With all of the economic uncertainty happening right now, it might seem like a scary time to start investing. But there is no “ideal” time to invest, financial experts say. Dipping your toes in now, if you haven’t invested before, can help make investing a habit in good times and bad.
“You can’t time the market” is standard financial advice for a reason. No one knows what will happen next, and it’s impossible to tell when the market will hit bottom and when it will rebound. That’s why many financial advisors suggest contributing money consistently over time.
Not everyone is in a position to invest right now, and you should not focus on investing if you do not have emergency savings. But if you are in a stable financial place, take some time today to learn which investment account makes the most sense for you.
Different types of accounts help with different types of goals: A 401(k) is great for retirement, while a brokerage account is better for those who have financial goals that are at least five years away, but closer than retirement, like buying a house or going on a dream vacation.
Here’s an overview of four common types of investment accounts.
401(k)
A 401(k) is an employer-sponsored retirement plan. It is what’s known as a “tax-deferred” investment account, meaning the money you contribute to it — up to $19,500 for individuals in 2020 — lowers your taxable income for the year. That tax break is meant to encourage you to save for retirement now. You pay taxes on your withdrawals in retirement.
Experts generally recommend contributing at least enough to your 401(k) to receive your employer’s full match, if they offer one. Typically, an employer will match whatever contribution you put toward your 401(k) up to a certain amount of money, say $1 for $1 up to 6% of your salary.
You can begin withdrawing money penalty-free at 59½ in most cases. If you withdraw money before then, you will pay a 10% early withdrawal penalty and income taxes on the distributions.
Remember, all of the accounts listed here are financial accounts that facilitate investing, not investments themselves. Once you decide which type you want to open, you will still need to pick what to invest in. This article details exactly how to pick investments for your 401(k).
One of the biggest factors for investing — regardless of account type — is fees. You want to minimize these as much as you can, especially management fees and investment expense ratios.
Individual Retirement Account
A traditional IRA is similar to a 401(k), but anyone can open one on their own at a financial institution like Vanguard or Fidelity. If your employer doesn’t offer a 401(k), or offers one but does not include a contribution match, you can consider an IRA for retirement investments.
Like a 401(k), you contribute pre-tax money — up to $6,000 in 2020 for those under 50 — and select investments based off of what the financial institution offers.
One benefit of IRAs is that you will typically have many more investment options than in a 401(k). That can help you properly diversify and keep costs low.
Roth IRA
Roths are a type of IRA, except that instead of contributing pre-tax money, you invest income that’s already been taxed. Then, when you make withdrawals in retirement, you don’t pay any taxes. You lock in your current tax rate when you contribute, which makes Roth IRAs an attractive investment account for younger people, who are likely in a lower tax bracket now than they will be later on.
Another benefit: Contributions can be withdrawn at any time, tax- and penalty-free, since you’ve already paid taxes on the money you contribute. That can make a Roth into a secondary emergency fund, should you need it. However, experts strongly advise against withdrawing funds you’ll need in retirement.
In some cases, you can also withdraw up to $10,000 for a first-time home purchase. If you’re able, investing in both a 401(k) or IRA and a Roth IRA is a smart move because it adds diversity to your retirement income streams, which is always a good idea.
That said, unlike traditional IRAs, Roths have income limits: Individuals must have a modified adjusted gross income (MAGI) of under $139,000 in 2020 to contribute to one.
Brokerage account
Brokerage accounts are taxable investment accounts that an investor can contribute to and withdraw from at their discretion. They are ideal for savings or goals that are five or more years down the line.
You can buy stock in individual companies and other types of alternative investments through these accounts, and typically there is a much wider selection of investment options than those available through your retirement investment accounts. You pay taxes when you make money on an asset in the account, such as selling a stock. But you can still invest in less risky options, like index funds, too.
While they have been growing in popularity, you should still be careful about starting with just a brokerage account. Most people do not have enough emergency savings or retirement investments, which should be prioritized before contributing to a brokerage account.
When trying to decide where to invest first, Ryan J. Marshall, a New Jersey-based certified financial planner, recommends the following order:
- Contribute to your 401(k) up to the full match
- Take advantage of a Roth IRA contribution if eligible
- Max out your company retirement plan
- Open a brokerage account for additional investments
While you can use a brokerage account to supplement your savings, remember that they are not the same thing. And as with all investing, there is always the risk that you will lose money, though historically the market has always gone up.
