Investing Your Summer Earnings

My summer internship should net $5,000 but I don't want it to sit in a savings account. What are my investment options?

QUESTION: I just finished my freshman year of college and am working at my first internship this summer. By the end of the season, I'll have somewhere around $5,000. I don't want it to sit in a savings account. What is the best option for someone in my situation? I'll be using this money to get started after college, which should be in another four years.

ANSWER:

Before you get started, however, you should investigate whether your summer earnings are entirely yours to do with as you please. Unfortunately, if you receive financial aid, such income can affect your package, warns CFP Mari Adam of Boca Raton, Fla. Worst-case scenario: You may be asked to chip in some of your summer salary, but probably no more than 35%.

Even if you have to share your earnings with the financial-aid office, you should still have some money available to invest. And while we realize that you plan to invest this money for the short term (i.e., graduation in four years), bear with us while we make the argument that you might want to extend that investment horizon by, oh, 40 years or so. Investing at least some of that money in a Roth IRA could have dramatic effects on your retirement, says McKinley. Retirement is probably not your top concern right now, but consider this: A 25-year-old who invests $1,000 a year for 40 years with a 10% annualized return would have more than $536,000 by age 65. And if you begin now, your scenario could be even rosier, says Adam.

If you salt this summer's earnings away in an IRA, chances are you'll still have plenty of cash to help you launch your postcollege career if you continue to work over the next two or three summers. And if not, keep in mind that with a Roth IRA, you always can withdraw your contributions without additional taxes or penalty. In fact, even the earnings can be withdrawn without penalty (although you would owe taxes) if you use the money for college expenses such as tuition, fees and books -- or for graduate school. You could even use it to buy your first home. Of course, we always recommend that you don't tap your IRA accounts prematurely except for a real emergency.

If you do decide to go the IRA route, at least part of that account should be invested in a large-cap stock fund. In fact, since you wouldn't have much of a portfolio outside of your IRA, you could even consider a solid index fund like Vanguard 500 (VFINX). (Since index funds tend to be naturally tax efficient, we often recommend that you hold them outside retirement accounts.)

So what should you do with what you don't invest in the Roth IRA? That depends on your tolerance for risk. No matter what, given your relatively short investment horizon until graduation, you should invest at least part of that money conservatively. You could, for example, put it in a money-market mutual fund. These safe accounts carry an average 30-day yield of 3.41%. That might not sound like much, but it's more than you'll get with a savings account at a local bank. Another conservative option is a short-term bond fund (30-day yield of 5.01%), says Adam, or possibly an ultra-short bond fund (30-day yield of 4.74%).

If you're willing to be a bit more aggressive, consider a balanced fund, which buys both stocks and bonds. And if you think might be able to stretch your investment horizon to a minimum of four to five years, you might even consider launching a well-diversified portfolio of funds, says Lincoln, Neb.-based CFP Bob FitzSimmons. First, he recommends putting at least $1,000 in a zero-coupon bond scheduled to mature in three or four years. These bonds, purchased through brokers and other financial institutions, don't pay out interest annually, but instead deliver their face value plus interest on a certain date. The remainder of your cash could be split between a large-cap value fund and a large-cap growth fund, and possibly a small-cap portfolio -- depending on how much you want to spread around that $4,000. If you're willing to carve up your portfolio even further, add an international fund for overseas exposure.

If you do decide to go with the multipronged approach, Adam suggests you open an account at a firm such as Fidelity, Schwab or Vanguard. That way you can have a money-market account with check-writing abilities, and can also begin purchasing funds -- in or out of a retirement account. "This is not just about where to put your money," Adam emphasizes, "but how to get some money savvy."