Investment Starters

Q: Where is the best place for a beginner to start looking for investments?? I am in currently in Iraq and don’t make as much money as I would in the civilian world. Where can I put my money to secure my future while I’m here?

-Christopher, Memphis, TN

A: Thanks for your service in Iraq! Let’s do a little “Investments 101!” First, there are three primary investment accounts you can use to build a nest egg for your future: employer-provided retirement plans, Individual Retirement Accounts (IRAs), and non-retirement accounts.

Employer retirement plans typically allow you to invest dollars on a pre-tax basis. In other words, your contributions are not included as income for tax purposes. The money grows tax-deferred and can be withdrawn after age 59 ½. At that time, it will be taxed as ordinary income. There are potential penalties and taxes if you withdraw the money before age 59-1/2. Some employers offer a “matching contribution” if you participate—you don’t want to miss out on that free money. The government’s plan for the military is called the Thrift Savings Plan (TSP), which, by the way, does not currently have a match. Other examples include 401(k), 403(b), and 457 plans.

Next up is the IRA. IRAs come in two varieties: traditional and Roth. A traditional IRA is similar to an employer plan in that the contributions you make may be pre-tax, grow tax-deferred, and can be withdrawn as taxable income after age 59 ½ without incurring a penalty. The Roth IRA does not provide any tax-benefit today, but it grows tax deferred and can be pulled out after age 59 1/2, tax-free, assuming you have held the account for greater than 5 years. You may set these accounts up with the bank, brokerage, or mutual fund family of your choice.

Finally, let’s look at non-retirement accounts. These are simply a bank, brokerage, or mutual fund account that you set-up. There are no special tax benefits to this type account, but there are also no strings attached—you can pull the money out and use it when you need to without IRS penalties (although there could be capital gains tax implications!).

Each of these accounts is an investment vehicle. Within them, you must pick specific investments like stocks, bonds, and certificates of deposit. You should also consider mutual funds, which are accounts in which your money is pooled with a lot of other investors’ money and it is then invested in stocks, bonds, cash investments or a combination. As a beginner, a mutual fund would be a good choice to consider because it would put a professional money manager on your side. If you choose a no-load asset allocation mutual fund, you could have a diversified portfolio with very little in the way of expenses! Asset allocation funds generally invest your money in a variety of U.S. and foreign stocks, bonds and cash. It can be a good way to put your program on auto pilot.

I hope that gives you a feel for the investment “playing field.” But first, I recommend you set aside an emergency fund of three to six months of your expenses. For this you can use a high-yield savings account or while you are deployed, the Savings Deposit Program (SDP). After that, I would consider starting up the Roth IRA. You can easily set this up online from completing the application to making the actual investment! If you can, contribute the full $4,000 that is allowed in 2007 and $5,000 for 2008. Again, a no-load asset allocation fund should be considered. Be sure to find one that is compatible with your risk tolerance. If you plan to stay in the military upon redeployment, the TSP is also a great program I recommend you look into. This should get you off to a good start.

Comments

[Ryan Delany]

This is a bit late, but I just wanted to add my two cents . . . June offered some very sound financial advice, but I would like to respectfully disagree on one point: (generally speaking) Mutual funds are a terrible investment. Why? Because 80% of mutual funds underperform the market average. That means that 80% of mutual funds don't do as well as say the S&P 500 index, or the Dow Jones. In general mutual funds underperform the market for 3 reasons: 1. some have expensive loads. 2. They need to be managed by expensive money management teams. 3. Mutual funds manage such large amounts of money that they cannot invest in growth stocks in any meaningful amount without inflating the price of the stock. If you must pick a mutual fund, get a fund that mimics the S&P, like the Vanguard 500 fund. The S&P averages about 11% annually as opposed to mutual funds which average around 8%. If you choose a mutual fund other than an index fund, make sure you track its gains relative to an index, and if it does worse than the index move your money out into an index fund. Another great option is SPDRs (ticker: SPY), this is like an index fund, but it is traded like a stock so it is very liquid. Hope this helps!
Ryan
http://semperfinance.blogspot.com/

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