I’ve produced a lot of content over the last year and some change. Over that time, I’ve stared to realize a trend of people who lack understanding of the basic investing terms that could really help break down the initial barriers.
Types of Accounts
This is often severely misunderstood, which is why I’m starting here. I can’t tell you how many times I’ve heard “I’m opening a mutual fund account tomorrow”. While they may exist somewhere, it’s likely a way for an insurance company to disguise one of their high-fee products.
- Retirement. These accounts are specifically designed for retirement savings. They include such offerings as the 401(k), 403(b), 457(b), Traditional and Roth Individual Retirement Account (IRA), along with a few others. You are almost always able to buy stocks, mutual funds, and exchange traded funds (ETFs) inside these accounts.
- Taxable brokerage. This is an account that you can open at nearly any large institution, including banks, credit unions, and brokerages. These accounts are taxable, meaning they have no tax-protections like retirement accounts, but are great for holding emergency funds, or other savings not geared toward retirement. These accounts are also good to use if you plan on retiring early before you’re eligible for traditional retirement account withdrawals at 59.5 years old. These accounts are open to stock, mutual fund, and ETF purchases.
- Savings. Your typical ole’ savings account like your parents setup for you. This account cannot purchase stocks, mutual funds, or ETFs. This is not recommended unless you’re holding cash for an emergency or a near-term purchase.
- Checking. Same as above, except this is the account you would normally use to hold money that is satisfying your obligations (mortgage, credit card bill, cell phone, etc.) It is not invested in the stock market, nor should it be. A debit card typically allows access to both the checking and savings accounts.
This covers the big account types. As you can see, there is no “mutual fund account” or “infinite compound interest account”. These things don’t exist, except in shady scenarios where the company is operating in the shadowy parts of the ethical spectrum.
Types of Investment
Now that we’ve covered the types of accounts you can open, we will look at the types of things you can invest in within the account. Look at it this way: the accounts we just talked about are the car and we are looking for passengers (investments) to put inside the car for a trip. At the end of the day, the car is parked in a garage (the brokerage or bank) for safe keeping.
- Stocks. This is exactly what it sounds like. You can buy individual stocks issued by publicly traded companies.
- Bonds. You can purchase bonds issued by municipalities, private companies, etc. Normally, these are only purchased by wealthier investors. Most people, myself included, purchase bonds in the form of a mutual fund or ETF.
- Mutual funds. Per Investopedia, a mutual fund “is a financial vehicle that pools assets from shareholders to invest in securities like stocks, bonds, money market instruments, and other assets.” Essentially, these accounts hold various stocks and bonds in a professionally managed portfolio. There are also money market mutual funds, which typically earn a fixed savings rate comparable to your banks savings account. Mutual funds are not openly traded on the market, and are often restricted depending on the issuer. For example, Vanguard mutual funds are more easily purchased at Vanguard rather than Fidelity or Schwab.
- Exchange Traded Funds (ETFs). ETFs are just like mutual funds, except, they can be traded openly on the exchange just like stocks. This makes them extremely attractive because you can buy any ETF on virtually any trading platform. I use Fidelity for nearly everything and I regularly purchase the Vanguard Total Stock Market Index Fund (VTI) within this account.
After reading this, you probably have some more clarity on how these things co-mingle. For example, if you are investing in VTI within your Roth IRA, you would say something like “I buy VTI in my Roth IRA “. See how simple that is?
If you were to say “I opened a compound interest account at Bob’s Life Insurance company, where I routinely purchase whole life insurance. He said I can borrow against this money, but not for 5 years because I’m in the early periods. Once I’m done, I can get paid 2-3% for a decade, then I can covert…” Yeah, I think you get it. This is overly complicated and confusing. What we recommend here at Wealthy Idiots is simple. Very, very simple. As it should be.
What accounts to open and how
Now that you understand the general mechanics of this, we’ll talk about getting started with your first dollar!
- 401(k) – up to the match. Most employers either offer or are beginning to offer 401k plans. If this is available, invest up to the match immediately. The vendor/company will be determined by your employer.
- Roth IRA. Investors should open this as soon as allowable. You need “earned income” to contribute, but once you satisfy that, you can contribute up to that amount or $6k per year, whichever is less. The Roth IRA is the bedrock of retirement accounts and grows tax-free for life.
- 401(k) to the max. Once the Roth IRA maximum contribution is reached, I would revert back to the 401k until the IRS limit ($20,500) is reached on it.
- Taxable brokerage account. This can be opened at Vanguard, Fidelity, or Schwab, and has no limit at all. This account has no restrictions, but your earnings (capital gains) will be taxable, and you may have some small taxes on dividend distributions as well.
Note – I did not include HSA accounts in this list, but they should definitely be used if available. They would fall before ‘step 3’, ideally.
If you are able to maximize your Roth IRA and 401k, you’ll be investing a minimum of $26,500 per year. This is a ton of money that will have a lot of long-term growth potential.
The results
It’s worth mentioning how far $26,500 per year can go. If you started at 22 and plan on working until 60, check out the results!
You read that right… after 38 years at 10% average growth, you would have $9.6M. Not a bad run, eh? Starting early is the greatest advantage in investing, and there really is no replacement for it. Get started today, and be wealthy tomorrow!