A Beginner’s Guide to Investment Accounts

There are so many different ways to invest. As a beginner, it can be a daunting task to try and figure out what investment accounts make sense. This post is a guide for beginners to help you learn about the different investment accounts for your money.

Getting into investing can be intimidating with all the different options out there. Not only are there different investment choices; there are also many different types of accounts to put money into.

With all these overwhelming choices, how do you know which are the best investment accounts for beginners?

First things first, you need to figure out what your investing goals are. What are you putting away money for?

Secondly, you need to know what options are out there, and what each account is best used for.

Finally, you can put together some simple contribution strategies for making the most out of your investments and reach your goals in the best way possible.

Disclaimer: I’m not a financial adviser or financial professional. Please do your due diligence and research before buying or selling financial securities and assets.

Before investing, what are your investing goals?

You need to determine your goals before you decide which of these investment accounts to prioritize. You also need to tally up the current state of your portfolio if you have any of these accounts already open.

What are you investing for?

Are you investing for retirement? Maybe you’re saving up for that home down payment?  Or, perhaps you just want to build financial wealth in general.

The first piece of advice is to not get tunnel vision.

Odds are, you have more than one goal, and you should be contributing to them all.

The main purpose is to determine which one to prioritize to obtain the maximum financial benefit.

First, take a look at all the investment accounts available to you. Then, we’ll discuss investing strategies.

Types of Investment Accounts

There are two broad categories of accounts. The first is Tax Advantaged Accounts, which are designed to encourage saving for retirement or other goals. The second is Taxable Accounts, which have no restrictions, but unfortunately are fully taxable.

Let’s dive into some more information on each of these different types of investment accounts.

Tax-Advantaged Investment Accounts

As mentioned, these types of accounts were designed to encourage and incentivize saving. They do this by saving you tax payments; either you will pay less taxes in the present, or you will pay less taxes in the future!

Individual Retirement Account (IRA)

The IRA is the simplest investment account of them all.

A Traditional IRA is a retirement account that lets you make tax deductions on the amount you contribute. Effectively, you don’t pay taxes on this money today, you are deferring the tax to the future when you are retired and are (hopefully) paying less in taxes. The money you invest comes from “pre-tax” dollars.

You can choose stocks, bonds, ETFs, index funds, or other assets, in an IRA. The main restriction is that penalties may apply if you withdraw this money before age 59 ½. The one exception is when buying your first home (hopefully by house hacking), where you can withdraw up to $10000 penalty free.

The annual contribution limit as of 2019 is $6000.

Roth IRA

A Roth IRA is nearly the same as a traditional IRA with one notable difference. You pay tax now on income that is contributed to a Roth IRA, but you don’t have to pay tax when you withdraw funds! We call this investing with “post-tax” dollars.

The other main difference is that you can withdraw funds at any time, for any reason. This means you may consider a Roth IRA if you are saving for a long-term goal besides retirement.

The annual contribution limit as of 2019 is $6000. Note this is the same $6000 as the traditional IRA; you cannot contribute more than that amount between these two account types in a given year.

401(k)

A 401(k) is offered through your employer. Your employer is part of a plan that you can contribute your “pre-tax” dollars into. Typically there are limited investment options to choose from in a 401k, most often mutual funds.

Like a Traditional IRA, a 401(k) has penalties if you withdraw from it before age 59 ½, however there is a long list of exceptions to that rule.

Now, why would you want this heavily regulated retirement account over a traditional IRA?

The answer is simple: contribution matching.

Contribution matching is a unique perk for a 401(k). This is when a company matches your 401(k) contributions up until a certain percentage or dollar value.

For example, if your employer offers $0.50 per dollar contributed up to $2000, then a $2000 annual contribution will actually add $3000 to your account. That is an instant 50% return on investment.

This is free money, no exaggeration here! All you need to do is contribute at least enough to get the maximum contribution match possible.

Other employer-sponsored accounts

There are other types of employer-sponsored accounts that are far less common than a 401(k). However, you should still become familiar with them in case they apply to you.

A 403(b) plan is something your employer may offer in lieu of a 401(k), although they are very similar. This plan is common for nonprofit organizations, some public-sector organizations, and religious organizations.

These plans have commonly been associated with expensive annuities, which you should avoid. However, this restriction is long gone and you should have different mutual funds available to you in your 403(b).

The other notable plan, the 457(b) plan is a variation of a 401(k) available to public servants. You contribute pre-tax dollars like you do in a 401(k) and 403(b), and your employer may offer contribution matching. The main advantage is that there is no withdrawal penalty for those under age 59 ½ !

Other Tax-Advantaged Accounts

The above mentioned accounts are the likely investment accounts for beginners. However there are a handful of other tax-advantaged accounts that will be briefly mentioned below:

• Self-Directed IRA – Not recommended for beginners. It is an IRA with virtually no restrictions; you can own real estate, private equity, and more!
• Health Savings Account (HSA) – Contributions to this account are tax deductible; meant for those with high-deductible health insurance.
• 529 College Savings Plan – Used to save for, you guessed it, college! Most typically has a beneficiary (ie. your children). Tax free investment earnings IF the money is being used for college and/or related expenses.

Taxable Investment Accounts

Taxable accounts (sometimes known as brokerage accounts) are the simpler of the bunch. They carry way less restrictions than tax-advantaged accounts, however, sadly you must pay tax on all net investment income.

Cash Account

This is the most simple investment account you can have. No tax advantages, no restrictions!

It is called a cash account because you actually need the cash on hand to purchase a security. Virtually all tax-advantaged accounts are forms of cash accounts.

Borrowing to invest is not allowed inside these types of accounts. However, you can borrow money externally to contribute to these accounts, such as a 401(k) loan.

Opening a cash account may make financial sense once your tax-advantaged account contributions are all maxed out.

Margin Account

Finally, there are margin accounts. Let me start off by saying margin trading is risky and NOT for beginner investors!

Margin accounts allow you to borrow money from the broker to make trades. This allows you to put leverage into play, similar to real estate. However, given the high cost of borrowing (compared to a mortgage) you have to earn a significant amount of money for this to be worth it.

Which Investment Accounts Should I Use?

There is no one-size-fits-all answer here. After all, personal finance is personal! Also, there is no one “best” account, but there is an ideal combination of accounts out there for you.

There are some rules of thumb that can help you figure out which investments and investment accounts to focus on first.

Max out your employer’s 401(k) contribution matching

As I mentioned earlier, this is literally free money! You should at least contribute enough of your pre-tax dollars to get the maximum contribution match that your employer will give you.

Remember, even if you don’t like what your employer’s 401(k) plan offers in terms of investments, it is still worth it to contribute and earn that employer match. You can always roll over your account to a more flexible IRA at one point in the future!

Build up your IRA and/or Roth IRA

The one you choose to prioritize depends on your preferences and goals. Here is some food for thought:

• The tax deferral of a Traditional IRA is ideal if you anticipate you’ll have lower taxable income in retirement than you currently do today.
• Investing your after-tax dollars in a Roth IRA is ideal if you anticipate you’ll have higher taxable income in retirement.
• A Roth IRA allows you to withdraw up to the total amount you’ve contributed at any time.
• A Roth IRA doesn’t force you to make withdrawals at age 70 ½ like the other accounts do (if you’re even thinking that far ahead!)

I really like this calculator from Bankrate.com that allows you to compare which type of IRA may be better for your situation.

Maxed Out? Make use of brokerage accounts

Investing doesn’t need to stop once you max out your 401(k) and/or IRA contributions. A brokerage account allows you to contribute an unlimited amount of money!

One downside of brokerage accounts is taxes, but thankfully both capital gains and dividend income are taxed lower than regular income if you do it right.

Here are a couple common strategies to minimize your taxes owed:

• Try to hold stocks for a minimum of 1 year to avoid paying higher capital gains tax.
• Try to keep interest income (ie. bonds) in your tax-advantaged accounts, since they are taxed at the normal rate for income. **
• Consider selling losing investments to offset your capital gains for that calendar year

** Note: Corporate bonds are typically fully taxable. Government bonds may be different; for example, interest from municipal bonds is often non-taxable. This is why you should consider consulting a financial professional to help lower your tax bill.

Start Investing Today and Build Wealth for the Future

Having an optimal strategy for your investment accounts can be a game changer, especially if you start young.

While everyone’s situation is unique, one likely common aspect is an employer’s 401(k) contribution matching. You need to take full advantage of 401(k) contribution matching. I cannot stress this enough!

From there, you need to create your own answer to the Roth IRA vs. Traditional IRA dilemma, based on what works for you. Personal finance is personal!

The fun doesn’t stop once you have all your tax-advantaged accounts maxed out; you can continue to invest through plain old brokerage accounts. Keep in mind some of the basic strategies mentioned above to reduce your tax bill.

Finally, you should consider hiring a financial professional down the road! The wealthier you become, the more complex your tax situation may get. A good accountant or CFP (Certified Financial Planner) will save you more money over the years than what it cost you to hire them.