Overview: There are lots of fantastic options for investing for retirement. Always start with tax deferred options like a 401(k) or IRA. Max out those accounts before looking at more creative options like a taxable brokerage account. Pay off high interest consumer debt like credit cards with 20% interest. Doing so is an immediate 20% return on investment. Finally, don’t overlook the value of a Roth IRA or even an HSA.
Once you’ve included a spouse or significant other to help write down your investing goals, put your financial house in order, and finalized your plan to start investing, the next question is: Where to invest?
Where to invest
These may not apply to everyone, but the farther down the list you can go, the faster you can accumulate what you need for retirement. A good goal is to save 20% of your monthly income for retirement.
0) Emergency Fund Have a steady amount of cash ready to help you out in times when you’ll need it most. Once your taxable account has grown to at least twice the size of your emergency fund, consider cutting your emergency fund down.
1) 401(k) Match The best place to start investing is in a sponsored plan at work up to what an employer will match. If you have a 401(k) with a match of 5%, by not putting in 5% you are losing out on free money.
2) Consumer/High Rate Debt After the free money, get rid of any high interest consumer debt like credit card balances. Get serious about dumping all of the 8% – 30% interest you are paying on short term loans and credit cards.
3) HSA If you qualify for an Health Savings account with a high-deductible insurance plan, max that out next. These are called “Stealth IRA’s” by many, because they have a lot of benefits. Many employers contribute to these as well, so it’s not too hard to max out.
4) 401(k) and IRA Investment choices tend to be a bit better in IRA’s than they do in company sponsored 401(k)s, so if that’s the case, aim to max out an IRA and a spouse’s IRA next. Conversely, some 401(k) plans have fantastic funds at very low institutional expense ratios, like 0.01% fees. If that’s true, load up on that account first.
There is always the debate about Traditional vs Roth contributions when it comes to 401(k)s and IRA’s. There is always a correct answer based on math, tax rates, and knowing the future. However, behaviors and opinions can weigh just as heavily on what we do as what a spreadsheet will tell us to do. Do the math, via TurboTax or some tax planning software, and see where the best answer fits.
Generally, with a high income, it’s best to save on taxes by contributing to a Traditional source. That way, high marginal taxes are deferred, and then never paid if withdrawn in retirement in a much lower tax bracket. This isn’t always the case: High earners with a pension may want to contribute to a Roth source because the pension will put them in a higher tax bracket in retirement.
Generally, with a modest income, Traditional sources work best based on tax credits, as Harry Sit explains here.
If you are in between a modest and a high income, Roth vs Traditional gets tougher, and tax planning software can tell which source is best for each year going forward.
Roth investments are great because once contributed, they are tax free. A more advanced post can discuss the Roth conversion ladder, where you convert 401(k) and IRA money into a Roth while in low tax brackets near or after retirement. Another, less advanced topic is the Backdoor Roth, a must for high income earners.
The 401(k) has high contribution limits, so it’s a great account to save in, no matter what your income level is.
5) Moderate Rate Debt With your retirement accounts mostly funded, look to pay off higher interest loans like on cars, student loans, or a high rate mortgage (or refinance it). Depending on how debt adverse you are, you may want to move this higher up the list, but honestly, these loans will pay off eventually, but time is on your side when funding accounts for retirement.
6) After Tax 401(k) Circle back to your 401(k) if you have more money to invest, making after-tax contributions to your 401(k) if your work plan allows them.
7) Taxable Account Open a taxable account at a broker like Vanguard or Fidelity. Taxable accounts often get a bad rap because they sound bad: “Taxable!” but really, they offer so much flexibility and have a lot of advantages over retirement accounts. They enjoy no early withdrawal penalties, no RMD’s, and lower capital gains tax rates, to name just a few. Use this account to save for retirement and other goals.
8) Low Rate Debt/Mortgage This is where I would pay extra toward a low interest rate mortgage, if you have one, or a low rate car loan. If it’s just a couple percent, I personally think you are better off investing your money before paying these off early. Again, you can always pay down your loans, but you can never go back in time to reap the rewards of compound interest by investing early in retirement accounts. Paying off low interest debt may feel good, but realize that you are trading a lot of future money to do so. It’s a personal choice, but make sure you realize the trade offs for paying extra on a low rate mortgage instead of saving more for retirement.
9) Real estate and rental properties Finally, property would be a good option after all your retirement accounts are fully funded. Rental properties are great for passive income and can act as a diversifier for the money you have invested in the stock market.
10) Build up reserves When you get to this level, I think it’s wise to have lots of liquid assets. Come back to the taxable account and start putting extra money into it. I Bonds are another good option (So good, the government limits how much can be purchased). Save money to be able to buy that next rental property, family vacation to Europe, cabin in the mountains, or whatever. This would be the cash/assets to have for jumping on the next investment opportunity or spending money.
The internet is full of opinions, mine included. This zero through ten order might sound crazy. That’s okay. Don’t take my word for it, do your own research and work a plan that works for you. In the end, it’s better to do something, than nothing at all (except maybe get suckered into buying a whole life insurance policy. Don’t do that.).