Saving for Retirement

I’d written this last summer for the Muslim Student Association here at MIT. I am by no means a financial expert, but I want to share with you all the things I’ve learned about saving for retirement in the United States of ‘Murica. If I’ve made mistakes, let me know and I’ll correct them – I invite comments! Without any further ado, let’s get into it!

Money is a kind of poetry – Wallace Stevens

TLDR;

Although retirement for the majority of us college kids is a long way off, I think it’s worth familiarizing ourselves with the process.

• Before thinking about investing for retirement, be sure to assess your financial situation first. For a lot of us, retirement is more than 20 years away, so meet your immediate needs first. Generally, when we say investing, we mean in the stock market. Now, remember, investing in the stock market and other securities is in no way guaranteed; in fact, investing and speculating can quite easily become synonymous – this isn’t necessarily a bad thing, but you do want your gains from being right to outweigh the costs from being wrong. It’s literally the definition of profit.

• Open a Roth IRA with one of Vanguard, Charles Schwab or Fidelity¹ because these accounts provide favorable tax treatment as opposed to a regular brokerage account. You can contribute up to $6,000 per year and you can withdraw your contributions anytime restriction- and penalty-free.

• Great, now that you’ve opened a Roth IRA, I suggest purchasing ETFs (exchange traded funds) so you have an exposure to markets and sectors as a whole as opposed to individual assets.

• Keep on contributing to your account, avoid early withdrawals, take care of yourself and others, and most importantly, enjoy life ❤️

Alright, before investing in securities (tradable financial assets like bonds, stocks, etc.) markets, it’s worth assessing your financial situation. Some good considerations to make are the following – in order of priority:

1. Do you have a budget? And just as important, are there ways in which you can immediately reduce any recurring expenses? Example: I realized my phone plan cost too much to justify my minimal usage, so I downgraded – that cut my monthly phone bill in half. The point isn’t to deprive yourself, but to honestly evaluate you (and your dependent’s) needs, and ensure that your expenditures are commensurate with the degree of those needs.

2. Do you have a small emergency fund? I think it’s a good idea to have some 3 months or so worth of expenses in a checking or savings account. Some may disagree regarding how much you need to have in an emergency fund. With that said, it’s also worth taking into consideration the lines of credit and/or family/friend help that you can expect in a time of personal emergency – be sure your assumptions are valid however; i.e. if you are on the hook for an unforeseen security deposit which you otherwise don’t have the cash for, you can’t assume that your sibling can front you. The pros and cons of having an emergency fund in a savings and checking account are the following:
   1. Savings
      1. Pros: You can get an interest rate varying between 2% and 2.5% nowadays using an online bank, i.e. Ally, Discover, etc. Up to $250,000 of your deposits is federally insured in the event of the bank’s failure.
      2. Cons: There is a federal limit on how often you can withdraw your funds. This limit is 6 withdrawals per month without penalty; after that, you’re charged a fee.
   2. Checkings
      1. Pros: You can easily access your money, as frequently as you like for the most part. The money is also federally insured in the event of the bank’s failure.
      2. Cons: Lower interest yields, ranging from 0.01% to 0.37% at the time this was written. Because you generally access your checking account via a debit or atm card you’re at greater risk for fraud and theft; so in such an event, your money will not be available while the bank investigates. Make sure you are aware of your bank’s fraud protection policy and aim to use a credit card in lieu of a debit card for day to day transactions.
         
         
3. What is the degree of your debts?² It may be worth allocating some of your cash flow towards servicing the interest on the debts or paying down the debt principal altogether. If you have “favorable” loans which accrue interest only once you’ve graduated, it makes a lot of sense to pay down as much as the principal as early as possible. I’m not American nor am I outwardly political, but please don’t bet on your student loans being forgiven in the next four or so years. That is, irrespective of what the forgive-college-student-debt, and the opposing camp say, maintain the course, but remain vigilant and flexible.

Don’t take any of the above as hard requirements (except taxes and any usurious debt 😔). These really are just considerations, and you can pretty much do ‘em all at the same time; especially if you have an income while you’re in college; i.e. x% goes towards your emergency fund, y% goes toward paying down debts, and you ‘unlock’ z% after having reduced an expense.

Saving for Retirement

Alrightio! once you feel comfortable saving for retirement and other large goals, opening a Roth IRA is an excellent option. (To be clear, you may never feel “ready”, but ‘tis life). Now, full disclaimer: investing in securities such as bonds, stocks and etc. are never without risk; there is always the chance that you will lose both your profits and the principal amount that you’d invested. Statistics and Machine Learning notwithstanding, we generally say that historical returns/profits are not fully indicative of future returns and profit. Finally, I, Mohamadou Bella Bah, am not responsible for your investment performance and/or resultant financial situation, that includes the good (yay!), bad (aww) and the average (meh). As ever, be vigilant of your own financial situation and what it means in the context of the world around you.

Phew, now that disclaimer™ is out of the way, let’s talk Roth. A Roth IRA is an investment account that offers you favorable tax treatment. Every year, you may choose to put up to $6,000 into the account and invest in whatever securities you wish – this is called a contribution. With a Roth IRA (there is another IRA, a Traditional IRA which I won’t get into here), any contribution you make has already been taxed at your current income tax rate. What this means, is that later, any earnings you make on your contributions will be tax free so long as you meet the age and/or eligibility requirements. Some of these requirements may include being 59 and ½ years old, or that you intend to use your earnings towards paying for a home or education.

How does this differ from investing in a regular brokerage account?

Mostly it comes down to how you are taxed. When you buy $500 worth of stock in say Microsoft (stock ticker symbol MSFT) in a brokerage account for example, the money you use to purchase said shares has been “already taxed” because of your income tax. While holding your stock in Microsoft, you’ll receive perhaps $10 worth of dividends (regular payments made every 3 months to shareholders), which are also taxed. When you choose to sell your MSFT stock for a capital gain (i.e. your shares are now worth $900), you’ll be taxed again. So, in a (contrived) way, there a three taxable events: purchasing the stock, receiving dividends from the stock, and later selling the stock for a gain. (Not to mention, that you may have to pay your broker a transaction fee to both purchase and sell the stock.) Within a Roth IRA, you won’t pay any taxes on the latter two events so long as you meet the eligibility requirements at the time of disbursement.

I’d say there are three good financial institutions to open a Roth IRA with, these are Vanguard, Charles Schwab (what I use), and Fidelity¹. I highly recommend Charles Schwab, but you can’t really go wrong with any of the three. Each offers you plenty of inexpensive ETFs (these are funds that hold stock in many different assets and companies as a means of diversification. Investing in individual stocks as a capital limited investor can be risky – or so goes the general wisdom). Whichever institution you pick, I recommend purchasing the ETFs that they offer to avoid any added transaction fees, i.e. if you want to own stock in the broad US equities market, purchase VTI (Vanguard Total Stock Market ETF) if using Vanguard, or SCHB (Schwab Strategic US Broad Market ETF) if using Charles Schwab. What people usually suggest is setting up a three-fund portfolio – this means within your Roth IRA, you allocate x% to US Stocks, y% to international and emerging market stocks, and z% to bonds. I did something a little bit different.

Bella, what does your ROTH IRA look like?

My Roth IRA looks like the following in order from smallest to largest in terms of allocation in my portfolio:

• SCHE (Schwab Emerging Markets)
• SCHF (Schwab International Equities)
• SCHD (Schwab US Dividend Equities)
• SCHX (Schwab US Large Cap ETF) ~ 60%

Note that this is not necessarily my desired allocation (read disclaimer™). Also note that you don’t have to purchase ETFs, you can purchase individual stocks, individual bonds and etc. as you’d like, but for the diversification purposes I’ve already mentioned, I wouldn’t recommend this. I don’t claim to be an investment expert, so it may be worth looking into what makes the most sense for you, i.e. your age, income, etc.

Generally, I strive to add $x to my account every 6 months or so (I lean more towards investing with lump-sum dollars, rather than dollar-cost averaging. See this Vanguard article discussing the two).

Where to Next Captain?

Going forward, I’d suggest reading the sidebars in the personal finance subreddit r/personalfinance, and sticking to a three fund portfolio.

That’s pretty much all I have to say on the topic for now. I love investing, finance and such things, so let me know if there’s anything you want to discuss!