In February, 2015 I wrote Am I Ready To Invest? explaining how people think they are doing right by saving and investing for their retirement, but in actuality they skipped two critical first steps: 1) eliminating their bad debt, and 2) establishing their rainy day fund. For those who have taken care of steps 1 & 2, congrats, you just took a huge step towards a better and brighter financial future for yourself and your loved ones, but now comes the crucial step of investing. So when you’re ready to invest where do you do it?
There are plenty of avenues to get yourself investing; this article will briefly look at three common places: 1) your company’s retirement plan, 2) a personal Individual Retirement Arrangement (IRA), and 3) a retail account.
More and more company retirement plans are shifting away from a defined benefit plan (like a pension plan) to a defined contribution plan (like a 401(k) plan or a SIMPLE IRA). The reason for the shift is because defined contribution plans put the investment risk on the employee and takes it off of the employer (as with a defined benefit plan). Your company would rather you bear the investment risk than it.
Generally I would make investing through your employer’s retirement plan your first priority because of higher contribution limits when compared to an IRA but with the same tax advantages. Naturally, you can only contribute to your employer’s retirement plan when you’re employed. If you’re at a firm without a company retirement plan you can always contribute to an IRA (as long as you have earned income), so the thinking is contribute to your company’s plan while one is offered, because it may not always be there for you. If there is an employer match available then it becomes additionally important to contribute to the plan. At the very least you want to contribute enough to get your full match, otherwise you’re just passing up free money.
If you have earned income you can always contribute to an IRA, it becomes a question of if your contribution is tax deductible and if you can contribute to the tax-free growth IRA known as a Roth IRA. The IRA is strictly funded by you if it’s a personal IRA and not a business retirement plan IRA (known as a SEP or SIMPLE IRA) and it can possibly be a lot cheaper than your company’s retirement plan because you have any investment available to you. Sometimes with company retirement plans you’re only offered a select choice of investment options, you’re out of luck if your company’s plan only offers high fee mutual funds – so you’re stuck paying $10 for $2 gas. But with an IRA you choose where to invest, so you can load up on low-cost mutual funds & ETFs from Vanguard and if your IRA is managed by a Dimensional Fund Advisors approved investment advisory firm then you’ll have access to DFA mutual funds (my two favorite investment companies).
Of the three investment buckets the retail account comes last because you don’t get the tax advantages that come with the first two. But with a retail account you’re not limited on contribution amounts like with a 401(k) or an IRA. And like with your IRA, you choose where to invest, so keep your investment costs low and make yourself even more money.
There are plenty of areas where you can begin investing and these are three of the most common, but the bottom line is just invest and the sooner the better, because with investing time is your friend and the more time you have the more money you will make.
In my next article I’ll explain why time is your portfolio’s best friend.
To learn more about Michael Pensinger, view his Paladin Registry profile.
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