When I look back over my life so far, I realize that it made perfect sense for me to start a financial blog. I can look back and notice all of the times that finances and investing were a really big interest for me.
My grandad, Joe, has always been a big investor. Not in a crazy wall street tycoon way, but a big investor compared to your average person.
In the 90’s when the stock market was really making strong gains, he was a part of that and was able to make a ton during those years.
I still remember being at my grandparents house and him having CNBC on, watching the stock tickers go by. Kids, that was before we had internet access at home. So in the olden days, you’d have to watch tv or read stock prices in the paper.
I also remember being on a big family trip and him having some stock that had to be bought or sold immediately. He was on the phone with his broker before we could leave our hotel.
So I grew up watching him participate in the market. Joe was my first really positive influence when it came to understanding how the stock market works.
When I was a music student in college, my trumpet teacher loaned me Charles Schwab’s Guide to Financial Independence. I was having a conversation one day about personal finances and he told me that with his saving and investing, he was planning on retiring as a millionaire.
I was blown away! Up until that point, the concept of being a teacher and becoming a millionaire was a completely foreign concept to me.
But the math is all there. People can become millionaires by the time they retire. In fact, you don’t have to have a crazy job to reach that status.
I think growing up in a teachers family from a small town, we just weren’t exposed to that possibility. I think that we don’t know what our money can do for us if we just take control.
Then something else happened during college that was very important for my understanding of how investing works. Joe gave me some of what would later be my inheritance early, not so that I could spend it, but so that we could invest it in the stock market and I could learn how it works. This lesson ended up being crucial for my confidence in investing.
We opened up a Fidelity investing account and put my money into a small cap growth fund. That means that it is a mutual fund made up of small companies that are highly risky, but also have the potential for strong growth.
So I was able to start learning how the stock market works, but the big lesson came in 2009.
That’s right, I was able to witness my fund lose half it’s value.
As Dave Ramsey says, the only people who get hurt on a roller coaster are the people that jump off.
I knew by that point that when you select your stocks, you want to be well diversified, and to ride it out. There are so many sad stories of people pulling their money out of the stock market when 2009 happened. The saddest thing of all is that as soon as you pull your money out, you lock in your losses.
I, on the other hand, had learned that the best thing to do is nothing. I was able to watch as I lost all of that value in my fund, and then watch as it came back over the following years. I earned every bit of my money back, just using a little bit of patience.
So today, I hardly ever check my investment accounts. I do every once in a while, but it’s not something I’m needing to do often.
When you understand how funds in the stock market work, you can invest with confidence and know ignore the noise.
So my objective is to take a very complicated subject-investing and saving for retirement, and make it simple for you. I will attempt to highlight the important things you need to know, and I’m going to leave out a few things that you don’t need to know right away. As you learn more, you can definitely learn those more advanced topics as you go.
Retirement Accounts
Often, we know that we need to save. But the subject of saving for retirement is understandably a big subject and very confusing.
Let’s try to make it simple.
The first thing you need to do is see what retirement accounts are available to you to save for your retirement.
Pensions
If you’re like me(I’m a Texas teacher), then you have a pension set up with your work.
My pension(called TRS) is a mandatory retirement plan for teachers in Texas. Basically, I put in money each paycheck and my school district puts money in for each paycheck. When I’m 62, I’ll be able to retire with a percentage of the money that I was making at the time of my retirement. I don’t control the money, and contributing to it isn’t an option. There’s some good and bad here.
Honestly, I’m not crazy about being forced into a pension. There are some things that are great about it, but if I were given an option, I would prefer to take that money and put it into a retirement account that I control.
But there are some good things about it. The first thing is that it forces teachers to contribute to a retirement plan as soon as they get started. Most people aren’t good about getting started on their retirement and you are at least going to have your pension when you retire even if you don’t save any more.
So, do you work for an organization that has a pension? My observation is that the pension is an older concept. It’s from back in the day when you would devote your entire working career at a company so that you could collect your pension when you retired. Most companies don’t do this any more and pensions are mostly still in place for government employees like me and other teachers.
401k, 403b
If you work for a private company, then you most likely have access to a 401k. A 401k is the new way that people save for retirement.
A 403b is pretty much the same thing- it’s just used by nonprofit organizations, schools, religious groups, and other folks like that. So it doesn’t matter if you have access to a 401k or 403b, they’re the same thing.
Using this account is going to be how you save for retirement. It will be offered through your employer and you want to take advantage of it to have an awesome retirement.
This is often where you’ll have your employer offer a match. So if you contribute 3% of your salary to your 401k, your employer will match that amount that is put in. You’ll need to find out the details from your employer on what they offer.
So the 401k is just a retirement account. You specify what kind of investing you take advantage of in the account. So if you have money in a 401k, that doesn’t necessarily mean that your money is doing anything within the account. You could have it just invested in cash and not earning any interest even though it’s in your 401k. So, remember that a 401k is just the retirement account.
IRA
So a 401k or a 403b is a retirement account that is set up through your workplace. An IRA is a retirement account that you’re able to get on your own.
An IRA trumps a 401k for a couple of reasons.
First, is control. You don’t always have the same choices and freedom that you have with your IRA when you’re dealing with your 401k. Sometimes you don’t have as many options for your investments inside the account.
Second, when you change employers, you’ve got to roll that 401k into an IRA anyway so that you can take it with you. When you change jobs, you don’t just keep that 401k that you can continue to invest in. You’ll set up a new 401k with your new job. An IRA on the other hand is just a personal investment account that isn’t tied to any particular job.
Traditional and Roth
So you’ve got your workplace retirement accounts, 401k or 403b, and then you’ve got your accounts that you set up on your own, your IRA. These accounts offer tax advantages. That’s the point. If they didn’t offer tax advantages, you’d just invest inside a normal account and there wouldn’t be any need for these retirement accounts.
But there are two ways they can offer tax advantages.
The first is a traditional account. That means that any amount that you contribute to your account this year, you’ll be able to deduct from your taxes. That’s a good deal. Let’s say you contributed $5,000 to your Traditional IRA this year. If you’re in a 22% tax bracket, that would save you $1,100 on your tax bill this year. That’s a good deal! That means that $1,100 could go towards paying off some debt, and upgrading something on the house. You could also use the savings to invest more. Your choice.
The other newer option is the Roth. If you have a Roth IRA, that means that you won’t be getting a deduction when it comes to tax time. So you won’t get that $1,100. But, it does mean that when you take money out of your retirement account, none of it is taxed. So it doesn’t matter how much you pull out when it comes to retirement time, it’s never taxed.
Now there’s all sorts of opinions out there about whether you should go with the Traditional or Roth option. A lot of it has to do with whether you think you’ll be in a higher or lower tax bracket when you retire. To me, it’s my observation that the Roth option is a no brainer.
I really don’t want to muddy the waters here, I’m really trying to make this simple. But by the time you retire, the majority of your retirement savings will be growth that accumulated through compound interest. So even if you pay taxes on your contributions as you make them, all of that growth, the majority of your savings, will be tax free.
So what are you supposed to do with this information?
So, to review-I talked about the most important retirement accounts that you’ll want to use when saving for Retirement.
We’ve got the 401k(403b) which is provided by your employer. You also want to find out what match they offer. If you work for a company in the private sector, there is a great chance that they match your contributions to this account up to a certain percentage of your salary, like 3-5%. The downside to these accounts is that you don’t have quite as much control and you need to roll that money into an IRA anyway when you leave your job.
Then, we have the IRA. It has the same tax benefits as your 401k but I argued that it trumps the 401k because of the control you have in your investments and the fact that you never need to move the account due to a job change.
Now, both of these accounts have tax advantages, but you have them in two flavors-Traditional and Roth. With traditional accounts, money that you contribute each year is deducted on your taxes, but that money that you pull out when you reach retirement is taxed in your normal tax bracket. The Roth option means that you pay taxes on your contributions now but that all of the money that you pull out of your account in retirement is tax free. Now, you could sit down to figure out which option is the better way, but it’s my observation that having the ability to pull out your money, contributions and growth, tax free far outweighs saving on your taxes this year.
So here’s what you’ll want to do:
Invest in your work’s 401k up to the match-This way you can take advantage of the free money that your employer is offering. If they have a Roth option, go with that but it may be that your account is traditional.
Then, invest in your own IRA-This way you can take advantage of the flexibility of the IRA. The current limit is $6,000 that you can contribute to each account each year. So if you’re married, you’d be able to invest $6,000 is each of your accounts.
If you still have money that you’d like to invest, go back to your company’s 401k- After you’ve maxed out your IRA, put any additional money back in your 401k so that you can continue to tax advantages of the tax benefits of the account. You can contribute up to $19,000 a year for each of your accounts.
So I’ve spent quite a few words seeking to explain the only terms you need to know when it comes to your retirement accounts. These are the accounts that you put the money in, but we haven’t covered what investments you will want to invest in inside the accounts. That’ll be coming up.
So in my quest to make this big complicated subject simple, I want to know what you find confusing. What part of investing still feels intimidating? Let me know in the comments or by sending me an email.
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