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If you are well-versed in personal finance, this post is not for you. I wrote this as a catch-all for the people I work with everyday who have no idea what it means- and especially how- to invest. There are obviously many more retirement and other investment accounts out there, but the following are among the most common in the retirement/investment world, and exactly what have applied to me as a nurse. Proceed.
The general public doesn’t know much about investing so they’re afraid of it. Nurses, especially. I mention the word ‘risk’ and they bolt from the conversation faster than Mr. Warcken running toward an In-N-Out. People tell me they’ve “been thinking about starting to contribute” to their employer-sponsored retirement plan. They tell me their parents manage their investments. They tell me they can’t invest because they’re saving for a house, or that their spouse won’t stop spending, or they don’t have any extra money, or that they just can’t afford the minimum pre-tax contribution to qualify for their maximum employer match. Some people don’t even know whether their employer offers a retirement account, and most have no idea what it is and how it works.
Note: I get it. My husband… Jamie “You Need A Life Plan” Warcken’s own husband… was one of those people as recently as January 2017. It’s not that Greg doesn’t know about these things, he just didn’t know his company offered a 401k until I opened a piece of his mail and said “This is about a 401k. Do you have a 401k at work?” “I don’t know, I’ll check!” He did. I channelled my inner Rafiki and calmly and rationally told him “I’m going to need you to enroll in that 401k.” He did.
Wait, no, not that one.
Yes, that one. It doesn’t matter- it’s in the past.
I’ve heard a lot of things from a lot of people about investing and I used to be in the same boat. But then I looked around and realized I didn’t want to be in that boat anymore. The boat without retirement and investments might appear big and fancy, but like the Titanic, it’s only as solid as the shift worker slacking on graveyard duty.
You can read the post I wrote about Our Investment Strategy to see exactly how we invest our own money, but if you don’t know what the hell I’m even talking about, here’s a basic rundown of two methods of investing- tax-advantaged and taxable- in my own (you know, a layman’s) terms:
A tax-advantaged account is any type of investment that is either excluded from taxation, tax-deferred until a later date, or offers other types of tax benefits. Typically there are penalties or fees for withdrawing money from tax-advantaged accounts before retirement age. 401(k)s, 403(b)s, and IRAs are all examples of tax-advantaged accounts.
A taxable investment is one you pay taxes on before you invest, and again on any gains, or earnings, you make on the investment. Taxable accounts are yours to do with what you please; you can access the money at any time. Individual stocks and index funds are examples of taxable accounts.
Stock represents a claim, or share, of part of a company’s assets and earnings. Simply put, when you buy stock in say, Google, you effectively own a sliver of Google and how much your share is worth rises and falls with the company’s gains and losses. Stocks can be extremely volatile, potentially gaining 20% one year and losing 20% the next, but over the course of history the stock market has steadily increased.
In his book Retire Inspired, Chris Hogan relates the stock market to a roller coaster and says, like a real roller coaster, the people who get hurt on the stock market coaster are the ones who jump off before the ride is over. Investing in stocks is long-term game. Leave your emotions out of it, stay the course, and buy at the bottom of the hill and sell at the top, not the other way around.
A bond is basically a loan to a government or corporation that funds various projects or activities, with changing or fixed interest rates that are credited back to the investor, or the person who buys the bond. Bonds are much less volatile than stocks, but bond prices have an inverse relationship to interest rates, so if interest rates go up, the worth of a bond falls. Because bonds are more stable than stocks many people invest more in bonds and less in stocks the closer they get to retirement. You know, in case the year you retire falls at the bottom of one of those hills and not at the top of the Pepsi sign.
A mutual fund is basically a collection of money from a bunch of people that invest in different assortments of stocks, bonds, money markets, and other investment vehicles. So you can buy into a mutual fund that buys stock, or bonds, in multiple companies instead of stock or bonds in just one company. Basically, mutual funds allow you to put your eggs in different baskets. You can invest in mutual funds under the umbrella of tax-advantaged accounts like a 401k or an IRA, or in a taxable fund.
An index fund is a low-cost mutual fund that buys all the same stocks or bonds you’d find in a specific index, like the S&P 500 for example. For those who don’t know, (in super layman’s terms) the S&P 500 is basically a collection of stocks in 500 Large US companies worth at least $6 billion. You know, your Amazons, Facebooks, Googles, Microsofts, and Apples.
The goal of an index fund is to buy into those same stocks, and try to mimic the performance of an index, like the S&P 500 for example. Index funds are basically investing for dummies, and where we Warckens keep all our money, because the goal of an index fund is just to track the performance of a given index. They don’t require those shouting dudes on the stock exchange floor, trading willy nilly throughout the day and charging you every time they do so. You pay a set expense ratio, and they roll along, passively managed, rising and falling with the stock market. Since its inception on 08/31/1976, the Vanguard 500 Index Fund has averaged an 11% annual return. Show me a savings account that can offer that kind of ROI. You can invest in index funds under the umbrella of tax-advantaged accounts like a 401k or an IRA, or in a taxable fund.
ROI stands for ‘Return On Investment’ and measures the amount of an investment’s return in relation to its cost. This can be measured in real numbers, like the annual cost of an index fund vs. its annual gains, or in real life terms, like the cost of a vehicle vs. its ability to get you to and from a job that makes x amount of money. Therefore ROI can be a very personal calculation.
While I certainly don’t consider my now-worth around $4,200 car to be an ‘investment’ because of every cars’ nasty habit of depreciating on a daily basis, mine does get me to and from a job that could potentially bring in 20-25x my car’s value in income every year. So for me, that’s an excellent ROI. But maybe others like air-conditioned seats and back-up cameras and think a $28,000 vehicle is great for taking them to and from a job that could potentially bring in the same amount of money that my job and nice used car can, but their annual income would only be around 2.5-3x the price they pay for a vehicle, vs. my 20-25x. See what I mean about personal ROI? #itscomplicated
Note: The ROI on our truck getting us to and from work is absolutely terrible. But its ROI on pulling a camper and getting us up into the mountains and allowing us to carry water and cook and sleep in the back is damn-near immeasurable. Understanding and establishing your own ROI principles is a critical part of building wealth, because it’s you reminding you what’s important to you, and spending, saving, and investing accordingly.
Now let’s talk about some individual accounts.
401(k) or 403(b)
A 401k is a retirement plan offered by your employer. A 403b is very similar, only they are offered by tax-exempt organizations (like a hospital). Employers and employees can both contribute to the plan, and typically employers offer an incentive match, like 50% up to a certain percent. For me this has always been 6% of my income. So if I contribute 6% of my income, my employers have always thrown in another 3% (50% of 6%). If you’re really lucky (looking at you, St. John employees) your employer contributes regardless, so you have a nest egg whether you like it or not. The annual maximum contribution for both a 401k and a 403b in 2018 is $18,500.
A 401k is considered a tax-advantaged account and unless it’s a Roth (after-tax) 401k, the money is taken from your paycheck before taxes, and therefore you are not taxed on what you contribute. But you will be taxed on the earnings, and on the distributions when you take your money out.
The biggest kicker with a 401k or 403b with an employer match is that employer match is free money. As part of your benefit package, they are giving you free money to fund your inevitable retirement. You all know how I feel about free money. If your employer offers a retirement account and you haven’t already enrolled, grab one of your financially savvy friends who already contributes and ask them to please walk you through the enrollment. Or walk down to HR and grab one of them (and shake them and ask why you haven’t heard anything about your retirement plan since your first morning of orientation) and ask them to please walk you through the enrollment. If I were there with you I’d do it myself. The grabbing and the shaking, I mean.
You should contribute at the very least the full match (again, that’d be that 6% in my example) to get the maximum amount of free money from your employer. Think of it this way: Your employer offers you an extra $3/hr, but you have to take ten minutes to go online to enroll for it. Would you do it? OF COURSE YOU WOULD. If you really don’t think you can afford to contribute 6% of your pre-tax income (for starters, you need a life plan), I would strongly suggest enrolling anyway at just 1 measly percent. Give it a month, see if you notice a change in your paychecks. If you don’t, increase your contribution to 2% and give it another month. And so on and so forth until you’re contributing 100% of your paychecks until you max out. What a dream!
Generally you cannot take money from a 401k or 403b until age 59 ½, but I’ll let the Mad Fientist explain ways on How To Access Retirement Funds Early. While I would suggest leaving your retirement accounts alone until actual retirement (unless you have a clear, deliberate financial plan), it’s important to know you do have options, and that all that money isn’t going to be tied up and inaccessible for the rest of your life.
An Individual Retirement Arrangement is typically a retirement account you fund with your own money, meaning your take-home income. There are Traditional IRAs and Roth IRAs, and in 2018 the maximum amount a person can contribute to one or the other, or a combination of both, is $5500/year. Unless you’re aged 50 or older, then it’s $6500/year.
Traditional IRA: Pre-tax contributions. Typically the money you put in isn’t taxable, but any earnings and the money you take out are.
Roth IRA: Post-tax contributions. The money you put in has already been taxed, so earnings and distributions are not taxable.
Both types of IRAs are considered tax-advantaged accounts and there are specific rules for withdrawing from either. Typically penalties apply to any money taken out before age 59 ½. BUT… I keep saying ‘typically’ because a lot of situations are different, and to know which is best for you, you should educate yourself on them, and/or go speak to a tax professional. We’ve done both those things, as well as utilized the Mad Fientist– his blog and podcast break down traditional and early retirement, and tax law for the laypeople. He’s a genius and has convinced me Traditional IRAs are in our best interest.
An HSA is a Health Savings Account is a tax-advantaged health plan for those with high-deductible insurance plans. That means you, and your employer if you’re lucky, can make tax-free contributions to an HSA that you can use to pay for healthcare related expenses, like copays and prescriptions. The money grows tax-free, and is distributed tax-free. That makes it triple-tax-advantaged- it’s tax-free going in, grows tax-free, and tax-free going out. But…
An HSA doesn’t have to be used just for healthcare expenses. The money you contribute to an HSA can also be used as what the Mad Fientist refers to as The Ultimate Retirement Account which is how we’re treating ours. And I quote: “If you don’t use your HSA funds for medical expenses, you can begin withdrawing money from your HSA account for any expenses after you turn 65, without penalty. You’ll have to pay income tax on any distributions that aren’t for qualified medical expenses, just like you would with a Traditional IRA, but you won’t incur any additional penalties or fees.”
You can put the money you contribute to an HSA into an FDIC-insured savings account (the safe bet) or do what we do and invest it in the Vanguard Total Stock Market Index Fund (the fun bet). I’m not giving you investing advice, I’m just telling you what we do.
If you have an HSA, stop what you’re doing and go read the article by the Mad Fientist, and make sure to keep all your medical receipts. The maximum an individual can contribute to an HSA in 2018 is $3450/yr, and the maximum a family can contribute is $6850/yr.
I hope all this clears up some basic investing terms for those of you who may not be familiar. Everything I know about investing I’ve learned by reading books and blogs, listening to podcasts, and asking questions of those who know much more than me. Investing is not even close to being as scary as the general public makes it out to be; it’s actually a whole hell of a lot of fun. And it’s 100% crucial to you, your wealth, and your inevitable retirement.
Whether it’s from an untimely death, illness or injury, or the fact that you just don’t want to anymore, we all have to bank on the fact that none of us will be able to work forever. Therefore planning for your future should take precedence over everything else. Looking at you, 529s. Secure your own oxygen mask before attempting to help others.
So what do you think- are you ready to max out your 401k and IRA this year? Ready to put an extra $10k in the Vanguard Total Stock Market Index Fund? Maybe not, but if your employer offers a retirement plan and you aren’t already investing in it, get off this site and go enroll in it right away. Start there.
If you’re scared of investing, or nervous, or think you’re in over your head, don’t be afraid to ask for help. Find a mentor, read some books, listen to podcasts on your way to work. Teach yo’self so you won’t be scared anymore. As always, I’m happy to help.
Questions, comments, concerns? I don’t know about you, but I’m exhausted after this post. Let’s all go take a nap.