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My wife and I are in our early 30s. Our gross combined income is about $125,000/year, and our rent is ~$2,500/month (we live in San Francisco). We have no debt, and we have about $85k saved up in a money market account at our credit union, which has an atrocious 0.20% interest rate. Our savings increase modestly each year; we probably end up saving about $3-5k each year and putting it in our money market account. We're also currently contributing 5% of our income to our employers' 401k plans.

We have no children and my wife is not pregnant, nor do we have any immediate plans for her to be, but we are talking about the possibility. For completeness, let's say we might have a child sometime in the next 2 years.

We don't own a house, and since we live in San Francisco, we have no plans to buy property any time soon (couldn't afford it). The possibility exists somewhere down the road, but we won't be purchasing a house purchase anytime in the next 3-5 years.

My question: What should we do with our $85,000 in savings? Friends have advised us that we should invest at least part of it to help protect against inflation. As I understand things, with the 0.2% interest rate on our money market account, our money is losing value each year. Would we be better off investing some of our savings in a conservative mutual fund? A different money market account? A CD? Some other option? Or should we just leave the money where it is?

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    Can I ask why you only wind up saving 3-5k? With monthlies of 2.5k rent, 1k food, 1k utils/gas, 5% 401k, and 30% taxes, I have you coming out at about $27k savings/yr. Throw in a large 12k for vacation + fun + misc, that's still 15k savings. What's missing? – Chelonian May 29 '12 at 17:28
  • Good question. Unfortunately, I don't have a great answer. We probably spend more like 20k/year on "vacation + fun + misc", so that's part of the problem, but I'm also just being conservative about savings. Our income has jumped quite a bit over the past few years, and we had a few big expenses over the past couple years (wedding, honeymoon, etc), so I wanted to be conservative about savings until I see how things "normalize" over the next couple years. – Michael May 29 '12 at 17:39
  • Is either 401(k) matched by the employer? – JoeTaxpayer May 29 '12 at 17:45
  • Yep, up to 5%, so we're contributing the maximum for matching. – Michael May 29 '12 at 19:53
  • Why not go above the matched amount from your employer? THis year you're allowed to invest $17k per employee (so that's $34k for the two of you), plus whatever the company may add/match. – warren May 30 '12 at 19:38
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Are there still people who keep significant amounts of money in a bank savings account? You could get ~1% by just choosing the right bank. ING Direct, for example, gives 0.8%, 4 times more than your credit union, with the same FDIC insurance!

If you do want to invest in something slightly more long-term, you can get a CD. At the same ING Direct, you can get a 5-year CD with 1% APR. Comes with the same FDIC insurance. Note that I mention ING Direct just because I accidentally had their site open right in front of me, their rates are definitely not the highest right now.

If you want to give up the FDIC insurance and take some more risks, you can invest your money in municipal bonds or various kinds of "low risk" mutual funds, which may yield 3-5% a year.

If you want to take even more risks - there's a whole stock market available for you, with ETF's, mutual funds and individual stocks.

Whether you should - that only you can tell. But you can have a NO-RISK investment yielding 4-5 times more than what you have right now, just saying.

  • Commentary. A 5-year commitment for a mere 0.2% rate bump is kind of weak; also if interest rates rise in 5 years then too bad, you're locked in. Use some caution with municipal bond funds - municipal bankruptcies are as likely as ever these days. Diversification (some cash in municipal bond funds, corporate bond funds, treasury bonds, and maybe even a bit in junk bond funds) may be more appropriate than pure munis. And even low-risk stocks are crazy-risky in the short term compared to most bonds: look up the stock chart for VDC in 2008; still not a bad idea for medium-term savings though! – fennec May 29 '12 at 18:10
  • @fennec completely agree. My point was that even the same risk and the same "lock" can easily yield 4 times more. For the rest a much more serious investigation is required. – littleadv May 29 '12 at 18:12
  • Bank of America has a product called a "No Risk CD" that lets you withdraw at any time with no penalty. – Bart May 29 '12 at 23:06
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Okay. Savings-in-a-nutshell.

So, take at least year's worth of rent - $30k or so, maybe more for additional expenses. That's your core emergency fund for when you lose your job or total a few cars or something. Keep it in a good savings account, maybe a CD ladder - but the point is it's liquid, and you can get it when you need it in case of emergency. Replenish it immediately after using it. You may lose a little cash to inflation, but you need liquidity to protect you from risk. It is worth it.

The rest is long-term savings, probably for retirement, or possibly for a down payment on a home. A blended set of stocks and bonds is appropriate, with stocks storing most of it. If saving for retirement, you may want to put the stocks in a tax-deferred account (if only for the reduced paperwork! egads, stocks generate so much!). Having some money (especially bonds) in something like a Roth IRA or a non-tax-advantaged account is also useful as a backup emergency fund, because you can withdraw it without penalties.

Take the money out of stocks gradually when you are approaching the time when you use the money. If it's closer than five years, don't use stocks; your money should be mostly-bonds when you're about to use it. (And not 30-year bonds or anything like that either. Those are sensitive to interest rates in the short term. You should have bonds that mature approximately the same time you're going to use them. Keep an eye on that if you're using bond funds, which continually roll over.)

That's basically how any savings goal should work. Retirement is a little special because it's sort of like 20 years' worth of savings goals (so you don't want all your savings in bonds at the beginning), and because you can get fancy tax-deferred accounts, but otherwise it's about the same thing. College savings? Likewise.

There are tools available to help you with this. An asset allocation calculator can be found from a variety of sources, including most investment firms. You can use a target-date fund for something this if you'd like automation. There are also a couple things like, say, "Vanguard LifeStrategy funds" (from Vanguard) which target other savings goals. You may be able to understand the way these sorts of instruments function more easily than you could other investments. You could do a decent job for yourself by just opening up an account at Vanguard, using their online tool, and pouring your money into the stuff they recommend.

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If I were in your shoes (I would be extremely happy), here's what I would do:

Get on a detailed budget, if you aren't doing one already. (I read the comments and you seemed unsure about certain things.) Once you know where your money is going, you can do a much better job of saving it.

Retirement Savings: Contribute up to the employer match on the 401(k)s, if it's greater than the 5% you are already contributing.

Open a Roth IRA account for each of you and make the max contribution (around $5k each). I would also suggest finding a financial adviser (w/ the heart of a teacher) to recommend/direct your mutual fund investing in those Roth IRAs and in your regular mutual fund investments.

Emergency Fund With the $85k savings, take it down to a six month emergency fund. To calculate your emergency fund, look at what your necessary expenses are for a month, then multiply it by six. You could place that six month emergency fund in ING Direct as littleadv suggested. That's where we have our emergency funds and long term savings. This is a bare-minimum type budget, and is based on something like losing your job - in which case, you don't need to go to starbucks 5 times a week (I don't know if you do or not, but that is an easy example for me to use). You should have something left over, unless your basic expenses are above $7083/mo.

Non-retirement Investing: Whatever is left over from the $85k, start investing with it. (I suggest you look into mutual funds) it. Some may say buy stocks, but individual stocks are very risky and you could lose your shirt if you don't know what you're doing. Mutual funds typically are comprised of many stocks, and you earn based on their collective performance.

You have done very well, and I'm very excited for you.

Child's College Savings: If you guys decide to expand your family with a child, you'll want to fund what's typically called a 529 plan to fund his or her college education. The money grows tax free and is only taxed when used for non-education expenses. You would fund this for the max contribution each year as well (currently $2k; but that could change depending on how the Bush Tax cuts are handled at the end of this year).

Other resources to check out: The Total Money Makeover by Dave Ramsey and the Dave Ramsey Show podcast.

  • +1 for all but the last paragraph. -1 for the Dave Ramsey reference. – littleadv May 29 '12 at 18:16
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    Why the Ramsey hate? (btw, thanks for the link cleanup, littleadv) – Waddler May 29 '12 at 21:42
  • personally, I wouldn't ever use a 529 plan, but that's me – warren May 30 '12 at 19:41

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