The 10-second version: Start maxing out your 401K and IRA as soon as possible. Due to the tax-advantaged nature of the accounts, you can generate significant long-term gains by starting early. Also, look into a Roth vs. a traditional version of the accounts to ensure that you are getting the most out of your investment.
Okay, let’s dive in:
I have a job and some discretionary income, what should I do with it?
The first step I’m taking is maxing out all of my retirement accounts. Seems crazy to think about what I’m going to do when I retire this early, but honestly it’s never too soon to get started. 3 reasons for that:
- Tax Benefits: There are a lot of tax benefits to retirement savings: I’ll get to those in a second
- Retirement: There are a lot of years that you have to account for after you retire (knock on wood): If you work for ~40 years and given an average life expectancy of ~80, that’s 20 years (60-80) where you are going to have to figure things out without a job. (And let’s be honest the corporate world won’t be too kind after you hit 50)
- Compound interest: Not going to dive too deep into this one, but 40 years of having money grow with compounding interest will result in some fairly sizeable savings.
Let’s assume you are convinced and talk about the options and their relative pros/cons.
There are 2 formal types of retirement accounts: 401ks and IRAs.
- 401ks are company-sponsored retirement accounts where you can contribute up to $19,000/year (as of 2019)
- IRAs are individual retirement accounts where you can contribute up to $5,500/year
Both are useful, though companies will often match some of your contributions to a 401k, so I would recommend starting there to get the most out of what you put in. For example, if a company is willing to match what you put into a 401k up to $6,000 and you put $6,000 in, then you’ll have $12,000 in the account. There is no reason not to take advantage of that.
Within each of these accounts, there are two further segments of accounts that you can look into, Roth or traditional. The table below will show the specifics:
| 401k/IRA | |
| Traditional | You put money into these types of accounts pre-tax. – Pros: You don’t have to pay income taxes now, so the money you put in today won’t take as much out of your monthly income as if you had put it in after taxes. – Cons: When you pull money out after turning 59 ½ years old that money will be taxed as if it is additional income. |
| Roth | You put money into these after paying income taxes on them. – Pros: When you pull your money out after you turn 59 ½ years old you don’t pay any taxes. – Cons: You have to pay income taxes now instead of putting it in tax-free |
The rule of thumb when deciding which type of account to use is if you think your tax rate now is lower than what it will be when you are withdrawing money from the account (after 59 1/2), you should use a Roth (chances are if you are just starting your career it will be). Otherwise, use a traditional account. My goal is to create a lot of long-term passive income, so I am assuming my tax rate now is lower than it will be later.
I used TD Ameritrade to open my Roth IRA, because:
- It took <15 minutes
- It gave me a broad option set to invest with and had extremely cheap transaction costs (free ETF purchases)
Once I had deposited my $5,500 in my Roth IRA I invested all of it in the SPY, an ETF (essentially a better version of a mutual fund) that mirrors the S&P 500. I will go into how I thought about how to invest my money in a different post.
I have been maxing my Roth since I was a sophomore in college (and honestly am sad that I didn’t start earlier). The main rule is that you have to have earned the money, but once you have some kind of income, I would start maxing this out immediately.
Do you have any retirement investment strategies that you would recommend?
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