How to Invest in Your 20s – Rainy Day Fund, 401ks & Roth IRAs

Updated : Nov 14, 2019 in Articles

How to Invest in Your 20s – Rainy Day Fund, 401ks & Roth IRAs


Alison Southwick: The next question
comes from Morrell? Morel? I’m not quite sure how to pronounce it.
Robert Brokamp: One of those. Southwick: I’ll pronounce it many ways.
“My wife and I are 26 and 28 respectively. I just started a new job with what I feel
is great pay and I’m trying to start good savings and investing habits. I’m getting aggravated
because there are too many goals to hit.” Are you ready?
Brokamp: Ready! Southwick: “First goal: need three-to-six months’
worth of income and savings for emergency fund, so a goal of $18,000.
We currently have $10,000 saved. Need [10%] for down payment
on a car; $4,500 for a $45,000 car. Need a 20% down payment for a house to avoid
PMI; $40,000 for a $200,000 home. Continue savings for baby expenses. It seems that all my savings energy is going
to amassing a minimum of $52,500 savings account just to meet the basics.
How in the world will we ever be able to invest? My wife and I both contribute minimum to match
amounts to our 401(k)s, but we are nowhere near maxing out those accounts
much less a Roth IRA or brokerage account. I feel we are decent stewards of our money
but it just seems like an impossible task to hit savings goals while investing at the
same time. Any help would be amazing.” Aw! Brokamp: Such sympathy…
Southwick: Well, it’s so much stress. Brokamp: I know.
Southwick: You’re doing great! Brokamp: I’m sure you’re doing great! First of all, you care about this and you’re
in your mid-20s, which is great sign. And it’s certainly difficult to hit all these
targets when you’re just starting out and you’re thinking of starting a family.
Here are my initial thoughts. You said three-to-six months of income
in a saving-for- emergency fund. As I’ve mentioned in previous episodes,
I don’t think it’s three-to-six months of income. It’s about three months of must-pay expenses.
You don’t have a mortgage at this point. You don’t have kids at this point.
I think you can get by with a smaller emergency fund. You’ve already saved up $10,000. That’s probably OK, especially if you
feel like your jobs are pretty safe. The $4,500 to put a
down payment on a $45,000 car. I would say lower your car needs. I don’t know what car you’re looking at,
but you can get a pretty good used car. Almost every car I’ve bought is a used car. Southwick: We just bought
a $16,000 new car and it’s delightful. I don’t care if it’s a manual transmission. That’s our best theft deterrent — the fact
that our car is a manual transmission. Brokamp: Not to mention
you can pop the clutch if the battery goes dead. Anyway, so I would say lower
your sights in what kind of car you need. Buck Hartzell: The average new car now —
I did this quiz with my family last night — is $36,000. That’s the average price, and largely because
they’re not making little cars anymore, very much, and they’ve all gone to the more profitable
SUVs, and that’s driven up the average cost, but $45,000 is probably for a nice SUV.
Brokamp: And then a 20% down payment to avoid PMI. I understand how difficult that could be. If you’re doing it for a $200,000 home I’m
jealous because we live in the Washington, D.C. area and you could
never find a home for that amount. I would say, especially with your first home,
it’s OK to put down less than 20%. Southwick: We did the FHA loan. That was 4%. Brokamp: And you can get out of PMI once you
have built up 20% equity, so the combination of you making your payments and hopefully
the home price increase means eventually you can get out of PMI, so you generally
don’t have to pay it forever. Just make sure you know what the
terms are before you take on that loan. Southwick: Also, you don’t have
to buy a house if you don’t want to. Brokamp: That’s another big thing.
We’ve talked about that. Home ownership is completely overrated. It’s the biggest mistake my wife and I made
that we’ve bought too many houses; partially because we bought the so-called starter home
and didn’t think down the line to how many kids we eventually would have. So if you’re at a point where you’re just
starting this job and you’re not sure whether you’re going to like it or not, and you don’t
know how many kids you’re going to have, you might want to wait on buying the house.
Hartzell: We see some house prices moderating. There’s not a whole lot of inventory right
now in most markets, and as more inventory comes on, it usually benefits
the buyer, too. So patience, sometimes. I’ll echo what Bro said.
You’re in your mid-20s. You’re doing phenomenally well.
Just prioritize things. I would add one that Bro won’t like,
and we sit on the retirement committee here, but I remember we did it for our first house. We borrowed from our 401(k) to make
our down payment for our first house. That’s not your first option, but you guys
are contributing to 401(k)s, so that is an option. And make sure that when you do buy that house
that you want to be in that area for seven years, at least, because it’s not something
you want to do — buy and sell houses. There’s commissions that go along with those
and usually around 6%, so it’s much more expensive to buy and sell houses than it is stocks or
anything else, so make sure that when you do buy, you make that commitment.
Southwick: Like the schools and those things. That’s a big deal in our area. Hartzell: Go visit that house
and do the early-morning commute and do the commute back
at nighttime, as well. And one thing for those of you,
since it’s not a house show… Southwick: Oh, I’m all houses all the time. Hartzell: Oh, you’re all houses. That’s right.
Southwick: We’re closing this Friday. Hartzell: Alison is closing, but look for
comparable rentals to your house, and generally you want to pay around 200x a comparable monthly rent.
It will fluctuate, but around there is pretty good. In the peak bubble times of 2005-2007 around
here, people were paying up to 400x monthly rents, and those people generally saw the
value of their house decline by 30-40%. Then you’re underwater
and that’s a bad situation to be in. So that’s a good tip when you start to value
what you should pay for a house. Brokamp: And since this episode comes out
right before Halloween, if you’re going to have kids, it’s a great time to drive around
and see which neighbor has the most little kids walking around. Who’s decorating
the most for Halloween to get that vibe. Southwick: That’s true! Brokamp: The final thing I’ll say is if you
can manage to save more money, the first place I’d put it is the Roth IRA because that money
grows tax-free and as we’ve pointed out previously, the money you put into a Roth IRA you can
take out tax and penalty-free if you need it. I wrote an article back when my kids were very young
about us using a Roth IRA as an emergency fund. We put it in there. Hopefully we don’t need to touch it,
but if we did need to get it we could. We didn’t need to, but we did look at that
as our emergency fund and it worked out pretty well. Southwick: So they could put that $10,000
that they currently have saved and shuffle it over to the Roth. Hartzell: The contributions
you can take out tax-free. Brokamp: Right, not the earnings. And the limit per person is $5,500 for folks their age,
although hopefully it’s going to go up in 2019. Southwick: The bottom
line is you’re doing great! Brokamp: You’re doing great!
Southwick: And you are investing! You’re just investing in a lot of stuff!
Hartzell: That’s right!

1 Comment

  • Great content. A few additional pointers for the couple: 1) $10k buys you an amazing, reliable and economical car. AND you won't have $300-$500 car payment every month. If you have to finance it, you cannot afford it. 2) Down-payment on the house – like one of the host said, there are MANY different ways to finance the real estate deals. I recommend you read The Book on Investing in Real Estate with No or Low money down. They talk about FHA loans or Seller Financing as form of financing the deal instead of having to put your money to work. Good luck!

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