Q Dear Rick:
I wrote you a couple years ago about my financial situation. At the time I had substantial charge card debt and you told me that before I start investing money I should pay off my charge cards. That is exactly what I have done and I can’t tell you how much better I feel knowing that I’m not in debt. Because I am no longer in debt I now have about $500 a month that I can invest. My question is what should I do with this money? I have already funded an emergency fund of money with about six months of my living expenses. I want to save this money for my retirement. Currently, I’m in my early 40s and I have nothing saved for my retirement. I work for a very small company and they don’t have a 401(k) Plan so I’m on my own. I don’t consider myself aggressive and I certainly don’t consider myself conservative, so I’m somewhere in between; any recommendations?
A Dear Louann:
First of all, congratulations, I know it is difficult to pay down charge cards, and I congratulate you for having the discipline to do that. I wish more people would do what you did and that is, before you invest, to pay off high interest rate charge cards.
Investors need to keep in mind that the average interest rate on charge cards is north of 18% and the interest is not tax deductible. Therefore, when you pay down your charge card you are receiving at least an 18% after tax return on your money. There is no investment that can come close to that return. That is why paying down a charge card is a great investment.
In reviewing your situation, I do like the idea of investing your money for long-term growth. After all, you will probably work for at least another 20 years and therefore, it makes sense to focus on the long term. In that regard, my recommendation is that you first fund a Roth IRA. One of the beauties of a Roth is that the money will grow tax free for your retirement.
With regard to the Roth, you can invest $5,500 a year. In addition, it’s not too late to contribute for 2015. You have until April 18, 2016 to make your 2015 Roth IRA contribution. Therefore, your first contribution should be allocated to 2015 and then begin making 2016 contributions. This will allow you to put more money away on a tax free basis.
Since you are a new investor it is important that you have a diversified and balanced portfolio. In your situation I would consider using T. Rowe Price for your investments (1-800-225-5132; www.troweprice.com). At least for the first year or so I would consider using a couple of T. Rowe Price funds. I recommend T. Rowe Price Spectrum Growth and then T. Rowe Price Spectrum Income. I recommend a 75 percent allocation to the T. Rowe Price Spectrum Growth and the remaining 25 percent into the T. Rowe Price Spectrum Income. Both these funds are fund-of-funds in that they are investing in other T. Rowe Price funds. Therefore, the T. Rowe Price Spectrum Growth Fund allows you to have a variety of growth funds within one fund. The same thing applies to the T. Rowe Price Spectrum Income Fund, but they are income-based funds as opposed to growth funds.
I cannot stress enough that paying down debt; particularly charge-card debt, is probably the best investment anyone can make. Therefore, if you are sitting on a balance on your charge card, the best investment you can make is to pay down that balance.
Rick is a fee-only financial advisor. His website is www.bloomassetmanagement.com. If you would like Rick to respond to your questions, please email Rick at email@example.com