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How Americans Can Start Investing & Preparing for Retirement

How to start investing as an American

When you think about investing for your future and possible retirement, you may be overwhelmed. With so many different accounts, options, fees, and more, how are you supposed to know how and in what to invest?

But investing doesn’t have to be scary or hard to start. In fact, it can be super easy to get started. In this post, we will cover the different investment accounts that you can choose from. We’ll also cover the pros and cons, what those accounts consist of, and how you can put them to work for you.

Where Does Your Money Go?

First, before we get into your investing options, let’s talk about where you can save your money. No matter what investment account you choose, your money will be invested in one (or multiple) of the following options.

Mutual Funds

A mutual fund is a fund that uses your money to invest in a diverse set 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 Dow Jones).

Mutual funds can be invested into stocks, bonds, or a mix of the two. But unlike individual stocks and bonds, a mutual fund invests in diversified options across the board. That means that your risk of losing money is slightly lower than just investing in individual companies and their stocks.

A mutual fund consists of different options too, including:

Money-market funds: including government bonds and CDs
Fixed income funds: including government bonds and high-yield corporate bonds
Equity funds: including stocks
Index funds: including both stock and bond options

And more! But overall, these are the most popular mutual fund options.

Stocks

The definition of stocks is that they are securities that represent an ownership share in a company. Stocks are sold in “shares” (ie. pieces of the pie) by publicly traded companies. As an example, Facebook, Amazon, and Apple are all publicly traded companies that sell ownership as shares.

An investor buys stock in hopes that the stock will go up in price and that they can sell it for a profit. For example, Tesla shares have jumped up hundreds of dollars in the last few years. So those that bought into it early on have seen quite a return. Stocks are a riskier investment since a company can always do poorly or go out of business altogether.

Bonds

A bond represents a loan made by an investor to a borrower. Typically, bonds are corporate debt. So a corporate company or the government issues out a bond or an IOU that they will pay back what they were lent. Then, that loan is paid off by the borrower, and you, as the investor, get the interest on top of the original investment.

Most bonds are considered lower risk than stocks. That is because bonds come with a fixed interest rate, as well as a promise that they will be paid back.

Exchange-Traded Funds (ETFs)

Exchange-traded funds (also known as ETFs) are similar to mutual funds. However, unlike mutual funds, ETFs are bought and sold on the stock markets. That means that their prices fluctuate just like stocks do. But, they’re also more diversified than stocks, which means you can minimize your risks even if you want to be “riskier”.

Investment Account Options

Now, let’s talk about investment accounts and the options that you will have as an investor. While you can have multiple accounts, you may not need (or qualify) for every single option. So make sure to do your research and figure out what works best for you.

Traditional 401(k)

If you’re an employee, you’ve most likely heard of the 401(k) plan. 401(k) plans are investment accounts that an employer offers to their employees. These employees can then contribute money from each paycheck into this account. In some cases, the employer will also “match” (or also contribute a portion) of money up to a certain percentage.

The best part about 401(k) plans? The employee gets to choose how they invest their funds. However, many of the types of investments in each 401(k) plan fall under stocks, bonds, and mutual funds (specifically target-date funds).

It’s important to remember that an employer may also have a waiting period for 401(k) investing. In other words, you may have to work at a specific employer for a certain amount of time before being able to invest in their plan.

The maximum amount that an employee can contribute, excluding employer contributions, as of 2020 is $19,500. If you’re at least 50 years old, that number jumps up to $26,000 for the year.

With traditional 401(k) plans, your contributions reduce your income for the year, which means you can lower your tax bracket and even taxes owed. However, if you were to withdraw money from your 401(k) before a certain age, you’ll be taxed on that income. You can start withdrawing money from your 401(k) penalty-free starting at 59½ years old.

Pros

Legal benefits (like being able to sue if your employer doesn’t pay you your benefits)
Employer match (in some cases)
High contribution limit
Even higher limit if you need to play catch-up on investing (past 50)
Can take out a loan (although not recommended) if a financial crisis happens

Cons

Investment options may be slim
Investment fees can be higher
It’s your responsibility to manage and monitor your account

My Favorite Books to Learn About Investing:

Roth 401(k)

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 deduction. However, you won’t have to pay those taxes later, which could be a win when you’re older. Ultimately, the choice is up to you on whether you want to be taxed now or in the future.

Pros

Withdrawals are tax-free
If you have a disability, you can withdraw money penalty-free
Can start withdrawing penalty-free at 59 ½
No income limitations

Cons

Have to pay fees if you don’t start withdrawing money by 70 ½
Have to pay taxes on the money you put in upfront

Simple IRA

Simple IRAs (also known as a Savings Incentive Match Plan for Employees) allow employees to set up and contribute to a Traditional IRA. These IRAs have no operating costs, which makes them ideal for small employers who can’t afford 401(k) plans.

Simple IRAs are way different from 401(k) options. For example, unlike with 401(k) options where employers don’t have to match your contributions, with a Simple IRA, the employer is required to contribute to the plan. They can do this by adding in a matching contribution of up to 3% of the employee’s salary for participating employees, or by contributing 2% to each employee’s IRA, whether they’re participating or not.

If you have an option for a Simple IRA, you are also 100% vested. That means that you have access to your money at any time after you open your account (and that includes your employer’s contributions).

Simple IRAs typically invest in a mixture of stocks, bonds, and mutual funds. This will depend on what you and your employer choose.

Pros

Easy and inexpensive to set up and operate
Employer automatically matches 2-3%
Pre-taxed, which lowers your tax liability

Cons

Lower contribution limits ($13,500 a year)
Can’t have a 401(k) and Simple IRA at the same company
Have to make minimum withdrawals starting at 70 ½

SEP IRA

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, an employer can contribute up to 25% of an employee’s salary. Plus, if you have a SEP IRA, you are 100% vested as soon as it’s created. If your employer has a SEP IRA, you are eligible to participate if you’re at least 21 years old, have worked for the employer for the last 3-5 years, and have received at least $600 that year.

The max that 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 must start withdrawing money by the time you reach 70½.

Just like Simple IRAs, SEP IRAs normally invest in stocks, bonds, mutual funds, and even ETFs.

Pros

You don’t have to invest your own money
Your employer can invest up to $57,000 each year
Immediate vesting

Cons

Can’t invest in a 401(k) if your employer doesn’t offer it
Can’t take out that money as a loan if you need it

Roth IRA

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, which means you can use this money at any time. Roth IRAs are also super beneficial for those who make a lower income, who are self-employed, or who need a little something extra to go along with their 401(k) contributions. And yes, you can contribute to both a 401(k) and a Roth IRA.

Just like with all other IRAs, Roth IRAs invest in a variety of options. But it’s up to you to decide where you want to invest your money.

Pros

No penalties or fees to withdraw the money at any time
No taxes to pay when you withdraw your money
Great for lower-income households

Cons

Contributions are not tax-deductible upfront
Can’t contribute if you make more than $139,000 if filing single or $203,000 if filing married, joint
Contribution limits are at $6,000 a year (or $7,000 a year if 50 or older)

If you are struggling with having enough money to invest (or increasing how much you’re investing) and/or need help with paying down debt and building up your saving and emergency savings, I would love to help you. You can find out more about my Cash Flow Confidence program where I help you to do exactly this, so you have a lot more money available to invest because you’ve paid down your debt!

Solo 401(k)

Self-employed people 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 can cover them as well.

Other than those differences, solo 401(k) plans work similarly to traditional 401(k) plans. For example, your contributions reduce your tax liability, and you do have to pay taxes on the money you withdraw.

Something to keep in mind with solo 401(k) is that you will have to manage your portfolio, the fees, and all other associated tasks yourself. But you can invest your contributions into a multitude of different options, including stocks, bonds, ETFs, mutual funds, and more!

Pros

Can use in addition to a Roth IRA
Can contribute up to $57,000 a year (and add an extra $6,500 to that if you’re over 50)
No age or income restrictions, but must be a business owner (with no employees except a spouse)
Can add another $20,000 to yearly contributions if married and covering your spouse
Pre-tax money, which can reduce your tax liability

Cons

Tax penalty if withdrawing before 59 ½
Could have higher fees based on what you’re investing in

Other Investing Options

Now that you know about investing your money and the types of accounts that you can have, let’s talk about other (and inexpensive) ways you can invest.

M1 Finance

M1 Finance is great for new investors, and they let you start investing for free. There are no broker commissions or fees. You can also start investing with as little as $100, purchase fractional shares of stocks, and set up automated deposits.

When you open up your account, you’ll set an investing goal, and then you can purchase and manage stocks and ETFs. M1 Finance will manage these investments for you to make sure that you’re in line with your goals and appropriately allocated. Read more about M1 Finance here.

Acorns

Got spare change? Then you can invest in Acorns. All you need to get started is $5. Acorns allows you to invest your spare change into low-cost ETFs. In other words, if you spend $5.07 at a store, Acorns will invest the .93 cents in change. You can also automatically deposit money each time you get paid.

One thing to note is that they do have a $1 per month charge for accounts under $5,000, and a .25% annual charge for accounts over $5,000. However, college students 24 and under can invest for free. Read more about Acorns here.

Robinhood

Robinhood is a great app option for new or experienced investors who want to invest in stocks. This app is also completely free to use if you want to buy and sell stocks. They also offer instant trading (up to $1,000), which means you can get started and get access to stocks right away.

Of course, as with anything, you’ll need to do your research on what stocks you should be investing in. Read more about Robinhood here.

Betterment

Betterment is a robo-advisor that is great if you want to start investing in ETFs. Plus, it allows you to open up a traditional IRA or Roth IRA right in their app. It’s also completely free to use, with no fees besides their annual advisory fee of .25%.

When signing up with Betterment, you’ll also choose what you’re investing for. For example, if you want to earn passive income, you can choose ETFs that pay dividends. If you’re focused on taking a bigger risk, you can choose more stock options. The possibilities are endless. And, no matter what, your portfolio is automatically rebalanced for you, which means less worrying about if you’re investing the “right” way. Learn and read more about Betterment here.