You're listening to Life Kit from NPR.
Hey, it's Marielle.
Okay, some confessions.
I didn't know how to light a match without burning my fingers until a few years ago.
Also, I have never seen The Godfather.
I still don't know how to pronounce the word feral.
Is it feral or feral?
And until recently, despite being a financial journalist for many years, I didn't know or had never thought about some of the tips in this episode.
Like this tip about looking at the fees in your investments from financial educator Amanda Holden.
If you're giving up 1 per year in a management fee, you're not giving up one piece of a 100-piece pie.
You're giving up one piece of a six-piece pie.
Hands off my pie.
By the way, she's saying, yeah, the management fee is 1%, but that fee eats into your profits.
If you're earning 6% returns a year, you really don't want to lose 1% of those returns or that pie.
We'll go into much more detail on this later.
But my point is, most of us are doing our best, but we have gaps in our knowledge.
We don't know everything.
We're busy.
And nobody taught us the intricacies of things like debt and investing and the tax code.
So on this episode of Life Kit, money tips nobody taught you.
If you know some of them, well, good for you.
But listen to the whole episode and I think you will learn something.
We talked to a bunch of financial experts and asked them to share their top tips.
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We're going to start with our simplest tip of the bunch.
It is straightforward, but it's important.
Takeaway one comes to us from Sean Spruce, a financial education consultant in North Carolina.
And big picture.
The takeaway is to slow your roll or take your time when it comes to borrowing money and to set borrowing limits for yourself.
So first of all, if you're looking to borrow money, take the time to see what your options are.
Shop around for the best possible loan terms.
Because when you're paying back a loan, the difference between a 6 and a 7 interest rate can be huge.
A lot of communities, they have affordable loan products.
They have nonprofits that provide lending services or community development financial institutions that can provide some of these small-dollar loans on more favorable terms.
Also, keep in mind, you don't have to take on the full amount you're offered if you don't need it.
Yeah, it's exciting to see that a lender is willing to give you all this money, maybe more money than you've ever had access to.
Some of these more modern loan companies.
You know they're willing to loan a lot and they'll loan pretty quickly as well.
But just because somebody is willing to lend you $10,000, maybe you only need $5,000.
Well, think about that.
Think about that because ultimately you will have to pay it back.
With interest.
Loans are not free.
Our next takeaway is also about debt.
It comes to us from Mary Childs, co-host of NPR's Planet Money and longtime financial journalist.
Takeaway two is to capture the carry on your low interest debt.
And I'll explain what that means.
Basically, what it comes down to is buy low, sell high.
If you borrow money, you will generally have to pay interest.
And if you lend money, which is technically what you're doing when you put your money in a savings account, lending money to the bank, you'll expect to make a profit.
So here's the rule of thumb.
When you're borrowing, you want to borrow for as cheap as possible.
And when you're lending, you want to lend for as much as possible.
Let's put this into numbers.
Say you're paying a mortgage on a house and your interest rate is 4.5%.
That's your cost of borrowing.
Now let's say you're making your minimum payments, but you're itching to pay the mortgage off faster, just to get it off your back.
So you think, maybe I'll make more than the minimum payments.
Before you do that, consider if there are ways that your dollar could earn you more than 4.5%.
Depending on the moment, you might earn more than that in a high-yield savings account at the bank.
You're going to have to run the numbers because interest rates change.
You could also earn more than that by investing through your retirement plan or a brokerage account.
Some quick math here.
Say you're paying 45 interest to borrow money for your house, but maybe you could earn and I'm being conservative here an average of 7 returns if you invested the money.
You'd pocket the difference between those, 2.5%.
That's what's known in the finance world as the carry.
Mary says professional investors do this kind of thing all the time.
It's called a carry trade.
Which is anytime you capture or capitalize on.
Take advantage of the difference between two interest rates.
Back to you and your money.
A few other things to consider here.
First off, you want to do this with low interest debt.
So if you happen to have a student loan that's only charging 3 interest, that would be a good one to capture the carry-on.
On the other hand, you probably don't want to do this with credit card debt, because the interest rates tend to be 20-something percent.
Also keep in mind putting your money in a high-yield savings account and investing it in the markets are two different things.
In an FDIC-insured savings account.
Your money will be guaranteed by the federal government up to 250000.
In the markets.
Your money is not guaranteed, though if you have time, you can weather the ups and downs.
The stock market returns 10% a year on average.
Next up, we're going to spend some time talking about investing.
Our next takeaway comes from Amanda Holden, the founder of a financial literacy business called Invested Development and author of the book How to Be a Rich Old Lady.
Her tips are relevant for non-ladies as well.
Takeaway three, when you're investing, it's crucial to understand fees.
Knowing about those will help you realistically predict your profits over time.
Remember when I said earlier that the US stock market returns 10% on average per year?
So if I invested 1000 today in a stock fund, at the end of the year I'd expect to have about 1100.
Historically, that is the case.
But this is also an average.
It is an average stretched across many, many, many years.
We're talking decades.
And so it does oversimplify the experience of actually getting those returns, because the reality is returns are going to be much higher and much lower.
But then again, stretched across these long time expanses, it may average out to about 10% per year.
Also, I need to note here that we can't be sure the US stock market will continue to return 10 percent per year on average.
And we're talking specifically about stocks.
So if you have a more diverse portfolio which experts recommend because that can be a buffer against downturns you'd also have some money in bond funds.
And those generally earn less than 10 percent a year, but they're lower risk, too.
So when you're making estimates about how your money is going to grow in the short term or in the long term, it's generally considered good practice to use a more conservative estimate.
And so, even if you were to believe that the future is going to be exactly like the past, you might use something like a 6 or a 7 or an 8 average return to calculate your returns into the future.
All right, now let's talk about those fees.
When you invest money in the markets through a retirement account or a non-retirement account, you will have to pay fees.
And this is what is so insidious is that...
You're never going to get a bill for these fees.
Amanda says, one type of fee that you'll have to contend with is a management and administrative fee called an expense ratio.
These are embedded into investment funds, and they might look tiny on paper.
It might be less than 1%, but in the world of investing, 1% is a lot.
Even something like 0.5% is a lot.
And so, instead of thinking about it as like one piece of a 100-piece pie as, of course, we are naturally trained to do, think about it in terms of those returns we could get moving forward.
Let's say you're expecting to earn a 6% return on your investments per year.
And you're giving up 1% per year in a management fee.
You're not giving up one piece of a 100-piece pie.
You're giving up one piece of a six-piece pie.
And the question is if there are only six pieces of pie, do we want the finance industry to have one of those pieces or do we want to keep all six pieces for ourselves?
So Amanda's advice, research the funds that you're considering investing in.
Luckily, this information is pretty easy to look up.
I use Yahoo Finance, which I know Yahoo is so vintage, but it's a very easy resource that you can use and you can just type in the name, or we call it the ticker.
You type that ticker into Yahoo Finance and it's going to pull up an info sheet.
And what you're going to look for is the expense ratio.
You can also find this info in your investment portal.
Something to keep in mind is that expense ratios will be higher for funds that are actively managed, meaning there's a person at the helm making decisions about what stocks to buy and sell, based on what they think is going to happen in the economy and in the markets.
It is very common to see an expense ratio or a management fee for active management.
That is maybe between like 05 percent and 1 percent.
Alternatively, there's something called a passively managed fund.
Those simply track the performance of a particular stock index or a set of companies.
And those tend to have fees more like 0.01% or 0.04%, which is a much smaller cut of your returns.
And the thing about active management that's interesting is that it would maybe be worth it to pay a fee if you were able to pay a manager to do better than the market's average.
But what we see year after year after year, after decade after decade, is that active managers are not able to do better than the market.
And in fact, they typically do worse.
And so not only do do you have to account for their fee, but you also have to account for their underperformance.
So again, 6% returns minus a 1% fee minus, let's say, 1% underperformance.
That leaves you with 4% returns.
And so you have just now taken all of the risk of being invested in the stock market and earning as much as you can earn right now if you put your money in a high-yield savings account.
Which would be a real big bummer.
We'll have more LifeKits after the break.
All right, we're back with Life Kit.
And I'm going to ask you to buckle your seatbelts, because we are about to hop on the magic school bus and dive straight into the black hole that is US tax law.
Takeaway four is to understand the tax benefits of different types of retirement accounts.
And don't let confusion or uncertainty stop you from investing at all.
The taxation of retirement accounts is probably the most misunderstood concept of investing.
And what I hate is that it creates this real roadblock to people getting started.
Amanda says the question is always, what's better, a 401k or a Roth IRA?
And her answer is, all retirement accounts are good.
Retirement accounts are bank accounts that hold investments.
As Amanda says in her book, you can think of them as a tax shelter for investment growth, a kind of container where your money can grow, shielded from taxes, while it does.
Compare that to regular non-retirement investing.
You'll generally do that through what's called a brokerage account.
And in that case, there would be two points of taxation.
You are investing money that you have presumably paid income taxes on.
And you are paying a tax on investment gains.
Whereas with a retirement account, there's only one point of taxation.
It's either being taxed as income on the way in or income on the way out.
So you're paying less in taxes.
And because you don't have to pay taxes on your profits yearly, your money gets to stay in the account and keep on growing.
What would be tricky for anybody to give you a clear answer on and that includes tax experts is which kind of retirement plan is the best option for you?
Which kind will leave you with the most money in the end?
Because, of course, they had to make multiple different types of retirement accounts.
It couldn't just be simple.
On the one hand, you have your traditional retirement accounts.
That could be an IRA, a 401k, a 403b, something like that.
On the other, you have Roth retirement accounts.
You'll recognize these because they all say Roth in the title.
Roth IRA, Roth 401k, etc.
Let's look at the traditional kind first.
You can take a certain amount of your income and shield it from taxes by putting it in a traditional retirement plan.
So let's say your tax rate is something like 23%.
You're not paying those taxes on the money you put into this account.
And so...
The bargain here is that, because you're not having to pay taxes up front with a traditional account, you presumably could invest more.
Say 23% more.
Then you invest the money.
It grows tax-free and you pay taxes once you start making withdrawals in retirement.
What that allows you to do is kick the can down the road, but you are going to have to pay those income taxes later when you withdraw.
The thinking is that you may very likely have a lower tax rate in retirement than you do now because of the way our tax system works.
On the other hand, there's a Roth account.
Roth is the reverse.
You are paying income taxes up front, but later on you won't have to pay any income taxes when you pull the money out.
Which means you'll never pay taxes on your investment profits.
And so here's the thing.
We can go to battle on which one is best.
It will probably have a lot to do with your tax situation, right?
If you are a higher earner right now, it may make sense to push those taxes until later, when you're gonna have a much lower tax rate in retirement.
If you're somebody that's not earning a lot right now, hey.
Go ahead and pay the taxes.
Give this gift to your future self and never have to worry about income taxes again on that money.
We can debate all day about whether Roth or traditional is better, but I think it obfuscates the point, which is that all retirement accounts are good because all of them allow you to grow your money tax-free.
Also, Amanda says when you game this out using different scenarios, a lot of the time you end up with a similar amount of money in the end, whether you used a traditional plan or a Roth.
Here's one more wrinkle, by the way.
We don't know what tax rates are gonna be in 20, 30 or 40 years, so we're making decisions based on an unknown variable.
Maybe the best thing we can do is give ourself a little bit of tax diversification and do some of both.
But the best thing you can do is not let it be a roadblock to getting started and just pick one and get to moving, because the much more important thing is what is happening inside of those accounts and the investing happening inside of those accounts.
Some other stuff to know.
With a traditional retirement plan, you'd pay a penalty for taking money out before age 59 and a half.
With a Roth, you can withdraw your contributions at any time without penalty.
Also, there are various kinds of Roth accounts.
If you're offered one through work, like a Roth 401k, you can contribute regardless of your income.
That's not the case, though, for a Roth IRA or individual retirement account.
There's an income cutoff.
It's currently $168,000 a year for single filers.
However, there is a workaround that folks call the backdoor Roth.
You put money into a traditional IRA money that's already been taxed and then convert the account to a Roth.
Asterisk here.
Consult a tax advisor if you're attempting this.
It is complicated.
That's the tax code for you.
What we know is that tax law in the US is like this haunted patchwork doll that has been added to and amended over time.
And you can think of retirement accounts as just one cursed limb of the creation.
That brings me to our final takeaway, takeaway five, the HSA.
An HSA is a health savings account.
It's tax advantaged.
It comes with more benefits than an FSA, a flexible spending account, and you should definitely consider getting one.
If you choose a health insurance plan called a high deductible health plan, you will likely be eligible to put money into a health savings account.
The HSA account is really the only triple tax advantaged account out there.
Diego Verdugo is a financial advisor with Principal Financial Group.
But assuming you are using the account the way it's supposed to be used, then there are no tax implications when those funds come out.
You can put up to 4400 a year into an HSA tax-free as an individual, and about double that if you have a family plan.
You do not have to pay income taxes on that money.
Very much like your retirement plan, very much like an IRA.
Those funds go in on a pre-tax basis that then are able to be invested.
The difference is when these funds from this account come out and they're used to pay for those qualified medical expenses, they come out tax-free.
So to be clear, that means you never pay taxes on the money you put into this account, as long as you use it for eligible medical expenses.
On top of that, in an HSA you can usually start investing those funds in the markets once you hit a certain threshold.
Usually that's around $2,000.
And as long as you use the money for eligible medical expenses, you won't have to pay taxes on the investment gains either.
That's what Diego meant by triple tax advantaged.
Another benefit is that unlike a flexible spending account, an HSA is not use it or lose it.
You carry the money over from year to year and after you leave a job.
And often your employer will make a sizable contribution to your account because they want to incentivize you to choose the high deductible health plan, which tends to be cheaper for them.
So when you're choosing your insurance next year, keep the old HSA in mind.
The insurance plan still needs to be the right fit for you.
You'll want to consider the cost of your premiums, how high that deductible is and whether you're likely to meet it, whether your company will put money into your HSA, what benefits are available under the plan, among other things.
And high-deductible health plans can be especially good for folks who rarely go to the doctor or need medical services.
Though, even if you do have a lot of doctor's visits, a high-deductible plan can still be cheaper than the other plans.
You just have to do the math.
But if the plan is a good fit, think of the triple tax savings.
Okay, time for a recap.
Takeaway one, take your time when it comes to borrowing money and set borrowing limits for yourself.
Just because somebody offers you a whole bunch of money as a loan doesn't mean you have to take it all.
Remember, you're going to have to pay it back with interest.
Takeaway two is to capture the carry on your low interest rate debt.
Basically, take advantage of the difference between two interest rates.
Buy low, sell high.
Takeaway three you need to understand fees to help you realistically predict your investment profits over time.
Takeaway four understand the tax benefits of different types of retirement accounts and don't let confusion stop you from investing at all.
And takeaway five, an HSA is triple tax advantaged.
It comes with more benefits than an FSA and you should definitely consider getting one.
Whew, that's our show.
Hey, before we go, I have a favor to ask.
If you have a moment, could you leave Life Kit a five-star review?
If we've ever helped you save a little money or make a healthier choice for yourself, made you feel a little more seen.
A five-star review is a great way to show your support.
And thank you.
This episode of Life Kit was produced by Margaret Serino.
Our digital editor is Malika Garib.
Megan Cain is our senior supervising editor, and Beth Donovan is our executive producer.
Our production team also includes Andy Tegel, Claire Marie Schneider, Sylvie Douglas and Mika Ellison.
Engineering support comes from Zoe Wangenhoven.
Fact-checking by Tyler Jones.
I'm Mariel Segarra.
Thanks for listening.
