Saving for retirement vs. your child's college education

A question from formspring: 

What is more important-saving for my retirement or saving for the kid's college education?

A: That all depends on your financial situation but if you're like most people the answer is your retirement.

The reason is simple: your child can borrow for education but you can't for retirement. And depending on your age, the years between new and your children's college graduation could be critical for you in terms of building a nest egg and adding to it with the appreciation you earn on your retirement investments. For example, if you weren't investing in stocks or mutual funds at all from late last year through the first quarter of 2010, you likely missed out on huge gains that could have offset any losses you took in the 2008 market crash.

Every parent wants to see their child do well but you have to remember that life will go on after your child has finished school and started a career. Not having retirement savings could not only harm you, but harm the start you're trying to give your children in life -- imagine how hard it would be for them trying to take care of you in your later years absent the retirement savings you could have socked away?

Keep the used car or get a new one?

Two interesting questions from one person I got on my formspring:

My 2003 Lexus runs reasonably well, has 83k miles. I think it will need about $2k in repairs & it will be fine. I do mostly city driving. I owe about $8k on it. I could pay it off, sell it, get newer used car & still have nice bit of cash left. Thoughts?

If your car is still running well and you only owe $8k , I'm baffled at why you want to get another one. Unless the plan is to sell the car for enough to buy a newer car in cash, then this plan doesn't make sense.

But to do that, you'd have to sell your car for $8,000 plus the price of the newer car. I know Lexuses have decent resale values, but I have a hard time imagining you selling a 7-year-old car with almost 100,000 miles on it and which needs $2,000 in repairs for enough to be able to pay off an $8,000 note AND still buy another car. Either you need to go into used car sales or that plan is seriously flawed.

Ok, you sold me. Keep car, pay it off, get it fixed. Done. So what do I do with the rest of the cash, around 40k? Can I have just 1 splurge? Please?

If you've got $40 grand in cash laying around, that's great and it's perfectly fine for you to buy yourself something. People get it twisted by thinking that folks who advocate frugality don't want you to spend ANYTHING. That's not the case; it's just that most people spend more than they take in, and don't save much at all.

Feel free to do something nice for yourself WITHIN REASON. Don't blow $25k of it in a weekend. Give yourself a (small) budget and have some fun.

After that, though, you need to consider what in the world you're doing with all that cash laying around? How much of an emergency fund do you have? If the answer's none, you need to stash enough of that money away in a savings or money market account to cover your expenses for several months in the event of a layoff or emergencies.

Already got an emergency fund? What about retirement? If you're not investing in a 401(k) and don't have an IRA, you need to start putting money away for your retirement.

If you've done both of those things, you're in good shape, but you can always afford to be in better shape by stashing most of that money away either for a rainy day or toward a home or some other goal you have.

Things for new investors to consider

Today's question from tweeted to me by @JNeedHisScrilla (love that handle):
What is the best direction to go for a first time investor with limited funds?
That's a tough question to answer, because like choosing a mate or a place of worship,choosing a smart investment strategy is intensely personal. Where you put your money, and how much of it you put there, should reflect your own goals, resources and time frame. There are as many reasons for investing, and kinds of investments, as there are people with things to spend money on.

But here are some common reasons first-time investors get in the game and things you should consider:

• To save for a first home. Usually, putting your downpayment savings into stocks or mutual funds doesn't make sense because of the risk of losing money. But if you're young and not planning on buying for 5-7 years, you might be able to weather a downturn and still see a return on your principal before you have to touch that cash. You probably still want to keep those holdings separate from any other investments.
• To save for retirement. This is likely to be the first introduction to investing that most young professionals will get. You start your first job and they hand you your benefits packet and that includes information on the company's 401(k) plan and an enrollment form. Read that information from first word to last, and then enroll at the maximum level you can afford to. If you're working and not in your company's 401(k) or other retirement plan, there's really no point in thinking about any other kind of investing.
• To save for a business. To build capital for a business. The same rule as saving for a home downpayment applies: don't put money into the market that you're going to need over a short time frame. But if you don't think you'll be hanging out your own shingle for at least five years or more, this might be an option.

In any event, the best thing you can do before you begin investing is to learn as much as you can about investing. Do you know the difference between equities (stocks) and fixed income investments (bonds)? Do you know what a mutual fund's expense ratio is (and do you even know the difference between funds and individual stocks?). Before diving into any major endeavor, you need to know as much as you possibly can to mitigate your risk.

Good luck.

photo courtesy of freedigitalphotos.net

I'm unemployed. Should I take money from my retirement account?

Another good question from twitter:

Don’t raid your retirement even to put food on the table when you’re out of work. Agree or disagree?

For the most part, I agree. That is if by "raid your retirement", you mean take an early withdrawal from a tax-deferred account like a 401(k) or 403(b). With a few exceptions like taking cash for a downpayment if you're a first-time homebuyer, early withdrawals from these plans do far more long-term damage than short-term good. For one, you lose the principal (the amount you take out) and thus any interest you'd make on that money over the years. That could be a substantial loss if you're in your 20s or 30s and still have two decades to pile on that interest.

Second, by taking an early withdrawal, you'll pay a heavy penalty on top of being immediately assessed taxes on money that you otherwise wouldn't pay until after you've retired, when your tax rate would be lower anyway. If you're in dire straits now, think how you'll feel when the government's tax bill comes at the end of the year.

That said, if taking money from your retirement is your only option and you're really, seriously on the verge of starving, it's probably better to not starve. But for most people who are still capable of finding some kind of way to put food on the table (have you filed unemployment or sought part-time work??), this is an absolute, positive last-resort of all last-resorts.

The Money Map

There are all kinds of systems and programs out there that are supposed to do essentially the same thing: put you on the right path in terms of handling your money. I usually don't post about them for that reason, but occasionally someone will put me on to one that is interesting or different.

Yesterday, my coworker showed me a copy of a "money map" developed by a group called Crown Financial Ministries. I don't know much about them except that they appear to use Christian principles to promote financial well-being. Their money map (available here) basically gives you seven "destinations" starting with building emergency savings, and ending with having a retirement that's fully funded. At each destination you check off specific goals like saving $1,000 for emergencies, paying off credit cards, buying an affordable home and funding your children's education.

Two things I think are notable: the plan encourages you to make some uncommon sacrifices, but it also builds rewards into the system at every destination. For example, you're not told to start saving for retirement, a home or your children's education until destination 4, after you've already paid off your credit cards and all other consumer debt. That runs contrary to most financial advice I've ever heard, which generally suggests that you allocate money to saving, retirement and paying off debt simultaneously.

In all I think it's an interesting and workable plan that I might adopt for a few months if for no other purpose than to blog about it here. Does anyone else have a plan that they're following that they can share?

60 Minutes: older workers might not get to retire

Today's post was supposed to be an update on Bobby and Aleks' house hunt but I get so many questions about 401(k) plans that I had to post about last night's episode of 60 Minutes. They looked at the devastating impact a tough economy has had on many people's retirement investments and gave a good history on 401(k)s and how they came to be so prevalent. It was sobering: many people in their 50s are finding out that they aren't going to be able to retire when they wanted to, or at all, because their portfolios have lost tens or even hundreds of thousands of dollars in value. What was also angering was the discussion of how 401(k)s were intended to be part of a "three-legged stool" of retirement finance that also included pensions and social security. But greedy companies have all but eliminated pensions and the government can't pay for social security for too much longer, what with all the wars it has to finance and the bank bailouts that are more important than your retirement.

Definitely watch the video, but keep a couple things in mind: before you get ready to pull out of your 401(k), remember that your situation is probably very different from the people depicted. People over 50 should definitely have lessened their exposure to losses by moving most of their investments over to bonds and cash, not the stocks that have taken such a beating. And if you're in your 20s, 30s or even early 40s, you still have time to make up what you lost over the past 18 months.

Look at my 401(k) losses so you can ignore yours

I'm starting off with an issue people have been worried about for a month: what's up with the value of my retirement account?

It's easy to see why: October was the stock market's worst month since I was 10 years old. The volatility probably won't end before '09, given the bleak forecast for consumer holiday spending not to mention Wall Street's unpredictable response to the election.

But I've been giving those who ask me if they should pull out of their 401(k)s the answer: Hell No!

Never jump out of the market at the bottom unless you absolutely have to, which is not the case for the majority of 401(k) owners. If you're in your 20s, 30s or early 40s, you're working with at least 20 years before you can withdraw money from a 401(k) without paying heavy penalties, so you'll lose MORE money by withdrawing now than by leaving your money alone and letting the markets correct themselves. And the market will certainly turn around between now and 2028, so chill.

Since the easiest way not worry about a 401(k)s is to ignore your own losses, I'm doing you a favor and posting my own losses below. When you get tempted to look at your own balances just look at how much I'm losing, thank God you're not me and forget about your own troubles.

My IRA lost 16.7 percent of its value in October;
My current 401(k) lost 8.3 percent;
My old one, which I still need to roll over, lost 17.1 percent;
Since May, my net worth has taken a dive of about 51 percentage points, mostly on retirement account losses.

Ain't it great not being me?