How to Rank Your Investments: Your Financial Pyramid

When it comes to investing for future goals, we can’t always do it all, at least not at the same time. We need to make some hard choices. But the best approach may not be super clear.

For example, if you have a child headed to college soon with nothing saved for his or her education, is it wise to pump the brakes on your 401(k) and, instead, allocate money towards a 529 college savings account? College is sooner on the horizon, after all.

And if you have a workplace retirement plan, should you invest in it over a Roth IRA? Which takes precedence?

And where might a diversified brokerage account stack on your financial pyramid?

Here’s an overview of long-term financial investments worth aiming for and the best ways to prioritize them.

Workplace Retirement Account: Start Here.

Retirement, in general, is the most significant investment bucket to fill when it comes to creating financial security down the road.

While some feel the need to invest for their child’s college first, it’s important to remember just how long we’re expected to live. A man reaching age 65 today can expect to live, on average, until age 84. A woman turning age 65 today can expect to live, on average, until close to age 87. If you retire in your 60’s, will you have enough money saved to last at least another 20 years? A government study suggests we have a ways to go. About half of households approaching the golden years have no retirement savings.

Social security isn’t going to solve much of our future financial needs, either. The average American claiming social security at age 62 will spend a majority of their monthly benefits on health care costs, according to a recent study. Nearly three in 10 current retirees say their social security benefit ended up being less than they expected.

Sorry for all the bad news.

But, if you have access to a workplace retirement account such as a 401(k) or 403(b), excellent! This can be a fine place to begin investing for your future. There are a number of advantages to these accounts, including a yearend tax deduction and possibly an employer match. 

Annual contributions (capped at $18,000 in 2017 or $24,000 if you are age 50 and over) can be deducted from your taxable income, reducing your tax exposure today. Your tax burden is deferred until you start making qualified withdrawals at age 59 ½.

What’s more is that many companies offer their employees a matching program of say, one dollar for every dollar they put in, up to five or six percent of their income.

A recent study found that in order to entice employees to save more, over 40% of companies now offer a dollar-for-dollar match. This perk is unique to workplace retirement plan. If your company provides it, it’s probably best to invest here before any other investment account.

Next Stop: College Planning

Once you’ve set up a retirement account for yourself and are making automatic contributions (10%-15% of your salary, including a match, is great), you’re next item of attack is college savings (if need be.) If not, jump ahead.

Remember that the cost of college, while daunting, can be afforded in a number of ways. The financial burden doesn’t have to be entirely on you. There are scholarships, grants, loans and even tuition-free schools. Start the college planning talks with your child as early as freshmen year of high school and begin exploring all the affordable and valuable routes to achieving a college degree.

If you have some time until your child starts college, the 529 savings plan is a popular vehicle. Plans are offered by each state and the savings are invested much like a 401(k) where your money gets placed in various mutual funds and other investment options. Your contributions grow tax-deferred so you don’t pay taxes once you start withdrawing the money towards education expenses.

Know that you are not bound to your state’s plan. You can compare each state’s offering at savingforcollege.com.

Want to Invest More for You? Consider an IRA

Once you’ve maximized your workplace retirement account and created a savings plan for college, you may want to explore some other tax-friendly investments to pad your financial future.

Enter: an individual retirement account or IRA that you can create at most any bank or financial institution. I’ve explored IRAs in-depth on the blog. The traditional and Roth are two popular types.

To recap, contributions made to a traditional IRA are tax-deductible, with future withdrawals in retirement exposed to income tax. Allocations to a Roth IRA, meantime, are not tax-deductible but you can withdraw from the account tax-free beginning at age 59 ½ (as long as it’s been at least five years since your first contribution).

The contribution limit for an IRA – traditional and Roth – is much less than a 401(k), set at $5,500 this year. If you’re 50 or older, you can make an extra “catch-up” contribution of $1,000.

Unlike 401(k)s and related workplace retirement accounts, IRAs typically offer a greater variety of investment options from which to choose.

So, which is best? A Roth or traditional 401(k)? If you’re hoping to diversify your tax exposure in retirement, some like to supplement a 401(k) with a Roth IRA. But if you’re more jazzed about paying less in taxes today, a traditional IRA can better accomplish that.

Note that you may not be able to invest in a Roth IRA, if you earn too much.  If you’re married and filing taxes jointly, the IRS says you can fully contribute to a Roth IRA, as long as your adjusted gross income is no more than $186,000. Single filers must earn less than $118,000 to contribute up to the limit.

Brokerage Account

Once the 401(k) and IRA bases are covered, another potential way to grow your money over the long-term is by investing in a diversified brokerage account. The tax benefits may not be considered as attractive, but these accounts tend to offer more flexibility. Plus, you can invest as much as you want – no limits.

To open an account, you can head to any brokerage and can choose from a massive variety of investments including stocks, mutual/index funds, CDs and bonds.

Automated-investment platforms like Wealthfront, Ellevest and Betterment also offer diversified portfolios that mainly invest your money in exchange-traded funds (ETFs) or index funds.

There’s no penalty for withdrawing your money from a brokerage account before age 59 ½ like there is with the 401(k) or IRA. This makes brokerage accounts more flexible and helpful for affording those not-too-distant goals.

For example, if you know you want to buy a home in 10 years, investing in a portfolio of index funds may help grow your money faster than if it were sitting in a checking account. And you can withdraw the money at any time, no questions asked.

Of course, there are tax implications.

The gains you make from selling your investments face a so-called “capital gains” tax, but depending on the types of investments you select in your portfolio – and how long you hold onto those investments — your tax liability may vary.

If you sell any investments in the portfolio in under a year, you’ll pay short-term capital gains tax, which is equal to your current income tax bracket (as high as 39.6%). If you wait and sell investments after a year, you’ll pay long-term capital gains tax on any profit, between zero and 20% depending on your current tax bracket.