How To Start Investing For Retirement – When you think about investing for your future and possibly retirement, you may be overwhelmed. With so many different accounts, options, fees and more, how do you know how and what to invest in?
But investing doesn’t have to be scary or difficult to get started. In fact, it can be very easy to get started. In this post, we will discuss the different investment accounts that you can choose from. We’ll also discuss the pros and cons, what these accounts consist of, and how you can make them work for you.
How To Start Investing For Retirement
First, before we get into your investment options, let’s talk about where you can save your money. No matter which investment account you choose, your money will be invested in one (or more) of the following options.
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A mutual fund is a fund that uses your money to invest in a variety of companies. And they can be managed actively (by a fund manager who picks for you) or passively (where your fund tracks a major stock market index, like the Dow Jones).
Mutual funds can be invested in stocks, bonds or a combination of the two. But unlike individual stocks and bonds, a mutual fund invests in a variety of options across the board. That means your risk of losing money is slightly lower than investing in individual companies and their stocks.
The definition of shares is that they are securities that represent ownership in a company. Shares are sold in ‘shares’ (ie a slice of the pie) by trading companies. For example, Facebook, Amazon, and Apple are all public companies that sell ownership as shares.
An investor buys a stock in the hope that the stock will go up in price and that they can sell it at a profit. For example, Tesla shares have risen by hundreds of dollars in the last few years. So those who bought it early have seen considerable returns. Stocks are a riskier investment as a company can always perform poorly or go out of business.
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A bond represents a loan made by an investor to a borrower. Bonds are usually corporate debt. So a company or the government issues a bond or IOU that they will pay back what was loaned to them. Then that loan is paid by the borrower and you, the investor, get the interest on top of the original investment.
Most bonds are considered less risky than stocks. That’s because bonds have a fixed interest rate, plus a promise that they will be paid back.
Exchange-traded funds (also known as ETFs) are similar to mutual funds. However, unlike mutual funds, ETFs are bought and sold in the stock markets. That means their prices fluctuate just like stocks do. But they’re also more diversified than stocks, meaning you can minimize your exposure even if you want to be “riskier.”
Now let’s talk about investment accounts and the options you will have as an investor. While you can have multiple accounts, you may not need (or qualify) for every option. So be sure to do your research and find out what works best for you.
How To Start Investing
If you’re an employee, you’ve probably heard of the 401(k) plan. 401(k) plans are investment accounts offered by an employer to its employees. These employees can then deposit money from each paycheck into this account. In some cases, the employer will also “match” (or contribute a portion) of money up to a certain percentage.
The best thing about 401(k) plans? The employee gets to choose how he invests his funds. However, many types of investments in every 401(k) plan include stocks, bonds, and mutual funds (especially target date funds).
It’s important to remember that an employer may also have a waiting period for a 401(k) investment. In other words, you may have to work for a particular employer for a certain period of time before you can invest in their plan.
The maximum amount an employee can contribute, excluding employer contributions, as of 2020 is $19,500. If you’re at least 50 years old, that number jumps to $26,000 for the year.
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With traditional 401(k) plans, your contributions reduce your income for the year, which means you can lower your tax bracket and even the taxes you owe. However, if you were to withdraw money from your 401(k) before a certain age, you will be taxed on that income. You can start withdrawing money from your 401(k) penalty-free starting at age 59½.
A Roth 401(k) is similar to a traditional 401(k). However, the key difference between the two is the taxes. A Roth 401(k) has contributions that have already been taxed. So there is no upfront tax credit. However, you won’t have to pay these taxes later, which could be a win when you’re older. In the end, the choice is up to you whether you want to be taxed now or in the future.
A Simple IRA (also known as a Savings Incentive Match Plan for Employees) allows employees to set up and contribute to a traditional IRA. These IRAs have no operating expenses, making them ideal for small employers who cannot afford 401(k) plans.
SIMPLE IRAs are very different from 401(k) options. For example, unlike 401(k) options where employers don’t have to match your contributions, with a SIMPLE IRA, the employer has to contribute to the plan. They can do this by adding up to 3% of a participating employee’s salary, or by contributing 2% to each employee’s IRA, whether they participate or not.
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If you have the Simple IRA option, you’re also 100% vested. That means you can access your money at any time after you open your account (and that includes employer contributions).
Simple IRAs typically invest in a mix of stocks, bonds, and mutual funds. This depends on what you and your employer choose.
A SEP IRA (also known as a Simplified Employee Pension) is for employers only. In other words, employees do not contribute to SEP IRAs. However, this option is listed because some companies offer it.
And the employer can contribute up to 25% of the employee’s salary. Plus, if you have a SEP IRA, you’re 100% vested the moment it’s created. If your employer has a SEP IRA, you are eligible to participate if you are at least 21 years old, have worked for the employer for the past 3-5 years, and have earned at least $600 that year.
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The maximum an employer can contribute to an employee’s SEP IRA is 25% of their compensation, or $57,000 (as of 2020). Just like with traditional IRAs, penalty-free withdrawals begin at age 59½. And of course you have to start withdrawing money when you reach 70½.
Unlike Simple and SEP IRAs, Roth IRAs are great if you want to withdraw your money tax-free. Plus, no matter what age you are, withdrawals are also penalty-free, meaning you can use this money anytime. Roth IRAs are also very useful for those with lower incomes, who are self-employed, or who need a little extra to top off their 401(k) contributions. And yes, you can contribute to both a 401(k) and a Roth IRA.
Just like with any other IRA, Roth IRAs invest in a variety of options. But it is up to you to decide where you want to invest your money.
If you’re struggling to have enough money to invest (or increase how much you’re investing) and/or need help paying off debt and building savings and emergency savings, I’d love to help you. You can find out more about my Cash Flow Confidence program where I help you do exactly this, so you have a lot more money available to invest because you’ve paid off your debt!
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Freelancers rejoice! While a traditional 401(k) isn’t possible when you’re self-employed, you can still qualify for a solo 401(k). A Solo 401(k) is just for self-employed people with NO employees. However, if you have a spouse, your plan may also cover them.
Other than these differences, solo 401(k) plans work similarly to traditional 401(k) plans. For example, your contributions reduce your tax liability and you have to pay taxes on the money you withdraw.
Something to keep in mind with a solo 401(k) is that you must manage your portfolio, fees, and all other related tasks yourself. But you can invest your contributions in a number of different options, including stocks, bonds, ETFs, mutual funds and more!
Now that you know about investing your money and the types of accounts you can have, let’s talk about other (and inexpensive) ways you can invest.
Start Investing Today For The Tomorrow You Want
M1 Finance is great for new investors and they let you start investing for free. There are no commissions or broker fees. You can also start investing with as little as $100, buy some shares and set up automatic deposits.
When you open your
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