In this episode, Nikita covers all the basics of understanding investing. Many people struggle to differentiate different account names and tax treatment. This is a great starting place to build a solid foundation in your investment knowledge.
Topics covered:
In this episode, Nikita covers all the basics of understanding investing. Many people struggle to differentiate different account names and tax treatment. This is a great starting place to build a solid foundation in your investment knowledge.
Topics covered:
Nikita: 0:00
Hey 3rd Decade Community, I hope you’re having a great week. I’ll be using today’s episode to talk all about investing… we’ll discuss what we consider “investing for retirement”, account types, tax-treatment, general guidelines for how much to invest, and notoriously low-fee custodians. Let’s dive in!
I want to get one thing out of the way before we dive into more of the details. What we consider “investing for retirement”, is not what you probably see advertisements for on TV or social media. Single stock investing can be fun, the same way that gambling can be fun, but our philosophy on it is that it should not be done unless you are already investing 10-15% of your gross income in low-cost index funds that you’re holding for the long-term (we’re talking 401ks, 403bs, & IRAs, among some others). Additionally, single-stock trading is not something that you should be doing unless you’re prepared to fully lose that money. All of that being said.. If you’re taking care of your future self through investment strategies with a proven track record, we’re not saying you can’t have some fun with it, but just don’t believe the lie that you’ll retire off of it, because 90% of people lose money investing in single stocks.
To add to that issue… the apps that encourage this behavior are designed to make it look beautiful, enticing, and FUN! I like to call this “sexy investing”. My goal here is to drive home the point that investing doesn’t have to look pretty in order to be effective. In fact, it’s usually more cost-effective to go with the boring, non-confetti routes. They’re not actually providing a more valuable service - they’re just making you pay a surcharge to make it look nice and use a neat little app to do it. What I mean by that is that you’re paying a *slightly* higher cost per share simply for using the 3rd party service. It’s also hard to find their fees to know that you’re overpaying!
Okay, now that we’ve gotten that out of the way, let’s go over different account types. We have 2 broad overarching categories that we’re talking about when we say Retirement Accounts. We have Employer-Sponsored, and Self-Directed.
Employer-Sponsored accounts would include those that your workplace offers you.. The most common being a 401k, 403b, or a 457b. There are also Self-Employed options for “employer retirement accounts”, but we’re not going to get into that today because we’ll do an entire episode in the future on self-employment. A side note for pensions… this would also be considered an employer-sponsored retirement account, however, you don’t have choices when it comes to how much is being contributed for your pension plan (these are set across the board for all employees) and you also don’t get a say in how they’re invested. Pensions are complicated enough that they deserve their whole own episode, so we won’t be building them into the discussion of this episode.
So those would be the Employer-Sponsored Accounts I’m talking about: 401k, 403b, or 457b.
The other overarching category would be “self-directed”. This is what you hear us refer to as an IRA - or, “individual retirement account”.
NOW, to break this down further, retirement accounts are taxed in 1 of 2 ways. They are either considered “traditional”, and for this, you won’t often see the word used, or they are considered “Roth”, which is always stated at the front of the title for the account type. For example, a Roth IRA and an IRA are different account types, because they’re taxed at different points in time. Additionally, a 401k and a Roth 401k are separate accounts. The only difference is when they’re taxed.
“Roth” means that you’re paying to invest with money that’s already been taxed (i.e. you’re throwing $200 a month into a Roth IRA with leftover money from your NET paycheck). This means that when you go to do your withdrawals in retirement, NO ADDITIONAL TAXES are taken out. You already took care of the taxes on the front end of your investment journey for this account.
Alternatively,
“Traditional” accounts allow you to put in money that is NOT taxed until you withdraw it in retirement. This is how 401k’s through your employer work, contributing before taxes are calculated. And for Traditional IRAs, this is done by reducing your taxable income at the end of the year.
Because no one fully knows what the tax system is going to do between now and the time you retire, it’s generally recommended to have “tax diversification”, which means, some accounts that are Roth and some that are Traditional.
Many employers now offer both versions of their retirement accounts, often letting you choose to use both account types if desired. For instance, maybe you’re used to a 401k, but now your employer offers a Roth 401k - you can select to do 5% to each for a 10% total. (this doesn’t mean that’s the amount you should actually select - I’m just trying to illustrate easy numbers).
Employer accounts are a good starting point, especially if your employer offers a match. If they offer matching funds, we encourage you to take advantage of this to its full extent. That means, if they say they’ll contribute 0.5% for every 1% you do, for a maximum of 3%... invest that 6%, so that you get the extra 3% from them. If you don’t, you’re turning down free money.
That being said.. 401ks and especially 403bs are notorious for having higher account fees than an IRA does. So If your employer doesn’t offer a match, or you’ve already met the match, you could contribute to an IRA past that point. Preferably a Roth IRA. We’re big fans of taking advantage of the Roth option.
Depending on your financial situation, you’ll need to determine if you can take advantage of the maximum contribution limits. The employer-sponsored accounts we’ve discussed have an annual contribution limit of $20,500 as of 2022. And IRAs have a $6000 annual limit. (each provides a small increase to this limit if you’re over the age of 50, but these are the numbers that most of you will be working with). Just to clarify, we’re not expecting that the average earner who makes, say, $55,000 a year, will be contributing the maximum amount to both accounts. If they wanted to and were able to, GREAT! Most people will do well for themselves by investing 10-15% of their gross income for retirement (I encourage people to strive for the higher side of that range if possible).
I’m going to draft out an example for you here…
Let’s say you make $60,000/year as your gross income at your job. You’re aiming to invest 15% of that per year, for a total of $9000/year. In this example, let’s pretend your employer offers a 3% match if you contribute 3%. So we are going to contribute the first 3% of our 15% goal into our employer 401k which would equate to about $1800 per year of that $9000 you’re already planning to invest between all of your retirement accounts. In our example, the employer account has unfavorable fees so we want to find a better value and will contribute the next percentage into our Roth IRA: 10% of our 15% goal towards the Roth IRA (we’re choosing 10% because this maxes it out at $6000 - you’ll want to choose whatever percent for you that maxes out the $6000 limit). This leaves us with 2% left of the 15% goal. We will contribute the remaining 2%, or $1200 into the employer's 401k. I know the math is heavy in this example, but writing it out will help it make more sense… This will mean at the end of the day, that you’re investing 10% into your Roth IRA ($6000), and 5% into your 401k ($3000) (and gaining a 3% match on top of that). This would mean that in total, we are invested 18%: 15% of our money and 3% of bonus money from the employer matching contributions.
Anything you want to invest beyond that, we would encourage you to just continue bulking up your employer contribution percent until you reach the annual limit.
Each person’s situation is going to be different, so you have to look at your own personal numbers. Also - this might feel super unachievable in some cases, so if it feels far out of the question to contribute $750/month to retirement right now (in the example of a $60,000 salary), try to find that number that IS doable. Something is ALWAYS better than nothing.
To end our episode, we wouldn’t be 3rd Decade if we weren’t shouting from the rooftops how much we love inexpensive and reputable custodians. The best we’ve found so far has been Vanguard, Charles Schwab, and Fidelity (no, we’re not being paid to say that). While the account types themselves don’t typically have minimums required to get started, the funds themselves sometimes do. For Vanguard, this is usually $1,000 or more, Charles Schwab is under $100, and Fidelity doesn’t have a minimum. Outside of your employer contribution - If you want a “set and forget” type of approach, you could automate a transaction every month (or at the frequency of your choosing), and select a Target Date Retirement fund with the year closest to the year you’d plan to retire. That would mean that the rebalancing is done over time, and as you get older, the fund will automatically shift more into conservative investments like bonds, and less into stocks.
Lastly, remember that the market goes up and down (sometimes significantly). Stay the course and don’t sell when you’re scared. This is how you lock in losses. In the S&P 500, holding periods for 30 or more years (which is many of our retirement horizons), have historically returned 8-9%. But those held for 5 years are all over the map. Retirement investing is for the long haul, and you don’t need to know what’s happening day-to-day to do well for yourself. As a matter of fact, it might be helpful sometimes not to know.
I hope this episode is helpful in your journey of learning about investing. If you’d like to rate or review our podcast, that will help it reach more ears. Thank you for sharing your time with me today. Have a great week!