In this article, we’ll explain that mistake and what you can do to avoid it.
Avoid This Mistake With Your Traditional or Roth IRA
Many people are making a simple error when they fund their brokerage accounts: They’re leaving their funds in a temporary settlement account and not taking the additional step of actually investing the money.
When you open an account, it should follow a predictable pattern: You open the account, you fund the account and then you choose your investments.
It’s that last step (shown on the right in the image below) that people are forgetting!
Understanding the Problem
When you open a brokerage account, the money you transfer to the account “lives” in a settlement fund until you choose to put it into this investment or that.
But what if you never select any investment?
Your money sits there, earning paltry interest in a settlement fund, while it could be earning bigger bucks in the stock market.
That’s the very mistake too many people make. They’re transfer money to their newly-opened brokerage account and think they’ve done everything they need to do.
In reality, that settlement account where your money lives at the brokerage is intended to be just a pit stop.
You’ve got to choose a final destination for your money. And money expert Clark Howard has a place where he likes for you to start.
“Even if it’s not your thing, I like for you to put the money in a target date retirement fund closest in year to when you want to retire. That way your money is invested from the get-go. If you later want to do something more exotic with how your money is invested, then you can do it.”
For a complete understanding of how target date retirement funds work, see this article.
How Bad of a Problem Is This Really?
Here’s an example: Let’s say that you contributed $10,000 to a brokerage account 10 years ago.
If that money went into your settlement fund and sat there, never being invested, over a period of 10 years, it would earn just a little more than $300.
Let’s say you took that same $10,000, sent it to your brokerage and actually picked an investment like an S&P 500 index for the money.
According to research from Charles Schwab, that money would be worth somewhere between $16,000 and $30,000 today.
So don’t make the rookie mistake of funding a traditional or Roth IRA or any other investment account but then not selecting a specific investment for the money to flow into.
How Can You Tell if You’re Making This Simple Mistake?
Now that you know what the #1 mistake people make when opening an investment account is, it’s time to check your account.
To do that, just log in to your brokerage account online and check the dashboard for something that looks like this…
This particular example is from a Vanguard brokerage account. As you can see, there’s about $20 in a settlement fund earning next to nothing.
OK, so $20 may not be a huge deal. But for you, it could be a problem of thousands of dollars sitting there!
If you’re not comfortable checking your account online, you could always call up your brokerage house and ask if you have any money hanging out in a settlement fund.
Here’s some contact information to get you started:
Opening an investment account but not actually picking any investments is a big danger for first-time investors. But you can avoid this common pitfall by taking a moment to make sure that your money is not sitting in a settlement fund.
If you need help picking low-cost places to invest your savings, check out our recommendations here.