Four Investment Accounts Young Investors Should Know About
Knowing which investment accounts to store your money can be challenging. We detail four investment accounts that can aid you in growing your wealth over time.
By SJS Investment Services Intern Jake Matthews.
You probably remember working your first job. The feeling after receiving your first paycheck is both rewarding and refreshing. But now, how do you store your hard-earned money? How do you protect your money from inflation? What steps should you take now to save for retirement?
Knowing which investment accounts to store your money can be challenging. Yet, the rewards to investing can be tremendous over your lifetime. Choosing the right investment accounts to use at a young age can be the first step in building generational wealth. Below, we detail four investment accounts that can aid you in growing your wealth over time.
IRA: Roth & Traditional
One of the most popular investment accounts is the Individual Retirement Account (IRA), which offers tax advantages to encourage U.S. workers to save and invest for retirement. There are two types of IRAs available to most income-earning U.S. workers: Roth IRA and Traditional IRA.
Roth IRAs and Traditional IRAs are subject to many of the same rules. In any given year, as long as you have enough taxable income, you can contribute up to $6,000 ($7,000 if age 50 or older) to a Roth IRA and / or a Traditional IRA. You can open a Roth IRA or Traditional IRA at many large brokerage firms in the U.S. (such as Schwab, Vanguard, and Fidelity), and can invest in a very broad range of investments including mutual funds, ETFs, stocks, and bonds. While the money is held in your Roth IRA or Traditional IRA, you do not pay taxes on any dividends or realized gains on your investments. Any money you withdraw before age 59 1/2 may be subject to income taxes and a 10% penalty.[1]
There are important differences between a Roth IRA and Traditional IRA. For a Roth IRA, you contribute after-income tax money, and any investment gains that you withdraw after age 59 1/2 are not taxed. If you are a single tax filer, your contribution limit starts declining once you earn $125,000 in a year, and you cannot contribute if you earn more than $140,000.[2]
For a Traditional IRA, you contribute pre-income tax money, and money (both what you contributed and any gains) that you withdraw after age 59 1/2 are subject to income taxes. If you are a single tax filer and have an employer-sponsored retirement plan, you gradually lose the tax advantages of a Traditional IRA once you earn over $66,000 in a year, and lose nearly all of the tax advantages after you earn more than $76,000.[3]
Particularly for young investors, we believe that a Roth IRA is generally more beneficial over the long-term than a Traditional IRA.
401(k): Traditional And Roth
Another popular investment account for young investors is the 401(k), a retirement account sponsored by your employer. While all employers with a 401(k) offer the Traditional option, only some offer the Roth option. 401(k)s are subject to many of the same rules as IRAs.
Unlike IRAs, no matter how much you earn, you can contribute up to $19,500 ($26,000 if age 50 or older) of your income per year to a 401(k). Because 401(k)s are employer-sponsored accounts, many employers will match their employees contributions up to a specified amount. 401(k)s usually have limited investment options (typically a lineup of mutual funds), and are often subject to higher annual expenses than IRAs. Instead of a 401(k), certain employers may offer a 403(b), which has similar rules.[4]
Many investors retire with their 401(k) as their single largest investment account.
Health Savings Account (HSA)
Some employer-sponsored health insurance plans offer for employees to contribute to a Health Savings Accounts (HSA), which allows you to save pre-tax dollars to pay for future medical expenses. Some employers also contribute to the HSA. For an individual, the total employee and employer contributions cannot exceed $3,600 ($7,200 for a family) per year. Some HSA plans allow you to invest in a limited lineup of mutual funds, and any dividends and gains are not taxed as long as they are used for future medical expenses.[5]
Because of the tax advantages, many young investors use their HSA as an investment account for the long-term.
529 Plan
If you plan to go back to school one day or have other qualified education expenses, you can consider contributing to a 529 Plan. You contribute after-income tax money to a 529 account, which can be invested in a limited number of investments. Any money you withdraw from the 529 account is tax-free as long as the money is used for qualified education expenses.[6]
Each state offers a different 529 plan, and you are able to participate in whichever state’s plan is most beneficial to you. Each state offers a different investment lineup, contribution limit, state income tax benefits for residents, and expenses. If you do not use all of the money in your 529 account, you can change the beneficiary to a qualifying family member with no penalty, subject to gift tax rules.[7]
Overall, a 529 account can be a great way to start saving for future education expenses for you or your family.
Benefits Of Compounding Returns
Albert Einstein reportedly said, “Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.”[8] By using these four investment accounts, you can invest to potentially allow your wealth to compound for the long-term while paying less in taxes.
To demonstrate this, the below graph shows what would happen if you contribute the maximum to your Roth IRA ($6,000 in 2021, expected to grow 2.00% annually due to inflation) at the beginning of each year, and invest the Roth IRA in a portfolio that earns a 5.00% annual expected return.
Graph created by Jake Matthews, and reflects hypothetical information based on the assumptions above. Actual investment results may be materially different than hypothetical returns. See Important Disclosure Information.
After 50 years, the above Roth IRA grows to over $1,842,920.47. That’s the power of compounding.
Conclusion
As a young investor, knowing which investment accounts are available to you as well as the associated benefits & tradeoffs can dramatically help you grow your net worth over your lifetime. We believe these four accounts provide a very strong foundation for any investor to begin the journey of saving for their future.
About The Author:
Jake Matthews is a rising fourth-year undergraduate student at Miami University, majoring in Economics & Finance. Jake is a member of Miami University’s Track Team, running the 200-meter and 400-meter. Jake enjoys learning about a wide variety of industries, particularly about alternative investments including real estate, collectibles, and cryptocurrencies.
Jake spent the last ten weeks interning at SJS, helping with client portfolio analyses, investment recommendations, and improving financial planning processes. We are very grateful to have gotten to know and work with Jake this summer, and we wish him all the best as he heads back to college!
Important Disclosure Information & Sources:
[1] “Individual Retirement Arrangements (IRAs)“. IRS, irs.gov.
[2] “Amount of Roth IRA Contributions That You Can Make For 2021“. IRS, irs.gov.
[3] “IRA Deduction Limits“. IRS, irs.gov.
[4] “401(k) Plans“. IRS, irs.gov.
[5] “Health Savings Account (HSA)“. Julia Kagan, 01-Mar-2021, investopedia.com.
[6] “An Introduction to 529 Plans“. U.S. Securities and Exchange Commission, 29-May-2018, sec.gov.
[7] “Complete Guide to 529 Plans“. Julia Kagan, 07-Jul-2021, investopedia.com.
[8] “Why Einstein Considered Compound Interest the Most Powerful Force in the Universe“. Jim Schleckser, 21-Jan-2020, inc.com.
There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
Statements contained in this report that are not statements of historical fact are intended to be and are forward looking statements. All forward looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties which could cause actual events or results to differ materially from those projected.
Advisory services are provided by SJS Investment Services, a registered investment advisor (RIA) with the SEC. Registration does not imply a certain level of skill or training. SJS Investment Services does not provide legal or tax advice. Please consult your legal or tax professionals for specific advice. This material has been prepared for informational purposes only.
Hyperlinks to third-party information are provided as a convenience and we disclaim any responsibility for information, services or products found on websites or other information linked hereto.
Suggested Reading
Saving as a Young Professional: Give Yourself Options
Wise decisions and actions today can often give you more options tomorrow. To that end, we will revisit some strategies behind a solid investment plan.
By SJS Associate Advisor Catherine Stanley and SJS Managing Director & Senior Advisor Jennifer Smiljanich, CFP®.
Never in a thousand years could we have imagined what it would be like to personally live through the upheaval of this 2020 global pandemic! While there are some silver linings, to be sure, many of us, to some degree, have been affected by feelings of fear, isolation, disruption, limitation, and boredom. Some of us are left feeling a little vulnerable, and it might not feel good.
But sometimes, uncomfortable feelings can serve as a catalyst, and can move us to take action that might not occur during times of “business as usual,” when we may feel happy and at ease. The uncertainty of our world today can open us up to thinking about how we can make our life a little safer, better, or a bit more comfortable in the future. Ironically, one of the greatest things we can do in an attempt to ensure a better future is to acknowledge that something should be done, and to start as young as possible with a plan to make it happen.
The something referred to here is saving and investing for your future. For young professionals in their 20s and 30s, the future, and the idea of retirement can seem very far off and too hard to predict. Not knowing where to start can seem overwhelming, to the point where doing nothing is an easy default.
Although we never know what tomorrow will bring, we do know that our future self will want to be able to choose from options. One of the ways for this to happen is for young professionals to start a savings and investing plan today, so that the power of time and compounding may work on your side. Wise decisions and actions today can often give you more options tomorrow. We hope the uncertainty of this pandemic, and knowing you have someone at SJS to talk to, may nudge you to start your savings and retirement plan. If you’ve already started, well done!
To that end, we will revisit some of the tried and true strategies behind a solid investment plan.
Live within your means
Simply put, spend less than you earn. By doing so, you can save to take care of future YOU! There are many thoughts on how much you should save, but according to George S. Clason, author of The Richest Man in Babylon, at least 10%. Mr. Clason states, “A part of all you earn is yours to keep. It should be not less than a tenth no matter how little you earn. It can be as much more as you can afford.”[1]
There are many good budgeting tools available to help you track how much you are spending to live within your means.[2] If you don’t know how much you spend, this is a good place to start!
Automate your savings / investing so it has priority
For every paycheck, set up an automatic transfer to your savings or brokerage account. Making YOU important enough to come first is very affirming!
Start young, start early, start now!
I mentioned the power of compounding before, and I cannot explain it any better than this powerful graphic. Take a look, and trust that you are doing yourself a huge favor by acknowledging its power and harnessing it for your own good. Save as soon as you can, as much as you can, and let time and interest on interest help build your nest egg!
Be prepared
By doing some pre-planning and using the tools available to you, you can increase the likelihood of staying on track.
Have a Plan B. Set aside funds in case of an emergency. Ideally, your emergency fund should be between 3-6 months of living expenses, kept in a safe, liquid vehicle such as a savings account or money market account.[3] So when your next “uh, oh” moment comes along, you will be ready.
Don’t just save. Invest for retirement. With investing, you will need to learn about the trade-off between risk and reward. Investments that give you higher returns may potentially get you to your retirement goal sooner, but they inherently come with greater risk. On the other hand, the safest of investment vehicles, such as a US Treasury bill, probably won’t earn enough return to outpace inflation over time. Find the right balance for you! Seek out a CFP® professional or trusted investment adviser to help you set a plan that meets your needs and stay the course. If you have a long-term plan and stick with it, then the daily volatility in the market may be just noise.
Maximize your resources. If your employer has a 401(k)-matching plan, take advantage of it to the greatest extent that you can…matching funds are free money! Consider making IRA contributions if you can. Pre-tax contributions to retirement plans and IRAs may decrease the amount of tax you pay on your income each year, and the funds will grow tax-deferred, compounding over the 30+ years you have until retirement.
Start a 529 education savings plan as a way to use compounding to help pay for your child’s college education. There is often a state tax deduction or credit available for 529 plan contributions, varying by state.
Starting your savings and investment journey today means you’ll have to balance today’s current enjoyment with tomorrow’s future enjoyment. Decisions or circumstances along the way may create diversions from the path, but if you have a strategy, you can always come back to it. The goal is to stay on track so that over time, future You will appreciate that you gave yourself options to choose from. At SJS, we are happy to have these conversations with you, and to help guide you to an investment plan for the long-term that you can stick with.
Important Disclosure Information and Sources:
[1] The Richest Man in Babylon. George Clason, 1926, Berkley.
[2] “10 Simple and Free Budgeting Tools.” Maryalene LaPonsie and Lars Peterson, 21-Jun-2019, money.usnews.com.
[3] “Emergency Fund: What it Is and Why It Matters.” Margarette Burnette, 20-Mar-2020, nerdwallet.com.
Advisory services are provided by SJS Investment Services, Inc.., a registered investment advisor with the SEC. Registration does not imply a certain level of skill or training. SJS Investment Services does not provide tax advice. Please consult your tax professional for specific advice. This material has been prepared for informational purposes only. There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
Suggested Reading
Three Traits Successful People Share
Within each story about “those humble beginnings” are the clues to the degree of success—and happiness—achieved in the end. Here are such three traits.
Do You Have Them? Are You Raising Your Children to Have Them?
By SJS Founder & CEO Scott Savage.
I’ve been fortunate in my life. My work as the Founder and CEO of SJS Investment Services puts me in front of so many fascinating people who are successful, many of them self-made. Each one has a story to tell, and I gladly listen. Because I’ve come to discover that within each story about “those humble beginnings” are the clues to the degree of success—and happiness—achieved in the end.
This unscientific, but easily observable pattern of what it takes to succeed, has guided me in my business, in my personal life, and in my parenting. I’d like to say I have hit a home run on all fronts, but I haven’t. It can be all too easy to forget these basic truths—particularly when my children are involved. I appreciate clients around me who share their stories and serve as gentle, yet powerful, reminders of not only what makes people great, but our nation great, too. Here are the three traits:
Many successful people have known adversity
In the case of the self-made success story, often the story began with some hardship or challenge. Maybe it was poverty, and they struggled to make ends meet—some of the most poignant tales come from The Great Depression. Or as young children, they were expected to be part of the family income stream and earn their way. Often as children, their paper route and babysitting money went to the family to help make ends meet. They were seldom given anything, and instead had to earn it on the farm, in their community and sometimes even in the family business. Adversity turns children into adults who are more likely to value what they have, because it was earned and not given.
Many successful people learned the meaning of hard work at an early age
Earl Nightingale said, “Success is the progressive realization of a worthy ideal.” And I have found in my life and in the lives of successful people I know that when you are working hard, you are on the journey—the progressive realization—of success. I hear my clients tell stories of their youth and speak with pride about rising before dawn and getting to their chores. They learned through responsibility that no matter how hard the task, you work until it is done. And I can see it in their eyes, and hear it in their voices as they remember those days, the same pride of accomplishment they felt as kids, often some sixty years earlier. Through hard work, children may learn to appreciate the value of working towards a goal and to achieve pride and confidence in their accomplishments.
Many successful people have saved all their lives
The successful people I know have never spoken of working to buy things. They worked because it had to get done and whatever rewards they got, they saved. Work was the green light to save money, not spend it. This belief became a habit in the way they ran their lives, their businesses and today their investments. Saving can turn hard-workers into millionaires.
I tell my clients, many of whom are farther down life’s path than I am, that they are role models for me. Their example and insights have helped me to prepare my own family for the future. I’d like to say I have raised my kids to have the strength to overcome adversity, work hard, and save, but I am far from perfect. Everyone wants more for their kids than they themselves had, and that means life often gets easier with each generation. But at a time when the next generation is entering a world economy, competing with others who grew up living a harder life, will our children be prepared to succeed? That question concerns me, and I know I am not alone.
I share this because it’s never too late to pick up good habits. And judging from my clients’ stories, it’s never too early, either.