Expert: Gina Boykin - 7/11/2007

Question
I am 25 and am just starting my financial journey.
I have saved about $3,500.  I want to know what you think is the best
option for me to put my saving into.
Right now I am not receiving any interest on my savings, so I was
thinking about putting about 3,000 in a saving account or money market
account for an emergency fund.  I was thinking about putting this amount in
an online bank account, because I haven't found any banks in my area
that offer interest anywhere close to the 5% that I have seen on the
online banks at bankrate.com.  I know that I want this savings to be
somewhat liquid, and with an online bank it may have some delays, but some of
the online banks due offer checking with their savings accounts.
With the remaining $500 I was thinking about starting a Roth IRA
through Scottrade.  My investing knowledge is minimal, so I was wondering if
these are the best option for me?
Are their any concerns with online banks, such as me losing my money
through hidden bank fees or anything of that sort?


Answer
It sounds like a good plan!

It is very important to have an emergency fund.  It is usually suggested to have at least 3 months of your expenses in this emergency fund.  Your savings account is a great place for this money.  Any bank that is FDIC insured is safe (it should have the FDIC emblem on the homepage of the website).  I have an account currently with ING and am very pleased. I am also familiar with Emigrant Direct, NetBank and HSBC.  Your savings account can be "linked" to your current checking account and transfers take a few days, as you said.  There are two ways to overcome this issue.  #1 Open an interest checking with the internet bank and dump your local bank.  Then there are no delays.  Just make sure that the internet bank doesn't have any ATM fees, and that there is no minimum balance requirement that you think you won't meet.  #2 Treat this account as a true emergency account, and keep a small overdraft savings account in the same bank with your checking.  Any true emergency should not require immediate use of your funds (that couldn't wait for 2 days).

With any bank, local or internet, you should read the schedule of fees very carefully.  There should not be any fees that are not listed on this schedule.  The main fees to watch out for are: fees for falling below the minimum balance, fees for too many transactions (savings and money-market accounts), monthly maintenance fees for not having direct deposit from your paycheck, and fees for ATM transactions that are made at another bank.  Read the schedule, and call the bank, if you still have concerns.

If the $3,000 you plan to deposit is less than 3 months of expenses, that is fine.  Just make a plan to add to it periodically until it does.  The best way to do this is to make it automatic.  You can set up an automatic transfer from your checking to your savings account monthly, bi-weekly, weekly, etc. Putting your savings on automatic pilot is the best thing you can do for yourself.  It's called PAYING YOURSELF FIRST.  You've done a good job so far.  If you continue you'll be in great shape.

You do have another option for your savings, which is a certificate of deposit.  The advantage- The rates are a little higher.  The disadvantage - you cannot add to it and there is a penalty for taking the money out early (usually you lose some of your interest).  You could place part of your savings in CDs and the remaining in the savings account.  There are many CDs that can be opened with $500-1,000 (check bankrate.com).  

Now to your investing...

A Roth IRA has great advantages.  Whatever your money makes (earnings) grows tax-free!  You can take your deposits out any time without penalty or taxes.  I would put this on automatic deposit also, until you reach the annual limit of $4,000.  Since you are not familiar with investing, I would start by placing the money in an index fund.  

An index fund owns all of the stocks in a particular index.  I'm sure you've heard of the Dow Jones Industrial Average, the NASDAQ, or the S&P 500 on the news.  An S&P Index fund has stock in all 500 companies that are in the S&P 500 (which are the 500 largest companies)  A Wilshire Equity 5000 Index fund has stock in all 5000 companies in the index (basically the entire stock market).  There are also the Russell 3000, 2000, and 1000 Indexes, which cover the small-cap (smaller company) stocks, and many other stock indexes.  Finally, there are bond index funds, which hold a large number or bond funds.  Since these funds just follow the market, there isn't a lot of work involved and very little turnover (changing the mix of stocks), so the fees are drastically lower (0.2% - 0.5% vs. 1-3% for other funds).  You most likely will never see these fees on your statement, but they are there and affect the growth of your money, especially over a 20-30 year period.  In addition, most managed funds do not beat the market over an extended period of time.

If you chose to go with something other than an index fund, make sure to get a no-load and no-transaction fee fund.  There are enough no-load and no-fee funds to chose from so this shouldn't be a problem.

Here are a few index funds you can check out.  I looked at Scottrade and it looks like they allow you to invest in Vanguard and Fidelity funds, and possibly others.

INDEX FUNDS
Vanguard Total Stock Market Index
Vanguard Star
TIAA Equity Index
Schwab 1000
Schwab Total Stock Market Index
Fidelity Four in One Index
Fidelity US Bond Index Fund
Fidelity Nasdaq Composite Index Fund
Spartan 500 Index Fund

Hopefully this answers all of your questions.

HAPPY INVESTING ;)