Investors today have more investment options than were available to the average investor just a few decades ago. While having multiple options is usually a good thing, too many options can cause system overload and lead many people to avoid making decisions. Investing is a broad topic that often seems intimidating to people who are new to investing. And that is understandable – there are dozens of investment vehicles and thousands of investment options. Before we let analysis paralysis get the best of us, let’s take a look at options for the first time investor.

DIY Investing or hire a financial planner? This article is primarily aimed at someone who plans on starting their own investment plan. However, these steps can easily be done with the help of a financial planner. If you are beginning your journey into investing, you want to choose a financial planner that will walk you through these steps and be able to easily explain why each investment option is good for reaching your goals, and direct you to additional information so you can better understand how and where your money is being invested.

Defining investment goals

The first thing we want to do is look at our investing goals. This will help us determine what type of investment vehicle is best for our investment. Before we go much further, let’s define saving and investing; normally saving is a short term engagement and investing is a longer term engagement.

Saving goals often include major purchases such as a car, down payment for a home, college tuition, major vacation, etc. Many traditional “investments” would be inappropriate for savings because they may lose value. Most savings should be kept in low volatile accounts such as a high yield savings account at an online bank or in a CD. Here is a list of high online bank interest rates that you may find helpful.

Common investment goals include longer term goals such as retirement, keeping pace with inflation, college tuition,and other longer term goals. You will notice that I listed college tuition under both saving and investing. Which group you place each of these under depends on your time frame. You can probably take on a little more risk for an intermediate length investment. For example, my daughter is 8 months old, so I can take a little more risk with college fund money right now than I could if she were 16 years old.

Find an investment vehicle

After determining your investment goals we need to find an investment vehicle that meets our needs. No, I’m not talking about buying a pristine 1953 Buick from the Barrett-Jackson Auction company. I’m talking about something more fun and exciting – things like IRAs, 401ks plans, college saving funds, brokerage accounts, and more. There are many specific investing plans that have tax breaks or other incentives that make them worthwhile to use. For example, IRAs and 401k plans are tax advantaged retirement plans that give users tax breaks either now or in their retirement years. 529 College Savings Plans and Coverdell ESAs offer tax advantages for college savings.

Open an investment account

Once you determine your investment goals and which investment vehicle you will use, you should open an investment account. This could be as simple as enrolling in a 401k at work (often done automatically), or opening an IRA, which takes about 15 minutes. Opening an investment account is often as simple as providing your information, signing a form, and transferring funds. But knowing the type of investment will help you narrow down the best place to open your investment account.

Stocks, bonds, and funds, oh my! The options are endless!

There are thousands of places you can put your money, including stocks, bonds, mutual funds, REITs, real estate, commodities, small businesses, and more. Again, I will point to the concept of analysis paralysis and the importance of having investing goals. Before becoming overwhelmed by the sheer number of options, take a hard look at your investment goals and eliminate anything that won’t help you meet your goals. You should be able to eliminate a large portion of the available options just by checking them against your investment goals.

The best investment for a first time investor. If you are a first time investor, you are probably doing well to get this far (defining your investment goals, finding the appropriate investment vehicle, and opening an account). If you are still overwhelmed with your investment options you may find it best to invest in a target date fund, which automatically diversifies your portfolio to a weighted asset allocation based on your target retirement date. Or, to put it more simply, a target fund is a mixture of stocks, bonds, and other investments that is designed to have more risk while you are young, then gradually transfer your funds to less volatile investments as you get closer to your target retirement date. The management is done automatically; all you do is invest and let the fund manager do the work.

Target date funds aren’t without their downsides though. They are often less flexible than an asset portfolio you create yourself, and may come with higher expense ratios than a do it yourself plan. I am not advocating target date funds as the best plan for everyone, but I will say that they are a great place to get started if you simply don’t know where else to start. The idea is to get in the habit of investing and get your money in the game – particularly in accounts that have investment limits per year (401k plans, IRAs, etc.). Get started, get in the habit, then move your investments to a more appropriate investment one you have a better idea of how you can accomplish your investment goals on your own.

Start Investing

At this point you have it all – the goal, the investment vehicle, an open account, and an idea of what you want to invest in. The next step is to get started. If you are just beginning your investments it’s probably not a good idea to try and time the market. Dollar cost averaging through automatic contributions is a great way to get started because it will help smooth your investment returns over the long run. You can often set up an allotment from your paycheck for 401k contributions and sometimes investment contributions to brokerage firms or other investments. Automating your contributions will make it easier to stay on track, just be sure to be aware of any contribution limits that may affect your investment planning. You don’t want to contribute too much money to your investments!

Monitor and Adapt

Ahh, you thought we were done, didn’t you? Not quite. Investing and saving are two different things. It’s easy to set up a savings account or CD Ladder and leave them alone until the term is up. But investing requires a more hands on approach. I’m not advocating day trading, but you do need to be aware of how your money is allocated and how your investments are performing. It’s a good idea to track your investments with money tracking software tools so you can see it all in one place, and it is good to perform periodic spot checks and adjust your asset allocation as necessary. Some people prefer to do this on an annual or semi-annual basis, or any time they have a major life event that changes their investment goals. (Maintenance is one of the reasons I recommend a target date fund for beginners; it removes one step from the equation until they can learn more about asset allocation and other investment vehicles).

Does anyone have any other helpful advice for the beginning investor?

~$~

Related Articles:

1. What is investing?
2. Where Do You Get the Best Roth IRA Rates?
3. College Savings Plans: 529 vs. Coverdell ESA

When faced with too much information and too may options many people take the easy road, which is doing nothing. This is called analysis paralysis – you are frozen by having too many options and no clear answers.

Inertia can cause many personal and financial problems, so let’s take a look at how we can get past analysis paralysis and make positive progress toward our personal and financial goals.

Example: The Cost of Inaction

One of the most frequent comments and emails I receive is from first time investors who want to know where they should invest first. This is understandable – there are literally thousands of investment options, as stock funds, mutual funds, real estate, and many different investments vehicles such as savings accounts, CDs, 401Ks, IRAs, and more. Unfortunately, many people don’t know where to start investing so they take the easiest route – they don’t invest.

That is the wrong way to think! Compound interest is one of the most powerful forces in the world, and over time, can make you a lot of money! Instead of leaving your money on the sidelines and not investing, put your money to work for you. Still don’t know where to start? Let’s take a look at how we can get beyond analysis paralysis and make progress toward our goals.

Spurring Action: How to get beyond Analysis Paralysis

I’m going to stick with the investing example, but I am going to apply principles you can use in other areas of life as well, including your personal life, finances, choosing an MBA program, career opportunities, business opportunities, etc. The following steps can help you narrow your options, eliminate the noise, and do the necessary research to take action.

Define Your Objectives

The first step in any process is to define your goals and objectives. You will find it difficult to measure progress and ensure you are on the right track if you don’t know where you are going. This principle applies to most topics, including investing.

Investing is a broad topic with many applications: invest for short term or long term, retirement, cash flow, wealth building, and more. The more specific you define your objectives, the easier it will be to reduce the noise and eliminate options that don’t meet your needs. Let’s use the example of retirement investing.

List and Categorize Your Options

Once your objectives are defined, you can easily narrow your options. List all the options that might apply to your objectives. At this point we’re not looking for in depth research; we only want to do enough to know whether or not the line item can meet our objective.

There are many investment vehicles, some of which are designed specifically for retirement. Make a list of all the retirement plan options you can find.

Eliminate Options

The next step is to remove the options that won’t help you reach your goals. Initially, you may find it easier to look for reasons an item doesn’t meet your objectives. Great! Do anything you can to make this step easier.

Look at your list of retirement plan options. If you created a thorough list, you probably have things listed such as self-employed retirement plans, Traditional and Roth IRAs, 401k plans, 403b plans, Thrift Savings Plan, etc. Cross any off the list that don’t meet your needs. If you are not self-employed, or are not eligible for some other retirement plan options because of contribution limits or because you don’t meet eligibility requirements, then you can eliminate those options from your list.

Research Your Options

By now you should have a reasonably short list of options that will help you reach your goals. This is where you will focus the majority of your time. Be organized and methodical with your research and list pros and cons to each option. You may also consider running a SWOT Analysis on your options to determine their strengths and weaknesses.

Going back to retirement investing, we can take a more in depth look at our retirement plan options and look for more information regarding which plan is best for our needs. Based on your situation you may have determined that you are not eligible for a deductible Traditional IRA, but you meet the Roth IRA income limits and you also have access to a 401k plan. If you can’t afford to contribute to both plans, then compare Roth IRAs and 401k plans and determine which is best for your investment needs.

Lights, Camera, ACTION!

If you have done a thorough job with these steps then you should have a clear objective, a list of viable options, and the research to back it up. You will also be well versed in your new topic and should know where to go should you need a backup plan.

Keep in mind that you may need to repeat this process more than once to reach your final goal. Let’s say you decided you wanted to invest in a Roth IRA. Once you make that decision you can repeat the process to find the best place to open an IRA, determine how to open an IRA, and then again to decide how to invest your funds.

The final step is to use your research to create an action plan and follow through with it.

Overcoming Analysis Paralysis

Sitting on the sidelines is great if you are watching a baseball game. But in real life you need to get out there and make things happen. Instead of letting too much information paralyze you into inaction, learn to focus on what is important. Define your goals, list your options, eliminate the noise, do more research, then choose the option that best meets your needs.

Analysis paralysis is a real and dangerous phenomena that can prevent you from achieving your goals. But it can also be avoided with some thoughtful planning and methodical action.

~$~

Related Articles:

1. Beginner Investing Strategies
2. Self-Employed Retirement Plans
3. What Are Your Financial Strengths and Weaknesses? Run a SWOT Analysis

Roth IRAs are a great investment tool for retirement planning. But there are certain rules regarding Roth IRA contribution limits that you need to be aware of. For example, contributing too much to a Roth IRA may subject you to additional fees (and unwanted attention from the IRS).

A common example is contributing too much to a Roth IRA based on your income level; the ability to contribute to a Roth IRA begins to phase out at higher income levels. Contribution limits decrease once your Modified Adjusted Gross Income (MAGI) rises above $105,000 for single filers and $167,000 for joint tax filers. You can no longer make Roth IRA contributions once your MAGI rises above $120,000 or $176,000 for joint filers.

Many people can easily plan around these contribution limits because they have a good idea what their income will be from year to year. But sometimes situations arise that make planning Roth IRA contributions a little more difficult. A raise or bonus can easily change the income qualification for some people.

Planning is essential, however, because contributing too much to your Roth IRA may subject you to a 6% excise tax if you don’t take care of the situation in a timely manner. Let’s look at some situations that could cause excess Roth IRA contributions, how you can effectively plan Roth IRA contributions and what to do if you contribute too much to your Roth IRA.

Ways you can contribute too much to your Roth IRA

Earning too much money to be eligible for Roth IRA contributions isn’t the only way you can contribute too much to your Roth IRA. You might, for example, have less earned income than your Roth IRA contribution. Another example could be contributing too much money to your Roth IRA by miscalculating your contributions or contributing too much across more than one IRA account. The IRS treats all IRAs as one account, which means the IRA contribution limits apply to both Roth and Traditional IRAs. (More information about handling multiple retirement accounts).

Planning Roth IRA Contributions

Getting your money in the game early is usually a great idea when investing, and many people like to contribute to their Roth IRAs early in the year so they have a longer period for their money to work for them. Some people prefer to make Roth IRA contributions throughout the year via dollar cost averaging. Both are great ways to make sure you get your money working for you and max out your Roth IRA contributions, if you know you will qualify for a Roth IRA.

Unfortunately, it isn’t always possible to know how much you will make in the course of a year, and some people may find that their income level exceeds the limit which allows them to contribute to a Roth IRA – only they don’t find this out until after they have made their Roth IRA contributions for the year. It might not seem like a big deal, but contributing too much to a Roth IRA can subject you to a 6% excise tax each year the funds remain in your account. Ouch! But don’t pay that tax just yet. This is a relatively easy fix.

Correcting Excess Roth IRA Contributions

According to the IRS Form 590, the 6% excise tax that applies to excess Roth IRA contributions can be avoided by withdrawing excess contributions or recharacterizing them as Traditional IRA contributions. Either action must be completed before the tax deadline, including extensions. There is a third option for correcting excess contributions, assigning your contribution to a future tax year. However, you may have to pay the 6% tax for the tax year your excess contribution is in your Roth IRA. More information about each option is below:

• Remove excess contributions. The 6% penalty tax can be avoided by withdrawing the excess contribution and any earnings or losses by the tax deadline, including tax filing extensions. Any earnings will be subjected to income taxes and a 10% early withdrawal penalty unless they are a qualified distribution (see Roth IRA withdrawal rules for more information).
• Recharacterize excess contributions as Traditional IRA contributions. Recharacterize is a nice word for “reclassify.” Basically, you can tell the IRS you wish to change the excess Roth IRA contributions to Traditional IRA contributions, assuming you qualify for a Traditional IRA.
• Apply excess contributions to a future tax year. You can apply excess Roth IRA contributions to a future tax year, provided the amount you apply to the future year is less than the maximum allowed for that year. The downside to this option is that you may have to pay the 6% tax for the current year.

Which option is best?

This is one situation where I recommend visiting a tax professional and working closely with your IRA custodian. Each individual will have a unique situation, so it is best to contact a tax professional who can offer you specific corrective actions based on your needs. In all cases you will want to resolve this problem before the tax filing deadline so you can hopefully avoid paying any fees or penalties.

~$~

Related Articles:

1. 2009 Traditional and Roth IRA Contribution Limits
2. 2010 Traditional and Roth IRA Contribution Limits
3. Increased 401k Contribution Limits in 2009

The Roth IRA is a great investment option that offers tax free growth and tax diversification, and is an important part of many people’s retirement planning. Unfortunately, things don’t always go as planned and you may need to make a withdrawal from your Roth IRA before you reach retirement age. Thankfully, the Roth IRA is also one of the most flexible retirement account options because you can make tax and penalty free withdrawals of your Roth IRA contributions at any time. However, it is important to understand when you can make withdrawals of your earnings, otherwise you may subject yourself to a 10% early withdrawal penalty.

Roth IRA withdrawal Rules

In general, you can make tax and penalty free withdrawals of the principle (contributions) at any time. However, the earnings from your principle cannot normally be withdrawn under age 59½ without paying the 10% early withdrawal penalty. Earnings can generally be withdrawn without penalties after age 59½, provided you meet the 5 year rule.

Roth IRA 5 year rule. Withdrawals from your Roth IRA will only be classified as qualified distributions if it has been at least 5 years since you first opened and contributed to your Roth IRA, regardless of your age when you opened it. As an example, you can normally make penalty free withdrawals at age 59½, but if you made your first contribution at age 58, you would need to wait until age 63 to withdraw any earnings made on that portion of your contributions.

There are exceptions to these rules. Read on to learn more about qualified and non-qualified distributions, and as always, consult with a financial professional if you have any questions before you make any withdrawals or distributions.

Roth IRA Qualified and Non-qualified Distributions

It is important to understand the difference between qualified and non-qualified distributions before making any withdrawals or taking distributions from your Roth IRA. Provided your it meets the 5 year rule, a qualified distribution from your Roth IRA will be both tax and penalty free, which is important because either of these can seriously erode any gains your investments may have earned. A non-qualified distribution may trigger both taxes and early withdrawal penalties, decimating the value of the investments in your Roth IRA.

Qualified distributions. Qualified distributions are withdrawals that are both tax and penalty free. In most cases, withdrawals made after age 59½ will be qualified distributions, provided they meet the 5 year rule for investment gains. According to IRS Publication 590:

A qualified distribution is any payment or distribution from your Roth IRA that meets the following requirements.

1. It is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for your benefit, and
2. The payment or distribution is:

• Made on or after the date you reach age 59½,
• Made because you are disabled,
• Made to a beneficiary or to your estate after your death, or
• One that meets the requirements listed under First home under Exceptions in chapter 1 (up to a $10,000 lifetime limit).

Non-qualified distributions. Non-qualified distributions are withdrawals which do not meet the requirements of a qualified distribution, and may be subjected to taxes or early withdrawal penalties. In many cases, non-qualified distributions will be taxed as ordinary income and be subjected to the 10% early withdrawal penalty.

Exceptions to early withdrawal penalty (aka 10% penalty)

There are some exceptions that allow you to make withdrawals from your Roth IRA that are subjected to ordinary income taxes, but are not subjected to the 10% early withdrawal penalty. Some of these include:

• The distributions are part of a series of substantially equal payments (minimum five years or until the Roth IRA owner reaches age 59½, whichever is longer).
• You have unreimbursed medical expenses exceeding 7.5% of your Adjusted Gross Income (AGI).
• You are paying medical insurance premiums after losing your job.
• The distributions are not more than your qualified higher education expenses (for yourself or eligible family members).
• The distribution is due to an IRS levy of the qualified plan.
• The distribution is a qualified reservist distribution.
• The distribution is a qualified disaster recovery assistance distribution.
• The distribution is a qualified recovery assistance distribution.

Order of Roth IRA Distributions

The IRS makes it easier for taxpayers to make penalty free withdrawals from their accounts by the way they assign the order of IRA withdrawals. Again, referring to IRS Publication 590, Roth IRA distributions occur in the following order:

1. Regular contributions.
2. Conversion and rollover contributions, on a first-in first-out basis.
3. Earnings on contributions.

As you can see, regular contributions are the first to be withdrawn, and they can be withdrawn at any time without taxes or penalties. The taxable portion of your withdrawals is held until the end, making it easier for you to make a penalty free withdrawal.

Roth IRA Withdrawals for first home purchase or college expenses

Roth IRAs have a feature that allows account holders to make qualified distributions for a first home purchase or for qualified college expenses.

First home purchase withdrawal from Roth IRA. Early Roth IRA withdrawals for the purchase of a first home are allowed up to a $10,000 life time maximum per account. Withdrawals can be made for the purchase of your first home, or the benefit can be used for your children or grandchildren. However, the $10,000 limit is always in effect, regardless of who the money is used for.

Using a Roth IRA for college expenses. You can avoid early withdrawal penalties associated with early Roth IRA distributions if you use the funds for qualified higher education expenses for yourself, your spouse, your children, or their descendants.

Pros and Cons of early Roth IRA withdrawals

The ability to make tax and penalty free withdrawals from Roth IRAs is a level of flexibility not found in most other retirement accounts. But just because you can do it doesn’t mean you should. Even though you may not pay any taxes or penalties to withdraw some of your funds, doing so may hurt your long term retirement planning.

Roth IRAs offer a great tax diversification strategy and making early withdrawals, qualified or not, hampers your retirement planning and limits the amount of money you will have in retirement. Compound interest is one of the most powerful forces in the universe, but making withdrawals limits the amount of money you have working for you and reduces the amount of time your money has to compound, effectively reducing your potential retirement nest egg. I recommend looking at all options before making early withdrawals from your Roth IRA.

~$~

Related Articles:

1. Comparing Roth IRA Versus Traditional IRA
2. The Real Cost of Withdrawing Retirement Funds Early
3. What if You Contribute Too Much to a Roth IRA?

TradeKing is currently offering a $100 Refer a Friend bonus to current members who refer new members to TradeKing. This is double the normal $50 Refer a Friend bonus. This offer is available now through February 11, 2010.

TradeKing $100 Referral Bonus Offer Details

This offer is only available as a referral from current members to new members. Here are the details you need to know:

• Clients must refer new accounts using the “Refer a Friend” dashboard accessed through their account at www.tradeking.com.
• The new referred client needs to fund their account with $1,000 and make a trade to qualify the account.
• You must have a regular investment (non-retirement) account, and you must leave the account open, with your referral money in there, for at least 6 months.
• Offer expires February 11, 2010.

How to send the referral

You must be a current TradeKing member to participate in this offer. Log on to your TradeKing account and scroll to the bottom right of the page. There you will see a box with the TradeKing Refer a Friend link. Click the link and enter e-mail addresses of your friends and family who you think may be interested in opening a TradeKing account. Be sure you have their permission (i.e. don’t spam people!).

Not yet a TradeKing member? Still time to participate

If you are not yet a TradeKing member, but would like to take advantage of this offer, then you will simply need to open a TradeKing account and start referring friends. Opening a TradeKing account takes about 10-15 minutes and requires all the standard information needed to open other financial accounts.

About TradeKing

TradeKing is one of the top online discount brokerage firms, and offers a flat $4.95 fee for online stock trades. TradeKing has won many industry awards, including the #1 overall discount broker award from Smart Money Magazine (The Wall Street Journal Magazine) in 2006 and 2007, and best in customer service in 2008. TradeKing received a a 4-star ranking in Barron’s 12th Annual Survey of Best Browser-Based Online Brokers. TradeKing was ranked second overall out of 15 web-based brokers for “usability” and “cost.”

TradeKing also offers free webinars and tutorials, free stock trading resources, free tax management software, a robust trading platform, an online community, and more. I have had a TradeKing account for almost two years now and I love the functionality and ease of use, as well as the inexpensive stock trades, which are some of the lowest in the industry. You can read more about TradeKing in the TradeKing Review that I wrote.

~$~

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I recently had one of my Prosper loans paid in full. I invested $125 with a borrower who wanted to borrow $24,000 to fully fund his SEP IRA, a retirement plan often used by small businesses and self-employed individuals.

Borrowing money to invest sounds risky, and it can be. But there are two interesting sides of this story, and I’ll share a little bit about the pros and cons of both sides – from a borrower’s and lender’s perspective. From there, you can make your own decisions regarding what you would do in either situation.

Note: Prosper is a peer to peer (P2P) lending company, in which people like you and I can fund loans for our peers (You can “be the bank”). Like many other investments, P2P loans are not guaranteed and there is associated risk.

Using leverage for investing

Using leverage to invest basically means borrowing money to make an investment. You are hoping that in the long run, you will be able to earn more money with your investment than you pay out in interest. A similar tactic is trading on margin, which is stock trading with borrowed money. But using leverage is not limited to stock trading; it can mean borrowing money to purchase a rental property, buy a business, or in this case, fully fund a self-employed retirement account.

Borrowing money to invest

Normally, I wouldn’t recommend borrowing money for investing unless you have a very good idea of the outcome. Personally, I wouldn’t trade stocks on margin because I’m not good enough at the stock market game to make short term trades with borrowed money.

However, there are some instances where it may not be a bad idea. For example, if you know what you are doing, then buying a rental property with borrowed money can be a great way to create a positive cash flow opportunity. The same thing can apply to buying a business with borrowed money and many other opportunities. But these situations are often less volatile than short term stock trading.

Should you borrow money to fully fund a retirement account?

As with any investment, there are risks. If you borrow money for retirement investing, or any other investing, you should have a clear idea of when you will be able to repay the loan, and limit the amount you borrow to be able to repay it as quickly as possible. Here are some pros and cons, with the negative possibilities listed first.

Cons. Investments are not guaranteed, and can lose value. Using borrowed funds to invest magnifies your potential for loss. Additionally, starting out by paying interest on the money used for your investments means you are starting in the hole and need to earn more money to break even. This last fact is mitigated by the long term nature of retirement investments, and the short term nature of the loan.

Pros. Many retirement contributions, including a SEP IRA contributions, are tax deferred, which means the contributor won’t pay taxes on those funds for that tax year. You also only have one shot at retirement investing each year – if you don’t make the investment before the contribution deadline, you can’t go back and put in money in for that tax year. A $24,000 contribution can substantially lower taxable income and save the borrower several thousand dollars the year the contribution is made, and maxing out his retirement plan gives more time for compound growth opportunity.

Why I lent money to fund a retirement account

Even though there is risk involved with this type of loan, I was intrigued enough to lend the borrower the money. Here is the purpose of loan, from the listing summary at Prosper:

I want to fully fund my SEP IRA. My company does not have a 401K and as such, a SEP-IRA is an excellent option. Particularly, I would like to make sure that I fully fund the SEP IRA for the pretax benefits.

The maximum contribution for SEP IRAs was $46,000 in 2008 when the loan was originated. The borrower needed $24,000 to fully fund his SEP IRA, which means he was able to fund $22,000 on his own. That gave me some confidence in his ability to pay off his loan. I also knew that he was employed in the software engineering industry, and I have seen some of the work he has done, which is impressive. Should he have lost his job, he would probably have been able to find work.

More borrower information. Prosper lists other financial information about borrowers, including their credit score, length of credit history, total number of open credit lines, amount of revolving credit, and more.

The borrower had an excellent credit score, a AA credit rating, a reasonable amount of debt, reasonable number of credit lines, owns his home, no delinquencies in the last 7 years, and other favorable information. In short, he looked like a good bet to pay off the loan in full.

More about the loan. The rate of the P2P loan was 9%, which offered much more opportunity for return than I would be able to receive from a standard savings account. The loan was paid in full this month, and in the almost 2 years it was open, I received just over $15 ROI ($140.57 on a $125 year loan). I would have earned more had the loan not been paid off early. While there are no perfect investments, I was satisfied with the amount of risk I took on and I am more than happy with the results.

My returns with P2P lending at Prosper. My average weighted yield from Prosper is 11.38%. Looking back, I should have seen that interest rates would continue to drop, and I wish I would have invested more money in this, and similar loans.

What are your thoughts?

Do you think taking out a 9% loan to fully fund a SEP IRA was a reasonable investment on the borrower’s side (note that he paid it off just over 1 year early, so he had confidence in his ability to repay the loan). What about from a lending perspective?

~$~

Related Articles:

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2. Pertuity Direct Review – a New Peer to Peer Lending Platform
3. Lending Club is Back; Prosper Goes Quiet

I recently rolled over a 401k plan from my former employer sponsored plan into a Rollover IRA at Vanguard. Rolling a 401k into an IRA is not a difficult process, but it does take a little time and preparation.

I put together this visual guide to walk you through the process of doing a 401k rollover into an IRA. Though this tutorial shows how to do it at Vanguard, the process should be fairly similar at other brokerages or financial institutions. I chose Vanguard because I have been with them for the better part of a decade and I prefer to keep my accounts as consolidated as possible.

Choose the best IRA custodian for your needs. You don’t have to go with Vanguard; there are many institutions that can serve as your IRA custodian. Here are more tips on How to Open an IRA, Where to Open an IRA, and What to Look For When Opening an IRA.

Deciding to rollover a 401k into an IRA

The first thing you need to do is decide if you should rollover a 401k into an IRA. You can typically only do a 401k rollover after you are no longer employed by the company that sponsored the plan [Some people over age 59½ may be eligible for an In Service 401k Distribution and do a 401k Rollover while they are still working].

In many cases a rollover is a good idea because it gives you complete control over how and where you invest your assets, while many 401k plans have more limited investment options. There are other options for your 401k than a Rollover IRA, so be sure to investigate the options for your 401k when you leave your job.

Once you decide to go with a Rollover IRA, you will need to open a Rollover IRA. At Vanguard you can open a Rollover IRA and complete most of the process online, you can download an IRA transfer kit and fill it our by hand, or you can call their customer service department for assistance. The Vanguard CS department is among the best I have dealt with and they walked me through the entire process on the Vanguard website, then did a conference call with my 401k custodian and myself to complete the transfer. The process took about 30 minutes, start to finish.

How to Rollover a 401k into an IRA at Vanguard

The basic process is simple, open a Rollover IRA, then transfer in your funds to the Rollover IRA. Of course, there are a few more details, which we will cover. Before you get started with Vanguard you will want to contact your current 401k plan custodian to determine how to initiate a transfer to another custodian. Some companies require several signed forms, while the company I transferred my account from would only release the funds via a phone call (and the requisite security questions). Armed with this information, you are ready to start the transfer process.

Step 1: Rollover IRA Funding Method

Once you log on to your Vanguard account or open a new account, you can start the process. The first bit of information Vanguard needs is an approximate amount of your Rollover IRA transfer, whether or not it is a Roth 401k, and the location of the funds (e.g. are they still in your 401k plan, or have you received a check for the funds).

The answer to the location of your funds will alter the process slightly; if you have already received a check you won’t need to involve the former custodian. However, you will have to handle more paperwork on your end and you run the risk of early withdrawal penalties if you fail to make the rollover transfer in time. Personally, I think there is less risk by having the financial institutions complete the transaction without sending you the liquidated funds.

The next step is to inform Vanguard what information your current 401k custodian requires to complete the transfer. The current options are shown below. My former custodian required the following information: Rollover IRA account number, who to make the check out to, and the address. If you don’t know what your current plan requirements are, the Vanguard customer service reps or the customer services reps at your current custodian should be able to give you this information.

Step 2: Select Your Investments

This is where you choose how you want to allocate your rollover funds. It’s a good idea to know which type of fund you want to invest in before starting the 401k rollover process or transferring your funds. That way you don’t get your asset allocation out of whack, and you won’t have to spend an hour trying to decide on which fund to invest in.

If you aren’t sure which type of fund is best for you right away, then consider rolling your funds into the Vanguard Prime Money Market Fund, or a similar low risk fund until the transfer is complete and you have more time to do a full asset allocation. You can choose additional Vanguard mutual funds once your account is open. (If you are doing this process at another mutual fund house or online brokerage, then consider an equivalent to the Vanguard Money Market fund, at least until you have time to rebalance your investment portfolio).

Step 3: Account Information

If you are already a Vanguard customer, this part is easy, as you can log in at the beginning of the 401k Rollover process and your information will be auto populated. If you do not already have a Vanguard account you will need to open one at that time. It’s been 7 or 8 years since I opened my Vanguard account, so I can’t tell you how long it will take. But based on other accounts I have opened recently, it shouldn’t be more than an extra 10-15 minutes.

Step 4: Review Your New Rollover IRA Account

The final step is a standard review and finalization process. You should go over your information to verify accuracy, electronically sign or print your application to sign it and send it in, and designate your beneficiary. The beneficiary is automatically set by law if you decline to specify anyone different.

Even though I already have a Vanguard account I was prompted to input my address for verification, but all other information was auto populated.

Not using Vanguard?

I wrote this review for rolling a 401k into an IRA at Vanguard because I have had an investment account with them for almost a decade. Most major financial institutions should have a similar process, though it may differ in some ways. Choose the financial institution you are most comfortable with and that best suits your needs, then call their customer service if you have any issues.

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Related Articles:

1. How to Rollover a 401k Plan into an IRA
2. Should You Rollover a 401k into an IRA?
3. How to Open a Roth IRA and What to Look for in a Custodian

Graduating college and entering the “real world” is an exciting and sometimes stressful time – you start your first job and begin an independent life in all respects, including handling all things financial. Most colleges don’t require any financial courses, and it’s not always easy to understand the how’s and why’s of investing, even if you understand many of the basics.

I received the following question from a recent college grad who is looking for more information about his retirement plan options:

I am a 22 year old recent grad and have been confused on what IRA to invest in given my situation. I have a 401k plan with my employer which isn’t active until January 2010. My salary is $60,000 however I started in September so it will be much less maybe $30,000. I want to put my money in a retirement fund. The traditional IRA will give me a tax deduction. However, for the 2010 year, I will have a 401k. I wanted to have a Roth as well… that’s three different retirement funds. Is that too many/diversified? So many options… and which funds should I pick for my 401k, traditional, Roth and in what combination?

Thank you, Joseph

Great question, Joseph. You’ve got several great things going for you right now, and it’s good to see you taking advantage of your opportunities while you are young. $60,000 is a very respectable salary, and with good financial management, you should be able to put yourself in a favorable financial position. Let’s look at a couple of your options.

Retirement plan options – 401k, Traditional IRA, and Roth IRA

These three options are the most commonly available tax advantaged retirement plan options for most people (or the non-profit 403b or government Thrift Savings Plan in lieu of the 401k). Before we go further, let’s give a quick explanation:

• 401k, 403B, TSP: Contributions are tax deductible in current year and are taxed when withdrawn in retirement.
• Traditional IRA: Contributions are tax deductible in current year and are taxed when withdrawn in retirement.
• Roth IRA: Contributions are not tax deductible in current year and are not taxed when withdrawn in retirement.

There are a few things to keep in mind – early withdrawal penalties and income and contribution limits, [see Traditional and Roth IRA contribution limits and Traditional IRA Account Rules for more information]. Tax advantaged retirement plans have specific rules regarding when you can make withdrawals, and there are contribution limits and income limits for some of these plans, which may affect your eligibility.

Benefits of tax diversification in retirement plans

One of the advantages of opening a 401k or Traditional IRA is the tax deduction you can receive the year you earn the money. The money is contributed before taxes have been assessed and will grow without the drag of taxes until you withdraw it in retirement (assuming you don’t withdraw it early; see the link above regarding penalties).

Roth IRAs offer a different advantage – you pay taxes on the money now, the money will grow without the drag of taxes until it is withdrawn, and you will not pay any taxes when you withdraw it. So you pay taxes now for the benefit of not paying taxes later.

Having contributions in both types of plans will diversify your tax bill both now and in retirement, potentially giving you more flexibility in retirement.

Traditional or Roth IRA for young investors?

There are several good reasons why young people should consider a Roth IRA. Let’s start with taxes. Most younger folks are earning less now than they will be when their careers progress, so they are probably in a lower tax bracket now than they will be later in their careers. So the benefit is paying taxes now at a lower rate and being able to make tax free withdrawals in retirement when their tax rate may be higher. Another factor to consider is the unknown – we simply cannot predict what taxes will look like when we retire. Many people speculate that taxes will rise, and a Roth IRA provides a hedge against future tax rates because they offer tax exempt withdrawals. There are a couple other benefits as well, including being able to make penalty free early withdrawals under certain circumstances and no minimum distribution requirement, which is found with Traditional IRAs.

The main advantage of using a Traditional IRA is the tax break offered now, which can help reduce your tax bill. But this benefit is also available with a 401k plan. A Roth offers the other side of the tax equation, which helps with tax diversification. Here is a Roth IRA and Traditional IRA comparison for more information about how the plans differ.

How many retirement plans can you have?

This is a common question, and the answer is – it varies. There is nothing wrong with opening a Traditional IRA and a Roth IRA and a 401k plan. You can even open multiple IRAs, and if you change companies, you can have more than one 401k plan. But having multiple retirement accounts makes it more difficult to track your accounts and maintain an asset allocation that meets your needs. The best way to go is to open only the minimum number of accounts necessary to meet your needs. You may be able to consolidate retirement plans if you change jobs or need to open another retirement account. [See How Many Retirement Accounts Can You Have? for more information about multiple retirement accounts].

Which funds, how should you invest, and where?

This is something I can’t answer directly. The best answer I can give is that you should invest based on your needs and risk tolerance. To start with you will need to define your investment goals, then determine your risk tolerance. From there, you can settle upon an asset allocation that you are comfortable with. *Note 401k plans and IRAs are vehicles for investments, they are not investments themselves. You can read more about this here: Where Do You Get the Best Roth IRA Rates?.

Where to open your IRA. You will open your 401k plan through your employer and fund it via payroll deductions. You will need to open your IRA through a qualified custodian, which could include an independent financial advisor, a bank, a discount brokerage firm, or a mutual fund house. Here is more information about how to open an IRA, and some of the best places to open an IRA.

Finally, I should offer this last reference article: Where Should You Invest First – 401(k) or IRA? This article covers how to maximize your retirement contributions to receive the max employer match and maximize your IRA contributions, should you decide to go with a Roth.

There is no right or wrong way to go

I hope you have a better idea of your options after reading this article and the reference articles. As you can see, these plans offer many different advantages, disadvantages, and variables. In the end, you will need to go with the plans and investments that best meet your needs and your risk tolerance. I recommend speaking with a professional, reading other sources, and thinking about your specific goals and needs. Best of luck, and congratulations on getting off to such a great start!

Readers – do you have any tips or comments to add?

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Related Articles:

1. 2009 Traditional and Roth IRA Contribution Limits
2. 2010 Traditional and Roth IRA Contribution Limits
3. Comparing Roth IRA Versus Traditional IRA