Recently a reader left this comment on Free Money Finance:
Let's just say YOU were 40 years old and this is YOUR first time investing/saving. YOU're a ONE income household (husband works, mom stays home) --YOU have $8000/ month ($1000 a month for 8 months) to ONLY INVEST or SAVE it.
How would YOU INVEST or SAVE it? The trick is, you're NOT allowed to spend this money. You have to come up with a plan that will convince your spouse that this money will NOT dwindle down to zero but, will in fact GROW and GROW into a really nice amount. Is this a dream or is this really possible? And how would you go about doing it or explaining it to your "deathly afraid of ending up homeless and on the streets" spouse?
Personally, I'd say index funds. In fact, you can invest only using index funds.
But what would the rest of you say? What other advice would you add?
I too would invest in index funds.
What makes this question difficult is the persuading of the spouse. I can appreciate to some degree the point of view of the '"deathly afraid of ending up homeless and on the streets" spouse'.
This makes me think that actually a CD might be a better option as it is tied up so it can't be spent easily and also generates interest (I'll assume that the spouse doesn't understand inflation).
Maybe it would work to invest through a Roth IRA as this money can't be spent easily.
If they were in the UK, I'd say put £250 per month into a mini cash ISA (6% interest tax free), £250 per month into a stocks and shares ISA (like a Roth IRA in terms of tax but easier to access), maybe the rest into high interest monthly savings account (can be 8% interest) or premium bonds.
I'd explain how it will grow using the miracle of compound interest.
Posted by: plonkee | May 02, 2007 at 08:24 AM
It sounds like this person has a very low tolerance to risk. For now, I'd recommend a Money Market account. ~ 5% isn't a bad return for the risk intolerant.
Tim
Posted by: Tim | May 02, 2007 at 09:00 AM
I would definitely go with the index fund if it were long term--for example, right now would not be a good time to plunk your money in the stock market and wait eight months. The market is high and the summer months are traditionally bad. But over many years, your investment would better. So if it was just eight months I'd go with high interest savings.
Posted by: Mama Money | May 02, 2007 at 09:17 AM
My life experience(58) has taught me that an emergency fund is the most important hunk of money you will ever save. It protects future investments (ROTH, 401k,etc.) from early withdrawal and allows you to invest more money by increasing deductibles on all insurance. That said, I would start a Vanguard Prime MM account (top 5% of all mm funds last 20 years) with the entire amount. Show my spouse the monthly statements so that she can see how the money is growing. Once she is comfortable, have Vanguard put a $100 a month in the Wellesley fund(VWINX) (70% bonds, 30%stock). If and when she feels comfortable with this investment(continue showing monthly statements to her), you can consider the Vanguard Global Equity fund(VHGEX) for a monthly allocation. Eventually, 50% in VWINX, 35% in VHGEX and 15% in Prime MM fund should be a long term asset allocation any conservative (scared, newby) could live with.
Posted by: CIWOOD | May 02, 2007 at 10:11 AM
First I think we need more information about their finances before you can make a suggestion. Is this really their first time investing or do they have other company investments like a 401k? What does their debt look like? If they have $20,000 in credit card debt, putting the $8k into a CD might not be the best thing to do.
If they have no retirement funds, I think a Roth or another retirement account would be best. At 40 they need to start saving fast, and $8k isn't going to cut it. If they want to contribute to a Roth they can put the money in a high-yield savings account and contribute monthly up to the yearly max. That keeps the money nice and safe, while earning a little interest and funding their new retirement account.
Posted by: Chris | May 02, 2007 at 10:22 AM
I would explain to your spouse that the only sure way to end up homeless on the streets is to not save and invest.
If you don't save, you will not have any cash when you are no longer able to work (either through retirement or unfortunate circumstances). If you do not invest, your money will not be able to keep up with inflation and will actually shrink as time goes on.
So, save (by spending less than you earn and putting the money away), and invest (by taking that money and purchasing assets that are expected to grow over time at a rate greater than inflation). As you invest, diversify.
For diversification, I would recommend either: a basket of index funds (see www.fundadvice.com for great advice on selecting a passive portfolio of low-cost index funds) or a balanced fund (a single fund that diversifies for you). I'd prefer the former, but it requires more work on your part and you may not be ready for that yet.
Due to inflation, avoiding risk is often the riskiest choice.
Posted by: | May 02, 2007 at 10:26 AM
Assuming the individual has an emergency fund established, and no extremely high interest rates on credit cards, loans etc., then I would recommend a diversification of index funds (such as a total market) and possibly a smaller portion in bonds and/or CDs.
I recommend the portion in bonds or CDs because this person is new to investing, and trying to get his family involved, who I am assuming are also new to investing. Having a portion of the investments guaranteed will give them a better piece of mind, and allow them to learn more about investing before decing whether or not to move their investment for a potential at higher growth.
Another great piece of advice is that they can ease their way into investing by starting off with the money in a money market fund (as mentioned by Plonkee), and slowly begin buying into funds as they determine their goals and the amount of risk they are willing to take.
One more thing: the money will grow, it just takes time! :)
Posted by: Patrick | May 02, 2007 at 11:30 AM
Sorry, it was Tim who made the money market suggestion!
Posted by: Patrick | May 02, 2007 at 11:33 AM
This scenerio sounds like me. Pretty raw to the investment scene but would like to start as I have 2 very young children. I see that most advices are pretty conservative at 5% growth. I get 4% from my bank so is it really worth the the extra effort after paying the admin fees for all the funds? Would you recommend using a financial advisor or to walk into a bank? I have heard that a healthy portofilo is one at earns at least 10% growth. Is it true?
Posted by: New Gal | May 02, 2007 at 01:45 PM
A well-diversified portfolio invested in equities has historically returned 10% over very long periods of time (> 30 years). However, it does not do so without some risk.
Risk in this case means that there will be years when your portfolio underperforms your savings account. If you can handle this emotionally (and you should if you want to achieve the 10%), then just leave your investments alone and know that over time they will outperform.
As I said above, I would recommend one of the passive portfolios recommended at www.fundaccess.com for a well-diversified portfolio that should outperform the market with less risk.
Posted by: Joey | May 02, 2007 at 03:01 PM
One cannot save for retirement. It is simply too large to ever accumulate enough by saving alone. Investing is necessary and the faster you learn about it the better. Index funds are the quickest way to start and if you put it on autopilot you shouldn't worry about the ups and downs. The longer you delay the greater risk you face. In investing, time is paramount.
Posted by: Lord | May 02, 2007 at 03:58 PM
For someone new to investing, I would recommend starting with some reading. Go through the 12 steps at www.ifa.com. Also read this eBook: http://www.investorsolutions.com/v2content/book/index.cfm#contents
Henry Blodget wrote a really good book for beginners called the Wall Street Self Defense Manual, and a lot of the content from it is available for free as articles on http://www.slate.com.
Gaining that knowledge is crucial to keep from selling at a loss when the market has a bad day. The spouse needs to read it too.
It's also important to know what NOT to read or watch: market news like CNBC and articles in Money Magazine with titles like "10 Great Mutual Funds!" Long-term, buy-and-hold investors just shouldn't follow market news too closely.
Now, for a really easy way to invest and assuming no bad credit card debt, I'd suggest Vanguard's target retirement funds. They offer sensible diversification through Vanguard's index funds with no fuss and very low minimums and expenses. Just pick the one with the right time horizon. It may seem intimidating at first, but it's actually shockingly easy to do.
Also, for a 40-year-old who hasn't done any investing before, $8,000 ain't going to cut it. I don't know the income, expected social security or pension situation, but you need a LOT of money to retire. Find some online calculators to figure it out. Fidelity has a decent one.
Also, to New Gal, don't walk into a bank. They tend to have high fees and limited options. Fees are guaranteed drag on your returns. Also, picking a financial adviser takes quite a bit of homework. A lot of so-called financial advisers out there will just rip you off. Read the eBook above; it explains how to pick a good adviser. Then again, after reading the book, you might feel ready to take it on yourself. I doubt many financial advisers do much better than Vanguard's target retirement funds anyway, especially when you consider their fees.
Posted by: Matt | May 02, 2007 at 04:37 PM
Based on the phrasing of the question, I'd guess at a relatively low risk tolerance--preservation of capital would be a high priority, with growth a close 2nd.
Particularly because of the "convincing" part of the question, I'd recommend education. Go to the library and check out some good books on investing. One of the lessons to learn would be that there's plenty of risk to not investing--if you're getting 2% in a savings account, with 3% inflation that means you're losing ground in terms of spending power. So a wise, conservative investment strategy actually lowers your risk.
I'd echo the sentiment that if there is no emergency fund, the first $1000 should probably go into a money market fund--you want that liquid, ultra-safe buffer for the unexpected emergencies. Even if you never use it, I think the peace of mind is well worth any "lost" return on the investment. And you will use it. Be firm about not using it for discretionary spending, and if you do use it, refill it before investing any more.
Given a low risk tolerance, I'd probably recommend a split between cash, fixed income, and stocks. Maybe 10% cash (money market), 40% bonds, and 50% stocks (low cost, no load index fund for broad diversification). With that mix, even a fast 10% correction in the market doesn't need to cause a panic--your money only went down 5%, probably less than that with the cash/bond returns added in. At the same time, the stocks will boost the overall return so you might be getting 7.5% or so overall, on average. I'd do this in a retirement account, making it harder to "raid" the funds for spending, and gaining significant tax benefits at the same time.
Posted by: Mike | May 26, 2007 at 01:34 AM