Invest and prosper

So you’ve opened a retirement account, moved some money into it and resolved to contribute to it regularly. Now what?

Before you invest your money, you need to know in what securities to invest it. A good retirement portfolio takes into account your age and your risk tolerance. There is an excellent, highly visual investment allocation calculator at Fulcrum Inquiry. Just put in your age, your risk tolerance (there is a worksheet to help you estimate this) and - voila! - you see what I think is an excellent model for a retirement portfolio.

Now don’t get too excited, I am not talking about tax evasion here. Uncle Sam gives us a perfectly legal way to let our retirement money grow tax-free; it’s called Roth IRA. You contribute your post-tax money, up to $5,000 per year (as of 2008) and this money or the earnings it generates never get taxed again (unless you take the money out too early).

However, not everyone can contribute to Roth IRA. There are income ceilings - if you make more than a certain amount, your allowed contributions will decrease and eventually become zero. Here are the numbers:

• Single filers: Up to $99,000 (to qualify for a full contribution); $99,000-$114,000 (to be eligible for a partial contribution)
• Joint filers: Up to $156,000 (to qualify for a full contribution); $156,000-$166,000 (to be eligible for a partial contribution)

In the year 2010, these income limits will be removed and everyone, regardless of income, will be able to contribute to a Roth IRA. But what if your income is too large to qualify for a Roth contribution?

You can still put around $10,000 into your Roth IRA before the year 2010, that you otherwise would not be able to do! Here’s how.

You contribute $5,000 this year (2008), and, if the contribution limit does not change, another $5,000 in 2009 to a Traditional IRA. During the years 2010 and 2011, the income limits for the Roth IRA will be temporarily suspended and you will be able to roll your money over to a Roth IRA! You will have to pay income taxes on the earnings (or deduct any losses) that you generated between now and 2010; however, for the rest of the life of your Roth IRA, this money will grow tax-free. Thus, you end up with $10,000 money in your Roth IRA than you would if you did not do this.

Not a bad deal, is it?

The best place, in my opinion, to keep your taxable investment account, is with a discount broker.

Both IRA and taxable investment accounts may be opened with a discount broker. Banks, premium brokers and full-service brokers are likely to charge significantly higher commissions on security purchases and sales, known as transactions. These fees can add up to significant amounts of money. it is important to research the discount broker prior to investing with one; here is a good discount broker comparison chart.

I personally like Tradeking - they have been rated #1 discount broker by Smart Money magazine 2 years in a row, in 2006 and 2007. They have also been top-rated by Barrons. Their commissions on stock and ETF (exchange-traded fund) trades are $4.95, which is very low. They do not have an IRA custodial fee.

Zecco offers 10 free stock and ETF trades per month to users with accounts valued over $2,500, otherwise trades are $4.50. This is hard to beat for a taxable account. However, they have an annual $30 IRA custodial fee.

Scottrade offers $7 stock and ETF trades, which is not bad; it also offers over 1150 NTF (No Transaction Fee) mutual funds, meaning you can buy and sell them free.

Every day, we hear about the importance of saving and investing money. Yet, there is relatively little simple, definite information about how exactly to save money and how to invest it.

Let’s outline one good option of getting started on the path to wealth.

To save money efficiently and consistently, I advocate the “pay yourself first” method. To use this technique, you set up automatic contributions into your savings account. One example of this is having automatic monthly or quarterly sums sent from your checking account to your savings account. The first thing to do in this manner is to accumulate an emergency “cash stash.” Ideally, you accumulate enough money to live on for 6 months or so. This means you should have the amount equal to your monthly income after taxes times six.

If you can afford to start putting money into your investment fund at the same time as you accumulate your emergency cash stash, you should do so. If not, you may want to wait to invest until your emergency cash stash is complete.

If you have an employer-sponsored plan, such as 401k, you should take advantage of that first, especially if the employer is throwing in matching contributions (that’s free money for you).

Then, you should begin to put money into tax-advantaged IRAs. IRAs are Individual Retirement Arrangements; two most common types are Traditional and Roth IRAs. IRS maintains a comprehensive information source on IRAs here (html) or here (PDF). In my opinion, Roth IRA is a better plan; however, you can see for yourself - IRS gives an excellent comparison table of the Traditional and Roth IRAs at the bottom of this page. You can use the above IRS documents to check your eligibility for these IRAs as well. More detail on where to keep your IRA money in future articles.

Then, after you’ve maxed out your IRA contributions and have taken advantage of the tax benefits Uncle Sam has to offer, you can start putting money into your taxable investment account. More detail on taxable investment accounts in future articles.