The most important thing about investing as a 25-year-old; on compound returns and a follow-up to Eithne

Marcin Wichary via Flickr under a Creative Commons license

Good afternoon to all of you and a very special good afternoon to Eithne (pronounced Enya).

Last week, I answered some questions that a reader named Eithne had sent in about how best to roll over an old 401(k) to something that made sense in her new capacity as a freelancer.

In that post, I talked through some details of the SEP IRA and the One-Participant 401(k) to help her decide between her options and got her started on thinking about what to consider when putting together an investment strategy.

However, I unfortunately forgot one huge aspect. The most important thing about investing as a 25-year-old is to do whatever it takes to contribute as much as you can as early as you can.

Sure, you can invest at any point between now and when you retire, but you’ll never see this long a horizon for your contributions to grow and recover from any downturns in the market.

Let me see if I can explain better with an example.

An example (based on my life)

Part 1: The early investor

Suppose I had started contributing $4000 to a Roth IRA every year since I turned 25. Suppose further that I had put all of that into a broad-based index fund; in this example, I’ll use the Vanguard Total Stock Market Index ($VSTMX) mutual fund*.

Click to enlarge

Click to enlarge

After plugging in the values for VSTMX taken from Yahoo! Finance, it looks like taking this approach would have left me with $64,167 as of the market close yesterday. Not bad for putting just a few-thousand dollars away every year, right?

Now, look at the next line after that. What that says is that if I were to never make another contribution again, then the value of my Roth IRA would be a not insignificant $157,769 when I turn 65 and am ready to retire.

Part 2: The later investor

Now, imagine instead that I had done the opposite — that is, suppose I had put nothing away until this point and instead, planned to put $4000 into a Roth IRA for the coming 31 years until I turn 65.

Click to enlarge

Click to enlarge

If I had waited to put anything, then I would end up with $188,367.

What you should notice is that yes, I do end up with more in the second scenario — 19% more, in fact — but it doesn’t seem to be substantially more, even though I made over three times as many payments.

Let me say that again more clearly: Investing for 10 years now will give you almost the same result as investing for 31 years later.

And one more time a different way: Investing $40,000 over the next 10 years will give you almost the same results as investing $124,000 later.

Look at these two graphs:



What these graphs say is that when you invest later, you have to keep working hard to keep putting new money in. But when you invest early, the money you put in does the work for you, thanks to compound returns.

Before I conclude, there are a few assumptions I made here:

  • I assumed that VSTMX would grow at a constant 8% annual rate; the market will likely not do this
  • I did not adjust for inflation because I’m comparing final results at the same future date, however inflation may play an important role in how much you’re able to contribute
  • I did not adjust the retirement strategy as age 65 approached; in practice, investors near retirement may change their investment mix or contribute more to catch up

Of course, what wold be even more ideal would be to both invest now and invest later.

Good luck, Eithne :)

*Important disclaimer: Do not take my use of this fund in my example as an endorsement of this fund, the fund family, or any implied investment strategy

Why blog? Reframing what a blog is in 2014

James Wheeler via Flickr under a Creative Commons license

This morning, during my continued attempt to keep a finger on the pulse of all blogs everywhere, I stumbled upon a post titled “What does a blog do in 2014?” at Scripting News, which included this gem of a quote:

Today there are lots of ways to scatter all kinds of stuff to the wind. If you do a search on a person, you’ll get a lot of random stuff, but for most people there’s no single place that represents the person.

So for me, until further notice, my blog is where all my scatterings come together. Usually it’ll just be stuff that I’ve created, but occasionally I’ll point to something from someone else that’s connected to what I do.

That’s an interesting reframing of what a blog is!

My own reasons have varied and evolved over the years. It’s always included elements of accountability, for sure. And when I have a strong opinion opinion, I’ve used blogging to get it out there, accessible instantly and globally — even if in practice, only a couple people read it.

A blog as a story

Something I catch myself doing more and more these days is reading back into my archives. I may never have intended for this blog to be a story, but that’s what it reads like. For one, the story has the fun dramatic device because the reader knows exactly how the story will end before getting into it — and BEFORE the protagonist himself knows what’s going to happen to him.

And not only does the time change as you read along, but the TRUTH changes as well. Ideas I believed about the world as it relates personal finance and ideas I believed about myself were reinforced, figured out (sometimes, publicly on the blog itself), amended, or chucked out the window.

The one place on the web that really represents me

All of that is a great reminder that what I think to be the truth today will likely be something totally different months and years from now.

And so yes, even though I leave information about myself in different profiles across the web like Twitter, Facebook, LinkedIn, and so forth, this blog offers the clearest picture of all those facts coming together because it shows my evolution and growth — mistakes and all.

I hope future employers, friends, partners, and others I’ll share a relationship with will forgive the earlier misgivings and instead, step back and appreciate the arc of a personal journey.

Enjoy your weekend :)


Reader question: As a new freelancer, how should I set up my retirement? Eithne’s story

Roberto Taddeo via Flickr under a Creative Commons license

I’m answering another reader on Debt BLAG today. Let’s look at a question from Eithne (Pronounced enya, not her real name):

I’m in my mid-20s and recently started freelancing after having a 401(k) at a company I left around January. I want to set up something to roll that money over into a new account. (1)

A financial adviser referred by family says I should open an individual 401(k) because the limit (2) is higher than a Roth IRA which has a limit of $5000, right? He also said I can take a loan from the fund at any time.

Signing up for a 401(k) with him would cost $40 per year for his company plus 1% for him. Should I look somewhere else? (3)

How should I decide where to invest my money each year? Does it depend on risk? I don’t even know what questions to ask. (4) -Eithne [with emphasis and numbering added by me]

Thanks Eithne!

First off, congratulations on making the move. It’s certainly takes a certain kind of courage to jump into that world.

Let’s go through your questions individually.

1) Rolling over an old 401(K) into a One-Participant 401(k) Plan or a SEP IRA

You mention two, but you’ve actually got four options here:

  1. Cash out with big penalties. You’ll have to pay taxes and a 10% penalty for not being of retirement age . Don’t do this.
  2. Keep it with your old employer. If there’s something you like about your old employer’s plan — maybe it has low fees or good investment options — then this could make sense. Just be mindful of required minimums to keep it open, which is important because you won’t be able to make new contributions.
  3. Roll over into an IRA. By rolling over into an IRA, you’d be able to make new contributions, which it sounds like you’re looking to do. As you know, you won’t be able to take loans against your balance, but you can take distributions that could be subject to taxes and a penalty. You mention a Roth IRA in your note, but because you’re acting as both employee and employer, a SEP IRA is what you would go for.
  4. Roll over into a One-Participant 401(k). You may also see this called a Solo 401(k) or an Individual 401(k). You can also make new contributions to a One-Participant 401(k). Some, but not all, One-Participant 401(k) trustees allow loans; it sounds like the one you’re talking to does.

I’d recommend one of the last two.

2) Contribution limits

Both the SEP IRA and the One-Participant 401(k) have a hard upper limit of $52,000 for the 2014 tax year, and it’ll be adjusted in the future based on a measure of inflation. How each option gets to that $52,000 limit is a bit interesting — again because you’re both employee and employer:

  • The SEP IRA lets you contribute 25% of your income.
  • The One-Participant 401(k) lets you contribute up to the employee cap of $17,500 plus up to 25% of income (As long as you don’t try to contribute more than 100% of your income).

The One-Participant 401(k) has higher limits, so because of the increased flexibility, I agree with your adviser’s recommendation to follow that route.

3) Exploring other options

It’s tough for me to say whether you should be talking to other people. Maybe try to think of it this way:

Suppose you’re starting with $4,000 in your 401(k), each year, before even dealing with market risk and inflation, you’ll lose 1% to his company (the $40 fee / your $4,000 balance) and 1% to him.

That’s not a insignificant hole starting out at all — especially in a world with plenty of discount brokerages and low-cost managers out there. Think long and hard when you’re balancing the value you’ll get from him against these costs.

4) Factors to consider when determining an investment approach

Unfortunately, I can’t get too specific here. I will say that your investment approach should depend on a lot of things including:

  • Your time horizon. The greater the gap between your age now and the age you plan to retire, the greater chance that your portfolio can overcome the occasional bump in the road.
  • Your tolerance for risk. In some cases, rewards increase relative to risks taken, but if the uncertainty of your portfolio makes you sick, then what’s the point?
  • Your anticipated income streams. I bring this up because you mentioned taking loans from your portfolio. Obviously, it would be better for the final value of your nest egg if you didn’t do this, but I can see how it might be inevitable given the feast-or-famine nature of finding freelance work. Make sure to mention this too.
  • The rest of your financial picture. If you’ve got a big emergency fund, no debt, other assets, and low expenses, then it decreases the chances that you’ll have to dip into your retirement savings early.

I could send you a ton more resources if you’re interested in portfolio theory.

That said, those last couple points might actually be the most important; you can’t control how the market affects the money in your retirement account, but you can control how much you put in by minimizing expenses and saving as much as possible.

I hope this all helps!

Did I leave anything out or get anything wrong? Who else has tips for Eithne?


The backdoor Roth IRA is a tax-advantaged retirement alternative for high-earners — a follow-up for Peter*

Craig Sunter (Thanx a Million !) via Flickr under a Creative Commons license

A couple months back, I worked with a reader named Peter (*Not his real name) who, as you might remember, had a lot of student loan debt and a high income. Among other things, I advised him to take a good hard look at some things he could cut from his budget and to aggressively pay down his debt.

Done and done.

The problem with Peter’s high income

We didn’t get too deep into retirement talk, but a commenter MoneyOCD pointed out that at Peter’s level of income, he would likely be ineligible to either contribute to a Roth IRA or to deduct contributions to a traditional IRA. A quick peek at the IRS charts of these income limits shows that he’s right:

  • Because he makes more than $129,000, he can’t contribute to a Roth IRA at all.
  • He can contribute to a traditional IRA, but because he makes more than $90,000, he can’t deduct those contributions.

You might think he should just keep his retirement funds in a taxable account because he’ll have to pay taxes on his gains anyway.

Lucky for Peter and other high earners, there’s another option.

The Backdoor Roth IRA

There’s a sole glimmer of light in the code for high earners like Peter looking to put away some tax-advantaged retirement savings in an IRA.

As of 2010, there has been no upper income limit to be eligible to convert funds in a traditional IRA into a Roth IRA, doing what most folks call a Roth conversion.

In practice, there’s a long complicated process to make this happen:

  1. Put money into a Traditional IRA
  2. Later, call up the financial institution that holds your Traditional IRA and Roth IRA accounts and tell them to move that money over
  3. Pay taxes on any earnings you move over

OK, maybe it’s not that complicated.


For Peter’s specific case, I don’t see any. He should put “Back door Roth” on his to-do list and go eat a peanut butter sandwich.

However, those who’ve been growing a Traditional IRA for many years should tread carefully. The IRS treats the amount being converted to a Roth IRA as though it came proportionally from the never-been-taxed portion (composed of earnings and pre-tax contributions) and the already-been-taxed portion (the non-deductible contributions made while your income was too high), and taxes accordingly. See IRS Publication 590 for more details, or  I could go deeper into this in a future post if there’s interest.

Also, remember that all these instructions only apply if your income is too high to either deduct contributions to a traditional IRA or contribute to a Roth IRA the normal way (Check the charts again just to be sure). In Peter’s tax bracket, I’d obviously prefer a deductible pre-tax traditional IRA to a Roth — back door or otherwise — but since he’s not eligible to deduct contributions to a traditional IRA, we’re going with the next best option which is a Roth conversion rather than keeping it in non-deductible Traditional IRA money or holding it back in a taxable account.

Welp! This ended up pretty dense, but I hope it helped someone. Obviously, let me know if I can fill in more details and especially let me know if I made a mistake somewhere.

What’s been your experience with Roth conversions?


My crazy-aggressive August 2014 goals, starting with paying off $3500 in debt

Andy Morffew via Flickr under a Creative Commons license

Good morning and welcome to the new week everyone.

Sure, July’s net worth results may have felt disappointing, but it wasn’t until I started going through my archives that I realized just how disappointing they were.

It turns out that July 2014 was the single worst month I’ve had since I started keeping track in January 2013.

I’m looking to roar back in August; it’s time to get aggressive.

Pay off $3500 in debt in August

Paying off debt is where this winner of a month has to start. “Debt” is in the title of this blog, for goodness sake! And yet, I’ve gotten very bad recently about paying off debt. This month, I’d like to remedy that by going at it hard and paying off $3500 worth of debt in August.

If you’re curious how far off my normal pace this is, note that I’ve paid off approximately $3500 total over the last five months.

Add $4500 to my net worth

Yes, I’m going to be focusing on paying off debt, but that doesn’t mean I should totally forget about retirement savings. That’s why I plan to also add $1000 to retirement savings, for a total addition of $4500 to my net worth. Boom.

No buying meat

Oh, what?

Food is one of the most variable costs in my budget, so if I’m looking to make aggressive moves this month, it makes sense to start there.

Rather than a dollar target for the month, I’m going at saving money from a completely different direction — I will not spend money buying any meat for the rest of the month.

So why is the goal no buying meat rather than no eating meat?

If someone hands me a bunch of meat and I throw it away so that I can go buy some kale or whatever, then that would mean I’d have to spend more money on top of insulting this meat benefactor.

Run 80 miles

Running is fun to do in the summer and keeps me happy. Staying happy keeps me from having to buy new things to get over the blues.

Tend to career

Oh look; this one is a tending goal, rather than a to-do goal.

Tending lists make more sense for tasks that are ongoing. I discussed them in a previous post titled, “Should you ditch your to-do list for a tending list to maintain the things you care about?“.

Rather than attempt to try to arrive at some endpoint, I’d like for this goal to act as a reminder that I should work on it from time to time, whether through accepting that networking lunch invitation, updating my résumé, or taking a step back and thinking about some next steps.

And those are my aggressive goals for August. Wish me luck!

What are you looking to accomplish this month?


Income limits to deducting contributions to a traditional IRA and contributing to a Roth IRA

Flemming christiansen via Flickr under a Creative Commons license

Oh hi! I hope your weekend is going well.

For most of us, there are two pretty great options for making tax-advantaged contributions toward investments for retirement.

Let’s walk through a quick refresher. If you’re eligible:

  • Contributions to a traditional IRA are deductible from income for tax purposes, but are subject to tax when taken out in retirement.
  • Contributions to a Roth IRA are not deductible for taxes, but are not subject to tax when used in retirement.

Choosing which you contribute to involves your expected marginal tax rate during retirement and other things, but it’s nice to have options.

Unfortunately, there are a couple income limits that apply here. For example, for the 2014 tax year, if you are filing as a single person and are covered by a retirement plan at work:

  • If your income (as measured by MAGI) is greater then $90,000, then you cannot deduct contributions made to a traditional IRA
  • If your income is greater than $129,000, then you cannot contribute to a Roth IRA

Above those limits, you might as well a taxable account or contribute to a traditional IRA and make a Roth conversion (what some call the Backdoor Roth IRA), but I can discuss those in a later post.

And, of course, because the IRS never likes to make anything simple, it isn’t the case that below these levels you can contribute completely and above them you can’t contribute at all; rather, max contributions are phased out over these income levels. Lame. Anyway, here are all the charts.

If you are not covered by a retirement plan at work and want to contribute to a Traditional IRA,-Employee/2014-IRA-Contribution-and-Deduction-Limits---Effect-of-Modified-AGI-on-Deductible-Contributions-if-You-are-NOT-Covered-by-a-Retirement-Plan-at-Work


If you are covered by a retirement plan at work and want to contribute to a Traditional IRA,-Employee/2014--IRA-Contribution-and-Deduction-Limits---Effect-of-Modified-AGI-on-Deductible-Contributions-If-You-ARE-Covered-by-a-Retirement-Plan-at-Work


If you want to contribute to a Roth IRA,-Employee/Amount-of-Roth-IRA-Contributions-That-You-Can-Make-for-2014


Again, pretty complex charts, but don’t worry too much about them now as they’ll make lots more sense in a later post. Enjoy the rest of your weekend :)


August 2014 net worth update — a disappointing month for debt pay-down and retirement savings; a call to action

Nemodus photos via Flickr under a Creative Commons license

A good morning to you.

It’s August now and that gives me another chance to update my net worth.

For those new to net worth updates, the concept is pretty simple. I talk a big game on the blog when it comes to trying to pay down my debt, but talk is cheap unless it’s backed up by action. Shutting my big e-mouth once a month to track how much debt I’ve actually paid off is my way of making sure that I’m actually being about it.

But, to ensure that my goals are constructive rather than destructive, I also add my retirement savings to the mix. In particular, doing so prevents me from being so laser-focused on paying down debt that I do something dumb like not taking advantage of my company’s match for contributions to my 401(K).

That said, let’s get straight to the numbers.


I’ll keep this short.

It’s good that my numbers are moving in the right direction — no question about that. I’m not taking on any more unsecured debt, whether with credit cards or student loans.

But check out this other chart:


Click to enlarge

It’s bad that I moved so slowly in that direction this month. Yes, the stock market’s lukewarm performance in July erased nearly all of my contributions this month, but my debt pay-down shouldn’t be moving this lesson.

So instead of sulking, my takeaway after looking at my performance this month is to make sure that I don’t end up feeling this way next month. In other words, get ready for big things in August.

I’m coming home.

Heads up: Credit Karma now shows your full credit report for FREE

Click to enlarge

Click to enlarge

Hi guys.

If you don’t already have an account at Credit Karma, I definitely recommend that you make one now.

Many of you know that Wednesday has become one of my favorite days of the week, because that’s when Credit Karma updates my free, weekly credit score. When I logged in yesterday, I was greeted with a big window telling me that I now had the option to get my FULL credit report with TransUnion data for free.

I clicked as ordered and sure enough, there it was.

Well done, Credit Karma!

Some neat things in the details

I’m still digging into it, but am really liking what I see so far — and that’s not just because Credit Karma’s interface presents the report in an easy-to-read format with the important stuff up front, which is a far cry from every one of my “real” credit reports I’ve seen.

For one, it looks like I can pull reports from as far back as February 2013, which matches up with when I joined Credit Karma, so that’s neat.

And just like my credit score, this free credit report will get updated every week.

What’s also cool is that if you head to the tab marked, “Inquiries,” it gives you a date when those should fall off your report, which is useful for knowing when your score will improve.

A couple notes

In case it’s not obvious, looking at this report is itself, not considered an inquiry meaning it won’t hurt your credit score.

Also, because Credit Karma only gets its data from TransUnion, you should still be taking advantage of your free yearly pulls from Experian and Equifax on — a free site operated by the three credit reporting agencies as mandated by the government.

I don’t believe I’m missing anything, but let me know if there’s more information worth passing along. Enjoy your day!

Can Kindle Unlimited, Amazon’s new e-book service, save me money? My math

Source: d-221 books via Flickr under a Creative Commons license

Oh hi.

If you’re like me, you are a voracious reader.

Whether food labels, street signs, or even this blog, it seems like I’ve always got my nose buried in something!

Amazon, already famous for their text-heavy website, decided to give us something even better this month when they announced Amazon Kindle Unlimited — a program that lets $10-a-month subscribers read as many e-books as they want.

What’s more is that you can read it without actually owning a Kindle too, because they have free apps for pretty much every mobile OS out there (Shockingly, even Windows RT), meaning that if you’ve got a smart phone, some other e-reader like a Nook, or a laptop or desktop, you can  take advantage of this as well.

So great; some new product is out there. Big deal. The question that really matters to me is can this thing save me money?

A little bit of Kindle math

The question sounds pretty simple on the surface. Kindle e-books cost between $8 and $11 each, so if you read more than one book a month — or more than 12 a year — then you should be better off.

But there are a couple extras in there.

For many books, you would also get the option to switch back and forth between reading the e-book and listening to an audiobook versions without losing your place. This would actually be pretty neat for people like me who like to switch between those two media when I go from the comfort of my sofa to a hectic subway journey with three transfers (or driving a car).

The thing I might appreciate most is not feeling guilty about giving up on books that I would have regretted buying. (This raises the question of whether it’s good practice to only read books that start out well…).

But having Amazon Prime already sorta gives you a bit of free reading

One of the less discussed benefits that comes with Amazon Prime is that you get access to Kindle First, which lets you read an editors’ choice new release or even not-yet-released book every month for free.

Anyhow, are you guys signing up? Has anyone already signed up who can report back on their thoughts?