June 2, 2010

Money management for laid-back young professionals

Disclaimer: I am not an accountant. This information is correct to the best of my knowledge, but I make no promises.

Disclosure: I could in theory make money by recommending ING to someone reading this post, which would make me an affiliate.


So you're doing alright


You've finished (or at least started) college. You're financially secure, except for the occasional Friday where you spend $80 on sushi or forties or candy cigars. You're reasonably careful with your money, and you've got a nice chunk of money sitting in your account.

Now, you know that real adults have all sorts of complicated financial problems that drive them to bifocals and reading the Wall Street Journal, but you can't be bothered with that! You are busy riding your hipster bike and learning how to cook a pot roast and wondering why your metabolism has slowed down so much since you turned 23.

Well don't worry. You should be managing your money better, but it turns out finance doesn't need to be very complicated. I will explain the things you need to know in 15 minutes, and then you can spend a couple hours setting up accounts. After that, you will be given money every month for doing nothing! Trust me, earned interest is like magic. Not only is it easy money, it's a great psychological payout.

I'll start with the most important things and move to the optional stuff. If you're easily intimidated, try the first couple steps and find out how satisfying good money management is, then come back for more.

Three golden rules


  1. Don't store large sums of money in your Wells Fargo savings account.
  2. Don't store large sums of money in your Wells Fargo savings account.
  3. If your money is doing nothing else, it should be earning you interest.

If you're still in college


There is one important thing for you to do right now. Go get a credit card. No, you don't need to use it for much (see below), but you should get one. Many banks have a "student card" that you can get with proof of enrollment. Here's why this is important: the second you graduate, getting a credit card becomes much, much harder. You're stuck in a Catch-22 where no one wants to give you a card until you have a credit history, but you can't establish a history because you don't have a card. So get a card now. Not tomorrow after you play some more Modern Warfare. Do it now.

Credit cards


You should have a credit card. You shouldn't actually use it for credit, but you should make one purchase a month and pay off your bill immediately. Treat it exactly like a debit card, with one extra step involved. It's a nuisance, but it's the easiest way for you to establish a credit history, and like it or not, you will want a good credit history at some point in your life, like when you go looking for a car or home loan. So play the game, find yourself a credit card.

The credit card business is filled with nasty tricks, but if you do like I said and never ever ever buy more than you can pay for at the end of the month, none of them apply to you. Interest rates are dangerous and complex, but if you don't carry a balance they can't charge you interest.

Rewards programs are a nice perk, but as a laid-back young professional your spending is pretty low, so your returns will be too. Just find a card with no annual fee and you'll be fine.

Savings


Rule number one, kids: don't store large sums of money in your Wells Fargo savings account. Don't store it in your Bank of America account or any other "traditional" bank either. Why? Because they're greedy bastards out for profit at any cost, but here's the kicker: they're so outdated and inefficient that they aren't even good at making a profit, so their strategy is simply to screw you. Really hard. Even when times are good, they only give you some fraction of a percent in interest. This is pathetic, and you can do so much better with so little extra effort.

Go ahead and keep a traditional bank account if you want the ATM access, the convenience of a brick and mortar location, and so on. But if you have a sum of money that you expect to hold onto for more than about three months, you should be putting it somewhere else.

Credit Unions

Credit unions are like banks, but they are member-owned nonprofits. What this means in practice is that they are generally less shitty than the typical for-profit bank. Interest rates are a bit better, they don't deluge you with junk mail selling life insurance and shit, and they're less likely to try shady tactics to fleece you.

Credit unions have some of the same disadvantages as traditional banks. Their rates, while better, are still not amazing. And they tend to be plagued by some of the relics of traditional banking, like crappy websites. Credit unions can have fewer real-world locations than commercial banks, but if you pick one in your area you may find it just as convenient.

I still do most of my day-to-day banking through a credit union. I mail in checks as I get them and get money out through my debit card, ATMs (if you live near a coop, they may have a fee-less ATM for credit union accounts), and the odd personal check.

Credit unions tend to have some sort of membership rules, but they're not too hard to get into. Look for credit unions serving your area; many accept members from a certain geographical region. Or ask your family members; some credit unions will grant membership to family of current members.

Online savings accounts

Online savings accounts are the triumph of efficiency in this brave new world of ours. They tend to utterly destroy traditional banks when it comes to interest rates, without any real catch.

Obviously, online banks come with the disadvantage of not having real-world locations. There are two ways to handle this. The first is to simply adjust your habits, and you may find that you never really needed a physical bank. You can mail in your checks, get your paycheck by direct deposit, and use ATMs and debit cards to pay for everything. The second option is to use an online savings account in conjunction with a traditional bank or credit union. Do your transactions in the traditional account, and then when you have accumulated a chunk of money that you don't plan to touch for a while, simply transfer it electronically to your online savings.

I use ING Direct, and I like their rates a lot. They offer some nice convenience features as well; for example, you can fill out an online form to have them mail a paper check to someone. Unfortunately, their website is possibly the worst banking site I have ever used, both in terms of usability and security, which is saying quite a lot given the field of contenders.

If you do want to sign up with ING, get in touch with me and I'll send you a referral code to use, and then we both get free money. Hooray!

Ally Bank is a newcomer, but looks promising. Their rates are about as good as ING, and they have a refreshing no-bullshit slant to their marketing and policies. I haven't tried them myself, but they are worth a look.

CDs

CDs are Certificates of Deposit (I don't know why they are called that). They're also sometimes called Term Certificates. The idea is this: you put money into a CD and lock it up for a specified amount of time (anywhere from six months to ten years). The interest you will make over that period of time is set when you open the CD and does not change. The tradeoff is that this money is inaccessible until the time the CD matures, so you should use CDs for savings you don't expect to need until well after the amount of time you choose. However, if some terrible emergency happens, you can withdraw early, usually at the penalty of three months' worth of interest - not all that harsh.

Think of CDs as risk-free, lazy investing. You know exactly what return you'll get on your money, and the only work you do is picking a length of time.

Pro tip: if you're thinking of buying into a longer-term CD (a couple years or more), realize that you are also buying into that particular interest rate. This can hurt you; if you buy a five-year CD at 1.5% and the market rises, they may be offering 3% the very next year, so you would actually have been better off buying a one-year and renewing. Of course, this can work in your favor, too. I beat just about every investor ever by continuing to make 4.15% on some of my savings for about a year after the housing bubble crashed (savings, mind you, that had not lost a third of their value like they would have if they had been invested anywhere in the stock market).

IRAs


IRAs are special accounts that help you save for retirement. You put in a limited amount of money each year to save for retirement, and the government gives you a tax break - it's like an internal revenue high-five.

First things first: your employer may offer some sort of retirement plan as part of the benefits package. It may be an IRA, a 401k (which is like an IRA but lamer), or a SIMPLE IRA (which is more like a 401k than an IRA and why did they name it that way). See if this includes "contribution matching." This is where you agree to put something like 3% of your salary into a retirement account and your employer will put that same amount into your account. If they offer something like this, take it. This is free money - you are doubling your investment simply by making it.

If your employer doesn't offer this or you would like to contribute more money, consider opening an IRA on your own. There are two kinds of IRAs: Traditional IRAs and Roth IRAs. With a Traditional IRA, money goes in tax-free, but when you get it out, you pay taxes. With a Roth IRA, you pay taxes when you put the money in, but when you get it out, no taxes.

Either type is a fine choice, but a Roth IRA is particularly well-suited to a laid-back young professional like yourself. Roth IRAs have rules about the maximum amount of income you can make and still contribute, but unless you've already struck it rich with some startup, you're good there. And it's a long time before retirement, which means you put a little money in now, and by the time you're getting wheezy it will have grown into a lot of money (thanks to the magic of compound interest), which you then get to withdraw tax-free. Excellent.

Another Roth bonus: you can't withdraw your earnings (i.e. interest) until you've retired, but you can withdraw your original contributions if something comes up. And you can even withdraw up to $10,000 of earnings if you're buying your first house. Uncle Sam has got your back, even if he's not going to help you pick out curtains.

Here's another thing to know: an IRA is just a container of sorts. Once your money is in an IRA, you still have control over what it's doing. You can put it in cash reserves or bonds (much like a savings account), take out a CD, or invest it (more on this later). The IRA just provides the special tax rules, the rest is still up to you.

Now: must you open an IRA and max out your contribution limit right away? Some people will tell you absolutely yes. They may even be unduly aggressive about it. My opinion? Probably, but it's up to you. Saving now will make your life easier in the future. Failing to start saving this very instant will not end with you as a rheumatic beggar wandering the streets of Tampa. It will just mean that later in life, you will have to take retirement saving very seriously; you will probably worry a bit more about your finances. But if you prefer the extra spending money now while you're young and carefree, and are prepared to accept the consequences down the road, it's your prerogative. As long as it's an informed decision, I won't knock it.

HSAs


An HSA is a savings account for health insurance. You pair it with a "High Deductible Health Plan," which is insurance that only kicks in after something like $2,500 out-of-pocket; before that you'll be paying for everything except preventative care. These plans are substantially cheaper than typical health insurance, which means you have money left over to put into an HSA. Money goes into and out of an HSA tax-free, as long as you spend it on medical expenses. This can mean a visit to the doctor, but you can also use the funds for things like eyeglasses, crutches, or some NyQuil from the local drugstore. Once in an HSA, your money stays there until you spend it, and if you still have it at retirement, your HSA becomes basically another IRA that you can withdraw from for any reason.

HSAs are a good deal if you stay reasonably healthy - money that would otherwise have gone to the insurance company goes into your own savings. On the other hand, if you get sick and incur a lot of medical expenses one year, you'll probably come out behind. It's a wager of sorts, and you know your own health the best, so it's up to you.

Investing


I am going to keep this section short because there is good news - all those people who obsess over stock picks of the day and use all sorts of acronyms and watch CNBC all day? You can ignore all of them. Picking your own stocks is almost always a losing proposal - you're going up against entities with insane amounts of resources at their disposal. And even if you pay some "financial expert" to manage your portfolio, statistically they're probably going to perform no better than the market as a whole. Experts are not actually as expert as you (or they) think they are.

So what's a laid-back young professional to do? Buy index funds. An index fund tracks the performance of the whole market - the market goes up, you win; the market goes down, you lose. Since markets tend to grow over long periods of time, you'll probably win. Or else you'll be stuck in a post-apocalyptic outback wasteland, and you should probably focus more on securing some petrol and escaping from Lord Humungus and less on the ticker price of your stocks and bonds.

Much has been written elsewhere about index funds elsewhere, so do a bit of Googling if you need convincing. I have an account with Vanguard and have been happy with it - they built their business on index funds, so they're a good bet.

So... many... accounts...


If you follow all this advice, you may end up with your money in a lot of different places. As of writing this, I have two savings accounts, two checking accounts, three CDs, two IRAs, and an HSA. That's a lot of accounts to keep track of, and you'll need to come up with some sort of system to make sure you don't get overwhelmed.

A quick plug: I use Mint.com, and I don't know what I would do without them. I can see all my accounts in one place, with a UI that doesn't suck, and a website that doesn't hassle me with stupid useless shit. They sort your transactions for you, and have shiny graphs and budgeting tools and the like. Using it is a pleasant experience, which is practically heresy in the world of finance.

Yes, giving your account information to Mint is a potential security risk, but they have one of the best-written security sections I've seen on a website. If you're concerned, I highly recommend reading it and deciding for yourself.

And no, they didn't pay me to advertise. I just really like Mint.

Go do it


You made it this far, so you're clearly motivated enough to put at least some of this into action. Start at the top of this article and work down. If you do nothing else, please don't store large sums of money in your Wells Fargo savings account. Or worse yet, in your Wells Fargo checking account. I'm shuddering just thinking about it.

6 comments:

Erik_Simpson said...

Great post, Ian! But are you really getting a lot more than 1% in a savings account these days? I just checked ING Direct and HSBC, both of which list 1.1% as their current rate for online savings. I wonder whether I'm missing something.

Ian said...

You're right, I didn't think through that number before I tossed it out. I edited that section to better reflect this brave new world we live in.

Amusingly, Wells Fargo is currently offering 0.03% on their savings account.

Angela said...

There might be a few people from Iowa reading this who would be interested to know that the University of Iowa Community Credit Union offers reward checking at 4.00% on balances up to $25,000. There are a few things you need to do each month but they come naturally to people who regularly use credit/debit cards and check their balances online.

Nick Malinowski said...

High-interest checking accounts like U of I credit union or Kasasa cash are a fantastic way to earn interest by doing the same type of banking 95% of us are already doing.

Christy said...

I want to give a piece of advice about credit cards. I got at student credit card when I was 18 and they gave me a variable interest rate, probably due to the risk associated with students. During my first year out of college, that rate was about 17%, which is NOT a good rate. I called the company (Discover) and asked for a lower rate. They dropped my rate to 3%, without any other trouble. So, don't be afraid to ask for what you want, especially if you have a good credit history.

Melanie said...

Ally isn't a new bank. It's just GMAC with a makeover. They do have very competitive rates, but I would just make sure to do my research before putting money there.

Erik-Sadly 1.1% is a pretty competitive rate. If you have an American Express card, you may want to consider putting your savings there. They have a 1.3% interest rate. You can always check current interest rates at bankrate.com