Basic Investment Advice

The Basics

The key steps to financial security are very simple:
1. Spend less than you earn
2. Invest what you save
3. Repeat until wealthy

There are two types of saving that you will do: retirement investing and rainy day savings.

For retirement investing, the eventual goal is to be able save roughly 20% of your annual salary per year. Initially of course that may not be possible but that should be the goal you work towards. The general thinking is that if each year you invest 20% of your salary then by 65-70 you should have enough for a comfortable retirement. Once you are retired, the rule-of-thumb is that you can pull 4-5% of your savings out each year and your retirement savings will last you for 25-30 years.

That 20% estimate is fuzzy of course because nobody knows what the stock market will do or how long they will live. Some people estimate that 15% savings per year is enough and others say you might need as much as 25%. I tend to think that 15% is probably enough to live on and 20% is enough for comfort, meaning maybe an extra trip each year or something. In other words, don't worry so much about hitting the 20% number as soon as possible.

I will discuss rainy day savings in more detail later on.

A Caution

As with anything else, it is possible to take money and investing to an unhealthy extreme. Please keep that in mind with all the advice I give here. What I don't talk about in detail among all this investing advice is how Mom and I have also prioritized tithing and charitable giving. We always pay our tithing first and then we make sure that we give large charitable contributions. Then we adjust our savings and investing.

These three quotes have been my guide regarding being charitable:

I am afraid the only safe rule is to give more than we can spare. ... If our charities do not at all pinch or hamper us, ... they are too small. There ought to be things we should like to do and cannot do because our charitable expenditure excludes them.
- C. S. Lewis, Mere Christianity (1952), p. 67

I am a firm believer that you cannot give to the Church and to the building up of the kingdom of God and be any poorer financially. ... If the members of the Church would double their fast-offering contributions, the spirituality in the Church would double. We need to keep that in mind and be liberal in our contributions.
- Marion G. Romney, Ensign, May 1986, p. 32

A religion that does not require the sacrifice of all things never has power sufficient to produce the faith necessary unto life and salvation.
- Joseph Smith, Lectures on Faith 6:7

The Details

The secret to step 1 ("Spend less than you earn") is to create a budget and stick to it. Figure out where your money is going so you can make informed decisions about where expenses can be cut to increase savings.

Step 2 ("Invest what you save") is a little more complicated. Even though the overall principle is simple, the details of investing can be tricky.

Here are my recommendations on what to do.
1. Maximize your 401k employer match
2. Pay down debt
3. Have a Rainy Day Fund in a local bank for emergencies like a doctor visit or a car repairs
4. Maximize your Roth IRA contributions (you and spouse)
5. Do other investing (kid's education, saving for trips, etc)
6. Maximize HSA contribution
7. Maximize your total 401k contribution

The first step is an absolute must! The others are a little more flexible. For example, I started investing in one Roth IRA, but also started putting money in education savings plans for the kids' college at the same time. Later on I started the second Roth (later than I should have but that is because I didn't understand all this stuff at that point).

Some people say that you should maximize 401k match > HSA > Roth IRA > 401k > college. If you want to retire as early as possible then this is probably the best advice. The thinking with this strategy is that if you maximize all your retirement investments early they will have much bigger gains than college savings (529) accounts. 529 accounts tend to have lower gains because they are shorter term savings and thus tend to be in lower risk, lower reward investments. So instead of investing in a 529, you put more into your retirement accounts and then just help pay for your kids' college with normal income.

With all this talk about maximizing your investments (like Roth, HSA, and 401k), remember that once you hit your target savings amount (like 20% of your income), you do not need to continue increasing your retirement savings percentage. So if I have my 401k match maximized, my Roths maximized, and a little bit going into my HSA, and that equals a 21% savings rate compared to my income, then I don't need to fully maximize my HSA and/or 401k. Adding more at that point will allow you to retire earlier or more comfortably, but you could also just start enjoying your extra money now by going on trips or doing other fun things.

401k

A 401k is a special retirement account that you put money into it tax-free (you don't pay any income tax on it from your paycheck), but you pay income tax when you take the money out in retirement. This is nice because generally you will be in a lower tax bracket in retirement. But is also nice because it means you are losing less money to taxes now.

Start with your 401k at work. Most employers do some sort of matching. My employer matches 50% up to the first 6% I contribute. So if I contribute 6% of my salary to my 401k, my employer adds another 3% of my salary. That is free money that is just lost if you do not contribute enough to get the full match. Always, always get the full match!

If you change jobs you will keep your old 401k and you will start a new one with your new job. You will not be adding any more money to your old 401k, but it will continue to grow as the stock market goes up.

You can just leave the money in whatever account you had with your old employer or you can move it into a new account called a Rollover IRA. I wanted to have as many of my accounts in one place as I could so when I left Keane I moved my old Keane 401k into a Vanguard Rollover IRA and invested the money into Vanguard Funds. The side benefit of this was that the fund expenses were much lower at Vanguard than they were at the other investment place. I discuss expenses in more detail later.

There is an annual maximum that you can put into a 401k. It changes occasionally but is currently $18,000. After you have maximized your other retirement savings options you can work on maximizing your 401k contribution if you need to in order to reach your savings percentage goal. 

401k example: If I want to invest $1000 in my 401k account, that $1000 comes directly out of my paycheck and goes straight into my 401k account. I do not owe any federal or state taxes on that money. Lets say that grows to be $16,000 by the time I retire. When I withdraw that $16,000 out of my 401k account and I have to pay taxes on it. If we assume that the tax brackets are the same, I would own 12% federal and 5% state taxes, or $2720, so I would end up with $13,280.

Debt

After maximizing your 401k match, paying down debt should be possibly your next highest priority. Ideally you will not get into any debt with the exception of something like for a home, car, or education. Even then it is always good to minimize the debt you are getting into (get a smaller house for example). You should never go into debt for anything else. Credit card balances should be paid in full each month. If you cannot afford to pay off the credit card balance you should not be buying those things. It is better to save up money first and then pay in cash than to go into debt to buy something.

Once you have a loan for something like a house you should try to pay extra to the loan each month so you can pay it off early. If you wait the full 30 years to pay off a home loan, you could end up paying 3x the original cost of the home. So to pay off a $250,000 home loan, you might end up paying $750,000 over the 30 year period. This is how banks make so much money! If you can pay extra each month on your house payment that can reduce the total you paid for the loan to $500,000 or less. Each $100 you pay early on can save you $1000 or more in the long run. The savings really adds up fast!

Roth IRA

A Roth IRA is a retirement account that you put money into after paying income tax on that money, but then all the money you pull out of the account in retirement is tax-free.

Once you have maximized your 401k match your next investing step will be to create a Roth IRA for yourself and another one for your spouse. Eventually you will want to maximize the allowed contributions to both Roths. The max for each account is currently $6000 per year, or $500 per month ($1000 per month for both accounts). You start small with maybe $50 per month and gradually increase the amount as you get raises until you are maximizing your donation to both accounts.

Roth example: If I want to invest $1000 in my Roth account, I first pay taxes on that $1000. I am probably paying 12% federal taxes and 5% state taxes, so I pay 17% in taxes, or $170, and then invest $830 in my Roth account. Lets say that grows to be $13,280 by the time I retire. I can take all $13,280 out of that account and I never have to pay any taxes on it.

If you compare the 401k example to the Roth example you probably noticed that the end amount after taxes is the same. Remember that those amounts assume that the tax rates remain the same as they are now. Taxes are near all-time lows right now, so it is possible that they will go up. If you end up in a 20% federal tax bracket when you retire then paying 12% now to put it in a Roth makes more sense than putting it in a 401k. It is all speculation, but Roth seems like it is more likely to be a good bet, so most people recommend maxing the Roth before adding more to the 401k past the employer match. Having both a Roth and 401k is also nice because then you can pull some money out of the Roth and some out of the 401k to minimize the amount of taxes you will end up paying.

Other Investing

Once you have maxed out your 401k match then any additional money you have can be invested either in the Roth IRAs or any of these others as you see fit. I would prioritize the Roths slightly ahead of many of these, but others can be just as useful/important. Here are some options in no particular order.

1. Put more into your 401k. There is no more free employer money to be had, but there are still the tax benefits. Since I prioritize Roths slightly higher than more 401k money, I would only do this after the Roths are maxed, but adding more to the 401k is never bad. It also immediately reduces what you pay in taxes which can be useful.
2. Put money into a non-retirement (brokerage) account. This does not give you any tax advantages, but this is money that you also have access to before retirement without penalty. So this money can be used for trips, emergencies, education, etc. I would probably do this after the Roths are maxed, but an argument can be made for keeping some of your short term savings in a relatively low risk investment like a bond fund.
3. Start college savings accounts. College accounts are great because the money is pulled out tax-free when used for educational expenses. The main downside is that you have no idea how much your kids will need for college, so you may over save or under save.
4. Add to a Health Savings Account (HSA). HSAs are like a 401k and Roth combo account! The money goes in tax-free, but it also comes out tax-free when it is used for medical expenses. It also can be used now, meaning you do not have to wait until retirement to use it. You contribute money to the HSA account each paycheck and then reimburse yourself from that account when you have a medical expense (doctor visit, prescription, glasses, dental visit, etc). It is generally better to let the money grow as much as possible, but it is there for when you need it and it saves you money in taxes.

HSA Optimization
The optimal way to use an HSA is to invest your HSA money in something like an Index Fund and let it grow. You would always pay for medical stuff with your regular money and save all the receipts. Then when you are retired you can pull money out of your HSA to reimburse yourself (tax free) for all those medical expenses.

What this does is it allows your HSA investment to grow over the years. You put money in tax free so you get the benefit up front like a 401k. But then you can also pull it out tax free like a Roth. If you reimburse yourself early on then that money does not grow.

Example: I invest $1000 in an HSA and let it grow for 40 years in the stock market with a 10% average return each year. After 40 years it will be worth around $40,000! On the other hand, let's say in the first year I reimburse myself for a $100 doctor bill so now I only have $900 invested. After 40 years that would only give me $36,000. Taking out that $100 early on ended up costing me $4000 in the long run!

The downside to this approach is that it requires you to be very organized with your receipts and save them for a very long time. Of course this could be made easier by taking photos of them and storing those somewhere online. I have been too lazy to do that, but I give you the information so that you can decide what you want to do.

Rainy Day Fund

It is always a good idea to have some money available for emergencies like a doctor visit, a car repair, bribing a local official (just kidding), etc. If all of your money is tied up in retirement accounts then you cannot get to it without penalties. If your other money is in a brokerage investment account then it could take a week to get the money into your checking account so you can spend it.

You should always keep some extra money in your local credit union or bank account so that it is available if you have an unexpected expense come up. What that amount is can vary greatly. Early on I tried to always keep a couple thousand dollar buffer in my account. Later on as my kids got older my expenses got bigger so my rainy day fund had to be larger.

Budgeting experts seem to agree that you should try to have a rainy day fund of 3-6 months of expenses. Note that this is not 3-6 months of income, but just what you spend. So if you spend (on food, housing, insurance, etc) $2000 per month then you will want to have a rainy day fund of $6000 - $12,000. With that much saved, if you lose your job, or have emergency car or home repairs, or have unexpected medical expenses, you will have enough money to get through that without having to go into debt with a credit card or loan.

Investing Principles

Index Funds
There are many, many strategies to investing. The bottom line, though, is that almost nobody ever beats the return of the general market. In other words if you take all the paid investors out there trying all their crazy "insider tips" to time their buys and sells just right (see Timing the Market), they still almost always do worse than if you just watch the stock market indicators like the Dow Jones or the Nasdaq. So in my opinion (and the opinion of many others) the best option is to put your money into a low fee index fund that basically just mimics what the overall stock market does. Also, many investors talk about he importance of diversifying your portfolio by buying many different types of stocks. The good news is that the index funds also already do that for you!

Lazy Investing
I like to call my preferred method of investing "lazy investing". I prefer to just stick money in diversified funds and forget about it. My favorite (and a favorite of many on the internet) is the Vanguard Total Stock Market Index Fund (VTSAX). I have a lot of my money in that one fund. If you want the simplest option then that is my advice. Another fund that is a little more diversified so that it has lower risk but also slightly lower returns and slightly higher fees is the Vanguard LifeStrategy Growth Fund (VASGX). Beyond those two there are other good Vanguard funds that you could choose but I am not an expert so you will need to do your own research. 

I personally have put most of my money in VTSAX and left it there for several years. Now that I'm getting closer to retirement (~15 years away), I have moved most of my money over to VASGX so it is a little more stable. Some would say that I'm moving it too early, but there are also a lot of financial experts that say having 100% stocks (VTSAX) is a bad idea. At this point, the 3% difference in return is not worth the extra risk to me, and I don't need the higher return of VTSAX in order to reach my retirement goal.

Timing the Market
Timing the market is when you sell your stocks, expecting that the market will go down in the future so that when it is lower you can buy back in. This is basically rolling the dice. You are generally more likely to end up selling right before the market continues to go up. Never try to time the market!

A corollary to this is to never panic-sell your investments. Remember that these investments are for the long-haul. When the stock market lost over 30% of its value at the beginning of 2020, some people moved their investments from stocks to bonds in order to be "safe" and to "not lose any more". But then the market went back up. When they were eventually convinced to move back to stocks they had missed out on a lot of gains. They essentially sold low and bought high, which is the opposite of what you want to do. The best strategy is to just invest your money in an index fund and ignore it for 30 years.

Expense Ratios
An "expense ratio" is how much the fund manager charges you each year to invest your money. When you are selecting funds to invest in, the options can be overwhelming. My general advice is to stick with an "Index" fund for the reasons I explain above. Then examine the available index funds and compare their expense ratios. Vanguard generally has the lowest expense ratios so that is why I chose to use them for my investments. You can also choose other investment firms. Fidelity or Charles Schwab are both commonly used. When I did research, Vanguard seemed to have the lowest expense ratios overall for what I was investing in so I went with them.

As an example, VTSAX has an expense ratio of 0.04% and VASGX has an expense ratio of 0.14%. Both of those are really low. An expense ratio 0.04% means that if I have an account (like a Roth account) with $100,000, that Vanguard will charge me 0.04% of that (or $40) each year as an administrative fee. The VASGX account would cost $140 per year for $100,000. The average expense ratio for an index fund is around 0.2% ($200) and some funds which are actively managed by people trying to beat the market will cost 1% ($1000) or higher. I think you can see why VTSAX has become such a popular fund.

Getting Close to Retirement
Long term, as you get closer to retirement, you will want to start to pull your money out of index funds. This is because the stock market can have very large swings. Picture what would happen if you lost a third of your retirement fund value during your first year of retirement - suddenly you would not have enough money. So as you get within perhaps 10-15 years of retirement you will probably want to start moving some of your money into less volatile funds like a Bond Index Fund.

Historically, stocks have tended to average a 10% return and bonds tend to average 5-6%. Stocks tend to have a negative return about every four years. Bonds are pretty constant. Recently, stocks have swung between -5% and +28%. Bonds have been around 2-4%.

You want to slowly move your money over to bonds because you don't want a year like 2008 or 2020 where the market lost over 30% to destroy your retirement. If you do not have time to wait for it to recover (which could be 5 - 10 years) then you are out of luck! On the other hand, if you already had 20-30% of your retirement in bonds then you could live off that while the rest of your investments recovered.

Now that I am about 15-20 years from retirement I am taking a little more cautious approach and I have started to move my retirement money to something less risky. I chose the Vanguard LifeStrategy Growth Fund. It is 80% stocks and 20% bonds, so it is still pretty high-risk, but it is a start. In 10-15 years I will probably move some of it to the Vanguard LifeStrategy Moderate Growth Fund (VSMGX) which is 60/40. I might just leave everything there until I die depending on the market, but if things start to tank I might move to the Vanguard LifeStrategy Conservative Growth Fund (VSCGX - 40/60) or even the Vanguard LifeStrategy Income Fund (VASIX - 20/80). My guess, though, is that I will never use the VASIX because the return on 80% bonds is too low.

Note: If you research the LifeStrategy funds you will see that they are just a mix of the Vanguard total stock market, total intl stock, total bond, and total intl bond funds. So you could do the same on your own without paying the higher fees of the LifeStrategy funds, but I am lazy and I know I would probably not keep up on rebalancing the investments every year.

Target Date Funds
The other thing you can do is invest in a Target Date Fund. These funds tend to not do as well as index funds and they have higher fees (expense ratios) but they can be nice because you can stick money in them and forget about it. These funds start with part of the money in bonds (which is why they do not do as well as index funds) and part in stocks. The fund manager will slowly move your money over from stocks to bonds as you get closer and closer to retirement. I have some of my retirement funds in Target Date Funds just to be a little more diversified. I also have split it up into four funds with target years of 2040, 2045, 2050, and 2055. That way the money will be moved into bonds more slowly than it would if all the money were in a 2040 fund.

Other General Advice

Credit Cards
Credit cards are a very useful tool when used correctly. My advice is to get a good credit card, use it for all your regular expenses (groceries, bills, etc), and pay off the balance each month. Having a credit card and paying it off each month helps you to start building your credit score. This allows you to get loans when you buy a home or a car.

A good credit card has no annual fee and it will give you cash back for using it. I use a Capital One Visa that gives me a 1.5% cash back bonus on everything I buy. That is like getting a 1.5% discount on everything!

The downside to a credit card is if you do not pay off what you owe each month you are charged an incredibly high interest rate. It is never worth carrying a balance on a credit card. If you are in a really tough spot and need money for an emergency, borrow money from us instead of keeping a balance on your credit card.

Life Insurance
Don't buy Whole Life Insurance. It is almost always a terrible idea. Buy Term Life Insurance instead and then invest the difference.

Financial Advisors
If you meet with a financial advisor, make sure that they are a Fiduciary. A Fiduciary is a person who is legally and ethically bound to act in your best interest. A non-fiduciary person is likely to be acting in their own best interest by selling you products that give themselves the biggest commission or fees (like whole life insurance). Any financial advisor (fiduciary or not) that tells you to buy whole life insurance is a bad one.