401K, Sounds Like a New Steroid Cereal

Good Morning FFD(Finance and Fitness Dreams),

As the year ends and we start thinking about Christmas, New Year's Resolutions, and Taxes  I thought it might be a good time to run down my thoughts and directions on a 401K and Roth IRA, two of the best investment vehicles around.  I don't pretend to be an expert and despite my stays at the Holiday Inn, I am not any smarter on the matter because of it.  But what I can do is give a brief common sense picture of what each one is and how I use them in our investment strategy.

First let's start with the 401K.  This is the definition from Investopedia, it's a little wordy but it gets the job done.

Definition of '401(k) Plan

A qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on a post-tax and/or pretax basis. Employers offering a 401(k) plan may make matching or non-elective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.


So a 401K is a place where you keep your investments, depending on what your company offers as a selection it's usually mutual funds and index funds.  What happens for most people is they make a selection when they first start working to take out a % of there pay.  The good news is this is all done pre-tax before the government takes out Federal, State, and Social Security.  So for example if you get paid $1000 each pay period and you have elected to have 1% taken out this would take out $10 from each paycheck and be put into the mutual fund or index fund you have chosen.   By taking this out before taxes it also decreases your tax bill overall since the government has less to be able to tax .   The 401K part is really just a way of saying this is how we are going to tax or not tax your investments.

Your 401K is for the long term, we are talking retirement and when I say retirement this time I mean the earliest you can take this money out is 59.5 years old, otherwise they penalize you and we don't want that.  I won't get into to many specifics on each rule because that's not the purpose of this little blog.  The main points are this money is growing from your pre-tax money so it's a little larger % then if it would be taken out if Uncle Sam got a hold of the pay check first.  Your investment grows tax-free, so when you pile up all this money it's growing and growing and you are adding more and more, which allows it to become a huge monster snowball along the way.

One of my favorite features that a lot of companies utilize is what they call the company match.  I like to call it my Retirement Bonus, they give it to me every year as long as I promise to not spend it till I get to be old and don't want to work anymore.  What they say is OK if you put in 3% of your money all year, you know what we will match that and put it in your 401K account at the end of the year, free of charge.  So using the example of someone who makes 50K, you would have put in 3% or $1500($300 for every 10K), they would then put that same amount of $1500 in your account and congratulations you just got a Retirement Bonus!!!  They most commonly put this in as cash or some form of the company stock, but either way it's yours.

Here's a little summary of the Pro's and Cons of 401K so far:

PRO

• Money is taken out pre-tax allowing you to save a little extra(this also decreases your tax bill)
• The investments grow tax-free
• Company match or Retirement Bonus
• Automatic way of Saving Money

CON

• This is a retirement account and you will be penalized if you take out this money before you get old and want to retire
• You do have to pay taxes on the money(Death and Taxes people), so whatever your current tax rate is when you retire, you have to pay Uncle Sam
• Limited Choices of Investments and Not very much guidance from investment professionals on what you should invest in

Here's another option becoming more and more available with employers, but first a definition from Investopedia.

Definition of 'Roth 401(k) 


An employer-sponsored investment savings account that is funded with after-tax money. After the investor reaches age 59.5, withdrawals of any money from the account (including investment gains) are tax-free. Unlike the Roth IRA, the Roth 401(k) has no income limitations for those investors who want to participate - anyone, no matter what his or her income, is allowed to invest up to the contribution limit into the plan.

So the main difference between the 401K and Roth 401K is the money is funded after tax money, which limits the initial investment, but like the 401K this is allowed to grow not only tax-free, but when you decide to take your withdrawls after 59.5 these are also taken out tax free!  For me on this one it's a horse a piece as an old saying goes, since you are contributing to a retirement investment account, I would worry less about which one you are investing in and instead rather that you are investing period.

So what do I do?

Currently I invest 4% of my salary, which is what my company matches as well, I have no plans of changing this now or in the near future.  This is my retirement account, so I treat it like an old man, quiet, nice, and a little boring.  I invest in index funds, which are low cost funds that mimic the stock market.  I have them spread over a broad range, but I have them split between 3 or 4 investments, including the S&P 500, International, Small Cap, and a Target Fund(this overlaps some of the previous index funds).  These funds are low cost, boring investments just how I like it for my retirement.  I don't plan on touching this money until I am at the earliest 59.5 and if my plan goes as I have it drawn up, this will actually be money that I do not rely on and instead is more of a bonus account when I get to when the world thinks you should retire age.

My suggestion is if you have a 401K option at your place of employment  that includes a company match, start it today and put your investment percentage to receive the maximum your company offers.  I believe the 401K is a great tool to help you in retirement.  Even better ask a few people you know who are in the retirement age and see what they did.  Are they living off Social Security?  401K?  Real Estate?  Still Working?  Pensions?  Annuities?  Would they have done things differently if they knew what they knew now?  I'm a believer in the 401K I don't think it's the answer to everyone's retirement problems, but I certainly think it should be apart of everyone's and it's apart of mine that's for sure.    Here is a link to a short video that encourages you to invest as well, take a look it might get you excited to start one today!!

http://www.investopedia.com/video/play/understanding-your-401k/

Money is Always on Mind, Every Morning at Least-Thanks Dave Ramsey

I like many of you out there are a creature of habit.  Some must have that morning coffee, bowl of cereal, leave at exactly in between 7:00 and 7:05, or in my case I change my routine to create some sense of spontaneity, but it's still a habit.

Right now I have been going with the morning coffee, made at home(trying to save that $10 a week and I prefer to be all jacked up by the time I get to work) and Dave Ramsey podcast every morning on the train.  I like Dave Ramsey and my other options are listening to Pandora cut in and out like a bad DJ or staring outside(p.s. the buildings or walls don't change much).  So about Dave Ramsey..................

I like to listen to someone telling me to pay items with cash, stay away from credit cards, and that he has made mistakes but here is why you should not do what I did.  It creates a mindset that if you spend money with bad decisions, you are going to pay for those bad decisions.  He is a strong believer in debt makes you a slave to the lender, I couldn't agree more.  I struggle everyday to get in this mindset, this is another reason why I listen to Dave Ramsey every morning.

Here's what I want to do with my money.  Put tons of money in my 401K, pay off every cent of debt I have today, fix up my house, pay off the house, and invest in stocks, other houses, take tons of trips.  This morning dose of Dave Ramsey reminds me to keep things in check, Rome was not built in a day, cliche yes, but very true.

I have a budget, I have a plan.  I don't want a 30 year mortgage, I want my mortgage to be paid off in 7 years, is it possible, absolutely I ran the numbers to know.  I read something by Zac Bissonnette said and I'm summarizing here, but poor people think about how financial decisions affect them this month or this week and wealthy people think in 5, 10 and 20 year blocks.  That makes sense to me, when buying a car the poor guy is thinking can I afford the payment of $200 month, the wealthy guy is paying cash and thinking how much money per month he is saving over a 5 year period.

So in summary every day is a battle with money, but the key thing is I may lose a battle today and go buy my lunch or spend money on something I don't need, but I will win the war, with God's help and with great influences around me.  Right now my biggest influences on money are my wife(smart lady and cute to), her family(they have great advice that gets funneled through my wife),  and personal finance blogs, podcasts, and books.  Make sure to surround yourself with great influences, if your brother likes to drive his leased BMW on his Wal-Mart cashier hourly wage, you might want to find a better influence. 

Automatic Plan-Make things Automatic-Debt, Savings, and Investments

1. Figure out Where all of your Money is Going
2. Make things Automatic-Debt, Savings, and Investments
3. Make paying off Credit Cards a Priority
4. Add additional payments to the Debt you like the least
5. Pay off home early
6. Make sure you and your loved ones are taken care of
7. Build wealth and give!

Make things Automatic-Debt, Savings, and Investments

There is a reason companies want you set up on an automatic plan, whether it be student loans, car payments, or a gym membership.  If you set it up to come out automatically versus writing a check and doing it yourself, there is much higher probability that the company gets paid.

So let's all be really smart and copy exactly what companies have been doing for years to get our money. 

• Most important thing, Pay Yourself-Even if it's $25 every pay period set it up to come right out of your check into your savings.   
• Because you know where all your money is now going from Step 1, you should have a good idea of your expenses.  The easiest thing to do is have everything set up at one central location.  You can set up your Bill Pay and all of your Savings Transfers.  After you have that set up there may be one or two bills that is easier to go through that company.  An example is my student loans, if I set up an automatic debit through my student loans I get a discount in my rate and still automatic, good for everyone.
• So if you haven't already start or set up your 401k with your work.  I have read many different ways to look at this, but I recommend starting with whatever your company matches.  If they match 3%, set up 3%, it really is a foolish thing not to use this.  Let's say you make 100K to make things easy.  You set aside 3% of your pay before taxes and have 3K in your 401k at the end of the year, well at the end of the year they match this total, so you now have 6K.  That's a good amount of money for just agreeing to save!

So you know where your money is going and now you have everything set up to where you want your money to go and even better yet it's automatic.  I think this is a great start, just make sure to monitor the comings and goings.  I like to make sure right before I get paid to make sure everything looks right and is going

What's Your Priority-Retirement, Travel, Cars, Boats

So recently my wife posted on Facebook about our upcoming trip to Nicaragua(she's there now, I leave in 5 days).  One of our family friends said "Don't you two ever stay at home" and this made me realize something, we have decided to make travel and vacation a priority. Now we didn't put it up on a bulletin board or write on our goal lists(well not entirely true, going to Nicaragua is one of 2012 goals).  But we have eliminated or tried other items as a priority, here's a brief look.

Retirement-Now don't get me wrong we save money in our 401k, have some money in an IRA, but to say we make it a priority would be a far fetch.  To me making retirement a priority is maxing out your IRA, 401K, or buying our home we plan to retire in.  While we are making a conscious effort to save for retirement, I can't say we talk about our retirement or retirement income daily, weekly, or even monthly, although I'm pretty nerdy so I try to talk about this with the wife from time to time.

Boats and Cars-Yes we own a car, no we don't own a boat.  As you can see not a big priority for us.  Let's start with the easy one, boats.  I do not own a boat, do not have a desire to own a boat, don't own a lake house, don't fish.  So this is not a priority pretty simple for me.  Cars on the other hand a little more complicated.  My wife owns and needs a car for work, she owns a 2007 Toyota Sequoia, it is fully paid for and like our previous retirement discussion we make a conscious effort to take care of the vehicle, but we are not planning on owning 2 vehicles or upgrading to the new 2013 model, we are happy with the vehicle and see no immediate need for anything else.

Travel-So without even knowing it, travel and vacation have become a priority.  We like to take trips, whether it is to see family or go some place we have never been before.  When we were dating due to being far away from each other we would basically go on vacations as our dates, we deemed ourselves the "Vacation Couple".  In my 2012 goals I wanted to travel to Nicaragua Hawaii and they are booked and scheduled.  We made travel a Priority!  


The lesson I took from all of this is it's ok to spend money on things you really love to do, if you love driving your 40K BMW that's great, but you have to make that your priority, but don't try do everything.  I didn't mention that we drive a Mercedes, have a nice boat, and travel the world.  We know that to stay within our means we have decided to make travel and vacations a priority.  I hope everyone does the same.

Updates

I have great news I lost 5lbs!!!!! It took me a week, but I am off to a great start. I have been eating healthy and working out(missed one workout). I even took a 12 mile bike ride down to Coconut Grove. Be consistent.

Money Updates

I officially listed the Benzo de Lorenzo for sale on craigslist yesterday and will be hoping for the best. I considered going to CarMax but after reading terrible reviews I opted to not go through the hassle.

Money Reminder

Make sure you are contributing to your 401k with at least the company match. You are giving away free money if you don't participate. Don't worry so much about what you put your money in(index fund or total fund) just putting money in your 401k makes you money, decreases your AGI, which makes taxes less now and when you do your year-end taxes. Plus if they match your contributions you are doubling the money you put in and also receiving tax deferred savings. It's the best of both worlds, sign up, pretty please.

I’m going to live on Social Security?

If I could I would, but you have to be at least 62 to start earning Social Security. Plus you don’t get enough money trust me. I have seen my Father’s check and hundreds of people’s checks due to me previously working at a bank. That’s what I want to talk about, making sure you are not making 12K when you’re 65. Here is my Generation X (I could be Y, I’m 27 idk) speech aka The Dad Talk. Put money in your 401K, because I said so! Down below you will see some info on what, when, and where for a 401K.

• What. A 401K is a type of account you put money in tax free. OK dumb it down more you ask. Say you earn 500.00 before any taxes are taken out, but after taxes you make 400.00. The 500.00 is what the 401K takes from. So in the end a 401k account takes from the 500.00 so you pay less in taxes.

• Where, So Where Does My Money Go? Your money goes into a type of investment like a mutual fund (mutual fund is made up of different stocks of a company). So let’s say you put 100.00 into your 401K every check. Your 401K buys 100.00 worth of that mutual fund tax free.

• When. As you are putting money in tax free it adds up faster. So not only are you avoiding taxes to put your money in, but you are helping it grow faster. Over time you are putting in more money and it is growing and growing, not losing money due to taxes you have to pay. This is where the Financial Adviser shows you the big graph of your money growing over time. Since I am not a financial adviser, there is not a chart, but bankrate.com is a great website for investments.

Here is another way to think about it. Think food and where you keep it. So your refrigerator is your 401k account (it holds all of food), the food is all the mutual funds aka stocks in the fridge (milk is Company A, eggs are Company B). The food because it is in the refrigerator I protects it from bugs and heat (the bugs and heat are taxes). So if you keep milk in a drawer it will get worse and worse just like taxes it takes away because it is not protected, you are not using the 401K account=Refrigerator.

OK son or daughter thank you for listening and make sure to send me a Father’s Day Card this year and not spend it on beer or clothes.