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Special section Save more, spend less in '07

Jump-start a savings plan to create an IRA.

Dr. Don Taylor, CFA, Bankrate.com advice columnistInvesting for the future

Dear Dr. Don,
I am 24 years old. After getting my finances in order, I found out that I have $400 extra every month. I opened a savings account, but the interest rate keeps dropping by a tenth of a percent every month. Are there any other options that guarantee a more stable and maybe higher interest rate until I can afford investing in stocks and bonds?
Thank you,
Duo Debut

Dear Duo,
Congratulations on getting your finances organized to the point where you can put a line item in your monthly budget to invest for your future.

Start out by building an emergency fund. Most financial planners recommend that you keep three to six months of living expenses in liquid investments so you can ride out financial emergencies. Ideally, you'll never need this money, so it seems shortsighted to keep it in low-yielding investments such as a savings account, but liquidity, not return, is the most important attribute for this investment.

While you're funding this account, you have time to think about what financial goals you're working toward. Most people in their 20s are more focused on financing homes and cars than they are on funding their retirement accounts. Try to find a balance when investing for your short-term, intermediate-term and long-term financial goals. The money you save in your 20s for retirement has 30 or 40 years to grow, making it easier to reach your financial goals for retirement.

If your employer offers a full or partial match in the company's 401(k) plan, you should look at investing at least up to the limits of the company match. Funding an IRA account, assuming you meet eligibility requirements, can give you some flexibility on financial goals, since you may be able to withdraw up to $10,000 from the account without penalty, using the account's first-time home buyer provisions.

Once your emergency fund is in place, you're ready to consider stocks and bonds. In general, the longer your investment horizon, the more risk you can accept when you invest. Be more conservative in investing for short-term and intermediate-term goals, and be willing to accept more risk (stocks and bonds) when investing for long-term goals such as retirement.

Starting out, I think it's better to concentrate investments in diversified mutual funds rather than diversifying investments in concentrated funds. Look at indexed stock and bond mutual funds. Keep an eye on annual-expense ratios, and especially for these diversified funds, avoid mutual funds with sales loads. Indexfunds.com provides a nice primer on investing in index funds.

Don't ignore certificates of deposit and savings bonds for shorter-term investments. You can shop CD rates on Bankrate and learn all about Series EE and the inflation-indexed Series I savings bonds on the Bureau of Public Debt's Web site.

The savings bonds now have a minimum holding period of one year and won't meet your liquidity needs in the emergency fund. CDs have interest penalties for early withdrawal but can be an investment alternative in an emergency fund.

To ask a question of Dr. Don, go to the "Ask the Experts" page and select one of these topics: "Financing a home," "Saving & investing" or "money."

Bankrate.com's corrections policy -- Updated: Dec. 29, 2006
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