- I’m a latecomer when it comes to money, and I was embarrassed to ask basic questions.
- But I finally had the courage to ask the financial planners things, what’s wrong with APY?
- I also asked how 401(k)s actually work and if it’s too late to start saving for retirement.
When it comes to personal finance, I consider myself a latecomer. As someone who never took a finance course in school (I was an English student) and wasn’t educated much by the people around me, I spent the beginning of 30s trying to learn as much as possible from books and financial experts.
Despite all my research, however, there are still some questions I was embarrassed to ask, mostly because I felt I should have known the answers by now. But I finally decided that, in the interest of achieving my financial goals, it was time. So here are the answers to a few money questions I’m embarrassed I didn’t ask sooner.
1. How does a 401(k) actually work?
At most companies I worked for before I became independent, I was hesitant to open a 401(k) and invest. The main reason I didn’t was because I didn’t understand how a 401(k) works – and I’m still not very clear.
I asked the financial planner Jay Zigmont to explain it to me: He said that a 401(k) is a specific type of retirement account that your employer may offer. Usually, you have two choices: you can save money in a 401(k) before tax (traditional) or after tax (Roth); sometimes you may have the option of doing both.
If you contribute to your 401(k) before tax, you get a tax deduction now, but pay income taxes when you withdraw the money in retirement. If you contribute after tax, you pay taxes now, but are tax exempt in retirement.
“Remember that a 401(k) is just an account and you actually have to invest the money in the account after you add it,” Zigmont said.
2. How much debt is too much?
One of the biggest regrets I’ve had since I was 20 is how much debt I’ve taken on due to bad spending habits.
Even though I’m more strategic now about how I save my money, I know that one day I’ll probably find myself in debt again (whether it’s because of a big purchase or a fleeting emergency, I don’t don’t have the money for funds). It made me wonder how much debt is too much debt.
Financial planner Kendall Clayborne shared that a good rule of thumb is to generally try to keep the amount of debt payments you have below 36% of your income, but every situation is different.
“It’s important to prioritize good and bad debt,” Clayborne said. “The idea is that we want to avoid ‘bad’ debt, meaning anything with high interest rates.”
This type of debt can include things like credit card debt or personal loans. In these cases, it is best to prioritize paying off that debt as soon as possible. Debt like a mortgage is considered “good” debt, since interest rates are usually quite low and the debt funds an asset (ie your home).
3. If I haven’t saved for retirement yet, is it too late to start?
For most of my 20s, saving for retirement was at the bottom of my to-do list. It’s only been a few years since I started putting money into a SEP IRA, and it made me wonder if it’s already too late to reach a substantial retirement goal.
Financial planner Evon Mendrin says It’s never too late to save for retirement. However, it’s important to start as soon as possible, and it might require spending adjustments today to start saving more for tomorrow.
“Retirement security involves many variables, including savings, the amount of assets, sources of income like Social Security and pensions, and most importantly, your expenses,” Mendrin said.
He said that for those who feel they are behind on saving for retirement, their goals might just need to be adjusted.
“For example, expense adjustments, part-time work, or completely postponing retirement timing,” Mendrin said.
Use Insider’s calculator to see if you’re on track for a comfortable retirement by answering a few questions about yourself, your savings, and how long you plan to keep working.
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*Need is based on coverage of 70% of your annual pre-retirement income and a life expectancy of 100 years.
4. What is compound interest and how does it work?
When it comes to personal finance, one of the most important things that so many friends and family members often tell me is to care about the power of compound interest. Although I have a general understanding of what it is, I was curious to see how it actually works.
Clayborne broke it down for me: compound interest is the interest you earn on your interest.
For example, if you have $10,000 and it earns 5% interest every year, that turns into $10,500 at the end of the first year and $11,025 at the end of the second year. The extra $25 would be the interest you earned on that extra $500.
“It may not seem like much, but over the course of 30 years, your $10,000 would turn into $43,219.42 due to compound interest,” says Clayborne.
5. What’s wrong with APY?
For the past few years I’ve tried to be smart with the savings accounts and CDs I put my money in so the money can grow as much as possible. I often search for the bank that offers the best Annual Percentage Yield (or APY), but when I sat down to think about that phrase, I found myself confused.
Financial planner Tracy Sherwood explained to me that the APY is the annual interest rate that your money earns and that rate is factored into compounding, or how often you will earn interest not only on your principal, but also on the interest you have earned so far this year.
“You earn a stated interest rate on your deposit or savings account and they specify how often they compound interest, such as daily, monthly, or annually,” Sherwood said. “The more compound interest, the better.”
A helpful tip shared by Sherwood was that when you compare savings accounts, some may offer a higher introductory rate or incentive for the first six months, but then drop it lower than other banks thereafter. . Be sure to check what that rate is after this deal ends.