What’s the best way to start investing in 2021? How should you choose what types of accounts to save your money in first?
Retirement will be here before you know it. Let’s begin preparing now!
Let’s start with tax advantaged retirement accounts. The most common are the 401k and the IRA.
Just recently, we looked at the difference between these and what the tax advantages are. You can watch the video here.
Quick recap is that, generally speaking, a Roth version of the 401k or IRA is best because it provides the most tax saving benefits long term.
Today we’re going to look at the order of investing and how to choose where the money goes first, second, and third.
If we’re talking the baby steps of personal finance, after paying off all consumer debt and saving a full 3-6 month emergency fund, you’re at Baby Step 4. This is where you save 15% of your income for retirement.
In order, this is where you want to put this 15%.
Look at what your company offers
Do they offer a 401k or a TSP (government equivalent)? Do they offer an employer match? Find this out from your HR department if you haven’t already.
If your company does offer a 401k, start by investing in that.
If it’s a Roth 401k
Go ahead and put your full 15% into that. You’ll get the most tax savings this way.
If it’s a Traditional 401k
I would recommend you contribute the required percentage in order to get the full match from your employer. You don’t want to give up any free money!
Start a Roth IRA
After that, I would start a Roth IRA and invest the remaining percentage in this.
Let’s look at an example
Let’s say you are paid $1000 gross every paycheck.
If you have a Roth 401k
If you have just a Roth 401k that is offered at work like me, feel free to just put your full 15% (or $150) in that.
If you have a Traditional 401k
If you had a traditional 401k but your company matched 5% of your contributions, put 5% (or $50) into it to get that 5% match.
Then contribute to Roth IRA
Then I’d recommend starting a Roth IRA and put your other 10% (or $100) in that. Then you’re getting the advantage of the free employer match with the 401k but the greater tax advantage of the ROTH IRA after receiving the full match.
Now you’re invested!
Personally, I have Roth IRA but I haven’t been contributing to it because my 401k is also Roth. And even though the max I can put in my Roth 401k is $19,500 this year, 15% of my paycheck isn’t going to hit that maximum (not even close).
Chances are, unless you’re in stellar financial shape, you aren’t going to need more than these two options. The 401k and IRA are both tax advantaged accounts. The 401k has a max of $19,500 per year of contributions and the IRA has a max of $6000 per year of contributions.
So unless you are planning to invest $25,501 this year, you’ll only need the 401k and IRA.
Here’s the third option
You’ll have to pay taxes on the money you put in as well as the growth that occurs as a result of the mutual fund growing. There are no tax advantages but you’ll still see way more growth on average than the traditional bank account, money market or otherwise.
Stocks? Bonds? Crypto?
What about other forms of investing?
Generally speaking, as financial coaches, we don’t recommend investing in single stocks because growth is entirely dependent on a single company.
We like averaging — it’s a bit more predictable. That’s why 401k, IRAs and other mutual funds are great. They average the growth of sometimes 200 companies from different industries.
And bonds? Those are safer and much more predictable than single stocks. However, they have a much lower rate of return than mutual funds. Incidentally, many mutual funds actually have some bonds as a part of the portfolio, just to give the fund a little more predictability and safety than otherwise.
Cryptocurrency isn’t something that I invest in because it’s not something that I entirely understand. I understand the general nature of it, but it feels different because it isn’t something physical that I can hold. Also, it can be far more volatile.
But who knows! Maybe crypto will be the money of the future.
So I’ll pass this question onto you: What are you investing in right now? Or how will this affect what you invest in in the future?
I want to hear from you in the comments below!
Like what you read (or watch)? Give the blog a follow in this little box below.
Get Financial Coaching
Are you overwhelmed by debt and feel like there’s no way out? Feeling intimidated by budgeting?
I can help! I’m a financial coach trained by Ramsey Solutions to guide people in their financial lives. Set up a free consultation below and I’ll listen to your situation and guide you on the right steps forward. Through March 1st, first session is completely free and there’s no commitment.