I recently had a conversation with two friends from work about personal finance and investing. Having read many articles about the precarious state of most American families’ finances, I am trying to discipline myself to spend less than I earn and plan for the future. Here’s my basic strategy:

  1. Build up “emergency savings” cash in a regular savings account, enough to pay all bills for 3-6 months. Bankrate is a good tool to compare offerings by online banks.
  2. Pay off debt, especially student loans since they are the only ones that can’t be discharged by personal bankruptcy.
  3. Put some of each paycheck into a roth IRA (can fund it up to $5000 per year of earned income)
  4. Within the roth IRA, buy index funds once every 2-3 months (and almost never sell, to avoid commission fees) to maintain asset allocation based roughly on the following formula:
  • 30% domestic (US) stocks, such as SPY
  • 15% real estate investment trusts, such as VNQ
  • 15% international developed market stocks (Europe, Japan), such as VEA
  • 12.5% government bonds, such as TLT
  • 12.5% inflation protected government bonds, such as TIP
  • 10% emerging market stocks (Brazil, China, etc), such as VWO
  • 5% commodities/ individual stocks, such as POT

Any dividends/interest/tax refund/etc gets reinvested in roth as well. I use Scottrade as broker but there are a bunch of other cheap ones too.

The reason I prefer index funds over individual stocks is because the risk is associated with the whole economy, rather than an individual company, and I don’t have the skill to predict which company will go up or down in the future (on the other hand, because the variation in returns is smaller, the potential for large gains is also less). Mutual funds have the same features of diversification, but the reason I don’t like them is because they often have high “management fees”. In the 401(k) you have almost no choice but to put up with such fees, which is why I like the roth IRA better. Here are some more articles that explain the pros and cons of index funds:

http://www.nytimes.com/2009/02/22/your-money/stocks-and-bonds/22stra.html

http://www.nytimes.com/2010/02/06/your-money/stocks-and-bonds/06wealth.html

Vanguard is a company that is well-known for its low-fee funds (example: VWO tracks emerging market equities)

Another example of an exchange-traded index fund (ETF) that tracks the S&P 500 index is SPY.

I also like the “motley fool” site for general personal finance advice.

Finally, here are a couple of counter-perspectives:

http://www.fool.com/investing/general/2010/12/08/does-warren-buffett-really-think-index-funds-are-b.aspx

http://www.investopedia.com/articles/stocks/09/reasons-to-avoid-index-funds.asp

 

Advertisements