More than any other topic, people seem to be totally befuddled by investing – especially people who’ve never tried it! Investing is actually far easier than most in the financial industry want people to believe. Everything I’m about to suggest can be done alone and without the help of a paid financial advisor!
When it comes to investing, there are really two questions: First, where to invest and, second, in what? I take a stab at the first question here. Check out this post for more info on “in what” to invest.
Where to invest? for almost everyone, in just three places: a work-sponsored retirement plan, a Individual Retirement Account (IRA), and a “taxable brokerage account” (which is just a way of saying, not in a retirement plan or IRA). There are other options – like permanent life insurance policies – but they’re only really meant for the wealthiest of us.
Investors contribute to these accounts and then invest in mutual funds, ETFs, stocks, and so on. These accounts are not investments themselves – they are places to hold investments.
I think of retirement plans and IRAs like “bubbles” that shield investments from taxes. Taxes on investments cost a typical investor about 1% of growth every year, which might not seem like much but can turn into “lost” hundreds of thousands or millions of dollars at retirement. So, to finally answer the “where” question, we suggest this order of contributions:
1. If your 401k (or similar work plan) offers an employer match, contribute up to that match. Let’s say the match is 3% if you contribute 6% of your salary. If you make $50,000 a year, that means your employer is giving you a free $1,500 for every $3,000 you put in. That’s an automatic, risk-free gain of 50%. Literally nothing in the market can compete with that, so this is a “no brainer” – even for people who need that money now! The gain is so high that they are better off contributing, receiving the match, and then pulling out the funds now vs. not contributing at all. Of course, it is even better to leave the money there to avoid penalties and witness investment growth.
2. After contributing to the match in the 401k (or if there is no match), try to max out an IRA. For most people, I suggest a Roth IRA because more people qualify, they are more flexible if you need to pull money out, and they are a hedge against increased tax rates in the future.
3. Not many people make it this far: maxing out the employer match plus an IRA is usually close to $10,000 a year and not many people invest that much every year. If you have the extra cash, the question now is to consider your goals. Are you trying to save for a big purchase, like a down payment for a house? If so, save into a taxable brokerage account so avoid early withdrawal penalties from a 401k or IRA. If you’re not saving for anything, go ahead and contribute more to the 401k.
4. Even fewer people max out a 401k and an IRA (that’s $23,500 a year in 2017 for people younger than 50). If you have reached this point, great! Consider contributing to a taxable account, or some other options like a Health Savings Account, 529 Plan, or, if you’ve really got a lot of income, a permanent life insurance policy.
Have more questions? Contact here at Nothing Funny About Money and we’ll help you get things going!