN Money article from a few years back. Nothing more recent. The Money article did seem to mention that he had a very plain, basic portfolio with nothing really extravagant in it. He also earns a “modest” salary in comparison to what he could earn on Wall Street.

The Federal Reserve is an interesting beast of an organization. They have government-like powers, but they aren’t a government institution. Despite not being a government institution, they carry a government domain name (federalreserve.gov).

Are there rules or laws in place to limit what the leaders of the board can invest in?

What if…

• Ben bought Bear Sterns’ stock at $2 then allowed/encouraged the price to go to $10 per share?
• Every time a significant change was going to happen in the interest rates that Ben bought securities that would benefit from the lower/higher rates?

There are a bunch of scenarios you could come up with that would seem quite sketchy. Anyone out there know about the “rules” for people like Ben when it comes to investing?

I noticed that Visa (V) IPO came out earlier this month. I had been meaning to track this more closely, but let it slip by. When I heard that it was already trading around $60/share, I could feel my emotions change a bit. Anxiety kicked in — had I missed a great deal? Was it too late? What could I do to get ‘in’ on this deal?

We have a stock and mutual fund sitting in a taxable account with Firstrade. This was leftover money from our house down payments. I am waiting for the stock to recover some of its value, and for the mutual fund to go back up due to the market fluctuations recently. As I sat here at my computer pulling up information about Visa, I began pondering the use of this money. I could sell both, take the proceeds, and buy some Visa stock. It’s bound to go up, right? I mean, look at Mastercard!

Woah, tiger. Let’s slow down for just a second. That’s the thing about investing… your emotions get involved. Let’s take a look at Mastercard (MA).

It’s kind of hard to see on the above chart, but since Mastercard went public in 2006 the share price has gone through the roof. It looks like Mastercard came out at around $45 per share. The current price? $216.50 as of yesterday’s close. Wow. That’s $171.50 per share in growth, or 381% in about two years. Not half bad, even by Warren Buffett standards.

So Visa is going to do the same thing, right? Not necessarily. This is what your brain is telling you. It sees the positives of Mastercard as well as the similarities in the businesses. Skipping all other logical thinking, it encourages you to go ahead and invest… and soon! However, these are two completely separate firms. There is no guarantee Visa is going to earn you 381% returns within the next two years.

Don’t get me wrong, I think Visa is a great business. I wish I owned it. But trading in a broad mutual fund plus one stock to get only one stock is foolish. This isn’t play money we’re dealing with here. So for now, I sit on the sidelines. Sticking to our plan. Sticking to our 2008 goals. There will be other stocks in the future that I will invest in. That is a few years down the road, maybe even decades. The bottom line is to keep your emotions in check when investing.

That being said, if I had the abilities to invest in individual securities, I would invest in Visa. Have any of you out there bought some Visa stock?

There has been a discussion out in the personal finance blogging world about P2P lending. P2P means peer to peer (just like when you used Napster back in college). Except this time, you are offering to loan a stranger some of your money in return for a higher interest rate than an online savings account.

There are two primary sites that have grown into this industry: Prosper.com and LendingClub.com. I joined Prosper a while back, but never lent out any money.

Gather Little by Little thinks P2P lending is a bad idea. There were several other blog responses arguing against GLBL’s point. I sit somewhere in the middle.

It seems like a great deal for the borrower. If you can’t get a loan from a bank, or if your credit card company has jacked up your interest rate (Bank of America has done this recently) then it is a less expensive source of funds. Plus, if you are unable to get a loan anywhere else, there is still the possibility of getting the loan through P2P lending. For those borrowers, any way to get the loan is a good thing for the borrower.

For the lender, I am not convinced it is a good idea. Sure there are some checks and balances like collection agencies and credit ratings, but you are still lending money to someone that you have never seen before. You don’t know if any of the details are true on the listing. In other words, I think this is an extremely high risk venture. In today’s market you would have to be a real thrill-seeker to go after additional volatility. I wouldn’t put my retirement savings into it even if I could get higher returns.

Contest

However, if I had some ‘play’ money sitting around, I might lend it out to get a higher return on one of the sites. To that end, I am going to start a little contest. I have seen several blogs with Lending Club ads up on site. I’m guessing the person who refers you into the system will earn some sort of referral bonus. (If I’m wrong and there is no bonus then this is going to fall on it’s face!)

I will join Lending Club to earn the $25 free sign-up bonus through your referral. I’ll try to keep this as simple as possible:

• Each point you earn will put another entry for you into the contest. If you earned three points and there were only 10 total points entered, you’ve got a 30% chance of winning. I’ll take the entires and put them into a random number generator. Your number pops out, I’ll sign up through your referral.
• How to earn points:
  • 1 point - leave a comment with your referral link
  • 2 points - write a post on your blog linking back here (of course with your referral link within that post so I can sign up if you win)

Thus, you can earn up to 3 points or entries by doing both things. That’s it! The contest will end on Wednesday, March 19th at 7:00PM Central Time.

An article on CNN’s website for Fortune makes me a bit nervous. It is titled Buffett: Don’t Bank on Big Returns. He points out that during the last century, the DOW went from 66 to 11,497. This averages out to 5.3% per year. If the market maintained that average until 2100 the DOW would be worth nearly 2 million. He thinks this is highly unlikely.

I’m not too sure to think… if the markets (and inflation) continue to grow, you think it would be as he describes. I think I need an economist’s opinion.

Yesterday I Googled “retirement calculator” so I could run some numbers. I wanted to pick an amount that we could contribute to our Roth IRAs each year — say, $3,000 each — and discover where we would stand in retirement. As you might expect, there were plenty of calculators to be had. The one I enjoyed using the most came from CNN Money.

I liked this calculator the most primarily because:

• it asks for a lot of data
• it shows you where your portfolio would stand at differing options (10% chance of knocking the ball out of the park with incredible returns, 25% of nice returns, 50% of this actually happening, etc.)

We have little saved for retirement — and that’s okay. With roughly $1,400 in a 401k (3% contribution), $3040 in a Roth IRA, and my wife’s retirement account with the state (5% contributed), we’re just getting started at ages 23 and 22. I put our ages in at 24 and 23 in the calculator because it was taking it off of what age we would turn this year. (Our birthday’s are in April and May.)

When input our data and add $6,000 in total Roth IRA contributions per year, we get some very favorable results. The end result is we should be able to have 70% of our pre-retirement income if our investments net a return of only 3.3%. This is extremely encouraging.

Do It In Excel (or Other Spreadsheet Software)

There is a way to do some of these calculations in Excel that I want to show you. You can calculate the future value of present dollars, plus any additional payments. It won’t account for inflation, at least not easily. Open up Excel (or OpenOffice Spreadsheet) and click on a cell. Type everything but the quotes at the beginning and end: “=FV(8%,42,-3000,0,0)”. What you are telling Excel you want to know is what is the future value (FV) of a constant return (8%) for the next 42 years (66-24=42) with constant payments of $3,000. The 0’s at the end are saying there is essentially no money in the account yet. And yes, you do put -3,000 in the formula or you end up with a negative number.

What do you come up with? $912,730.57. Not too shabby for only $3,000 per year.

There is a second way to estimate the future value in Excel. Essentially you calculate the gain for each individual year and run the calculation until X year of retirement. You can download the Excel file I did the work in, too. (It also shows the future value formula at the bottom.)

For the second method, you are going to calculate the beginning balance, contribution (payment), return, and ending balance for every year. Once you do it for the first two years, you can drag the results down to auto-complete for the next 20, 30, or 40 years.

This results in a slightly different end number that the future value formula: $1,067,848. I’m not sure why there is a difference, so maybe someone who reads this can explain. However, they are pretty close.

The Catch:

• This will show you what the future value of today’s dollars would be. It does not account for inflation. Essentially you are assuming that you will contribute the equivalent of $3,000 of today’s dollars for all of the years. So fifteen or twenty years from now, $3,000 of today’s dollars could be $4,800 or $5,500.
• This assumes a constant rate of return: 8%. Some years you may earn 15%, others you may lose 20%. It could average out to 8%, but that would affect the calculations. This is where the CNN Money calculator can help.
• The younger you are when you start, the better. If I waited 10 years until I was 34, then the end result is only worth $472,880. A difference of almost $600,000. So get out of debt, and get started.
• Waiting longer to retire is also extremely beneficial. If you look at the Excel file I put up, the last year the investment gain is $79,000! If I wait one more year, I’ll earn another $85,000+. There is some serious money at the end.

I hope this helps dissect some of the numbers for you. Additionally, now you know there are at least three different ways to guesstimate at your retirement nest egg (and you can do two yourself).

A few weeks ago there was a huge swing in the market over the Monday holiday. A lot of people were predicting a crash — some international markets fell 5%+. The Fed jumped in and cut the market rate 3/4ths of a point. The US markets went down, but seemed to have recovered.

http://www.mississauga4sale.com/images/Market-Emotions-Cycle2.jpg

That link pretty much sums up my thoughts on investing in the stock market. Most individuals sell high and buy low — the exact opposite of what you want to do. Stick to your investment plan, and invest regularly. Don’t try to time the market.

Or, as Warren Buffett puts it, “…try to be fearful when others are greedy and greedy when others are fearful.” That pretty much sums up the chart.

So how do you stay the course and follow Warren’s advice?

Set a day each year to review your asset allocation. I picked April Fools Day to reviews ours. If your target allocation is 90% stock funds and 10% bond funds, you look at all of your investments and see where you stand. If your stock funds have grown, your current allocation may be 93% and 7% bonds. You either sell off some of the stock investments and buy more bond funds, or you elect to simply put more money into the bond fund in the coming months. The latter would require more monitoring to make sure you were in line with your allocation, as you don’t want to miss any opportunities to buy more of the stock mutual funds at a lower price.

The best option is to not freak out when the market swings up and down. It worked for Warren!

That pretty much says it all. Last night I went to Vanguard’s website and signed up for our first Roth IRA (in my name). We had originally planned to open my account with Vanguard’s Total Stock Market Index (VTSMX), and the next contribution (whether to my account, or to open up one for my wife) would be Vanguard’s Total International Stock Market (VGTSX). We would continue to contribute to both funds for diversification.

However, it is going to be a while before we have another $3,000 saved up to invest in another Vanguard fund. That means it would be a while before we can better diversify.

So last night I made the choice to give us instant diversification with Vanguard Target Retirement 2050 (VFIFX). Target Retirement Funds are really “funds of funds”. This means the mutual fund doesn’t invest in individual stocks. Instead, it invests in other Vanguard mutual funds in this breakdown:

• 71.61% - Vanguard Total Stock Market Index
• 10.26% - Vanguard European Stock Index
• 9.89% - Vanguard Total Bond Market Index
• 4.66% - Vanguard Pacific Stock Index
• 3.34% - Vanguard Emerging Markets Index
• 0.23% - Vanguard Total Stock Market ETF

I think the bond allocation is way too high, in fact I would prefer it to be 0%. I looked at some of other Target funds and they all had very similar asset allocations. I’m willing to give up the 10% for bonds if I can get instant diversification. In the future, we may add more to the stock funds (buying them individually) to up our percentages.

Nonetheless, we’re started. And that’s worth something — first step counts!

This has been quite the busy week in our house. This past weekend I went on a road trip to Memphis with 4 of my best friends from college. Rendezvous ribs, Graceland, and a few nice pubs. And to top it off, I didn’t go into debt to do it. I had enough spending money set aside to pay for the whole gig. I also had a test in my MBA class last night, so the rest of the week was spent studying. Work has been hectic, and not allowed for a lot of writing.

So I have a question for anyone out there. I’ve posted it on the Get Rich Slowly forums, too.

The question:

We are planning on setting up our Roth IRA either this month or next. We should have the $3,000 required for investment with Vanguard. We are setting up the IRA for 2007, so we can maximize what we can contribute this year (2008).

Can I file my taxes, or should I fund the Roth IRA first before filing? That is, does filing my taxes officially close my ability to fund the Roth for 2007?

Any help would be greatly appreciated! Have a great Friday.