I’ve accumulated $3500 and I don’t know what to do with it.
As you may recall, I am carrying the remainder of my credit card debt in the form of a home-equity loan (or HELOC). The current balance on this debt is $15,000 and I’m paying a 9.25% finance charge. I intend to have this debt eliminated by March 2008. It’s an ambitious goal.
In order to make this happen, I’ve had to forego investing in my Roth IRA. I established this retirement account last spring, but only put $650 into it before focusing on the HELOC. Now I have the money to fully fund it, but don’t know whether to do so, or to continue attacking the debt aggressively. There’s a time-pressure to this decision: Roth IRA contributions for 2006 must be completed by April 17th.
On the surface, this seems like a no-brainer. By paying the $3500 toward the HELOC, I’d be saving $26.98 per month in finance charges. That’s a lot of money! But since I intend to have this debt repaid within a year anyhow, my maximum savings is only about $325. There are strong arguments for putting the money into my Roth IRA, despite the lack of a guaranteed return.
Here are the factors that weigh in my decision:
Once the funding deadline has passed, I can never put money into the 2006 IRA again.
If I fund the 2006 IRA, there’s no guarantee that I’ll have the money to fund an IRA for 2007.
If I put the money into the IRA, I will invest in an index fund.
By paying down the HELOC, I am earning 9.25% on my money, but it’s a one-year return. That is, after a year the HELOC will be gone and the returns will no longer compound.
Though funding the IRA may return less than 9.25% over the next year, the money will continue to compound over time.
If something goes wrong and my income declines, I will much rather have paid down my debt.
Debt reduction has a bigger psychological payoff than retirement savings. The debt is a burden.
In the long run, the IRA is the best choice with regard to taxes.
There’s an income ceiling to Roth IRA contributions. If a couple makes more than $160,000/year, they cannot contribute to them. We don’t make anything near $160,000 right now, but we may in the future. And if we do, we’ll no longer be able to add money to our Roth IRAs.
Which one will I choose? I’m going to fund the retirement plan.
Why?
I seem to have licked the Debt Monster. I stopped acquiring new debt long ago. Complete debt elimination is so close now that I can taste it. It’s a priority. Debt is no longer a psychological barrier for me, but saving for retirement is. When I think of how little I have saved, I panic. I must start saving, and funding my Roth for 2006 would be an awesome first step.
I moved the money into my retirement account last night. Now I need to decide which index fund(s) to purchase. I thought the decision would be easy. It’s not. Though my account only allows me to purchase exchange-traded funds, there are still dozens of options: QQQQ, SPY, IWM, EFA, VTI, TIP, etc. It’s like alphabet soup.
Note:This is the best choice for me and my circumstances. It’s not necessarily the best decision for everyone choosing between debt reduction and retirement savings. Do what works for you!
You’ve heard how awesome Roth IRAs are and how starting one now can mean big bucks when you’re older. You’ve even done some research so you have a vague idea of how a Roth IRA works. Now what? How do you actually open a Roth IRA for yourself?
The good news is that it’s surprisingly easy to set up a retirement account and begin investing in your future. Here’s what to do…
How to open a Roth IRA
Decide where to open your Roth IRA account. Financial services providers such as Vanguard or Fidelity will have IRA products.
Gather your information.
Transfer money into your account.
Set up an automatic investment plan.
1. Where to Open a Roth IRA
One of the reasons people fret about opening a Roth IRA is because there are so many financial institutions offering IRA products. It’s important to search for a company that suits your needs, but how do you evaluate each company’s strengths and weaknesses?
Consider reputable Advice
If you already have an investment advisor, ask her for recommendations, but look at other options too. Some banks and credit unions also offer individual retirement accounts. My credit union, for example, has Roth accounts but they’re limited to certificates of deposit at 1.50%.
2. Gather Your Information
Gather all your information in one location when you are ready to begin. Most firms provide online applications, but some still require that you download forms and mail or fax them to the company. (If you’re opening an IRA through a brick-and-mortar bank or broker, take this information with you.)
From this point, it’s just a matter of answering simple questions. The entire process should take about an hour of uninterrupted time. (Actually, you’ll probably only need 15 minutes, but allocate more time just to be safe.) Before you begin the application, make sure you have all the documents listed below:
Here’s What You Need to Open an Account
Your social security number.
Your driver’s license or other photo I.D. like a passport.
Your bank account information — your bank’s routing number and your bank account number.
Your employment information — your employer’s name and address.
Some money. (Depending on where you choose to open your IRA, you may need $25 or as much as $3,000.)
Note: For each beneficiary you choose, you will need to supply their name, social security number, and date of birth as well.
3. Transfer Money Into Your Account
Once you’ve completed the application process, you will be asked to transfer money to your account. This money will probably earn interest in a money market fund until you choose an investment. [In Part 4 of this series, we’ll discuss good investment options for Roth IRAs.]
4. Set Up an Automatic Investment Plan.
I’m a big fan of automatic investment plans. Most of the companies mentioned later in this article offer some sort of program that will pull money from your bank account every month to invest in the stocks or mutual funds you designate. By setting aside $50 or $100 or $500 in this way, saving becomes a habit. You don’t notice the money is missing. It’s a regular expense that just becomes incorporated into your budget.
A final note: Opening a new account usually is quick and simple. However, be aware that it may take a few weeks before you can start trading. That’s because they will wait for checks you send to properly clear the bank.
Ongoing IRA account transactions at banks, brokerages or mutual fund families happen quickly, but they all take some time to activate a new account. In other words, don’t become impatient if you can’t buy things right away.
Related >> IRA Contribution Limits, Deadlines and Deductions
Before You Invest
There are two things you should take care of before opening a Roth IRA:
Tuck away at least $1,000 in a savings account for emergencies.
Pay off your credit card debt. At the very least, make a significant dent in your debt and have a plan for its elimination. (I chronicled my choice between debt and savings here.)
Related >> Which online high-yield savings account & money market is best?
Related >> Real-life choices: Retirement savings vs. debt reduction
An Excellent Way to Begin Your Retirement Savings
When you’ve finished paying off your debt, take the amount you were using for debt reduction each month and, instead of spending it, stick it into a retirement account.
You’ve already developed the habit of using the money to improve your financial life. This is just another way to do it!
Consider Taking a More Active Role
If you’re willing to make some decisions on your own, you can open a self-directed IRA through a mutual fund company or through an online discount brokerage.
In general, you have two choices:
A mutual fund family, like Vanguard or Fidelity, which will open an IRA account for free and sell you their funds for free. The benefit is that you pay no commissions, but the downside is you can only buy the funds they sell.
A brokerage, which allows you to pick any index fund, managed mutual fund, or individual stocks and/or bonds but may charge a commission on each trade. The major online brokerages (E-Trade, TD Ameritrade, etc.) usually have no fees to open an IRA but will charge around $10 or less per transaction for most transactions.
How to Evaluate a Roth IRA provider
Is there a minimum initial investment?
Does the company offer automatic contributions?
Are there minimum contributions?
What types of fees are assessed to the account?
What investment options are available — stocks? mutual funds? real estate?
Is it possible to download statements automatically to your money management program?
How reputable is the provider?
Mutual Fund Family
If you decide to go with a mutual fund family, many people recommend starting at one of the big three Vanguard, Fidelity, or T. Rowe Price because of the large variety of managed and indexed funds they offer. If mutual funds (indexed or managed) are the cornerstone of your investment strategy, it makes the most sense to go with one of the major fund families.
For those focusing on index funds, Vanguard is the most logical choice, because they specialize in index funds and offer the widest variety. They actually created index funds to begin with, and their costs tend to be the lowest. Click here to open a Roth IRA at Vanguard.
For those who prefer managed mutual funds over index funds, your best approach is to go to a review site like Morningstar or Zacks to see which of the funds that pursue what you have in mind (e.g., foreign stocks, domestic bonds, etc.) perform the best. Click here to open a Roth IRA with Fidelity.
All the major mutual fund families make it easy to open no-cost accounts. Simply go to their website and follow their instructions. But there are still other places that you can open a Roth IRA.
Click here to open an IRA at T. Rowe Price.
Discount Brokers
Discount brokers appeal to many people because they have a low barrier to entry. They offer lower fees than traditional brokers because they don’t have research departments and they don’t offer investment advice. They act purely as middlemen for trading in the market.
The primary benefit of using a broker is that you can pick from many different mutual funds or, if you prefer, individual stocks or bonds.
How to Bridge a Gap
Discount brokers are a good option if you are short on cash. Most of them will also offer a cash account, similar to a savings account. You can use that account to accumulate the money necessary to meet the minimum initial deposit.
Online discount brokers want your IRA business and, consequently, they make it very easy to open an account. You can compare their fine print details, but for the most part, their pricing is very similar.
The major players in the discount brokerage space are E-Trade, Scottrade, and TD Ameritrade. Simply visit their home page and look for the link offering a no-cost IRA account. Some have minimum deposits of $500 or so; but if you commit to a monthly automated contribution, many will waive that requirement.
Don’t Delay Because of These Misconceptions
I always believed opening a retirement account was difficult, but that’s all there is to it really. The most difficult part is deciding where to open your account. Set aside an hour or two some Saturday morning to explore your options over a cup of coffee. With some research, you should be able to find a company and program that fits your place in life.
I also used to think, I don’t have money to invest. Last year I forced myself to find the time and the cash to open a Roth IRA, and I can say that it has been one of the best financial decisions I’ve ever made.
The GRS Introduction to Roth IRA Series
Understanding how important it is to get started saving for retirement, check out the rest of our Roth IRA series to learn about how to start your Roth IRA, which investments are best, and other general questions about these great accounts.
Part 1: The extraordinary power of compound interest Part 2: What is a Roth IRA and why should you care? Part 3: How to open a Roth IRA (and where to do it) Part 4: Which investments are best for a Roth IRA? Part 5: Questions and answers about Roth IRAs
One of the most puzzling things about money is knowing where to begin. You get out of college and suddenly find yourself in the real world, with a job, with rent, with student loans, and wonder how you’re going to make ends meet, let alone save for retirement. Retirement seems so far away. It’s easy to just forget about it.
Ignoring retirement could be one of the biggest financial mistakes you’ll ever make. Compound returns favor the young. Time is money. Invest now and your 40-year-old self will be grateful. But where do you start?
Frances Leonard’s 1995 book, Time is Money, is an excellent introduction to retirement for people in their twenties and early thirties. Leonard preaches the important message: start now.
If you start soon enough, your dinky little monthly investment will take care of your golden years. You won’t have to worry about retirement for the rest of your life. The hundreds of dollars per month that late starters need to save for retirement will be all yours — yours to do all the things you’re dreaming about, instead of having to deny yourself all the good things just because you missed your best chance to amass a fortune mostly made of money you’ll get for free.
At the heart of this book is Leonard’s “four steps to a fortune”, a simple program which, if followed, can enlist time as an ally to help you build your retirement nest egg. The four steps are:
Find your number.Time is Money provides several tables to help you determine how much you need to save now in order to retire with the money you need. For example, if you’re 27 years old and believe you can achieve a 10% investment return, then you need to save $143 each month for the next forty years in order to have a million dollars upon retirement.
Invest at 10 to 12 percent. This may seem like a rosy assumption, but over the long-term, the U.S. stock market has offered these sorts of returns. The key, says Leonard, is to invest in an index fund.
Invest in a tax-deferred account. Taxes can take a huge chunk out of compounded returns. Take advantage of tax-deferred retirement accounts and other breaks. (This book was written before the advent of Roth IRAs. I believe Leonard would now advocate putting your money into a Roth first.)
Protect your fortune from inflation. Leonard recommends that at the beginning of each year, you track down the Consumer Price Index from the year before (free from the government), and adjust your monthly contributions by that amount. Using the $143 example cited earlier, if prices have risen 4%, then the new contribution would be roughly $149/month.
Time is Money features chapters on mitigating risk, types of retirement accounts, fighting inflation, starting from “zero minus” (i.e. a position of debt), and more. There’s a great chapter that defines financial terms like annuities, derivatives, and leverage. (Stay tuned to GRS in April for a series that will help to de-mystify financial concepts like these.)
This book is a clear introduction to the power of compound returns, and offers strong motivation to begin saving now, no matter how old you are.The only major drawback is that it’s twelve years old. Because it was published in 1995, it doesn’t have information on Roth IRAs and other recent developments.
If you’re just out of school and looking for guidance to set up retirement savings, this is a great place to start. Look for it at your public library, a local used book store, or from Amazon (which has 25+ used copies for under five bucks).
(While preparing this review, I found that Nickel wrote about Time is Money two years ago. He liked it too, calling it the: “personal finance book that forever changed the way I think about money.”)
The series on Roth Individual Retirement Arrangements (Roth IRAs) has covered a number of topics — what they are, how (and where) to open one, and which investments are best. Now, in the final part, we turn to some of your questions. Remember: I am not a financial adviser. I’m just a regular guy trying to gather information to help you. If you need more specific answers, please consult a CPA or an investment professional.
All of the questions below were submitted by Get Rich Slowly readers via comment or email. If your question isn’t here, please drop us a line so we can research an answer and add it to the list. If you are new to Roth IRAs, this article is not the place to begin. Start here, instead.
Types of Accounts and How Much You Can Contribute
Which is better: Investing in a Roth IRA with after-tax dollars or investing in a 401(k) with pre-tax dollars?
Also, does it make a difference if there is an employer match?
And if I already have a 401(k) through work, then why would I want to add to a Roth IRA?
There are a lot of variables here, so the answer for your situation may be different. But the traditional answer to this question is to…
Invest in the Following Order:
If your job offers a 401(k), contribute to that each year until you’ve reached the limit of the employer match. Never turn down free money!
If you still have money to invest, contribute to your Roth IRA.
If you still have money to invest, then max out your 401(k).
Once you’ve contributed all you can to these investments, then invest however you see fit in regular, taxable accounts.
Some people like to have all their accounts in one place. If you’re this sort of person, you may benefit from simply putting all your money into a 401(k) and not worrying about a Roth IRA.
However, there is another wrinkle to consider: When debating whether to invest in a 401(k) versus a Roth IRA, why not check with your employer to see if they offer a Roth 401(k) which allows you to invest with after-tax dollars (and withdraw tax-free in retirement)?
Also note that you can actually invest in both a 401(k) and a Roth IRA as long as you meet the requirements for both programs.
Is It Possible to Roll a 401(k) Into a Roth IRA?
It is possible, but you have to be careful. It is not a one-step process. Also, it’s difficult to do with an active 401(k) account. A mistake along the way could cost you a lot of money, so it’s a good idea to consult a financial adviser for help.
Here’s a discussion of the subject in the forum.
Can I have more than one Roth IRA? For example, can I have one at USAA and another at Vanguard?
To understand the answer, let’s step back and look at what an IRA is exactly: The “A” in IRA does not stand for “account.” If you look on the IRS website, you will see that the official definition of “IRA” is “Individual Retirement Arrangement.”
Every taxpayer can have only one Roth arrangement, but you can have multiple accounts as part of that arrangement. You can have as many Roth IRA accounts as you’d like.
Contribution Limits for Roth IRAs (and Traditional IRAs)
Contribution limits for 2015 and 2016:
Under 50 years of age: $5,500
Age 50 and over: $6,500
Note that your contribution limit applies to all of your IRA accounts (Roth and traditional) collectively; they don’t each get a $5,500 limit. In other words, you can contribute $100 each to 40 different Roth IRA accounts, but not $1,000 to each of them.
Who Can Invest and are There Limitations?
Can legal U.S. residents who are not citizens open an IRA?
Is it a good idea?
What if I don’t plan to be in the U.S. at retirement age?
Anyone with earned income in the U.S. can contribute to a Roth IRA — citizenship is not required. However, for greater flexibility, you may want to consider a traditional IRA or other investment accounts, depending on your goals.
Be sure to check with a tax professional to see which solution best fits your exact situation.
How does the IRS know that you contributed to a Roth IRA?
How does it know if you contributed more than you were allowed?
At the end of the year, the investment company submits Form 5498 to the IRS, which reports the amount that you invested. For example, it might show that, in 2015, you invested $5,000 in a Roth IRA. The IRS computers then match this form electronically to your tax return to check for discrepancies. If you are over the income limit, your return will be flagged.
What happens if I contribute too much to a Roth IRA?
If you contribute more than allowed, you are subject to a 6 percent excess-contribution penalty. However, you have until the annual contribution deadline (generally April 15th) to withdraw any overage from the account before the penalty is assessed.
What options are there if I earn too much to contribute to a Roth IRA?
Your Contribution May Be Affected by Your Modified AGI
These tables show whether your contribution to a Roth IRA is affected by the amount of your modified AGI as computed for Roth IRA purposes. They show how to determine the amount of Roth IRA contributions that you can make for …
If you make too much to contribute to a Roth IRA, be sure you’re maxing out your 401(k), if you have one. You can also contribute to a traditional IRA.
Both of these are excellent options. But note that, if you have a 401(k) at work, your contributions to a traditional IRA may not be tax deductible. Another option for high-income individuals to consider is to contribute to an annuity.
Here are two more forum discussions about Backdoor Roth and 401(k) rollover strategies and What to do when Roth IRA isn’t an option.
My wife is a stay-at-home mom and doesn’t have any earned income. Does this mean she cannot have a Roth IRA?
To every rule, there is an exception. If you are married and filing a joint return, then both spouses can max out IRAs from a single income (so long as the other Roth IRA requirements are met).
I’m self-employed and I make more than the maximum allowable for a Roth IRA. Does a SEP-IRA make sense?
A SEP-IRA may make sense, but that will depend on your individual circumstances. Basically, self-employed people can contribute roughly 20 percent of their first $200,000 of pre-tax earnings to a SEP-IRA. However, they must contribute the same percentage for all employees. If you are the only employee, or if you don’t mind giving all employees the same retirement benefits, then this may be a good choice. This is another case in which you should consult a financial adviser.
Types of Roth IRA Investments
I want to open a Roth IRA, but I’m confused by the mutual funds offered by different companies.
For example, ING Direct (now Capital One 360) offers six funds, and another bank offers only five. What’s the difference?
Which should I choose?
Only you can answer that question. Here’s how I would approach this problem: I would first locate the investment I want to purchase. Is it an individual stock? Is it real estate? Or is it, as I encourage, an index fund?
Once you’ve decided on an investment, then find a company that will let you buy the investment from within a Roth IRA at the lowest cost. This shouldn’t take too much effort. If, like me, you decide you like Vanguard’s mutual funds, then open an account directly with Vanguard.
Can I really use my Roth IRA to buy a house?
Sort of. There’s an animal called a self-directed IRA which allows you to invest in real estate. However, you cannot invest in anything directly related to you, like your company or your primary residence. This is definitely a topic you should take up with a tax professional if you have a strong interest in doing something like this.
In many cases, complex Roth IRA questions are best answered by a qualified financial professional. Each person’s situation is different. It is difficult to give one-size-fits-all advice in the context of this blog. Use the National Association of Personal Financial Advisors to find an independent, fee-only adviser.
I opened a Roth IRA at a local bank, but I noticed that I’m only getting a 1.98% return. This seems unusually low. Should I withdraw my money and move it to Vanguard, Fidelity, or T. Rowe Price?
Your money is probably in a savings account or certificate of deposit. Your bank may offer additional financial services — check with them to see where else you can put the money. Barring that, yes, absolutely move the money to a different location. You may have to pay a transfer fee, but it’s worth it.
As Mandy writes in the forums, “Traditionally, banks are one of the worst places to invest because they typically offer high-load/high-fee or very conservative investments and charge higher service fees than most other brokerages. Banks are for banking, not investing.”
(See Which investments are best for a Roth IRA? for ideas on where to put the money.)
Withdrawing From a Roth IRA
Can I really withdraw money from my Roth IRA without penalty?
That depends on what you would consider a penalty. Here is a direct quote from the IRS website:
“You can take distributions from your IRA (including your SEP-IRA or SIMPLE-IRA) at any time. There is no need to show a hardship to take a distribution. However, your distribution will be includible in your taxable income and it may be subject to a 10% additional tax if you’re under age 59 1/2. The additional tax is 25% if you take a distribution from your SIMPLE-IRA in the first 2 years you participate in the SIMPLE IRA plan. There is no exception to the 10% additional tax specifically for hardships. See chart of exceptions to the 10% additional tax.”
David Bach is perhaps best known for coining the term the latte factor, a phrase that has almost become a joke in personal finance circles. That’s too bad, really, because Bach has some good ideas. And the latte factor is a marvelous concept, applicable to many people who casually spend their future a few dollars at a time. Bach’s most popular book is The Automatic Millionaire. I’ve referred to it often, but never reviewed it until today.
The Automatic Millionaire is based on sound financial concepts. The author encourages readers to eliminate debt, to live frugally, and to pay themselves first. But the core of his book is unique: rather than develop will power and self-discipline, Bach says, why not bypass the human element altogether? Why not make your path to wealth automatic?
The Latte Factor
Bach argues that wealth is not a product of what we earn, but of what we spend.
Most people believe that the secret to getting rich is all about finding ways of increasing their income as quickly as possible. “If only I could make more money,” they declare, “I’d be rich.” How many times have you heard somebody say that? How many times have you said it yourself? Well, it simply isn’t true. Ask anyone who got a raise last year if their savings increased. In almost every case, the answer will be no. Why? Because more often than not, the more we make, the more we spend.
Bach has an excellent point. Remember how you used to live when you were in college? How much did you spend each month? How much do you make now? If you lived like a college student, what sort of monthly surplus would you have now? If you lived like this for five years, how much could you sock away? What if you lived like a college student for ten years?
Even if you choose not to reset your lifestyle to what it once was, Bach suggests that it’s important to examine your current expenses for subtle small drains. If you drink a latte a day, you’re probably spending about:
$3.50 a day
$105.00 a month
$1250.00 a year
$12,600 in ten years
Each person’s latte factor is different. For my wife, it’s actually lattes. For me, it’s comic books. Regardless, Bach says that if instead of spending money on our splurges we invested an equal amount, we could be well on your way to becoming millionaires. He’s doing nothing more than stressing the incredible power of compound returns.
In essence, a latte doesn’t just cost you $3.50. It costs you $3.50 plus the potential compound returns over the next 20 or 30 or 40 years. You’re not just spending pocket change — you’re spending your retirement.
If we can forego these indulgences and funnel the money toward savings, we’ll profit in the future. But the problem is — we like our 180-degree nonfat lattes. We’re not about to give them up. How do we bypass the human element?
Make It Automatic
You’ve all heard that you’re supposed to “pay yourself first”. But what does this really mean? This concept simply states that before you pay your bills, before you pay your taxes, before you pay anything else, you set money aside for yourself. This isn’t money to spend, but money to save for the future.
“But how can I do this?” you might say. “I only make minimum wage.” It doesn’t matter. This principle says that no matter how much you earn, you must force yourself to set aside something for your future. If you don’t do it, nobody else will.
But, Bach says, human nature makes this difficult. Most of us think we don’t have enough to pay ourselves first. Whether we earn $8 per hour or $80 per hour, there’s always something to spend the money on. Bach writes:
In order for Pay Yourself First to be effective, the process has to be automatic. Whatever you decide to do with the money you’re paying yourself — whether you intend to park it in a retirement account, save it as a security blanket, invest it in a college fund, put it aside help you buy a house, or use it to pay down your mortgage or credit card debt — you need to have a system that doesn’t depend on following a budget or being disciplined.
The best way to do this is to make our savings automatic. For some people, this is easy. If your employer offers a retirement account such as a 401k, take advantage of it. Max it out. Contact your human resources department and request that a fixed percentage — 5%, 10%, 15% — be transferred from your paycheck to your retirement account. It’s best to do this now, but if you think you can’t possibly survive without the money, then wait until your next raise. Instead of taking the raise in your paycheck, have the increased income set aside in your retirement account. Continue to live on the amount you’ve been earning.
What if your employer doesn’t offer a 401k? What if you want to do this on your own? Open an Individual Retirement Account. “Whatever type of retirement account you open, arrange to have your contributions automatically transferred into it, either through payroll deduction at work or an automatic investment plan” run by a bank or brokerage firm.
Related >> What is a Roth IRA? A Short and Simple Guide
Make It All Automatic
If you can make saving for retirement automatic, why not do the same thing with your other financial obligations? The Automatic Millionaire features chapters on how to automate emergency fund savings, how to automate housing payments, how to automate debt payments, and how to automate tithing (or charity contributions). Bach’s basic tenet is this: by removing human nature, we can automatically do the right thing with our money. We can strive to become “automatic millionaires”.
(Much of Bach’s writing reminds me of my own pursuit of paperless personal finance.)
Related >> Frugality Advice from Millionaires
Conclusion
If you have your personal finances in order, you probably don’t need to read The Automatic Millionaire. But if you’re struggling to gain control, this book can make a big difference. I read it in the winter of 2005-2006, as I was beginning to take control of my money. I learned a lot.
I’m not sure that it’s important to own The Automatic Millionaire — once you’ve read the book, you get it — but I think many people can learn a lot from what Bach has to say. This book is ubiquitous. You probably know a money-savvy friend from which you can borrow a copy. I guarantee that your local public library has it. If you’ve been struggling to set up a retirement plan, I encourage you to read The Automatic Millionaire. It just might change your life.
I recently mentioned two Liz Pulliam Weston articles in passing. They’re good enough to merit closer attention. Both articles profile couples who found the courage to save money when they were young so that they could enjoy the freedom of early retirement. Weston writes:
Think it’s impossible to retire in your 40s? I’d like you to meet some ordinary folks who have done it. “Ordinary” may be a misnomer, because retiring after just 20 years or so in the workplace is an extraordinary act, and most took extraordinary measures to get where they are. But they’re ordinary in the sense that they were working people with pretty regular jobs. They didn’t strike it rich with stock options, inheritances or the lottery.
[…]
Their retirements look different from the retirements depicted on television. These folks don’t live on the golf course or roam the country in 32-foot recreational vehicles. Most, in fact, are actually still working — but usually part time and in their own businesses, doing things they feel strongly about. They’ve retired from the 9-to-5 world, but not from their passions.
In Retired by 50: What it really takes, Weston looks at Brad and Janine Bolon, who took the lessons of The Tightwad Gazette and Your Money or Your Life to heart. By being frugal, they made early retirement happen.
Brad was fortunate to find a high-paying job in southern California. But rather than live like they were earning a quarter million dollars per year, he and Janine pinched pennies. They bought a house across the street from his office so he could walk to work. They made use of the public library. They watched their costs wherever they could:
“We saved $35 a month by hanging the laundry instead of using the dryer,” Janine said. “We didn’t use our air conditioner more than six or seven days of the year,” an accomplishment in sunny Southern California.
“We went to ‘U pick it’ farms. I’d go with the kids and we’d pick fruit … and can them and make preserves,” Janine said. “And I used a price book. That saved us $3,000 to $5,000 every year.”
Though the family had a salary that many people dream about, they lived like Brad earned much less. After eight years of frugal living, the Bolons sold their home and moved to Utah. They could now live solely off investment income, but they continue to work.
I love this story because it highlights a couple that focused on a dream, pursued it, and made it a reality. It might be easy to write off their success by saying, “Yeah, but if I made a quarter million per year, I could do that too.” I’m not so sure. First of all, it takes a lot of work to put yourself into a situation where you can earn that kind of money. Second, I think it shows tremendous restraint to live frugally when those around you do not. It’s easiest to accumulate wealth when you minimize expenses and maximize income.
Pulliam’s second article, Retired by 50: Real-life stories, profiles three more couples who have achieved this dream.
One of the couples — the Hennesseys — found inspiration in books like the afore-mentioned Your Money or Your Life and Paul Terhost’s Cashing in on the American Dream: How to Retire at 35 (which I recently ordered from Amazon, and hope to review later this week). On unremarkable incomes, the Henneseys made all the right moves to ensure they could retire early:
They reduced their grocery bill by making beans, rice and powdered milk staples of their meals. (Of course, they could also eat at the restaurants in the days they worked there, which helped liven up their diets.) They replaced their light bulbs with compact fluorescents to save energy — and this was back in the early 1990s, when that was unusual. They paid off their debt, including car loans, student loans and their home mortgage, to eliminate interest payments. They also kept meticulous records of their spending.
For most of these couples, early retirement means partial retirement. Instead of leaving the workplace completely, they downshifted into jobs that are more meaningful, but for which they earn less. This supplemental income also means they don’t have to draw heavily on their retirement savings.
Early retirement has always been one of my goals. I used to dream of retiring at 35 and moving to a cabin in the woods. I’m 38 now, and though I don’t have my cabin, I do have a good life. I still dream of early retirement. But now my dreams resemble the sorts of lives these couples lead.
October 21st-27th is National Save for Retirement Week in the United States.
So you are in the market for a Roth IRA, that popular, flexible, tax-advantaged vehicle that can be used to save for retirement — smart choice — but here comes the next question: which investments are best for a Roth IRA?
Roth IRA Mutual Fund Options For Investment
There are three basic options for your Roth IRA investments:
Index funds
Exchange traded funds (or ETFs)
Managed mutual funds
It’s essential whatever you choose it has as low an expense ratio as possible. Small fees can really add up. The expense ratio is what the fund charges you to run it, reflecting operating expenses such as compliance and other administrative costs. Even the cost of marketing the fund to you is passed down in some way through the expense ratio.
One very popular investment vehicle, The Vanguard Fund, has an average fund expense ratio of 0.18% and many investors see it as a low-cost leader. Regardless of what you choose, make sure you know the fund expense ratio and it’s as low as possible, for sure under 1%.
Here’s more about each:
Index Funds
A mutual fund that invests in indexes which are compiled and calculated independently, such as the Standard & Poor’s 500.
Two main attractions with index funds:
Index funds typically offer the lowest cost to manage your investments. (Since you are not doing it yourself, there’s no escaping having to pay someone else. The goal, of course, is to keep that amount as low as possible.)
Index funds generally outperform managed funds. You would think a paid professional who runs a mutual fund would do better than a market average, but history has consistently proven that to be a false expectation.
Related >> How to Start a Roth IRA
By far, the most popular index funds mimic the S&P 500 stock market index. There are other funds which purport to be index funds; however, they don’t track an actual index. (Bond funds, for example, are called index funds simply because they offer the low management costs commonly associated with index funds.)
Exchange Traded Funds (ETFs)
One of the benefits of investing for your retirement through a Roth IRA (or a traditional IRA, for that matter) is the fact that you are not restricted solely to mutual funds. Through an IRA, you can invest in individual stocks, which opens the door to ETFs, which are nothing more than mutual funds which trade on a stock exchange just like stocks.
Related >> Considering EFTs
Most ETFs are index funds, but they offer a wider array of specialized investments. For instance, if you want to invest in gold, there are several ETFs which allow you to do that. One such ETF (which uses the GLD symbol) owns the actual gold bars, and they hold more gold than all national governments except the big three.
ETFs offer low costs, but not always quite as low and the index funds referred to above. If cost is an important consideration for you — and it should be take the time to check out all the costs of anything you want to invest in before you take the plunge.
Managed Mutual Funds
Although somewhat maligned recently, managed mutual funds still account for more than 70 percent of all retirement investment funds. There are a few reasons for that:
Convenience. Managed mutual funds are usually the most convenient way to invest as an employee.
Low risk. They are the oldest of the three options listed here, and have proven themselves to be pretty safe in terms of risk.
Variety. They offer by far the widest variety of specialized investment options. For instance, if you don’t want any investment dealing with GMO, tobacco, or other issues, you are more likely to find a managed mutual fund to meet your needs than an ETF or index fund.
Related >> A primer on mutual funds
The popularity and wide variety of managed mutual funds come with two penalties, though:
High cost. Of the three options, managed funds usually are by far the most expensive. You may see rates which look low, e.g., 1.5 percent. Remember, though, that your long-term return is unlikely to be more than 7 or 8 percent. That means they will take 20 to 50 percent of your annual growth. That’s a steep price for many.
Bewilderment. It is not easy to distinguish between the bewildering arrays of managed mutual funds. They all seem to offer things like value and growth, and you never know which buzzwords are simply marketing gimmicks to get you to pick their fund.
When you consider that index funds and ETFs are generally simpler and cheaper, it’s easy to understand why they have grown much more in recent years at the expense of managed funds.
Conclusion
Most people consider the best way to invest through a Roth IRA is by putting your money every month into index funds. They typify the get-rich-slowly ideology. Some of you will want to purchase individual stocks in your Roth IRA. Some will want to purchase real estate or invest in precious metals. If you make educated decisions, these can be excellent moves. However, for most investors, index funds are a smart way to own a piece of the market while mitigating risk.
Part 1: The extraordinary power of compound interest Part 2: What is a Roth IRA and why should you care? Part 3: How to open a Roth IRA (and where to do it) Part 4: Which investments are best for a Roth IRA? Part 5: Questions and answers about Roth IRAs
Learn More:
Safety – the Main Objective for Retirement Investments
The main objective of any investment for retirement is safety: You don’t want to invest in anything risky. You may enjoy investing in things like individual stocks or property, but we all know those can be risky investments. When it comes to your retirement funds, you want to stay away from things with inordinate risk.
Flexibility is a Good Thing (Unless It’s a Bad Thing)
The fact that you can use a Roth IRA to hold a variety of investments is good news – it offers flexibility. What’s good about it is that you can invest in pretty much any type of investment through your Roth IRA – stocks, bonds, exchange-traded funds (ETFs), mutual funds (including index funds), and even real estate.
The bad news is that you can invest in pretty much anything – including things which might not work for you. For instance, if you thought Twitter was going to be a good stock to invest in, you would be banging your head against a wall right now.
Consider This When Selecting an Investment
With a clear understanding of the purpose of an IRA – a tax-advantaged vehicle designed to help you save for retirement – we can begin to answer the question about which investments are best for a Roth IRA. Here’s what to consider:
Funding
By far, the majority of the population earns their living from a job, which typically gives them two paychecks every month. The Roth IRA is perfect for that since you can easily put away a certain amount every month, a little bit at a time. But investing in rental property is quite a bit more difficult (effectively precluding that type of investment for many) because it requires a big chunk of money at a time.
Automation
If you’re like most people, setting time aside to make investment decisions is a challenge because your life is a daily whirl of activity. The tactic most successful people use is automation: They have a set amount deducted from every paycheck which is then automatically deposited into their Roth IRA account. For automation to work, you want to pick an investment which lends itself to a set amount invested every two weeks or so.
Basic Investing Concepts
It’s a mistake to jump into investing and make your decisions blindly. Before you begin any investment program, it’s important to have an understanding of basic concepts. Here are a few posts on some important topics:
Before we fire off the gun to start the ‘Compound Return Marathon’, let’s cover some basics on what compound returns are and why you should care.
What is compound interest? You probably became familiar with the term ‘compound interest’ when you first started placing money in your bank accounts. Most of us recognize compound interest as the interest we receive from holding money in a savings account, certificate of deposit, or other low rate of return investment at the bank. Any form of compound interest is great, but this post isn’t about avoiding depreciation in cash value by earning just enough to out-pace inflation with low rate returns (which is about all no risk interest accounts are able to do). Let’s discuss a different type of compound interest.
Compound returns When you purchase index or mutual funds, you are often asked what you would like to do with any dividend or capital gains disbursements from that particular investment’s holdings. When you select that you would like to ‘re-invest’, you are, in effect, compounding your returns. The same goes for dividend producing stocks. You are offered the choice of receiving your dividend in the form of a cash payout, or re-investing the amount into more stock.
Why should I care about compound returns? When fully harnessing the power of compound returns, you can save less, make more, and retire early. There is sacrifice. You will need to start saving at a time when many of your peers are getting takeout food every night, leasing vehicles they can’t afford, and buying all the latest tech gadgets. If you’re in your 20’s or 30’s, this post should instill a sense of urgency in you. If you’re a little older, you have some making up to do, but it’s not too late. Additionally, maybe there’s a young adult in your life whom you can help get off to a financial running start with the aid compound returns.
The Compound Return Marathon Let’s take a look at five different retirement strategies in the form of five hypothetical “marathon” participants (based on personas that we are all familiar with) and crunch some numbers to see who wins. Before we test the strategies, let’s take a look at the rules:
The average annualized rate of return for U.S. stocks was 13.4% from 1926 to 2000. The worst average annual rate of return for U.S. stocks in any 65 consecutive year period has been 8.5%. For this Marathon, let’s take the average between the two, and assume our participants are able to get a 10.95% return on our investments every year for each participant that invests in stocks.
Our conservative participant invests in a CD, which will earn 5%, compounded annually.
For simplicity, we’ll ignore taxes.
Everyone invests until age 67, the projected official retirement age in the future.
And now, let’s meet the participants:
Early Bird Bob: Bob didn’t follow the urge to blow his cash flow and ‘make up for it later’. He has decided to follow his own rules to utilize the power of compound returns. He invests $5,000 per year in domestic stock funds (earning 10.95% annualized) starting at age 20, and stopping at 40. Because he sacrificed early, he’s also able to stop investing 27 years before anyone else does.
Conservative Carrie: Carrie invests $5,000 per year in certificates of deposit (earning 5% annualized) starting at age 20 until age 67. Carrie sees the value in compound interest and has the right idea in saving early. She could get a reward for her consistency, but the fear of a market crash paralyzes her willingness to invest in stocks.
Live-it-up Larry: Larry invests $10,000 yearly in domestic stock funds (earning 10.95% annualized) starting at age 30. Larry discovered the power of compound returns after living it up in his 20’s, but regrets not discovering it 10 years earlier, so he is making up for it by doubling Bob’s yearly contribution amount.
Late bloomer Bill: Bill invests $20,000 yearly in domestic stock funds (earning 10.95% annualized) starting at age 40, until age 67. Bill has a high income job and is trying to make up for lost time with huge contribution amounts. He has downgraded from a Benz to a Lexus and cut back from three times a week at the golf club to two.
Mid-life crisis Melissa: Melissa invests $40,000 yearly in domestic stock funds (earning 10.95% annualized) starting at age 50, until age 67. Melissa spent most of her money throughout life to impress her friends, but since they all left her because she was too materialistic, she now has a load of time to make extra income to apply towards retirement. Is it too late for Melissa?
You can view the results of the Compound Return Marathon in a free Google Doc. Here you can see how much each participant was able to amass up through age 67. Additionally, you can see how much money they personally contributed to their retirement efforts.
Here’s how they finished:
Early Bird Bob contributed $5,000/yr. for 20 years ($100,000 total contribution). His nest egg at age 67 is $5,938,625.
Conservative Carrie contributed $5,000/yr. for 48 years ($240,000 total contribution). Her nest egg at age 67 is $940,127.
Live it up Larry contributed $10,000/yr. for 38 years ($380,000 total contribution). His nest egg at age 67 is $4,644,805.
Late bloomer Bill contributed $20,000/yr. for 28 years ($560,000 total contribution). His nest egg at age 67 is $3,168,398.
Mid-life crisis Melissa contributed $40,000/yr. for 18 years ($720,000 total contribution). Her nest egg at age 67 is $2,005,735.
Now that the race is over, let’s see what we’ve learned.
You’re better off starting late and taking risk than starting early and taking no risk. Being risk averse is dangerous in many ways. When looking at Conservative Carrie’s results, you’ll see that despite starting earlier than three other participants and investing every year, she wound up earning the least for retirement, in dramatic fashion. With that being said, starting early and welcoming a little extra risk can pay the biggest dividends.
Even if you start extremely late (Melissa), you can still drastically impact your future. Despite investing only 18 years, Melissa is still able to triple her total contributions.
Fully taking advantage of compound returns is your only opportunity to retire early. Take a look at all participants at age 50. Bob could realistically retire at age 50 and live off the interest, at least to get him up to retirement age and social security. None of the other participants stand a chance of retiring early.
Compound returns are pretty darn powerful.Early bird Bob contributed much less than anyone else, and stopped contributing at age 40 (27 years before everyone else), yet ended up with over $1.3 million more than any other participant. He contributed much less, quit early, and still wound up beating everyone else easily. In fact, he almost made 60 times his original return. Compare that to only three times for Melissa, the latest adapter.
The Bottom line: If you’re not maxing out your contributions as early as you possibly can, you’re falling behind.
J.D.’s note: As with some of the commenters, I believe the 13.4% average annualized return isn’t realistic. I used 8% for my own article on compound interest this morning. I’ll do some research to explore the notion of compound returns over various time periods, and share the results in the next couple weeks.
As with many things in life these days, it all started with an episode of the Peter Attia podcast.
In this edition, our nation’s most Badass Doctor was interviewing a guest I initially dismissed as not overly applicable to my own lifestyle. A young,excessively handsome dude who happened to be a writer with a new book out. But the headline of the episode was just intriguing enough to get me to click.
“The Comfort Crisis”
Wow, what an amazing turn of phrase, and what a concise summary of the core of this whole Mustachianism thing I’ve been trying to express for the past dozen years.
While the news headlines cry constantly about our nationwide personal debt crisis or health crisis or any other number of things that suggest that life is so hard these days, I have always seen the opposite: on average, we Americans seem to have a problem of ridiculous overindulgence and easiness in our lives, and our main problem is not recognizing it, and the damage it does to us.
So of course I had to click, and then listen to the whole two hour episode, and then buy the book, and then spend the past month reading and digesting it in small, meaningful chunks like the modern-day chunk of scripture-like wisdom that it is. And wow, am I glad I did so.
The author is Michael Easter, a former writer for Men’s Health magazine was also once catastrophically addicted to alcohol – and descended from a long family line of ancestors with the same affliction.
He was lucky to catch himself from that fall in time to save his own life, and that story alone makes the book worth reading as someone who has stood by helplessly as loved ones battled with addiction. But I think his history with overindulgence in the hollow comforts of alcohol also gives him an edge on writing about the battle between comfort and hardship on the bigger stage of life in general.
So what is The Comfort Crisis about, and how can it make all of our lives better?
The best part about this book is just what a damned good writer this Easter guy is. Like many of the most fun popular science books*, it follows a split narrative which jumps back and forth to interweave the story of an insanely difficult caribou hunting trip he joined in a remote pocket of Alaska, with the appropriate bits of science, psychology and cultural commentary that help us explain and learn from each chapter of the epic shit he had just endured. This allows us to process and apply the lessons in our own lives.
For example, have you ever wondered why the type of bored, rich suburbanites who populate the board of your local Homeowner Association and whine about unacceptably tall weeds or unauthorized skateboarding on Nextdoor are so insufferable?
Why can’t they do something better with their time?
It turns out that there’s a scientific explanation for these unfortunate people, along with most of our other problems:
The tendency of humans to always scan our environment for problems, regardless of how safe and perfect that environment is.
The book cited a study in which researchers told people to look for danger, in an environment which gradually became safer and safer:
“When they ran out of stuff to find they would start looking for a wider range of stuff, even if this was not conscious or intentional, because their job was to look for threats.”
“With that in mind, Levari recently conducted a series of studies to find out if the human brain searches for problems even when problems become infrequent or don’t exist.“
“As we experience fewer problems, we don’t become more satisfied. We just lower our threshold for what we consider a problem.“
In other words, even when our lives are virtually problem free, instead of appreciating our good fortune we just start making up shit that we can complain about instead.
And then our politicians cock their greasy, finely-tuned ears in our direction and make up policies to appease our mostly-insubstantial concerns. And they invent their own trivial “wedge” issues to get us to all bicker about our different cultures and religions, suddenly caring about things that would not have even been problems if nobody told us they were.
And there’s America’s weakness in a nutshell, and meanwhile our strength comes entirely from the times we choose not to waste our time stooping to this level.
Meanwhile, the opposite effect holds true: people who survive in rougher environments than us end up more resilient and less prone to complaining.
In a series of recent interviews, Ukrainian people living in the war zones of their occupied country were asked “is it safe to live where you live?” and a strangely high percentage still said “Yes” – not all that different from the responses of US residents when asked the same question about their own cities.
This adaptation principle also explains why some first generation immigrants tend to build businesses and wealth while their own offspring in second and third generations are more likely to become complacent and spend it down. As an immigrant myself, I can see why this is: conditions were just slightly more harsh and less comfortable and wealthy where I grew up, so I adapted to those conditions as “normal” which made the United States seem posh and easy by comparison. Which made it easier to spend less money and accumulate more.
Tree Therapy
The trap of pointless worry is just one of the many revelations of The Comfort Crisis. It also gives insightful explanations for why spending time in Nature boosts our mental and physical health, while cubicles and car driving grind us down.
There’s something in our biological wiring that responds instantly and powerfully to everything natural, in ways that you can’t get anywhere else.
Even placing a single plant into a hospital room will measurably improve the recovery of almost all patients from almost all ailments. So can you imagine the power of the medicine you are inhaling if you step into a real, living forest? And what if you spent several hours there, or even several days?
Later, we get lessons on our human adaptation towards the ratio of effort to reward:
It’s proven the harder you work for something, the happier you’ll be about it,”
And our bizarre natural aversion to physical exertion:
A figure that shows just how predisposed humans are to default to comfort:
2 (two).
That’s the percent of people who take the stairs when they also have the option to take an escalator.
Which is remarkable, given the absolutely insane cost this tendency imposes upon us.
Moving your body, even a bit, has enormous benefits – again to almost all people towards reducing the probability and severity of almost all diseases. So can you imagine the benefit of moving your body for several hours per day in a natural environment, and including heavy load bearing and bits of extreme exertion?
These things are not speculative pieces of alternative medicine. They are known, easily and reproducibly tested, and proven to be the most effective things we can possibly do with our time.
So why, the actual fuck, are people still sitting inside, watching Netflix, driving to work, and then driving to the doctor’s office to get deeper and deeper analysis of a neverending series of exotic and mysterious and unsolvable problems with their physical and mental health?
We should at least start with the stuff we know is essential – maximum outdoor time every day, heavy exertion including with weights, minimal time spent sitting and driving, and minimum junk food, sugar, and alcohol. You definitely don’t have to be perfect, but just understand that these are the big levers for physical and mental health.
Only then, once you reach these minimum basic things for human survival, should you expect that more exotic and niche medicines and treatments are the only course of action.
By all means, follow your doctor’s orders and don’t just dump all of your medications down the sink because of this MMM rant. But at the same time, realize that the stuff that is hard and uncomfortable is very likely to be the stuff that improves your life the most.
It’s all the stuff that Mr. Money Mustache has been telling you since 2012, but with more detail and less distraction. This book is a concentrated packet of advice for solid living.
Real Life Inspiration from the Good Book
In a happy coincidence, I happened to be in the middle of some hard stuff** of my own as I worked my way through The Comfort Crisis and I found the perspective quite useful and transformative to apply hot off the press.
Normally somewhat of a homebody, I had embarked on a solo journey for some Carpentourism deep in the mountains of Southwestern Colorado. I had my whole life shrunk down into the new Model Y including food, bed, and the necessary tools and materials to tackle a pretty long laundry list of tasks on two different construction projects (fixing up a mini-resort property in Salida, and starting construction on a small cabin in Durango)
The trip immediately took a turn towards the dramatic as I climbed into the mountains and drove straight into the most torrential rainstorm I have ever seen, then accidentally broke a traffic law in a remote mountain town right in front of both of the local police officers ($115 fine and two points off my license), then five minutes after that had a small pebble hit my brand-new windshield which instantly spread into a crack that spans the whole thing, all before finally limping into Salida to unpack and get started on the work.
“Big deal”, I can already hear you saying, “Retired man experiences two minor incidents while taking a vacation in his luxury car.”
And you’re right, and that is exactly my point.
My life is so stable and comfortable that even these two miniature challenges threw me off balance, and I arrived in a slightly bummed and stressed-out state. But I still knew that in the bigger picture, they are good for me if I accept them as I accept them as the lessons they are rather than choosing to continue to worry about them.
As the trip went on, more things happened, almost as if The Comfort Crisis book were trying to prove a point. I drove three hours deeper into the mountains and up the steep dirt road to arrive at my second friend’s piece of land – a plot of forest in the mountains just outside of Durango.
My work days in that high desert environment in the peak of summer were hot and physically demanding. It was hard to keep my tools, and my food supply in the cooler, and myself protected from the scorching sun (and a strange neverending blizzard of tree pollen) while still getting the job done. There was no indoor plumbing and we had to be very careful with our limited water supply. And then at the end of each day I had to reshuffle everything and set my car back up as a bedroom and crawl in for the night. Alone and far from home.
But instead of feeling depressed as I experienced this constant hardship, the opposite thing was happening: I felt more alive and more badass with each passing day. I got better at being a feral forest man.
One day, my co-builder and I decided to take the afternoon off and head to the wild, remote Lemon Reservoir for some paddleboarding. We didn’t bring our phones or any other conveniences or amenities – just two boards and the minimal clothing required for swimming. And we headed out into a stiff headwind and little whitecap waves, laughing at the freedom of the experience.
It was hard, and slightly scary, as we got further and further from the shore. Progress was slow even with serious paddling, and we didn’t have any particular plan beyond the spirit of “let’s GO!”
But again Michael Easter was there whispering in my ear, saying,
“Is this difficult, Mustache? GOOOOoood! Then you’d better keep going!”
So we did. And we got way out into that lake, to a point where the water was shielded from the wind by the mountains on the other side. And it was awesome.
We cruised over to the shore to explore a particularly scenic meadow, coated with the softest green mossy grass and exuberantly colored wildflowers, and set at an impossibly steep angle. And damn I wished that I could have taken pictures, but in a strange way this forced me to burn that spot more thoroughly into my memories using my own senses instead.
Then we headed back out into the center of the lake, set down the paddles, and just laid down on our boards to let the wind and the waves take us back towards the far end of the lake where we had started. And what a strange, serene feeling it was, floating on just a tube of air over two hundred feet of cold blue water, feeling like a jungle man with no cares and no plans and no material possessions. It could have been scary, but instead it was one of the best and most relaxed moments of my life.
Eventually, this week of forest living and exertion had to come to an end so I could get back to my own town to be a Dad again. But it ended with a final reminder of the principles of the Comfort Crisis – after so many days relatively extreme work and a relatively sparse food supply, I had grown used to a healthy background hunger. Which is yet another thing that we are meant to experience as humans – being satisfied and free from hunger all the time is neither normal nor healthy.
But when my hosts took me out on the town for a final night thank you dinner at the Mexican restaurant, the immense Burrito platter I consumed turned out to be the most delicious meal of my life.
Purposeful Hardship vs. Purposeful Spending
There has been a lot of talk directed at the FIRE community recently about how bad we are at spending our money, and how we all need to loosen up. And there’s a small amount of truth to it, as my local friends Carl and Mindy recently admitted during a grilling on the Ramit Sethi podcast.
But we also need to keep this whole idea of excessive comfort in mind, and the damage it does to the natural human condition.
It’s great to spend money on adventures and improving yourself, being generous to others, and making the world a better place.
But it’s also way too easy to fool yourself into thinking you “want” things that just make your life easier and easier.
So your job is to catch yourself before this happens, and learn to keep things challenging, even as you upgrade the rest of your life experience.
In other words: buy yourself better tools, not softer chairs.
—-
* Another great book that follows this style is Wired for Love by neruroscientist Stephanie Cacioppo – highly recommended for reading in parallel with a lover, whether new or old.
** not actually hard by reasonable human standards, but it seemed hard by my comfort addicted first world standards
When the subject of Individual Retirement Accounts (IRAs) comes up, the one question that seems to cross everyone’s mind is: Which investment vehicle is better, a Roth IRA or a traditional IRA?
The subtle differences between the two types of IRAs are the source of all the confusion, but the answer depends largely on whether you expect to be in a higher or lower tax bracket when you start to draw funds out in retirement — however, there is actually more to consider than just your tax bracket.
Four Important IRA Features to Consider
For most Get Rich Slowly readers, the four most important considerations are these:
Contribution limits: For Roth IRAs and traditional IRAs, the contribution limits are identical. In 2015, you may contribute a maximum of $5,500 a year to your account. If you are 50 or older, you may contribute an additional $1,000.
Income limits: Both Roth and Traditional IRAs have income limits. (You can get the details on the IRS website: Form 590 for Roth, and Form 590-A for traditional.)
When contributions are taxed: Both types of IRA are tax-advantaged, but in different ways.
Traditional IRA — You are usually able to fund a traditional IRA with pre-tax dollars, so you pay taxes when you withdraw the money. (If you or your spouse has a retirement plan through an employer, the deductibility of your traditional IRA contributions may be subject to income limits.)
Roth IRA — The money you put into a Roth IRA has already been taxed and will grow tax-free; therefore, you are able to withdraw it tax-free.
Annual distributions after age 70 ½: You must take yearly distributions from a traditional IRA (and pay taxes) when you are over 70 ½ years old. There is no such required minimum distribution with a Roth.
Comparing Features: Roth IRA vs. Traditional IRA
Roth IRA
Traditional IRA
2015 Contribution Limit – < 50
$5,500
$5,500
2015 Contribution Limit – > 50
$6,500
$6,500
2015 Income Limits
IRS Roth IRA Info
IRS Traditional IRA Info
Required Annual Distribution
None
Required at 70.5
When Contribution Is Taxed
Before contribution
At withdrawal
How to Choose Between a Roth IRA and a Traditional IRA Account
So if you qualify for both, which one is best? In general, the rule of thumb is:
Choose a Roth IRA if you suspect that your retirement tax rate will be equal to (or greater than) your current tax rate.
Choose a traditional IRA if you think your tax rate will decrease during retirement.
Of course, nobody knows what their future tax rate will be. As a general guideline, take an honest look at your lifestyle and your dreams for retirement. If you live a frugal lifestyle, your withdrawals from your IRA should be low enough so as not to put you in a high tax bracket. In that case, a traditional IRA might work best for you.
However, if you are starting early and you know you will have a substantial nest egg which you plan to use to travel the world in style, you can expect to be withdrawing a high enough amount to put you in a higher tax bracket then. If that is the case, a Roth IRA might make more sense for you.
Looking at it from the other side, if you are in a high-paying job now, a traditional IRA might be attractive because you save a significant amount of income tax from the deduction you take. If, however, you are in a low tax bracket at the present, a Roth IRA might make more sense, because you won’t get a significant tax saving from your deduction.
Getting More Specific
If you want more explicit information, you should search the web for an IRA retirement calculator. Be aware, though, that your assumptions about the future are just that — assumptions. Nobody knows what tax rates will be like in the future. If you make very little now, you can guess that your tax rate will probably be higher in retirement. If you make a lot, your tax rate could very well be lower. But what about the rest of us?
I asked Dylan Ross of Swan Financial Planning for his advice:
Because many people will have tax deferred savings from other sources anyway, it usually makes sense to go with the Roth when you have the choice.
Most people will not be withdrawing their entire IRA in a single tax year. It’s entirely possible that some years will have higher tax rates than present and some years will be lower. This is why I think it makes sense to try to have tax-free (Roth) and tax-deferred savings, so I can have options in the future. If I want to save some of my tax-free when I’m retired because tax rates are at a low and I suspect will eventually rise, I’ll pull from my traditional IRA. If tax rates are super high, I’ll tap the Roth.
I’m an advocate of diversifying the tax treatment of my retirement savings; but in the end, when you have a choice, putting it all in the Roth is usually the better move.
The Question Remains, and the Answer is Personal
Traditional and Roth IRAs are great tools to help the average American save for retirement. There are several subtle differences between the two accounts that affect everyone whether they are just starting out in their retirement planning career (and it is a career, the only one from which no one can ever be fired or laid off) or they happen to be near (or even in) retirement.
So which is better? It depends. Your circumstances determine which account makes the most sense. If the choice is not clear to you, you should probably consult a qualified professional such as an accountant or a certified financial planner. Most of the time I route people to one of my previous articles if they want to get a better handle on the subject:
If you are more interested in 401(k)s than IRAs, the same train of thought applies. (And because you are dealing with an uncertain future, a train of thought is the closest you can hope to get to a firm scenario.)