Reader Mailbag: Audio

What’s inside? Here are the questions answered in today’s reader mailbag, boiled down to five word summaries. Click on the number to jump straight down to the question.
1. First investments
2. Credit question
3. Yoga teacher training
4. Credit counseling agencies
5. Taxes and inflation
6. Amazon and library synergy
7. Student loan repayment options
8. What’s real poverty?
9. “Cashflow” board game
10. Gas prices and inflation

Almost all day long, I have some sort of audio playing in my office. I listen to podcasts. I listen to music. I listen to the local radio show of someone I know socially.

I don’t pay deep attention to these programs. I usually just let them flow in one ear and out the other. What I find, though, is that sometimes ideas from these programs stick in my head. I’ll recall them later and be stunned at how useful they are.

Q1: First investments
I am currently a 20 year old college student, I have no debt, or student loans. I work full-time and go to college in-state and also stay at home with my parents to save. I currently have 10,000 in savings with very little in my emergency fund (1,300). I want to invest it but I am not sure where to start. I thought of putting it into an IRA but I do not qualify for the tax deduction since I am a full-time student so I opted to wait 2 more years to contribute the maximum amount. What is the best option for me? I currently make very little (18K a year) but I manage to save at least half. Should I wait another year to save another 10K? My amount seems too little for the stock market.

– Beth

The big question I’d ask is what you were saving for and when.

Do you intend to spend this money when you graduate in order to relocate and set up your own household? Are you going to try to live as lean as possible until you can buy a home in, say, ten years? Is this all for retirement?

If your goals are long term, you certainly can invest in the stock market with $10,000. You can sign up at Vanguard and put all of that money right into a broad-based index fund, then just sit on that until you need it. However, I wouldn’t do that unless your goals really are long-term, like buying a house in ten or twelve years.

If your goals are short-term, such as a quick post-graduation goal, then I would keep that money in cash for now.

Q2: Credit question
I’m starting up graduate school in the fall and will be moving in with my fiancee. Her salary will be able to support us both over that period. The only credit history I have is from my credit card, as I have been fortunate to avoid student loans. My fiancee has student loans as well as a credit card. Both of us have always paid all our bills on time. My question is with regards to what happens when we get married, as I’m concerned I won’t have much of a history to get approved for a mortgage. Do our histories combine? Or should I take out a small student loan and consider the interest paid as a small cost for a better credit history? Thanks for the help.

– Kevin

When you take out a mortgage, a lender considers both of your credit histories when deciding whether to lend to you.

While you’re correct in that your limited credit history probably means you don’t have a spectacular credit score, you probably have a very solid one. I wouldn’t take out additional loans.

If you’re still concerned about it, I would try to get a mortgage from an institution that does manual underwriting. That means that, rather than just basing everything on your credit score, they actually look at your full credit history and your personal situation in making their decision. This usually works in the favor of people like yourself.

Q3: Yoga teacher training
I am an avid yogi and spend $79/month on a yoga membership.

There is a yoga teacher training at my studio and I am considering it as an option for making extra money in the summers when I’m not teaching high school and a couple times per week during the school year.

My issue is that I don’t have the money yet to pay up front. The program is 8 weeks and costs $2000.

I will have the whole summer off after the training to find yoga work at the several studios in my city.

The catch- there is another training in September. For this one I could have enough money to pay the whole thing, but will be teaching full time on top of teacher training.

I am hesitant to do the training with a fat chunk of change on my credit card but am confident that this would improve my life, income and yoga practice. In addition, I would no longer have to pay the $79/month at any studio where I work.
– Jenna

Are you certain that you will be able to find seasonal work as a yoga teacher? That would be my chief question here.

If yoga studios would be hesitant to hire you because of that seeming requirement, then I wouldn’t invest that money into teaching accreditation.

Another approach might be to see if there is a bartering system you could work out with that studio. Could you take the class for free or at a reduced rate in exchange for teaching some classes there afterwards for free?

I would be very hesitant to put this onto my credit card unless I was absolutely sure that I would earn money with it on the other end.

Q4: Credit counseling agencies
I was wondering what your thoughts were on credit counseling agency. Currently I am paying off my credit card debt on my own, adding an extra payment where I can. Does working with credit counseling agencys hurt your credit? Do you recommend working with agencies? What are the benefits of working with this type of service?

– Justin

Not all credit counseling services are the same. Some can hurt your credit. Others don’t. Some can charge outrageous fees. Others don’t.

While I don’t have any specific recommendations for you, I would suggest researching as many different agencies and programs as you can. Look for personal stories. Look for the real numbers, too.

Be aware, though, that such services mostly just provide a structure around things you can do yourself. I view them as being much like a coach. They’re coaching you through things you could do yourself and giving you a training regimen for making it possible. Is that of value to you?

Q5: Taxes and inflation
Looking at history, I can assume that as I get older inflation is going up and so are taxes. So I will pay more in taxes when I retire (I’m 30 btw), and the value of my retirement dollars will be less. Based on these assumptions, how does tax-deferred savings in my company’s 403b make any sense? Isn’t there a better way to take advantage of compounding interest?

– Devin

This is exactly why I usually encourage people to invest in a Roth IRA rather than in their 401(k) or 403(b), with the exception being when they can get matching money from their employer (which is valuable enough that it overcomes inflation and tax increases).

A Roth IRA, if you’re unfamiliar with it, is an account you sign up for yourself with a reputable investment house (I use Vanguard). You then deposit money into that account (up to $5,500 per year) and designate that money to one of many investment choices, much like a 401(k)/403(b). The big difference is that you’re using after-tax money and the gains you make, if withdrawn at retirement, are not taxed, either.

Most people, in my opinion, should contribute to their 401(k)/403(b) up to the amount necessary to get all matching funds from their employer. After that, they should be funding a Roth IRA.

Q6: Amazon and library synergy
I thought of you when I saw this posting on parenthacks (I don’t remember if you follow parenthacks them or not):

http://www.parenthacks.com/2011/03/let-amazon-help-you-better-navigate-your-local-library.html

She basically covers how she uses Amazon features (other books like this one, oher books by same author) to help select books at the library.
– Scott

I do this exact thing for both my library books and for PaperBackSwap.

I often hop onto Amazon, look up books that I know that I love, and see what similar books are recommended. Because of the enormous amount of buying patterns and reviews and ratings on Amazon, their recommendations are pretty good.

I then just take those titles to other sources and get the books for much less expense elsewhere.

Q7: Student loan repayment options
I have almost $30k in student loans @ 2.125% interest. Assuming I have the money to pay it off (either all at once, or under the normal pay structure), what’s the wisest thing to do?

Here are a couple of scenarios that I’ve come up with.
-Pay it all ASAP.
-Pay as little as possible and consider it a cheap loan for a car, house, travel, etc.
-Pay as little as possible and invest any extra money in something that would return more than 2.125%, but be liquid enough for me to pay the loan monthly.

I prefer the last idea, but I’m not sure if that exists.
– Josh

The big question is whether or not that 2.125% is fixed or variable rate. If that rate is fixed and you have it locked in forever, I would pay down that debt as slow as possible regardless of what I used the money for.

It’s worth noting that there is no guaranteed and liquid investment right now that consistently gets 2.125% without some caveats. However, as the economy rebounds, interest rates will slowly inch upwards and you’ll find savings accounts that do beat it.

If that 2.125% is a variable rate loan, I would probably focus on paying it down. Again, if interest rates go up, that rate can rebound and become very nasty very quickly.

Q8: What’s real poverty?
I am sure you have many reasons why this article is crazy.

http://wonkette.com/442001/welcome-to-poverty-everyone-you-need-household-income-of-68k-to-live
– Marilyn

This article argues that a family is in poverty if they earn $68,000 a year or less. I can speak from personal experience that a family can thrive on that level of income.

My personal feeling is that this number is too high, but that the federal poverty line is too low. There’s a happy medium between the two.

Location is also an important factor in this. The cost of living in rural Iowa is much lower than the cost of living in, say, San Francisco. There does need to be some location information included in asking the question of poverty.

Q9: “Cashflow” board game
Have you ever played the board game “Cashflow” from Rich Dad Poor Dad? If so, do you feel that it is a good way to learn about basic money management and investments?

– Jen

While “Cashflow” has some good money management ideas in it, the game is so encumbered by rules and repetitive gameplay that I would find it easier to just talk to my children about money and show them what I do than to play this game with them.

I don’t think there’s any one game that does a great job of teaching personal finance. The ones that actually mirror personal finance really well tend to be poor games.

Why is that? I just don’t think modern personal finance translates well to board games. It’s not an exciting theme.

I did create a draft of a Dominion-like deckbuilding game that simulated personal finance that was quite fun, but when I showed it to a publisher, he practically had a heart attack with regards to the theme.

Q10: Gas prices and inflation
Adjusted for inflation, are the current prices the highest in history?

– Jennifer

It might be, but it’s not a runaway. It’s near one of the three previous historical peaks, when adjusted for inflation.

The first peak was in the very early days. The price of a gallon of gas, adjusted for today’s dollars, in 1918 was about $3.80. In 1981, the price of a gallon of gas adjusted for inflation was about the same, and we hit a similar peak in 2008.

The current peak, as I write this, isn’t quite as high as those earlier peaks. Of course, ignoring those other peaks, the current gas price blows everything else out of the water.

Got any questions? Email them to me or leave them in the comments and I’ll attempt to answer them in a future mailbag (which, by way of full disclosure, may also get re-posted on other websites that pick up my blog). However, I do receive hundreds of questions per week, so I may not necessarily be able to answer yours.

If you enjoyed reading this, sign up for free updates!

Loading Disqus Comments ...
Loading Facebook Comments ...
  1. Johanna says:

    Q3, Jenna: If you do the training now, what’s the worst that could possibly happen? You don’t find work this summer and you’re stuck with a $2000 credit-card debt. That’s really not so terrible, since it sounds like you’re spending a lot less than you earn – if you could save up the $2000 between now and September, you could pay down a $2000 debt in not much longer than that. You’ll pay a bit of interest, but not too much.

    Since the downside is relatively minor compared to the upside (the opportunity to find work this summer, plus an extra summer to reap the personal benefit of the training), I would say go for it. Do the training now.

  2. valleycat1 says:

    Q3 – I’m with Johanna on this, particularly since you could or would probably get some other kind of summer job if the yoga teaching doesn’t work out immediately. Additionally, if your CC offers you ‘checks’ for cash advances at a greatly reduced rate for a limited time, you could use that. [I just got some that would have given me 0% interest for 6 months.] Just commit to paying everything you can toward the $2K so you pay the least interest.

  3. Rob says:

    Q5, Devin: While you can assume that taxes will be higher when you retire, it’s not a gimme. The best strategy is to mix up your retirement savings between pre-tax and post-tax vehicles, like Trent said. This is going to give you the flexibility to basically choose your tax bracket when you retire.

    Q7, Josh: In general, it’s always best to pay down your debt before investing. But you’re in the sweet spot where it won’t be too difficult to achieve gains greater than your interest payment plus taxes. You just have to keep a couple of things in mind.
    a) There is no way to do it without accepting some amount of risk, however small.
    b) It’s not a good idea to start picking stocks willy-nilly. Stick with index funds for a while until you’ve learned enough to pick stocks (I recommend The Intelligent Investor as a good starting point.)
    c) It costs money to play the game. Keep an eye on your trading expenses and make sure you aren’t giving away your gains. It does you no good if you make a few bucks and end up giving it all back in brokerage fees.

  4. Johanna says:

    Q5: Sigh.

    For the umpty-first time: As long as you are paying a non-zero amount in income taxes now, it is almost always a good idea to put some money into a pre-tax retirement account (such as a 401(k)), even if you don’t get a match. This is because of how tax brackets work. If you do not understand how tax brackets work, go read about how tax brackets work. Not only will it help you make smarter financial decisions, it’ll make you a more informed citizen.

  5. Riki says:

    Q3 – Jenna: I would take the class now. $2000 is a reasonable amount to spend in this situation, and you can easily put in a clearly defined plan to pay off that debt in a short period of time.

    Sometimes the benefits of carrying a small amount of debt really do outweigh the risks. Go for it, and good luck!

  6. Courtney20 says:

    Q3 – I agree with Johanna and valleycat1 also. If you put the $2000 on a credit card, and could have saved up that amount by September, then even at an outrageous 28% interest rate it will only cost you $180 in interest. That’s a very low opportunity cost given that you would pay that much in less than 3 months for your studio membership.

    As an aside, I’m not sure what Trent meant by “If yoga studios would be hesitant to hire you because of that seeming requirement…” What seeming requirement? The requirement to have a teaching certificate? That’s how the system works…she wouldn’t have gotten hired at her high school without a teaching certificate either. The requirement that she only work seasonally? She says ‘summers plus a couple times a week’ – so it’s not just seasonal work.

  7. Gretchen says:

    Yoga: ” confident that this would improve my life” would be enough for me.

    Do it.

  8. Johanna says:

    Q8: If you click through to the full report on how they calculated the $68,000 number, you see that they’re figuring that the 4-person family is paying $821/month for housing. So they’re not living in San Francisco.

  9. Nate says:

    Q1: 10 to 12 years is a short time horizon for a stock market index fund. You could lose a significant percentage of your capital if you follow the advice of investing it all right now in an index fund and selling it all 10 to 12 years from now to use the proceeds to purchase a house. You have absolutely no way of knowing where the stock market will be in 10 or 12 years. Please do more research before making that move.

    Q5: While your tax rate may be higher when you retire, this in itself does not make a Roth IRA a better vehicle than a 401k or Traditional IRA for you. Funds placed in a Roth IRA are taxed up front. Funds placed in a 401k or Traditional IRA are taxed only upon withdrawal. 401k’s and Traditional IRA’s allow money that would have gone to taxes up front to appreciate or accrue interest and to compound over years. Even if your tax rate is higher upon retirement, the effect of appreciation and compounding of the money that otherwise would have gone to taxes up front could put you in a better position in the end. The right way to approach this is to actually do the math with all the variables. Don’t just assume that one retirement investment vehicle is better than another simply because you expect a higher tax rate in the future.

  10. Becca says:

    There are a lot of yoga studios that will trade classes for a few hours of manning the front desk. You could get free classes while learning about the industry/networking.

  11. Tracy says:

    @Q8

    Those numbers make sense – the ‘poverty’ was used for shock value and to draw attention, but it does go on to clarify that as ‘living paycheck to paycheck’ which is spot on. Keep in mind that it’s describing a particular (if not uncommon) situation:

    2 parent household with small children where both parents work outside the home for around 33k.

    The real cost here is the childcare. A two-parent, single-but-high-income (which is essentially what Trent has, since he works from home) is going to have less expenses and, as in his words, ‘be able to thrive’.

  12. Rache G says:

    Q4

    The benefit of brick and mortar credit counseling agencies is that often times if your credit debt is significant they will negotiate with your creditors to have your interest rates lowered to somewhere below seven percent. This can be beneficial for people who swimming in debt with huge interest rates. Also they generally require you to stop using those credit cards altogether. There plans have you paying off your debt in under five years.

    Make sure to do a lot of research on these agencies some common agencies are Green Path Debt Solutions, Consumer Credit Counseling, and Money Management International. All of these agencies require training courses for their employees, and their fees are based on a sliding scale of income.

    Best of luck!

  13. Katie says:

    Those numbers make sense – the ‘poverty’ was used for shock value and to draw attention, but it does go on to clarify that as ‘living paycheck to paycheck’ which is spot on.

    Yeah, and the link was to Wonkette, which takes that kind of snarky, over-the-top tone for everything; that part of it shouldn’t be taken seriously.

  14. Pat S. says:

    #1: Since you are not able to put the money in a Roth IRA or traditional 401(k), I’d think about an S&P 500 Index Fund. This will keep expenses and taxes low when held in a taxable brokerage account while also minimizing taxes due to the low turnover. The added bonus here is that you will be able to access the cash in a pinch, rather than having it tied up in a tax deferred account.

  15. NewReader says:

    Q3: Depending on where you live, the availability of yoga teaching jobs can be pretty scarce. It is very profitable for yoga studios to teach yoga teacher training, therefore there are increasing numbers of trained yoga teachers vying for the same jobs. I have several friends who struggle to find part-time yoga teaching gigs, and wind up teaching a class here, a class there, for very little money. If your heart is in it, it might still be a good plan for you, especially since teaching yoga is a part-time gig for you and you have a regular teaching job. Good luck!

  16. Diane says:

    Q1 – I’ll take a non-professional swing at this one, based on my own life experience. (I’m not a financial expert, so for those of you who are, please don’t nitpick this to death. This is about the miracle of compound interest + long periods of time. Your mileage may vary.)
    I have always been good at saving, but sucked at figuring out what to do with the money. I was about your age when IRA’s first started. I believe that the initial limit was 2k per year. I never opened one because I was saving for a house. By the time I was 30, I had more than year’s salary banked. My goal was to buy a house by myself and I did. Fast forward many years. I now own a townhome in a very high COLA and a retirement home in a resort area that’s a rental until I’m ready for it. I count my blessings for having good loans on both and not being upside down on either. What I don’t have is a ton of cash in investments or a loan payoff date in sight… Of course now that I’ve achieved the house(s) goal, I wish I’d been a bit more balanced in my other financial planning.

    ————————————————–
    Here’s what I wish someone had taught me way back then: If a person saves 1k per year each year for ten years from the ages of 20 to 30, invests it in a diversified manner and never touches it, that person will have more money at retirement than someone who starts at age 30 and saves/invests 1k per year every year for the rest of their life! (Naysayers, hush about a decade of flat stock market returns – that’s simply untrue if one held a balanced portfolio and rebalanced regularly.)
    ————————————————–

    The question posed by #5 is also relevant here. If you save the money pre-tax, you will have a larger amount invested earlier in the game. So what if you have to pay taxes on the money? Years from now, when taxes have inevitably gone up, your money will have grown exponentially too. You’ll have plenty of do-re-mi with which to pay those pesky taxes. You won’t like it a bit more or less than you do now.
    Now, Roth IRAs were not around back then. When your income does allow you to contribute to a Roth, take advantage of that option, too. The money you contribute each year doesn’t have to go into the same pot.
    Here’s the final key: saving the money is not good enough. You must also invest it wisely. I wish I’d known that investing wisely does not have to mean buying individual stocks! There are tons of other options. Making the time to learn about them (especially the low-cost options) could net you more monetary rewards by retirement than your college education. It’s that important.
    There are a slew of great financial books out there. Two that have made a lasting impression on me are “YMOYL” (how to save it), and “Ordinary People, Extraordinary Wealth” (what to do with it). They are well-written and easy to understand. Your library should have both of them.
    You are so smart for asking these questions now. You are well started on the path to success and way beyond most of your peers.

  17. Telephus44 says:

    Also in Q1 – “I thought of putting it into an IRA but I do not qualify for the tax deduction” – that doesn’t mean that you CAN’T put it in an IRA. It just means you won’t get a deduction on your taxes this year.

    Depending on your goals, I would be tempted to put it in a ROTH. You can withdraw your contributions after 5 years (I think, not 100% sure on that) and take up to $10,000 out for a first time home purchase without penalty. And if you don’t end up buying a house, well, your retirement account is that much larger. I started my ROTH right out of college, and did withdraw $10K for my house – at 22, I wasn’t on the “hurry up and get married and buy a house track” so it didn’t seem to make sense to just keep a large down payment on a house fund. In hindsight, it was great to have that flexibility and I’d do it again.

  18. Scott says:

    @#1 One can still invest in an IRA even if he is a dependent if he earns money through a job.

  19. Johanna says:

    @Nate and @Diane: In choosing between pre-tax and post-tax retirement vehicles, “the power of compounding” is a red herring. If the percentage you pay in taxes is the same, it doesn’t matter whether you pay the taxes before the money compounds or after. The amount you’re left with in retirement is the same.

    The reason the pre-tax account is a good idea is that the percentage you pay in taxes is *not* the same. When you put money in a pre-tax account, your tax liability is reduced according to your marginal tax rate (i.e., your “tax bracket,” e.g. 25%). When you withdraw the money in retirement, you pay taxes at your overall rate, which is less, because of how tax brackets work.

  20. Andrew says:

    Q1– This may be an unpopular opinion.

    Beth is 20, lives at home, goes to college, and works full time. She has a total of $11,300 saved with no defined purpose. Granted, I don’t know her, and she may be having the time of her life, but to me it sounds like she is spending her youth practicing to be old.

    She should take the money and blow it all on a trip to Europe. She will never be 20 again.

  21. wisnjc says:

    @Andrew
    I get your sentiment. Perhaps she could keep part of the money in savings (liquid, Roth, IRA, etc. – whatever she decides) and use the other part for a study abroad experience, intership in a higher cost of living area, etc.

  22. Kevin says:

    Q2 (Credit counselling):

    Here’s a quick summary of how those credit-counselling services work.

    Step 1: They cancel the cards and cut them up.

    Step 2: They tell you to send a single monthly payment to them, instead of the 5 or 6 credit cards.

    Step 3: They collect your money and sit on it for months, or even years, sending absolutely none of it to your creditors.

    Step 4: This step can go one of two ways. If the credit counselling company is relatively upstanding, they’ll eventually contact your creditors one-by-one and offer them some of the money they’ve been collecting from you. They’ll offer pennies on the dollar. If you owe Visa $5,000, they’ll offer $500. Visa, having not received a penny from you in months/years, will accept the deal and close the account. They repeat this with your other credit cards.

    If the counselling company is NOT upstanding, then they could simply disappear with your money, and pop up somewhere else with a new name. You’d still owe your creditors everything, plus interest and fees.

    In either case, your credit will be ruined. There is no way to get out of paying your bills without it damaging your credit.

  23. TLS says:

    @#20 Andrew
    Great advice. I totally agree.

  24. Sarah says:

    I’ve wondered about the value of yoga teacher training, too. I live in a city where yoga is popular, and I see advertisements for the teacher training all the time. I’m sure that it’s close to impossible to teach yoga without the training now, but do all these people taking the $2k courses find work? My hunch is that teacher training courses function as a value-added product for the yoga studios. They want to offer a separate (and higher-priced) product to the committed practitioners, so the teacher training courses fill that product niche. Also, some yoga studios are affiliated with a parent organization that might have some particular revenue requirements or membership requirements – perhaps the teacher training courses help the studio reach their targets.

    Anyhow! If I were Jenna, I’d wait until I had the money in hand to pay for it. It sounds like she’s doing it out of love, but why spoil the feeling with some yucky debt that’s hanging on?

  25. Steve says:

    +1 to what @Johanna has been saying. A Roth is *NOT NOT NOT* the clearly superior choice, and in fact is a poor choice for many people. There are a few situations where a Roth is superior, but they are exceptions to the rule. The only way a Roth becomes a clearly superior choice for everyone is if this country has a paradigm shift in how taxes are collected, away from the current progressive structure. (And even then, the average tax rate would probably be lower than many people’s marginal tax rate today.)

  26. George says:

    Q7 – If you have the funds to pay the student loan off now, then you could plop that money in a municipal bond fund paying 7%-8% and the income is exempt from federal taxes.

    The danger is that muni bond funds are not guaranteed to continue paying the same dividend and there is a risk to the capital. However… provided you hold the bond fund until the student loan is paid off, even if the dividend is cut in half, you’d still come out ahead of paying the loan off early.

    [I think there are ways to purchase guaranteed CDs in, say, Australia or Canada that would pay a decent rate of interest, but it's complicated to pull off and you'd be subject to foreign tax]

    On the other hand, if you don’t have a lump sum to pay off the loan, you’re still better off investing any extra funds and not paying off the loan.

  27. Des says:

    Q7 – I think there are some additional factors that Trent didn’t address here:

    1) Student loans cannot be dismissed in a bankruptcy. No one thinks they will go bankrupt, and you probably won’t, but if something should happen (a failed business, a sick child, a disability, etc.) it puts you in a more risky position.

    2) Student loans are debt, and debt payments count against you when you apply for a home. That may or may not matter to you, depending on a number of factors.

    3) Reducing your monthly expenses puts you in a better cash flow position, which adds flexibility to your life and open up options you might not otherwise have. (As in, you have the option of taking a lower paying job with better chance for career or personal growth. Or, better cash flow could allow one parent to stay home with your future kids, etc). Cash flow should be a factor along side total interest paid/earned.

    Maybe it is still a good idea to hang onto the loan even with those additional risk factors. I was in your position and I chose to pay mine off, and I definitely don’t regret it.

  28. Aaron says:

    Q5 and #9 response by Nate,

    This is more specifically at Nate. When comparing Roth vs Traditional, you can’t factor in the appreciation or compounding effect of the additional money put into the account as an argument for traditional.

    Case in point, if your tax bracket is 25% right now, if you could afford to invest $1000 in a Roth, you could afford to invest $1250 in a Traditional ($1000 + ($1000 * 25% tax break today)). However, you cannot give one bit of advantage to the Traditional because $250 extra is going into the account that will compound. You MUST invest more money into a Traditional in order to break even with a Roth because you’ll pay taxes on both the money you put AND the earnings later instead of your current tax rate on the money you’re contributing today and 0% tax on the returns on a Roth assuming your tax rate in retirement on that money is the same as it is today. This assumes the same investments are used, your tax rates are the same between when you contribute and when you retire, etc etc.

    The absolute only consideration when choosing between a Roth and a Traditional, assuming the same investment vehicles, is if your current tax rate on the money contributed is higher or lower than what you think your tax rate will be when you withdraw it in retirement. If your tax rate on the money contributed today is lower, Roth is the better choice. If lower when you withdraw, Traditional is the better choice.

  29. Ashlee says:

    Q1: Ahh Beth! I admire you so much for what you’ve accomplished! Yay for you!!! I’m kinda jealous, I don’t have nearly that much saved and I have student loans too! Good for you sweetie!

  30. Eric says:

    The 2011 IRA contribution limits are $5000/year, not $5500.

  31. Chris Darland says:

    Trent re: your game.
    Ever consider self-publishing on ArtsCow or something? I’m into games and finances, and would love to combine those 2 areas and help my kids learn about personal finance. Being as how you have a big following here, you might be able to either make some money, or at least post the files for people to print on their own (I know Pandemic has some decks like that).

  32. Nate says:

    Thanks Aaron. Good points.

  33. jackson says:

    Q1: It all depends on your time horizon. If it is really long term, put it in two or three index mutual funds at Vanguard or Fidelity and not just one. This provides greater protection against market flucuations. Possible indexes might be S&P 500, Russell 2000, and DOW.

  34. jackson says:

    Q8 Poverty
    How much you need really depends on where you live. Salary.com has cost of living comparisons for different areas within the US. $100,000 in San Francisco or New York isn’t a lot of money.

  35. Justin says:

    @Q7, I have to agree with Trent’s response. Anything with an interest rate of lower than 3% should be paid down slowly.

    You can almost certainly make better than a 2-3% return with a mutual or index fund or some other kind of investment.

  36. jim says:

    Q1 Beth : There is general reason students can’t invest in an IRA. If you get W2 wages then you should be qualified. Being a student does not disqualify you for an IRA. If however your wages are a fellowship treated as a scholarship/grant then you may not have W2 wages and that could disqualify you from an IRA. If you do have a regular job type job then you can do an IRA. A Roth IRA may be a good choice for you given your current lower income level. Plus you can more easily use the money in a Roth IRA for other things if needed.

    Q2 Kevin: Don’t get a loan and pay interest just to raise your credit score. Check your credit scores and credit reports. If your scores are both >700 levels then I wouldn’t worry.

    Q4 Justin : If you do check out credit counseling then look for a non profit. Try nfcc(dot)org

    Q5 Devin : Inflation will impact any/all investment vehicles the same across the board. Roth IRA’s aren’t immune to it and aren’t any more special regarding inflation than any other investment vehicle. Roth versus traditional depends on tax levels. Taxes in general are not destined to go up no matter how many times people keep saying so. As long as Trent keeps arbitrarily recommending Roth IRAs to people I’ll keep pointing out that they aren’t necessarily the best choice. Max your 401k/403b to the match first as Trent recommends IS always a best choice though.

    Q8 : That ‘poverty’ blog article was written on April 1st. I think the article was meant as an April Fools tongue in cheek article, not a serious declaration that $68k is really the poverty level. The underlying study is explicitly NOT about poverty. It says: “WOW has reframed the national debate on social policies and programs from one that focuses on poverty to one that focuses on what it takes families
    to make ends meet.”

  37. Katie says:

    That ‘poverty’ blog article was written on April 1st. I think the article was meant as an April Fools tongue in cheek article,

    Not an April Fool’s joke; just the style of that blog. Any post you read is written the same way; out of context it does sound ridiculous, but the rhetoric shouldn’t be taken seriously.

  38. jim says:

    I said
    “There is general reason students can’t invest in an IRA.”

    I meant that there is NOT a general reason that you can’t do so.

  39. Doug says:

    Regarding the Cashflow game: No, it is a waste of money. A friend bought it, we tried it. Do yourself a favor and don’t bother.

    A much better game for learning about money? Monopoly. Yep, because you have to balance your funds against your purchases, and little unexpected things come up that may cause you to have to mortgage your properties. Thus, one learns the value of an Emergency Fund. And, one learns what happens when one gets in over his head (that would be bankruptcy).

    Plus, Monopoly is WAAAAAAYYYYY cheaper.

  40. Kathleen says:

    Aren’t Roth IRAs always better because you don’t pay tax on the gains, whereas you’ll pay taxes on the gains with a traditional IRA? That is, you get tax-free money with a Roth, but traditional IRAs lead to taxes on a bigger chunk of change (regardless of what that rate is)?

  41. Johanna says:

    @Kathleen: No. This is what I was trying to explain was a red herring in my earlier comment. Here’s an example with some numbers to make it concrete:

    Suppose you have $1000 to invest (before taxes), your tax rate is 25%, and whatever you invest will grow by a factor of 10 between now and retirement. (None of these specific numbers is critical to the example – you can substitute whatever numbers you want.)

    With the pre-tax account (401(k), traditional IRA, etc.), you invest the whole $1000, and it grows to $10,000 in retirement. Then you pay taxes: At a rate of 25%, you pay $2500 and you are left with $7500.

    With the Roth account, you pay taxes up front. So the IRS gets $250, and you have $750 to put in the account. That $750 grows to $7500, which you get to withdraw tax free. So either way, you get $7500.

    But I assumed that you pay 25% in taxes on every single dollar you withdraw from the traditional account. That’s not actually true – you actually pay much less than that, because of how tax brackets work. Therefore, the traditional account wins.

    Actually, the best strategy would be to have just enough in a traditional account to take advantage of all the tax brackets that are less than what your marginal rate is now, and put everything else in a Roth. To get that exactly right, you’d have to be psychic. But still, as long as your tax rate right now is not 0%, you’re much better off having some mixture of pre-tax and Roth accounts, rather than 100% Roth.

  42. Mark Gavagan says:

    Q9 – Trent, regarding your “Dominion-like deckbuilding game that simulated personal finance,” consider putting forth your entire idea, including mock-up images, as a blog post would allow you to see what readers think of the game and how their suggestions might improve it. Also, given your enterprising audience, you might find someone with the resources and interest to publish the game (perhaps even as an app video game, if appropriate) and pay you or a charity a royalty based upon sales. Good luck.

  43. Tamara says:

    Q4: I am currently in a debt management program through a non-profit counseling agency. I lost my job Nov 2008 and was unemployed for 8 months. Never had much in savings to begin with & was pulling about $800/month in unemployment. My interest rates got jacked up to 30% on the 3 cards I had and I just couldn’t make the payments. I didn’t want to walk away, I feel that would be unethical, (but it’s also unethical of the bank to charge these usurious rates, imo) so I chose credit counseling. Now my interest rates are 0%, 7% and 10% respectively, over credit line fees are waived on the one I’m still over on, and I only have to pay the agency $17 a month! It is SO refreshing to log on to Credit Karma every month and watch my total debt slide ever further downward. The key is finding a non-profit agency. Any place that advertises on the side of the road or promises to ‘clean up’ your credit is a shady operation!

    Trent does have a point that trying to work out deals with the card issuers themselves is an option, however I used to work in the collections department of one of the major banks (one of my cards is through them) and set up these payment programs all the time, and those programs would drop your payment but not your interest rate (at least that was the case with this bank). So you would be saving on the front end but that interest would still be growing & growing.

    Officially I will be ‘done’ (ie: out of debt) in another 18 months, but I’m planning on finishing well before that! Good luck! :)

  44. getagrip says:

    Q5 and #40 Kathleen. You need to consider a lot of things. Look at the tax brackets now for a single person:

    0-8500 10%
    8501-34500 15%
    34501-83600 25%
    83601-174400 28%
    above 174400, don’t talk to me, go talk to a financial advisor :)

    So, say you make $50K a year, $8500 is being taxed at 10%, $26,000 is being taxed at 15%, and the remaining $15,500 is being taxed at 25%. All of it is not being taxed at $25%, just the amount over $34,500.

    If you put $5500 in the Roth, it comes off the top, after taxes, so that amount gets taxed at 25% and really cost you $6875 (5500 plus 1375 as 25% taxes). If you put into an 401K, no taxes are taken out now, and to make it equivalent you put in $6875 (remember the 401K limit is $16500 on a company sponsered plan versus the personal limit of $5500 for individual Roth or IRA).

    Thirty years from now you retire. Say taxes have gone up a bit (for illustration I’m keeping the same values and brackets) to be 5% higher:

    0-8500 15%
    8501-34500 20%
    34501-83600 30%
    83601-174400 33%

    So, if you have the Roth, great, pay no taxes on your withdrawls and your $5500 over thirty years at 4% above inflation yields $308,500 and you can take 4% of that a year or $12,339.

    If you have the 401K, and put the $6875 into it (5500 plus the taxes of 1375) for the same 30 years you end up with $385,584 or $15,423 at 4% taken out annually. That money now gets taxed at the 30 year later rates, the first $8500 at 15% and the next $6923 at 25%, which is $3005, leaving you with $12417, or a bit above the Roth.

    What if the rate went up 10%? $8500 at 20% taxes and $6923 at 25% taxes makes it $11,992, below the Roth, but not a killer. Think about it, a 10% increase in income tax, but only a 3% loss in your 401K result versus the Roth.

    What if you have a more optimistic view and your retirement fund comes back with 7% above inflation? You get $519534 and $20,781 annually with the Roth and $649417 and $21205 at 5% higher taxes and $19906 at 10% higher taxes with the 401K.

    What if, lo and behold, tax rates are the same (may be probable in the lower brackets)?
    With the assumption above you’d still get $20,781 annually with the Roth, but now get $22,503 with the 401K.

    Yes there are assumptions above, and the numbers change a bit here and there, and there are other reasons a Roth may be a better place for your money, but the real point you should take away is:

    *Both* options provide you something down the road and the differences are less important than the fact you are putting money away! Stop waffling and fretting over which is *best*, start putting something away now because the biggest factor is TIME. The same $5500 in the Roth for 35 years @7% is $760,302 and its $950,378 for the 401K! Even if you got to 30 years ($519,524 for the Roth) and got more conservative and only earned 4% for the next 5, that would be more than $100,000 in earnings plus the $22000 you put in!

  45. jim says:

    Two points about taxes.
    1) Retired people have lower incomes
    The vast majority of people have lower incomes when they retire versus when they are working. REtired people naturally see a drop in income as their retirement savings and social security don’t often replace >100% of their working income. Unless you do very well with retirement savings which most people don’t.

    2) Income taxes for middle class are not really that low today and havent’ changed that much over the decades.
    Marginal tax rates at middle income levels have not changed drastically over the decades. THe marginal tax rate for median income is usually in the 20-28% range and doesn’t go up or down all that much. Most of the time it has been at 25% or 28%. The EFFECTIVE income taxz rate for median income earners has been in the 8-12% range. We are NOT at historic lows for marginal or effecive tax rates when you look at middle income earners.

    THis goes back 7 decades and covers periods with very high debt (post WWII) and consistent budget deficit spending and debt accumulation. Politicians on both sides of our system are NOT in favor of soaking the middle and low income brackets with high taxes. Top marginal tax rates have gone down drastically over the decades for the high income earners. But not the middle class earners.

  46. Tina says:

    This site has really given me alot of inspiration over the last year as I’ve been digging out of debt. I created a spreadsheet for myself to use as my first step. Now its occured to me to offer to anybody for free. Hey- when you’re digging out, you can’t afford to pay for any assistance, you need to get it for free. Just come to my site and download it. There is an Excel version and an Open Office version.

  47. Another Elizabeth says:

    It’s interesting that you should mention Dominion and personal finance, because I’ve often found while playing Dominion that I end up thinking about concepts of personal finance. Dominion was the first deck-building game I really played and as I learned that it can be better to invest in a particular card here, or save up for a better card there, or as I observed how the deck (with it’s money) comes around in a cyclical way, I found it to be very similar to planning real-life finances with regular paychecks and with future outcomes affected by my choices on this turn. I would be somewhat interested in a finance-themed Dominion-style game, but I think that it could be just as practical to simply play the original game with my kids (when they’re a little older) and talk through the real-life applications.

  48. eaufraiche says:

    Q3… Jenna, reread #10 and #15!

    the yoga teacher market is saturated in so many areas – what are your prospects for the future with this training?

    at the very least, why not wait until Sept when you’ll have the money at hand? i’m a teacher, too, and understand the challenges of working on other major undertakings during the school year (2 masters degrees, private music studio, running hobby)

    if it was easy-peasy for you to get that 2 grand put aside in the bank, wouldn’t it be there? (only asking that question cause i tried to convince myself that a similar investment was worth racking up a credit card debt – did it, and the card is not totally paid off 3 years later. gulp. and i’d been debt free prior to that bad spending day! this bugs me daily)

    ALSO, are you sure you can’t figure out a way to lean into teaching yoga w/o the completion of the training? Just wondering this, because at the yoga studios I frequent, teachers in training teach classes! So, somehow, people w/o the magical paper are ok for instructing…. (plus,i started taking yoga classes before studios offered the pricey teacher training programs, so always wonder about this…)

    There’s this Jack Canfield strategy called leaning — basically, one just figures out a way to begin doing what one aspires to doing. Could you find a way to teach some yoga classes – even as a volunteer somewhere to build experience and credentials, and then for $$$…. maybe at a senior center, rec center, summer day camp, through a community college, something like that?

    not saying it wouldn’t be advantageous to get the training course eventually – even this fall, but there might actually be a way to get going on this w/o creating debt.

    it’s so tough to get rid of debt!!!!

  49. Kirk says:

    On the library thing, be sure and check out if your local library allows you to check out books digitally. Mine does. You have to wait for a book, just like you would for a book that is already checked out, but they have lots of new titles. Our library uses the Overdrive Media app which is available on many phones and I use it on my iPad. Sadly, I do not think a Kindle is supported. I suppose Amazon would rather sell you the book.

  50. Steve in W MA says:

    @ #1, the only requirement for being eligible for contributing to an IRA in a given tax year is whether you have earned income that year. The fact that you are a full time student is completely irrelevant. If you had earned income in the 2010 tax year, you can contribute your earned income up to the limit on contributions for the year, currently about $5,000.

    If you have a low earned income, say below $26,000 per year, the government will even PAY you in the form of a tax credit to contribute money to your IRA. This is intended to encourage low wage earners to save for their retirement.

  51. Steve in W MA says:

    In other words, if you have $5000 worth of earned income, and your expenses are 30,000 this year, and your parents gave you $30,000 or you paid for it with loans, so that your total available funds for the year were $35K, then you are eligible to contribute the full $5000 to your IRA.

    Is there another way to say that the only factor that determines eligibility for contributions is that you can only contribute to the top level of your earned income or $5000, whichever is less. Regardless of whatever else is going on in your life. And regardless of whether you “spent” the $5000 you earned and the only source of the $5000 you want to contribute is a gift from, say, your family.

  52. Steve in W MA says:

    @Q3, if the yoga teacher training is entertainment/hobby, then evaluate it on that basis. It is true that the number of certifications exceeds the needs of the market in terms of need for teachers, but the fact is that many of those who get certification aren’t destined to become yoga teachers anyways in the sense of providing their primary income. It is more like in-depth study to the and, maybe, flirting with the idea of the job/vocation.

    If it is to be professional (you are motivated to promote yourself consistently, continue to educate your until you are established and have a niche in your market, which, along with skill, talent, and stage presence, is what it takes) then I’d say shell out for the certification and training now instead of waiting.

    this is without seeing your overall picture financially. Still, if you intend it to be your job, and you can swing it financially, do it now because the sooner you start working in the field, the sooner you will be established.

  53. Steve in W MA says:

    @ “I am hesitant to do the training with a fat chunk of change on my credit card but am confident that this would improve my life, income and yoga practice. In addition, I would no longer have to pay the $79/month at any studio where I work.”

    there you go, you have your own anwswer. No need for Trent or for my advice, either. The answer is clearly “do it now”–unless you can’t handle the monthly payments on $2000, in which case you are seriously near the financial edge. The fact that you say you can have the money available in toto by September indicates to me that you can probably handle a minimum payment of around $80 per month, which is what the maximum minimum payment will be on that charge. So I’d say, given your certainty and your enthusiasm, DO IT.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>