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February 06, 2008

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Hum, my advice.
1. Depending on what your job is I would keep 3 - 6 months of emergency savings in your Money Market. If your job is stable go low end. If it has the potential to change such as commission job then 6 months.

2. Your young! I'd put only the % your company matches into the 403b and then max out the Roth IRA limits. If there is any money left after that, then add that amount back to what is going to fund your 403b at work.

3. Personally, I would try to pay off the student loans as fast as I could. It doesn't sound like your interest rate is high but I hate having a debt with a monthly payment that will last years. It is a great feeling to not have debt except for a mortgage payment.

4. As for wedding and house. If it is happening in under 3 years I'd open a saving account with ING Direct or another Money Market Account for savings. If it is longer, I'd go with a growth type of mutual fund with Vanguard.

5. When you do get a house with a mortgage make sure you stick to the OLD ratios they used to qualify folks with. Your mortgage payment with principle, interest and escrows should only be 25% of your net income. Adding any debt like student loan then it is 33-35% of net income.

I think I would put the $3K on the loan, it seems to me that this person is pretty level-headed about finances. She has an emergency fund, is saving for retirement, plus has an extra cushion in the MMSA (although I'd shop around for a higher rate of return on that account). Over the long run, doesn't the interest on the loan cost more money than the earning potential of savings?

It sounds to me like she's doing great, but isn't sure on how to start investing in the market. I remember that when I started, I used fund recommendations from my father. I didn't know where to start researching, or even what that was. As is the advocated position here, index funds are probably the best bet to start.

But how to invest in one?

There's a pretty sizable list of mutual funds and ETFs. I prefer index ETFs since they're priced like stocks and some pay dividends. The list on wikipedia is pretty good.

http://en.wikipedia.org/wiki/Exchange-traded_fund#Top_U.S._ETFs

Pay off the smaller loan. The interest rate on the loan is higher than that on the savings account, so it makes a lot of financial sense.

I guess there might be some deduction of student loan interest to take into account, but I think it's unlikely to make a difference, and there's a risk that the savings account interest rate will decrease.

I would pay off the smaller loan. There's such a psychological benefit to it, at least to me. And the interest rate is probably higher than what she could earn in savings right now, especially after taxes.

Congratulations to her for having such a good grasp on money management, especially at such a young age. I don't think that house is as far off in her future as she thinks!

I'd play the interest rate game: Pay off the loan with the interest rate that's higher than you're earning, keep the loan with the interest rate lower than what you're earning. 3k isn't a ton in the house saving's account anyway, and it looks GREAT on a credit report to have a school loan paid off.

I just question playing the lump sum on the financial aid when the interest is a deduction. I think I would consolidate that loan if at all possible.

Pay off the $3k loan. The other is such a low rate that it is practically free money. I would continue to save and pay down the debt. Sounds like she is on the right track.

absolutely do NOT pay off any of your student loans. the interest rates are extremely low and your total payment shouldnt be much more than $100 a month.

keep a 6 months emergency fund in your MM account and invest $5000 per year in a Roth IRA. the funds which you put in the IRA can be invested as you choose. at this point in time, you should probably buy a stock such as GE which has good appreciation potential and pays a 3-4% dividend (higher than the interest youd earn elsewhere).

youre young, take a bit more risk. money markets are basically guarunteed return, you should be shooting for 8-10% + at your age. i personally hope for 15-30% a year. good luck

I would pay off the higher rate student loan to get that "good feeling" from crossing another debt off my list. Plus, you're paying more in interest on that loan than you're getting with the savings, so really no benefit to keeping that money there except for liquidity. But you'll still have $10k saved, which should be enough in an emergency.

You should be able to make that $3k back within 2 years if you do end up needing it for a house or wedding.

First let me say that it is nice to see someone at such a young age be level headed about their finances.
In my opinion there is no benefit other than personal satisfaction in paying off the student loans. The interest rate difference on the $3000 portion only costs you and extra $30-40 dollars a year to service.
As long as you real estate market in your area is stable that is where I would concentrate my savings, but I would look beyond a MMSA to growth your savings.

Why in the world would you pay off those loans?

If you haven't done so, consolidate them to a fixed blended 3.7%(ish) rate and see what cuts you can make to that rate. Usually you get 50 basis points for setting up payments through direct deposit and another 50 bp for not missing a payment over a certain timeframe (e.g., 2 years). I would delay paying a 2.7% debt(that's tax deductible to boot) forever, if possible.

Your money will get better than 2.7% anywhere but your mattress.

DO NOT pay anything extra towards the 10k school loan at 2.6%, that would be the worst thing!!!!

Fully fund your Roth IRA, 5k/year and keep building up the wedding/housing savings. If you have money left over and the two school loans are bothering you, pay off the 3k loan for ease of mind.

1) 5k emergency saving looks like a 3-5 months expense. It sounds sufficient.

2) Let's look at her short-term goal (say 2-7 years) first: Wedding can cost between 5-25k. 20% down depends on the location, it can go between 30-100k. Of course, the numbers will immediately cut in half if her future husband will pay half of that. Expect: approximately 15-65k

3) Assume she has a 25% federal tax and 5% state/city tax. She needs to earn at least 6.5% to make that equal to the 4.5% interest paid on the more expensive loan. Therefore, it's a great idea to pay off that 4.5% loan, that's equivalent to a 6.5% instant risk-free investment return.

4) After the 4.5% loan is paid off, she will have 10k left. She will save 35% of after-tax income, that will equal to 10k/yr savings. Since the short-term goal may come as soon as 2 years later and can cost 15-65k. To reach the low-end of her short-term goal, she will need only 5k more.

5) Therefore, 5k should go relatively risk-free into a 1-yr CD for a higher rate (4.5%+), especially when the interest rate is not going to head up anytime soon. After a year, she will decide again where to put the money depending on the interest rate at that time.

6) The leftover 5k and any future savings (10k/yr) can go into the stock market. Since she doesn't have an IRA set up, Roth IRA is a great choice for tax purposes as contribution can be withdrawn at anytime tax-free (earnings grow towards retirement). After the limit of 5k annual contribution is up, she can then put money in taxable low-cost mutual funds (Vanguard, T Rowe Price, Fidelity), which consist of 70% equities (60% US/30% international/10% emerging) and 30% bonds.

7) The market may continue to go down in the near-term but with dollar cost averaging, she should do fine in 2-7 years. With her IRA, she can withdraw 10-35k contributions tax-free. For the taxable account, assume a modest 7% return, she will have about 17-55k in the mutual funds.

8) Combining the 5-6k she makes in the CD, altogether, she will have 32k in 2 years (100% success rate meeting low-end/median goal and 50% high-end goal) and 96k in 7 years (100% success rate).

Good luck!

First, CONGRATS on being so young and having your finances in order like that! I'm jealous! I can't imagine saving 35% of my take-home pay!!

I would pay off the 3K student loan. It sounds like it is doable and it would be psychologically healthy for you to not have that debt on your plate anymore. Even though it is a low interest rate, it is higher than the other one. You will be able to put that money each month into savings and earn interest rather than pay interest, or put that money towards your other loan and pay it off sooner!!

That's my two cents!

I have a 19 year old brother.
Marry him.
Follow AA's advice. It's dead on.

Obviously, paying off the 3k loan at 4.5% is more beneficial than getting 3.5% back on it in your MMSA. Mathmatically, it makes sense to continue making minimum payments on the 10k student loan, and stretch that out as long as possible.

Interest on the 10k loan is about $260/year. The interest also directly reduces your adjusted gross income, meaning that your taxes are reduced by about 15% of that $260 (around $40). That means that it effectively costs you about $220/year to borrow that $10k.

With that being said, there is also tremendous satisfaction that comes from being debt free. If it were me (and I was in that situation about a year ago), I'd get rid of your debt completely. You are talking about spending $220 per year to earn $350 (3.5% on $10k). To me, the peace of mind that comes from being debt free is well worth $130/year (less than $11/month!)

Thanks for all of your advice, everyone, I really appreciate it! I am going to pay off that smaller loan just to get rid of the annoying $28 monthly payment :-)

AA: I like your idea of buying a $5K 1-yr CD and investing my future savings in taxable low-cost mutual funds (I am keeping $5K emergency money in my MMSA); would a money market mutual fund count in this category? I have been under the impression that investing in the market for the short term (<5 years) isn't enough time to ride out the market's downturns, but that MMMF's were a stable option.

Thanks so much!

You have made an excellent start to plan for your financial future. First, you have initiated a basic plan and, second, you are seeking advice by asking questions. Learning the right questions will help you to avoid many mistakes and unnecesary lost of time, energy, and MONEY.

1. Pay off the $3K loan.

2. You did not indicate whether your employer provides any benefits to protect your income in the event of a disability. You should strongly consider your alternatives if you suffer a long term disability.

3. You should limit your annual contribution to your 403b Plan to the amount that is matched by your employer.

4. Determine the maximum amount that you can contribute to a ROTH IRA in conjunction with your 403b projected annual contribution. Initiate a ROTH IRA with a no load mutual fund.

5. Begin looking at potential homes for purchase NOW in order to develop a sense of what's available in your price range. Develop a relationship with a banker and learn about mortgage alternatives. Are you capable of buying a home that needs some work that you can do yourself? It is nice to put 20% down, but it is more important start building equity; therefore, if you find a great property at a good price, consider a 5-10% down payment.

6. Investments in your 403b should be very aggressive, but diverified. I favor blended funds that allow the fund manager to choose between growth and value, stocks and bonds, large and small caps, domestic and overseas, etc. Use Morningstar.com to assist you in making your choices.

7. If your plan is to use the contributions to your ROTH IRA as part of your home down payment, invest very conservatively. Otherwise, these funds should be invested like your 403b.

8. Finally, write down your long term goals in specific terms: goal, time horizon, dollar amount. Monitor your results every six months.

9. Surround yourself with advisors who know you and your situation. You need a banker, insurance agent, investment manager, lawyer, attorney, and financial planner. You can fill some of these roles and you can find some advisors to fill one of more of the other roles. Good luck

It really depends on how much you plan to spend on a wedding (varies) and how much the housing is (?).

If you plan to spend close to my low estimate (15k), then you can certainly invest conservatively, else you need to take a bit more risk in order to reach a higher estimate (65k). You should adjust the risk-return ratio accordingly.

In general, this is your game plan under the current economic condition:
1) Emergency savings (3-6 months of spending): MMA
2) Short-term goal tier 1: CD
3) .. tier 2: Bonds/income/balanced funds in IRA
4) .. tier 3: Equity funds in IRA
5) Retirement goal tier 1: IRA (if still under limit)
6) .. tier 2: 403(b) (after matching)
7) .. tier 3: Low cost funds/ETFs in a taxable account

Since insurance was mentioned, yes, you need to have at least medical and disability coverages.

Wow - you're doing great so far. I would advise you to incorporate further education/training into your analysis. One of the best things you can do for your overall financial health is to improve your earning capacity. What are the opportunities in your current field to increase your salary without getting an advanced degree? If the sky's the limit and you love what you do, then no problem. But if you're going to hit a ceiling at say $60 or 70k, you may want to plan for another degree that will put you into the six figures. If that is the case, you may decide it's better to pay off your student loans early so you have a fresh slate when you go back to school.

I agree with those who say you should fund a roth before maxing out your 403(b). That way, you can take out your contribution amount to buy a house without a penalty.

I wish I had your JOB - I am 24 and in law school - with double the amount of your debt (at 5.8%) and I HOPE that I will have a job that I make 47k out of school.

I agree with the emotional benefit that comes from paying off debt. You cannot put a price on that.

I would leave the student loan debt. 4.5% is still very low. Make maybe an extra payment or two a year, but I wouldn't go any further.

Next I would open a Roth IRA. I would love to hear what type of options you have inside your 403b. About 90% of the 403b plans offer absolute garbage inside them. Expense ratio's above 2%, .50 12b-1 fees that will make investing "extra" money inside the 403b not as good as you think.

Open up that Roth IRA through Vanguard and get into a Target Retirement mutual fund that aligns with your age, probably the 2050 fund.

Aside from that, keep saving away. Although I wouldn't recommend it, you can take up to $10,000 from the ROth IRA for a first time home purchase.

I'd pay off the loan (since my wife and I are in a similar position). Being free of debt is great feeling.

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