An often asked question is, “How do I get started investing?” People hear about the stock market and such in the news, but it all seems so distance. I associate stocks with a horn and bells ringing. The first thing you do is get a job. You cannot invest without income to invest. Most of the investment technicalities are tax benefits that work in your favor with some strings attached. One should always start by utilizing these investment accounts with tax benefits. To start investing, you need to setup a brokerage account. I will go over the various options.
Step one. If you work for a company that offers stock options or stock purchases, you should try to at least take some if not all. If for some reason purchasing your own company’s stock is undesirable, you should find another company to work for. One should always like their workplace.
Step two. If your company has a 401(K) plan, you should invest up to the level that your company matches. That’s your company giving free money to you. This is similar to donating up to the amount that your company matches to a charity. You want to maximize the impact of dollars spent for charities and your own retirement.
Step three. Invest in a ROTH IRA up to the yearly allowance. They put a limit on this for a reason, since it is a very beneficial account. In a ROTH IRA, you put earned income that has been taxed into the account and when you take money out during your retirement it is tax free. If you’re starting out, you’re likely to be in a low tax bracket, so the taxes aren’t that heavy. When you retire, you wish to retire in style, hopefully by now your money is working for you and you’re in a higher tax bracket.
Step four. Invest up to the maximum contribution level of your 401(k). The tax benefit is that you put pre-tax dollars to be taxed later when you retire.
Step five. Invest in an educational IRA for your children. If you’re middle class by the time your children go to college, then expect to pay a lot for their tuition.
Step six. By now if you’ve followed all these steps, you have invested roughly $20, 000+ per year in accounts with tax benefits. That sounds pretty good, right? If your income is too high, then you won’t qualify for some of the accounts.
Step seven. If you still want to invest even more money you need to open a personal account, which is subject to capital gains tax. Capital gains tax take a chunk of the monetary gains from selling a stock. It’s like having a rat slowly nibble away at your big cheese.
Review of steps
1) 401(k) up to employer matching
2) Roth IRA up to limit
3) 401(k) up to limit
4) Educational IRA up to limit
5) Personal account to your heart’s content.
Why did I put Educational IRA behind 401(k) contribution?
I don’t have kids that I know of. There are also restrictions on how the Educational IRA money can be spent. Your kid may be smart and get a full scholarship or be dumb and not go to college. Uncertainty puts options lower on the list.
Why did I choose a ROTH IRA over a traditional IRA?
In a ROTH IRA you put post-tax money to have tax free withdrawals during retirement. In a traditional IRA, you put pre-tax money to be taxed later when you withdraw. If you’re really being a taxed a lot, then you’re likely to not qualify for these accounts. Investing is about being wealthy later. As people are living longer, they are also still working and contributing to society during their retirement years. The only case where I would choose a traditional IRA over a ROTH IRA is if I was an older person who would soon retire and earn zero income when I retired.