The Carr Report: Talking about investing with a 20-year-old Pitt student

by Damon Carr, For New Pittsburgh Courier

You’ll be amazed at the questions that I received from a 20-year old University of Pittsburgh Student. He’s going into his third year of college. He received a full academic scholarship to attend college. He says he doesn’t want to work his entire life. He wants to retire early. He’s looking for ideas and knowledge on how to invest. He’s looking to start aggressively saving and investing now while he’s young. In this article I’ll refer to him as Danny.

Danny: What’s better, a traditional IRA or a ROTH IRA?

Damon: An IRA stands for Individual Retirement Account. IRA’s are designated retirement plans that allow you to save for retirement with certain tax advantages. Under IRA’s and as of 2020, you’re allowed to invest up to $6,000 per year. If you’re 50 years old or older, you can contribute an additional $1,000 to catch up contribution for a total of $7,000 per year.

Under a Traditional IRA, you’re awarded upfront tax deductions and earnings grow tax deferred. For example, if you earn $50,000 per year and you invest $6,000 in a Traditional IRA, you’ll only have to pay taxes on $44,000. That’s because you get the $6,000 tax deduction from contributing to a Traditional IRA. The earnings within the Traditional IRA grow tax deferred. Only when you withdraw money from the Traditional IRA will you have to pay taxes on both contributions and earnings.

Under a Roth IRA, there’s no upfront tax deduction. Therefore, contributions are made with after tax dollars.

For year 2020, In order to contribute to a ROTH IRA, your adjusted gross earnings has to be under $139,000 if you’re single and under $206,000 if you’re married filing jointly. Contributions and earnings made to ROTH IRA grows Tax Free. Withdraws made from ROTH are Tax Free.

What’s better? Tax free is better than tax deferred. Contributions and earnings grow Tax Free Under a ROTH IRA. Withdrawals are Tax Free under a ROTH IRA. Roth is better.

Danny: I want to invest $1,000 in stock. Where should I start?

Damon: Let’s start here. All savings and investments should have a mission statement. Why are you investing this money? When do you plan on accessing this money?

Danny: My main reason is because I have money that’s been sitting for a few months. I haven’t touched it. It needs to be invested. I want to move after I finish school in two years. I will use this money as a down payment or for moving expenses.

Damon: Money that you’re going to use within the next 5-years should not be invested in the stock market. Investing in the stock market is a long-term game. Any money that you’ll need within 5-years is a short-term goal. With short-term goals, you should be more concerned with preservation of principal, not return on investment. Park this money in a savings or money market account. A money market account pays slightly more interest than a savings account. But the rate of return on both is low. Just accept the fact that money earmarked for short-term goals should be kept in a liquid, safe account earning a low rate of return.

Danny: What if I split the money between investing and a money market account?

Damon: Your goals and time horizon always tells you the best way to park money. You stated that you want to save money for moving expenses and a down payment on a home in the next 2 years. That is less than 5 years. My advice doesn’t change. If you were looking to save money to purchase a home in cash in 10-years, then we can discuss investment strategies. Let’s assume you want to split the $1,000 and save $500 for moving expenses and save the other $500 for retirement. Retirement is a long-term goal. In your case 47 years away. Now we can talk about investing. I would suggest you open a ROTH IRA, and park the $500 in the ROTH, using S&P 500 Index funds as your investment option. Most long-term investing is something that you save/invest for that you will access money 5 years away or greater. This includes saving for retirement, college, paying cash for a house and wealth building.

Danny: Is Wealth Building exactly what it sounds like?

Damon: Yes, Wealth Building is essentially saving enough money where earnings from your investments are sufficient to pay for your lifestyle and living expenses. Once you amass this type of wealth, you no longer have to work unless you want to. Being that you’re young understand this: When investing rate of return is important. However, time is more important. The longer you have time to allow compounding interest to work it’s magic, the better and easier it is for you. I wish I had your mindset when I was your age.

Danny: Ok, I get it. I’m better off saving right now. But can I still use the market for fun?

Damon: Investing for fun isn’t a mature strategic move to make. But it’s your money. If you want to lose your shirt in the market, I mean have fun—have at it. But know this. Investing for fun comes after you’ve laid down a solid secure financial foundation for yourself. Do you have a fully funded emergency fund? Are you actively saving for short-term and long-term goals? Is your income source or income sources stable? Only after you established a solid financial foundation, should you consider investing for fun. Even then, you should limit your total investments in individual stocks to no more than 10 percent of your total investable assets. For example: If you have $10,000 to invest, only $1,000 should be invested in individual stocks. Here’s why: The key to winning with investing is not to do anything stupid. Diversification or spreading your risk around is how you mitigate risk and avoid doing something stupid. Why place all your bets on one stock hoping and praying it does well when you can own the entire market? Limiting your exposure to only 10 percent allows you to have fun without the risk of losing everything. Who knows, you might pick a winner.

(Damon Carr, Money Coach can be reached @ 412-216-1013 or visit his website @ www.damonmoneycoach.com)

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