Expert: Steve Hach - 8/1/2009

Question
Where I am not:
I am 22 and have been investing since the beginning of this year.  I can live off 60% of my income and put the 40% directly into my savings account.  I put 8% of my income into the 401k, the minimum required to get the maximum match from my company.  I would put more but the front-end load is 5.75% and 1.5% gross expense ratio.  Is that excessive, because it seems so to me.  The rest of the 40% leftover I have been putting into savings and my 3 month cushion is now satisfied.  What should I do with my money?

My plan:
I want to invest thinking about the long term so my 401 would be a nice spot but I am planning on investing in the Vangaurd 500 Index Fund considering the no-load and .18% expense ratio.  Is this a good idea?  Also, I don't all of my savings going to this fund and I am looking for advice on long term strategies.  Lastly, once I set a system up I won't have a hard time keeping it but what happens when I want to buy a house?  Should I start saving for a down payment and stop contributing to my investment strategy?  Or should part of my strategy be building a money market account to serve as a down payment?  

Answer
Hi Jon,

I get lots of these questions, and out of all of them you are --by far --way out in front of the game.

First of all, you need to continue saving and investing as much of your money as you can.  Keep up with that plan, there is no such thing as "excessive" when it comes to putting money away at a young age.  Every penny you save now can do major work for you--even in the lowest risk/return vehicles-- because you have @45 years for the money to earn interest.

So, I will just provide some general thoughts for you.

1.  Be careful with the company 401k.  Make sure you aren't putting too much money into company stock due to matches and such.  People that do this get burned if the company ever runs into trouble-like Enron, Bear Stearns, etc.

2.  Remember that some IRAs you can withdraw 10k for the down payment on a home with no tax penalties, so you can put money in an IRA and use it for mortgage down payment with no issues.

3.  The fees on that 401k do seem excessive to me but I am not an expert in that field so I would do a bit of research.  If you can figure out the exact return penalty vs your returns elsewhere and you find that your outside investments do better than I would not feel beholden to the company 401k.  Remember too that many companies are messing with their matches during the recession so you cannot always count on promised matches and such.

4.  Index funds are definitely a good idea if you cannot pick individual stocks.  But, keep in mind that you want to be diversified here too.  I would consider some emerging market/overseas exposure rather than putting all money solely in US markets.  Especially Brazil, India, and China.  If you find that the loads associated with the mutual funds bug you, then you may want to consider an ETF that follows the index you want--but be careful here, some of the ETFs fail to provide the same results as the index they purport to match.

5.  Long term, stocks have typically provided better returns, but this maxim has fallen apart lately, over the past 20 years or so--due to the recent market crash--safe bonds have actually outperformed the stock market!  Keep this in mind and make sure that you don't feel pressured to be in stocks/mutual funds just because everyone says "they always go up eventually." Since you have started saving at such a young age, you are ahead of the game and if you keep putting money away at what seems like a very low rate of return via compound interest you will reap a lot of rewards later in life.

Hope this helps.

Best,

Steve