How To Actually Invest

I am saving money, but how do I go about actually investing it?

You will need to open up an investment account so that you can buy stocks and bonds. There are many options when looking into which brokerage you want to handle your investments for you.

Fees

Fees can add up to a significant portion of your investments over time. This is true especially if you are a frequent trader. Imagine you buy a stock for $1,000 and later sell it for $1,200. If you pay a $10 fee per transaction, you would spend $20 total to buy and then later sell the stock. 10% of your gains would go toward fees. This isn’t even including the taxes you would pay on this. Over a lifetime of trades, this can make a significant difference in your final balance. Most discount stock brokerage companies charge transaction fees of around $10, but prices can range from free to $100s of dollars. My favorite is Vanguard because they have the lowest cost mutual funds and ETFs and when you have a Vanguard account, they don’t charge transaction fees for their funds.

Minimum Balance

The minimum balance is really only a consideration when you first start investing. Once you have spent some time building your investments, the minimum balance will not be an issue for all but the most exclusive investment companies. Most stock brokerages require a minimum balance around $1,000 but some go as low as $0 and others go upwards of $10,000.

Containers

What I am calling a container is the type of account you will need to open to hold your investments. The main types of containers are taxable, pre-tax, and Roth accounts. Each has its own benefits and drawbacks so you will have to look at your personal situation to determine which is best for you.

Taxable Brokerage Account

Benefits:

  • No restrictions on your contributions or withdrawals.
  • Freedom to invest in anything.
  • Long-term gains are taxed as capital gains instead of income. Long-term capital gains are gains from investments that are over a year old and are lower than your normal tax rate.
Long-term capital gains rate Single Married Filing Jointly Head of Household
0% $0-$38,700 $0-$77,400 $0-$51,850
15% $38,700-$426,700 $77,400-$480,050 $51,850-$453,350
20% $426,700

Long-term capital gains rate for corresponding taxable income.

Drawbacks:

  • Short-term gains are taxed at your marginal income rate. Each trade will reduce the amount that can grow your account.
  • Capital gains rate is usually higher than 0% that you would get in a tax-advantaged account. Each trade may reduce the amount that can grow your account.

Traditional IRA

Benefits:

  • Qualifying contributions to your traditional IRA will reduce your taxable income by the same amount. This has a bigger benefit than most people realize because the tax savings are at your marginal rate. Most people know this is high for high wage earners, but it is often high for low-income people because it can get their taxable income low enough to take advantage of generous government subsidies and tax credits.
  • You aren’t taxed on profits while your money remains in the account.
  • Similar freedom for investments as a taxable brokerage account. May limit use advanced trading strategies using margin or options.

 

Drawbacks:

  • Limits on contributions. You may only contribute up to $5,500 unless you are 50 or over at which point you can contribute $6,500.
  • Limits on full deductibility.
Filing Status No Work Retirement Plan Work Retirement Plan
Single/Head of Household $62,000 Any amount
Married Filing Jointly $99,000 Any amount
Married Filing Separately $10,000 (not a typo) $186,000

2017 Maximum MAGI (wages before most deductions) for full IRA deductibility

  • Withdrawals are taxable and add to your taxable income that year. This is at your effective tax rate which is generally much lower than your marginal tax rate
  • 10% penalty tax If you withdraw your money before you are 59 ½, you will pay a 10% penalty tax in addition to your income taxes. However, there are some exceptions to this rule, such as for first time homebuyers, permanent disability, medical bills exceeding 10% of your AGI, and college costs. You can also set up substantially equal periodic payments (72t) that gives you access to this money early penalty free.
  • Withdrawals for college can negatively affect financial aid.
  • Required minimum distributions (RMDs) starting at age 70 ½ years old. These prevent you from keeping your money indefinitely in the tax-advantaged account.

Employer-Sponsored Retirement Plans (401k, 403b, etc…)

There are slight variations between the different accounts but the key aspects are mostly the same. 401ks are for for-profit companies, while 403bs are for governmental or non-profit agencies. 457s have fewer restrictions on withdrawing the money (usually as long as you are no longer working at the company you can withdraw the money penalty free)

Benefits:

  • Qualifying contributions to your 401k will reduce your taxable income by the same amount. This has a bigger benefit than most people realize because the tax savings are at your marginal rate. Most people know this is high for high wage earners, but it is often high for low-income people because it can get their taxable income low enough to take advantage of generous government subsidies and tax credits.
  • You aren’t taxed on profits while your money remains in the account.
  • Contributions are often matched by the employer (free money). These contributions are also tax-deferred and can significantly increase the annual contribution limits.
  • Sometimes able to contribute past deductible contribution amounts and then immediately convert to a Roth IRA (known as a backdoor Roth IRA)

Drawbacks:

  • Limits on contributions. In 2018, you may only contribute up to $18,500 unless you are 50 or over at which point you can contribute $24,500.
  • Limited to mutual funds selected by the 401k sponsor
  • Additional charges by 401k sponsor
  • Limits on full deductibility.

ROTH IRA

Benefits:

  • No taxes on the gains or
  • No taxes on withdrawals from your account. These withdrawals do not affect your other taxable income.
  • More generous income limits for contributions than traditional IRA
Filing Status Maximum MAGI
Single, Head of Household $118,000
Married Filing Jointly $186,000
Married Filing Separately $10,000 (not a typo)

For full $5,500 contribution.

  • No penalty for withdrawing contributions
  • No penalty for withdrawing conversions from other retirement plans after 5 years
  • Similar freedom for investments as a taxable brokerage account. May limit use advanced trading strategies using margin or options.

Drawbacks:

  • 10% penalty for withdrawing gains before age 59 ½ years old. However, there are some exceptions to this rule, such as for first time homebuyers, permanent disability, and medical bills exceeding 10% of your AGI.
  • Contributions made with after-tax dollars.
  • Contribution limits are shown in the table above.

Walkthrough

  • Go to vanguard.com
  • Click “OPEN AN ACCOUNT” at the top of the page
  • Answer questions. If you get stuck, call  (800-992-8327)
  • Buy your desired mutual funds

Here is a video I had created of the actual steps for opening up an account and buying investments. This was part of a course I had created on investing in stocks on udemy.com. At the time, I undervalued the traditional IRA because I am not eligible for tax deductions due to my retirement plan through work. However, I would choose a traditional IRA over Roth IRA if the contributions will be tax deductible and my marginal tax rate was over 0% and maybe over 15% depending on life circumstances.

I hope that you enjoyed this article. Please read the previous investing articles and let me know if you have any questions. What brokerage do you like most?

Investment Considerations

Investment Recommendations

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s