Readers call or write:
Q-I am 21 years old and fresh out of college. I was very lucky to get a job right out of school in a large corporation. I am making about $35,000 a year. I put 10 percent of my income in a 401(k) plan: 60 percent of it in the company stock and 40 percent in Fidelity Contrafund and Vanguard Wellesley mutual funds. I think that I will probably keep investing this pretax income and will eventually go up to 15 percent. Is this a good idea?
Needless to say I am very young and willing to take some risk, but I don’t want to jump into anything crazy.
A-Good idea? Try fantastic; you are on your way to becoming a millionaire, and without having to save one penny of your take-home pay.
If you keep putting away $3,500 a year-10 percent of your current income-and earn an average of 9 percent a year on your investments (quite realistic over the long term) you will hit your first million before you turn 59 1/2.
That’s the age you are allowed to take the money out without tax penalties. And you will have made your million with money you never missed, because it was taken out of your paycheck before you cashed it.
My only concern is that you are putting a lot of money into the company stock. You didn’t say where you work, but no matter how strong the company, it is not a good idea to rely so much on any one investment. Your two mutual funds offer an attractive combination of long-term growth potential and yield. With dividends reinvested, they stand to make you a lot of money before you stop working.
Another advantage of starting to save young is that if you increase the amount of money you put in, or are able to achieve a high rate of return the first few years, you may not need to save so much money later. Or you may not need to put your money at risk.
In other words, you may have so much money salted away by the time you turn 50 that you could afford to save less, or stop saving altogether. Or you could keep the money in a money market fund, with almost no risk to the principal (other than loss of purchasing power, due to inflation). But now, at age 21, with so many years to go before retirement, you are not doing anything “crazy” by investing for growth. In fact, it would be crazy not to.
On the other hand, I get letters from retirees in search of high returns who are tempted to sink all their life savings into arguably good but volatile investments that could drop 20 to 25 percent in one year. I also hear from people with sizable nest eggs who still are not satisfied and want to make more.
My answer: Minimize risk at this stage, rather than try to make a killing.
Q-You claim to keep to the $30,000 the average American family spends in a year before taxes. This is fantastic. Unfortunately, your expenditure pattern is different from the average family.
You have no debt. Most families have at the least a home mortgage, car loans and about 70 percent of credit card balances not paid for.
My conclusion is that you probably do spend $30,000 per year, if that, but not in the way a normal family spends, partly because you have saved so you have no interest.
A-That’s exactly the point! I’ve been saying it for years: Getting rid of debt, and staying out of debt, is the winningest move in the savings game. It is simply amazing how much you can save every month when you don’t have to waste hundreds of dollars in interest.
My wife and I have saved and invested enough that: a) we don’t have to save so much now, and b) we don’t have to take unnecessary risks.
Just three years ago, we had to make 9 percent on our money and also save $2,000 a month of our take-home pay to make our goal of $1 million in cash (not counting the house or other assets) by the time I turn 55 in the year 2000. But now if we make 7 percent, and save only the money automatically taken out of my paycheck (including what my company contributes to my savings plan) we will have the $1 million. That means we can play it more conservatively with our investments, and still meet our goal.
In reality we spend more than the average American family in fun things such as weekend outings, movies, plays, compact discs and tapes, eating out, vacations, etc. Why? Because we spend zero in mortgage payments, car loans and credit card debt.
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Humberto Cruz welcomes questions and comments from readers. Although he cannot respond to each one individually, he will answer those of general interest in his column. Write to him in care of the Orlando Sentinel, P.O. Box 119, Orlando, Fla., 32802-0119.
