Roth IRA vs. Traditional IRA: Which Is Better?

What’s The Difference?millennials

Many adults can’t even answer this question!

This post comes directly from a comment left by a reader in a previous article. That person wanted me to explain the difference between a Roth IRA and Traditional IRA, as well as explain how to open one, where to open one, and how much to contribute to one.

All of those questions would make for an extremely lengthy article. Instead, I’ll be breaking it into a few posts. Today, I’m going to just start by explaining the difference between the two. This is really easy for me to answer and may seem obvious for those who know about them. But for many college students (and adults for that matter), retirement accounts are a topic everyone seems to have questions about.

Retirement! Only 40+ years awayRetirement beach writing

I’ve indirectly explained the significance of starting to save for retirement at a young age in another article on compound interest. If you haven’t seen that, it might help to start there. Click HERE to read all about compound interest.

I will end up explaining more in-depth the importance of saving for retirement in your 20’s in another article. It’s really just important to start a ground zero if you will, and explain what the benefits and cons to these accounts are.

What is an IRA?

IRA stands for Individual Retirement Account. Meaning that you, the owner of the account, are solely contributing to the account and receive no contributions (help) from an employer. IRA’s are in contrast to a 401(k) retirement account that an employer typically provides where they contribute money in addition to what you contribute. I will explain more about 401(k)’s in the future.

Why Would I Need One If I Will Have a 401(k) From My Work?

This also seems to be a question that pops up a lot. The quick answer to this is so you can save additional funds for retirement outside your employer and possibly get better returns on the money you invest. In a lot of employer given 401(k) plans, there is a limited number of investments you can choose from. Employers set it up for employees to select from a smaller number of funds they have chosen. They do this to reduce costs on their end and also provide lower fund fees for you. Because this article isn’t about 401(k)’s, that’s all I’ll say about them in this post. If you want to know more, definitely research it or drop me a comment below!

Traditional IRA’s

An IRA is an account set up at a financial institution that allows an individual to save for retirement with tax-free growth or on a tax-deferred basis. Money put into an IRA is from your own income after taxes. This money you’re putting in is on a post tax basis, meaning it is income that has already been taxed just like all your other money. This is in contrast to a 401(k) that allows you to put money into it before taxes are taken out.

With a Traditional IRA, you make contributions with money you may be able to deduct on your tax return. Any earnings potentially grow tax-deferred until you withdraw them in retirement. All the money you make on your investments will not be taxed up until when you retire. Traditional IRA contributions are also tax-deductible on your tax returns for the year you put money in. So you’ll end up getting some savings on your taxes for doing this. To learn more about this, click HERE.

PROS:

-Tax deferred earnings you won’t pay until you take money out during retirement

-Tax deductible on your taxes each year you contribute to the account

-Contribute $5,500 a year to one of these bad boys, regardless if you’re rich or poor

CONS:

-You’ll end up paying taxes at the end when you retire which will definitely decrease your money for retirement

ROTH IRA’s

These are great for young people. Here’s why.

With a Roth IRA, you make contributions with money on which you’ve already paid taxes. Your money can then potentially grow tax-free, with tax-free withdrawals in retirement, provided that certain conditions are met.

What this means for you is that just like a normal IRA, you contribute money after taxes to the account. But when you withdrawal during retirement, there is NO TAXES. NONE. You keep all the money.

No taxes! What’s the catch?

The catch is you have to meet certain income requirements. You have to make less than less than $132,000 a year if you’re single (it’s higher for married couples filing taxes together). This is why they’re so great for young people. Early in your career, it is doubtful you’ll be making over $100,000 a year. Where as later in your career, it is possible that you may not qualify for one of these if you’re making the big bucks. Which YoungMoney really hopes you do.

PROS:

– Tax free withdrawals

-Contribute $5,500 a year to one of these, but only if you’re making less than 132k a year

-After five years, up to $10,000 of earnings can be withdrawn penalty-free to cover first-time homebuyer expenses

CONS:

-Money put into these are NOT deductible on your income taxes

-Have to make less than 132k a year to be eligible

Which One Is For Me?

There are pros and cons to both as you can see. But at a young age, many experts recommend contributing to a Roth, especially if you expect to not qualify for it later on. You can always switch to making an IRA account later on. Also to keep in mind is you can contribute to both if you like. However, that $5,500 annual contribution limit from the IRS isn’t per account. It is in total. Meaning you can only contribute 5,500 to any IRA in one given year. If you put 5,500 in a Roth one year, you’re maxed out and can’t contribute to a regular IRA that year.

I can’t tell you which is for you, but if you’re interested in reading more about them here is more info from Fidelity. Click HERE.

Hope That Helps!

Hope that gives you a better understanding of them. If you have any questions, comment section is below and you can comment anonymously.

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See you next week!

-Matt Dalton

Why You Need An Emercency Savings

You Need This Before You Do Anything Else!

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If you’ve been reading my blog closely, you’ve noticed the last few articles I’ve written have all mentioned setting up an emergency savings account. Today, I want to share with you why you need one before you save for (or buy!) anything else.

Why This Topic?

From my own experience, I’ve noticed very few people around my age seem to have one of these. If something were to happen like their car breaking down, scholarship money not being received, or getting fired from their job…they would have nowhere to turn except hoping their parents might help them out. For many, their parents are the emergency fund, and that’s fine for now. But what happens for these people when their parents can’t/won’t help them OR they graduate college and need to begin figuring things out on their own?

Ask yourself these questions:

  • Could I cover an unexpected expense of $500-1000 if I needed to? (Average cost of a car repair)
  • If yes, would that unexpected expense kill my budget for a month, two months, or more?
  • Would an unexpected expense keep me from being able to pay other obligations?
  • Would I resort to having to put that expense on my credit card?

If you answered yes to any or all of these, you definitely need an emergency savings. An amount of money set aside to easily dig you out of situations when you need it.

So What Is An Emergency Savings?

This one should be pretty obvious. An emergency savings is a separate savings account from your primary savings, checking, retirement accounts, and all other monetary accounts you have. It is set up to be used only in case of an emergency. You never spend anything out of this unless you absolutely HAVE to. This isn’t for when you spent too much money in PB last night.

Why Do You Need One?

Even if you do have coverage from your parents right now if an unexpected expense were to pop up, you’re going to thank yourself in another few years if you start learning to build one now. At some point, your finances will all (hopefully) be on you. If you learn to put money aside for emergencies now, you may end up with more money to put towards other things down the line. My own personal emergency savings is set up to cover me up to a year without working and covers living expenses, bills, gas, car payments, food, fun. I could honestly take a year off and change nothing about my style of living. Pretty nice, right? I want you to have that kind of security too.

So What Is Supposed To Be Used For Then?

Primarily, people set these up to cover them in the event of job loss. If you started working full-time and lost your job for whatever reason, an emergency savings is traditionally used to cover a few months worth of living expenses while you search for a new job. It’s like insurance in a way. You hopefully won’t need it. But you’ll sure be happy you’ve got it when/if you do.

However, this has been expanded by financial experts recommendations to also cover smaller emergencies such as a car repair, family issue, or whatever else is truly a critical emergency and you need money. Your pet monkey BoBo gets taken by kidnappers and holds him for ransom. You need cash. You get it.

How much do I need to save? The 3-6 Month Rule

So here is something that is really tricky to answer. Honestly, it depends on you. Someone working full-time and supporting a family probably needs more than a college student looking to learn to build their financial chops.

A broad guideline from many experts is three to six months’ worth of the money that you need for all non-discretionary expenses (such as health insurance, your rent, food, other essentials to live on). That way, you have enough that if you were to lose your job, you’d be able to continue paying your bills while you looked for another one.

The Problem With The 3-6 Month Rule

This assumes no variability. Some people go into professions that are more secure than others. Someone working for a Fortune 500 company has a lot more job security than a freelance photographer lets say. The more secure your job is, you could save maybe just 3 months. If you’re going to be working in a job that is less secure, you’ll probably wanna stash away a bit more in case something happens.

What Financial Experts Recommend: F**k 3-6 Months. You need more.

Many financial experts now recommend having 8-12 months of salary stored away. This also deals with people’s tolerance for risk. If you’re not someone who worries as much, you may me comfortable with only 3 months living expense stored up. Someone like me who is more risk averse when it comes to this subject, has saved an entire year up*.

Financial experts also recommend having some money saved for small expenses or emergencies such as car repairs, etc..

(*Side Note: my savings is accounting for a full year on my estimated living expenses after college. If you really wanna know how much I’ve saved, you can ask me personally or shoot me an email on the contacts page).

How Much You Need (as a college student) – Start With $500-$1,000

Now, I totally realize saving tens of thousands is hard to do. Although it is possible. BUT, for many readers this may seem overwhelming. So start small. Saving $500-$1,000 would be a good place to start. It’s where I started.  Keep it for when something happens and replenish it if you have to use it.

This small sum can get out of a lot of tricky situations. It’s enough to pay a speeding ticket, average car repair, a forgotten bill, losing your wallet in Vegas, and most other issues that may pop up for you.

Saving just $1,000 would make you better off than most American’s

Read this link: http://www.marketwatch.com/story/most-americans-have-less-than-1000-in-savings-2015-10-06

“Approximately 62% of Americans have less than $1,000 in their savings accounts and 21% don’t even have a savings account, according to a new survey of more than 5,000 adults conducted this month by Google Consumer Survey for personal finance website GOBankingRates.com. “

Did you read even that little excerpt?! 21% don’t even have a savings account? Holy Sh*t. And 62% have less than a thousand. That’s so scary. By just saving a thousand, you’ll be better off than 62% of the United States.

Where To Save

Don’t listen to any other baloney out there. You want your emergency savings locked up tight in a savings account. Not the stock market, not a money market, not bonds. It needs to be liquid and easily accessible – FDIC backed.  If the rate of return on that account is small, that’s okay. After all, says Greg McBride senior financial analyst at Bankrate.com, “It’s not an investment—it’s a safety net.”

I personally recommend an online savings. They pay a lot better on these than anyone else. I use Ally.com for my emergency savings. But you can keep it wherever. Just needs to not be touched and left for when it is needed.

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Have a great weekend and see you again next week!

-Matt Dalton

Having More Money In College

Help! I Spend All My Money.

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Here we go. The top question I’ve gotten since the launch of this site.

How on earth did I save so much money during college? The answer to this question is honestly pretty boring.

People asked me a lot of ridiculous questions after I published how much I’ve saved. Let me just start by dispelling any rumors.

I didn’t win anything. I didn’t get a ton of money by receiving scholarships. The biggest scholarship I ever got was the $732 middle-class scholarship (Thanks, Obama).

Here is the big one: “Did you make all that investing in the stock market?”

The answer is no. Actually, the only investing I do currently is through my retirement accounts.

Like I say in my introduction to this website, it all has come from simply saving money I’ve made from working throughout college.

What Do You Mean No Stock Market?

I’d like to actually address the stock market question specifically. Stocks are sexy apparently, because that’s what everyone assumes is the sure-fire way to make money. Don’t get me wrong, it is. But any finance professional will tell you the stock market is a long-term play unless you’re a wiz like Warren Buffett. Even then, you’re going to need a bit of knowledge and a ton of luck to beat the markets.

You also have to understand where you’re at in life. As a college student, I can’t imagine you’ve got tens of thousands in capital just lying around at your disposal to invest in the stock market. Well, then again, I suppose many reading this went to Del Norte High School. Scratch that, you might.

All kidding aside, the amount of money you could put into investing would buy you probably a handful of stock shares. Not thousands. Unless you’re going to do some penny stocks, Jordan Belfort sh*t. If you are, god speed. A handful of shares even getting you a huge return (20%+) would make you a small amount by the time it went through Short Term Capital Gains Tax. As any accounting student will tell you, it’s hefty if you sell a stock if you haven’t owned it for over one full year. Yes, less than one year is considered short-term by the IRS.

Save More Today Than The Stock Market Will Make You

Here’s some food for thought. Let’s say I think Twitter is bound to shoot back up in value after Disney & Apple both decided to not purchase it today. (Did you know Twitter is for sale?) I put in $500 in order to purchase 25 shares at $20 a piece. Twitter comes through for me and shoots up 20%. This is a HUGE gain. I mean, seriously read that as a Donald Trump HUGE.

The stock price is now at $24. I made $4 on every share I own. My $500 turned into $600. HELL YEAH. Let’s cash out. I made 100 bucks doing nothing. BUT…now it is time for taxes.

Short term capital gains is done by your income tax bracket. Let’s say I’m in the 25% bracket. My 100 gain is now only 75 bucks. Thanks again, Obama.

So you made $75. You know where else you could have gotten $75 from? By just saving $75 from your paycheck instead of spending it. Chances are, you can end up with more money by just saving that you can make doing short-term sales in the stock market without investing a lot.

The Truth Is That Saving Money Is Boring.

To get better with money, you have to start by learning to save. People hate this. Mostly because it takes a while to do and also to get good at doing. It takes the commitment of making it a habit. You can’t half-ass it and do it for two weeks like people who promise to get themselves into the gym every new year.

But let me tell you something I learned.

You Learn To Love It

It took me a while to get going, but once I was consistently saving money, I loved it. You get excited to see your bank account balance growing and begin to set mini-goals for yourself. The more you start to save, you’d be surprised how much more you watch every aspect of your spending.

So How Do I Spend Less? I Have Bills, BRUH.

So do I. And I also love going out with my friends and buying stuff. But it can be done! Slowly but surely.

HOW TO START SAVING

  1. Figure out how much you’re spending.
    • This might hurt. It’s like waking up after a night out and checking your bank account.
    • Start by going back through your bank account and determining all your spending for one full month.
    • You can’t start saving unless you know how much you’ve got to manage
    • Many banks offer a tool to check your spending categories and break it out for you!
  2. Determine money spent on needs vs. wants
    • Figure out what you have to spend money on (Rent, food, utilities, gas, etc..)
    • Figure out how much you’ve been spending on wants (Going out, drinks, eating out, movies, dates, your Amazon cart)
  3. Make A Budget
    • You can do this easily in Excel if you like that or I recommend Mint.com.
    • THIS IS KEY TO STARTING TO SAVE
    • Figure out how much money is coming in. (Paycheck)
    • Take away all money you must spend on your needs
    • You’re left with money you probably normally spend all on wants
  4. Determine How Much You’ll Spend On Wants OR how much you want to save
    • This can start two ways. People who are looking to really start saving may decide how much per month they want to begin saving. They save and then the left over is “spending money”
    • This might be tough for those who go out a lot currently or feel like they’re always low on cash. So start by deciding how much you’ll spend on those wants. $200 a month, $300 a month. Whatever it is.
    • The rest will be your savings
  5. STICK TO YOUR BUDGET
    • This is all your own self motivation. You have to stick to the budget. Divide your monthly spends into weeks so you have $50 a week to spend instead of one big sum you blow through at the start of the month.
    • Set limits through your bank. If you really have issues with this, you can tell your bank to cut you off. You can set a limit on yourself that once you spend a certain amount, the card stops working.
  6. Save
    • Put money into you savings account. Ideally one that might be separate than the bank you use for your checking/debit card. That way it’s harder to touch. So you’d have to request a transfer and wait a couple of days before getting it in your account.
    • Don’t take it out. You’re only hurting yourself.
  7. Watch your money grow!
    • This isn’t rocket science. It’s easy to do but hard to stick to doing. Just like going for a short run everyday isn’t that hard, but the hard part is you have to keep doing it.
    • You also don’t have to only save money for no reason. Save towards something. You first need an emergency savings for when stuff comes up. After that, you can save towards a vacation, a car, Coachella. Whatever. Learning to save really benefits you.

I really hope this helps to put you on the right track if you’ve been needing it. Ask any questions in the comments below!

Thanks for reading!

Matt Dalton

Compound Interest: The Stuff Of Savings Dreams

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How Do People Build Wealth?

There is really only a few options.

  1. Inherit money! Why are you reading this website? Get back to maxin’, relaxin’, and livin’ large! You belong on East Egg and probably had your father give you a small loan of a million dollars to start out. Dope, dude!
  2. Zuckerberg somebody! Get out there and steal someone else’s idea and profit on that sh*t. No mercy.
  3. Come up with a billion dollar idea! Get your Elon Musk on. This is probably the fastest way to make a huge amount of money. You already knew this.
  4. Become a really smart investor. This also takes time. Warren Buffett didn’t just wake up one day to find he had billions in the bank. He makes smart picks, no doubt. But don’t think he’s always beating the market. The only person who can do that is someone with insider trading knowledge.
  5. Invest Money & Let It Grow. This is how most of us do it.

Sorry to bum you out if you were hoping I had an answer to making you wealthy through the first 4 options. If I did, I’d tell ya.

The truth is that most people build wealthy slowly and overtime. That’s how people save for retirement. They invest money as they go and eventually have a sizeable nest egg to retire on.

UNLESS, of course, you don’t invest enough or do so at a young age. Plenty of people can catch up if they work at it. But honestly, no matter how much you think you could catch up later on, there is NO advantage to building wealth better than TIME. The more you have of it, the more wealthy you’ll be based on how much you put in.

Now, you’ve most likely heard this before. That saving money while you’re young is really important. But hey, it’s tough to save money when you’re young. You don’t have as much of it right now. But it’s okay, even a little bit will make a huge difference.

What Is Compound Interest?

Investopedia defines it as, “Compound interest is interest calculated on the initial principle and also on the accumulated interest of previous periods of a deposit or loan.”

Okay, so what does that really mean? It means that when you invest money in the stock market, a mutual fund, a bond, a savings account, whatever…you’ll be paid in interest for investing your money. Stocks go up, you’re making money. Duh, you know this.

BUT, here is what it really means for you. Let’s say you invest $100 in your savings account. The bank pays you 5% interest. (We can only dream, but it works for this example)

After 1 year, you now have $105. ($100 you invested plus the $5 they paid you in interest for the year)

Now is when you start making MONEY ON YOUR MONEY. This is the sh*t if you’re into finance.

After 2 years, you now have $110.25. Wait, shouldn’t I have only $110 if they pay me $5 every year? NOPE. They paid you interest money on the $5 you earned last year too. So lets calculate that. $105 * 5% is $5.25. Add that together to get $110.25. You made 25 cents on the interest money they paid you from year one. Interest on your interest! Get it?

How Huge A Deal This Is

Here is an example of someone saving money and investing in the stock market that assumes a 7% return. (From BusinessInsider)

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Damn, Chris. You’re a millionaire now. You’re all all-star. Get your game on, go play.

So what happened here? Chris invested way earlier than the other two as you can see. This is what I was talking about in regards to time being on your side while you’re young. Compound interest doesn’t make a huge difference until around 40-50 years old for him compared to the others. But after 50, he skyrockets away from those other shmucks. This is because compound interest begins to snowball as you get older.

The Rule Of 72

There is a rule that says to find the number of years required to double your money at a given interest rate, you just divide the interest rate into 72. Let’s try it with Chris’s presumed 7% return. 72/7 =10.29. This means that every 10.29 years, he doubles the total amount of money in his account.

So if he is starting 10 years before anyone else…he doubles his money 1 more time than anyone else. This is where the ending of retirement gives you HUGE gains. Just by starting 10 years earlier, he has the chance to double his money once more before retirement. That is why he has roughly double what Bill has. Chris roughly got to Bill’s number 10 years before he did. Therefore, he doubled his money once more by the time they retired. Instead of 500k, he has over a million. One more time…Damn, Chris. Back at it again with that compound interest.

Do you see how big of a difference it can make to start early? Even small contributions earlier on makes the difference in how much you’ll have later on. And this assumed Chris ONLY had a 7% return. The AVERAGE return of the stock market from 1928 to 2014 was 10%.

How big of a difference would 10% make for Chris? He would have $2.8 Million.

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What if he bumped up his savings to 10k a year instead of just 5k? $5.6 Million

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Imagine The Possibilities!

This is how compound interest works and how people really build wealth. They invest wisely and save as much as they can. And they do it earlier than later.

THE PROBLEM

People in the United States don’t realize this. They push this off until later in life when they think they’ll be making more money and have more to save for retirement. But later in life you’ll probably have a significant other…then a spouse…then some kids. There is always an excuse for not saving. Which is why older generations getting ready to retire are in CRISIS.

Here are some stats to scare you. (Found here.)

  • 45% of Americans have saved nothing for retirement, including 40% of Baby Boomers.
  • 38% don’t actively save for retirement at all.
  • 20% of Americans tap into their 401(k) assets early, either through a loan or withdrawal.
  • 80% of Americans between the ages of 30 and 54 believe they will not have enough saved for retirement.
  • 36% of American adults over 65 are completely dependent on Social Security.
  • 63% are dependent (but not necessarily completely reliant) on Social Security, relatives, friends, or charity at age 65.
  • Social Security is running out of money, and will only be able to cover 77% of promised benefits beginning in 2034.

All those dreams of traveling the world in retirement? Consider them gone if you don’t seriously start thinking about this. There will be millions of American’s who will be just scraping by in their old age. It’s sad and it shouldn’t be that way.

But the reality is no one cares more about you than you. So do yourself a favor and begin saving as young as possible.

The Great News

You’re super smart. Yep. You are. You obviously care about this enough to read this site or have done some digging on your own. You can set yourself up and benefit from the knowledge others don’t have. Start thinking about saving!

In a future article, I’ll tell you where to do it and how to do it.

Thanks for reading! Subscribe to my email list! I’m basing how often I write on the subscribers I get. If you enjoy my content, please help me out and let me know you do. Just joining my email list is all I need to know you’re enjoy the posts!

Until next time!

Matt Dalton