I Have Money, Now What?

Some of my friends have wondered what to do with their money now that they can comfortably pay for rent, food, and drinks with some cash leftover. Sure, they know enough to put it in a savings account, and may even know enough to keep enough savings for a few months in case or emergencies or their current employment situation deteriorates. But soon that savings account balance begins to grow beyond what is needed for that emergency legal advice about what to do with the kilo of yayo, and beyond what is needed to feel comfortable without a job for a few months. What then?

Why lots of cash is bad to hold on to
Welcome to the world of investing. Banks, due to the Fed’s low rates that are a result of a slow economy (#thanksobama), currently offer extremely low interest rates (the current highest from bankrate.com is 0.95% from Ally Bank). Inflation, on the other hand, was 1.7% in 2012 and 3% in 2011. That means, if you leave cash in your savings account, it loses that purchasing power each year. And even with the highest rate available with a savings account, you’d make up only about half of that eroding value in 2012 if you kept your money in cash.

You might think you should just purchase all the beer you can then, if cash loses value. Unfortunately, beer goes bad too. And even though liquor keeps, your landlord may not accept that.

So what the hell do you do?

What the hell you do
You have a few choices – one of which I’ll go over that probably applies to 95% of the population. Before we go into the choices, if you work for a place that happens to match retirement contributions, max those out — it’s free money. Also, make sure you do have enough cash set aside where you are comfortable if you are fired, quit, or just can’t handle pushing paper around anymore. I’d say the main goal of investing is for you to be comfortable. Everyone has a level of risk they are willing to accept. If you want 6 months of expenses saved up, and that’s what makes you feel comfortable, do it. Moving on.

You either like the idea of following separate companies, keeping up on how business is going for them, betting on them, and taking responsibility for those choices, or you don’t have time for that crap.

If you don’t have time for that stock picking crap
This is what you do with the cash outside of your emergency fund:

1. Open up a Vanguard account.
2. Transfer in whatever pile of cash that you have sitting around.
3. Allocate it as follows: 45% Total Stock Market (VTI), 20% Total International Stock (VXUS), 20% Total Bond Market (BND), 10% REIT (VNQ), and 5% Materials (VAW).
4. After this, once a year, readjust your holdings to match the above allocation. This just means sell those that are above the allocation percentage and buy more of what’s below your target percentage.

Why the above choices? It’s just a general type of portfolio that gives you exposure to plenty of assets, and unless you’re trading in and out of stocks, Vanguard allows you to invest in their funds for free. Each one of these exchange-traded funds (ETFs) holds several different stocks (i.e., the Total Stock Market fund holds Apple, Exxon, GE, Chevron, IBM, Microsoft, AT&T, Johnson & Johnson, Pfizer, and P&G in its top ten holdings…with about 2,990 other stocks). The international fund is obviously less U.S.-centric. Bonds are seen as less risky than stocks. REITs give you exposure to real estate and typically offer nice dividend yields (which is kind of like interest from a savings account — currently Vanguard’s REIT fund VNQ offers 2.36%). And, I’m just a fan of materials (chemicals and metals) based on how much more food and raw resources humans will seem to need in the future.

But, you can totally change these allocations to suit your needs. Don’t think materials are a good bet? Take that out of your allocation and put that 5% back into the Total Stock Market (VTI). There are plenty of other allocations that might suit your feelings as well. Remember, it’s about being comfortable.

ETFs versus index mutual funds
A side note on ETFs. There are some who speculate that ETFs can collapse. I don’t think this is likely, and if they do collapse, you probably have a lot more to worry about than a collapsed ETF (see zombies). But, if that collapse argument makes sense to you, use Vanguard’s index funds instead. The difference between these is spelled out here – and mainly that ETFs can be sold during the day while the index funds have a day or so lag. The corresponding funds for the above allocation are: VTSMX, VGTSX, VBFMX, VGSIX, VGPMX.

The costs of investing
With these funds, you will be paying an expense ratio. For example, the Total Stock Market fund has an expense ratio of 0.06%. However, the fund yields 2.1%. Additionally, this 0.06% is pennies compared to other managed funds. Now, you don’t get the same “expert” managing of your money with a Vanguard fund that simply buys everything possible in the market, but you don’t pay a 0.85% expense ratio like one of the largest mutual funds in the country. And the most important point is that 80% of mutual funds underperform the market. You may get one of the 20% that beat the market, but odds are simply against you. Also, since Vanguard doesn’t charge transaction fees when you use their account service, you avoid what other brokers normally charge.

Will you lose money with the above allocation? It’s possible. But if you do, chances are that everyone else will too — you own a little bit of all of the market. For example, the Total Stock Market fund lost about 50% of its value from 2008 to 2009, just like the rest of the market. But, if you didn’t panic (like you shouldn’t have), and held on, the ETF and market returned back that 50% over the rest of 2009. Beating inflation takes some acceptance of risk.

Socially responsible investing
You may not want to support some of the companies that these funds invest in. This is called socially responsible investing. If you care, you can look at what each fund holds and determine if you think it deserves your money. You might want to check out the Vanguard Social Index Fund (VFTSX), as well. But if you really want to avoid supporting the share prices of companies that you may have ethical or moral reservations about, you will probably have to invest on your own outside of index funds. You may also choose to invest in index funds now, even though it may compromise your values, and use whatever money you earn to fight those greedy, corporate bastards in the future.

Retirement accounts
Finally, you might wonder what the hell to do with a retirement account. Vanguard has funds for those as well, based on the year you aim to retire, and will allocate your money to safer assets as your retirement year approaches, so you don’t even have to reallocate anything yourself.

When do you start throwing money in a retirement fund? Well, after you have that emergency fund, and have maxed out any company-matched retirement contributions, and put aside whatever you have to save for that trip to Aspen or vacation or blow or other immediate spending goals, put some away for yourself in the future. Because ‘future you’ will appreciate it. Chances are you’ll need roughly a kajillion dollars to retire comfortably by the time that comes, especially for air conditioning based on the way the climate is going, so get started on that — while still having fun today.

And you might wonder whether to get a Roth or a traditional IRA. With a Roth, you pay taxes on contributions now. However, if you make $110,000 or over, you can’t contribute anything to a Roth. With a traditional IRA, you are taxed on the money you withdraw when you hit retirement age. It gets pretty confusing, so you really have to read up on this yourself.

If you like the idea of picking your own stocks
Now, if you do have time for that crap, you have time to research what the hell you should do on your own, and should get used to doing research. Good luck.

In closing
Your idea of acceptable risk will be different than others’. Do what makes you comfortable. If you want to keep half of your portfolio in cash, and only begin to invest a little of your savings, go for it. Additionally, while timing the market is pretty impossible, right now it’s hitting all-time highs. Maybe only invest a tenth of what you aim to, and keep investing a tenth over the next year or two until you’re fully invested – that’s called dollar cost averaging. While some studies prove it doesn’t do much, I think psychologically that it helps you feel comfortable that you’ll never really invest at the worst time ever.

Remember this advice was free, and that’s what it’s worth — while I think it applies to a majority of people, your situation may warrant a different tack. If you’re really worried, go see a financial advisor, but know that they also have their own incentives. The best usually charge a percent of your assets, and the worst likely get commission for each transaction.