Investing can seem so complicated that some people just shut down and do nothing — or hire an advisor to guide them. This guide helps cut through the confusion, no matter what your investment experience is.
Back to basics: What is a 401(k) and what’s a Roth IRA?
If you are a regular listener or viewer, you hear me talk about both Roth IRA accounts and 401(k)s a lot. The purpose of both is to give you your earnings a tax break to save for your future.
- A traditional 401(k) is a retirement savings plan through work that allows you to invest money now, and defer paying income taxes on the saved money (and earnings) until withdrawal, which is ideally when you retire.
- A Roth IRA is a modified individual retirement account in which a person can set aside after-tax income up to $5,500 per year ($6,500 for those age 50 or older). Earnings on the account are tax-free, and tax-free withdrawals may be made after age 591/2. This tax-free status beats just about everything. And best of all, you can set up a Roth account yourself. I’ll show you how.
Where do you put your 401(k) money?
If you work for an employer who provides a 401(k), you get to deduct a set amount from your paycheck each time you are paid. This money is then directed into your 401(k) to be invested for your future.
There are a lot of 401(k) plan administrators out there that companies could work with. Vanguard, Fidelity and T. Rowe Price are a few of the ones I like. All three offer low management fees so more of your money can go to work for you, not them.
Unfortunately, there’s not much you can do to get your employer to work with another plan administrator. You’re basically stuck with whatever they’ve got. That’s why it make sense only to contribute to your 401(k) up to the company match and then to fund a Roth IRA yourself separate from work…
Where do you put Roth money?
Unlike a 401(k), you get to pick where you stash your Roth cash. And you can do so just about anywhere you want: At a bank; credit union; full-commission stock broker; financial planner; in no-load mutual funds (a fund sold without commission) or with a discount stock broker.
When you are young, I like for you to put the money with a discount broker or a no-load mutual fund. That’s because I want all your money working for you!
Roths are really flexible depending on which company you choose to put your money into. You can start with as little as $100 with some companies, or $500 or $1,000 with others.
(Here are some of my favorite low-cost investment options, broken down by the dollar amount you need to get started. )
Special considerations for the self-employed
If you are an entrepreneur, I’d like for you to consider opening up a simplified employee pension (SEP).
The paperwork to set up a SEP is simple, and you can typically open it wherever you want — at a low-cost investment house like Vanguard, for example — at no cost.
SEPs work like a traditional IRA or a 401(k), with a current year tax deduction, but withdrawals are taxed at retirement. They also offer flexibility, in that you can put in nothing in a year or as much as $55,000. That can be really helpful during the feast or famine years when you’re launching a business.
Dollar cost averaging
No matter which route you choose, my goal for you is to have an automatic deal where you put in a set amount of money each month to build the habit and reduce the risk to you.
By making regular contributions monthly in equal amounts, you are doing what’s called “dollar cost averaging.” That’s just a fancy way of saying that in months when the stock market is tanking, your money buys more shares. Though in months that the market is climbing, your money buys a smaller number of shares.
In other words, dollar cost averaging is a way to pace your investing so that you’re buying more shares when prices are low and fewer when they’re high. Over time, putting money in this way reduces the possibility of panic in you and keeps you steady as you go. And staying in the game makes you more money over the long haul.
Investment Guide for all experience levels:
I hear from a lot of people who have the first part down, as in the discipline of saving money. But they are lost on the second part — where to put the money and what to put it in.
On my investment guide choice list, I show a number of my favorite investments that could lose money in the short-term, but make big bucks long-term. Based on your level of investment knowledge, pick one of the following guides…
The EASY guide is for beginners, or those who want to “set it and forget it.”
The MEDIUM guide is for intermediate investors, requiring more involvement.
The ADVANCED guide is designed for the most experienced investors.