By Katy Macek
We all want to make our money go further, but it can be confusing to know where to start. Regardless, it’s recommended that you invest your money to capitalize on its growth over time — known as the “time value” of money.
Terry Belken, a financial planner with Dupaco Credit Union, says the secret to good financial planning is spreading out your finances over multiple accounts for specific purposes, or diversifying investments.
“The time value of money is so important, and can exponentially grow over time,” he says.
Belken also says there are three big questions you should ask when investing: What is the purpose of the money? What are your financial goals? And, when do you need it? Working with a financial advisor can help you plan for your specific needs.
Here’s a high-level breakdown of common investment accounts that can put your money to work.
TRADITIONAL 401(K)
This is the most common employer-sponsored retirement plan. Investments in a traditional 401(k) grow tax-deferred until retirement, but investment options are usually limited to what is offered in your employer’s plan. There are also contribution caps.
These funds can be withdrawn penalty-free at age 59 1⁄2, when you must take required minimum distributions (RMDs).
ROTH 401(K)
A Roth 401(k) is also funded via your paycheck and offers pre-selected investment options. The difference is that the contributions you make have already been taxed, meaning when you take out money down the road, there won’t be additional tax liability.
Belken says the Roth 401(k) can be beneficial if you are in a lower tax bracket, and if you are just starting out.
“The earlier you start [putting money] into a Roth or tax-free vehicle, the [better],” he says, because your investment grows as your income grows because of the power of compounding.
ROTH INDIVIDUAL RETIREMENT ACCOUNT
A Roth IRA is similar to a Roth 401(k), but the annual contribution limit to a Roth IRA is much lower.
For example, if you are under age 50, the maximum yearly contribution is $7,000 (versus $23,000 in a Roth 401(k)). Contribution limits also depend on your tax filing status and income.
This can be a good option if you believe you’ll be in a higher tax bracket in retirement and want the ability to withdraw money before age 59 1⁄2 without penalty.
TRADITIONAL IRA
IRAs are good for those who don’t have an employer- sponsored 401(k) or want to invest in more than just a 401(k). There is a wider variety of investment options, and you pay taxes upon withdrawing funds. Traditional IRAs also require you to take RMDs at age 73.
This is a good option if you want an immediate tax deduction, believe you’ll be in the same or lower tax bracket when you retire and can wait until retirement to access funds.
STOCKS
When you buy a stock, Belken says, you are essentially buying part of a company, and you have to buy a whole share. These offer potential on higher returns if the business does well, but are often risky because there is no guarantee. If a business does poorly, the value of the share declines.
Stocks are great investment options for someone who can invest more money above and beyond their retirement accounts (401(k), Roth IRA, etc.) and is able to take on more financial risk. But, buying stocks typically shouldn’t be your only form of investment.
BONDS
Bonds are designed to raise money for governments and corporations. You’re essentially loaning money when you buy a bond, and receive payment in the form of interest, which is fixed in advance. Bonds are less risky than stocks.
MUTUAL FUNDS
Mutual funds can be a mix of stocks and bonds depending on the investment objective of the fund. You invest in them, but they are managed by firms that make decisions about where those investments go.
Belken says these are great for people who are just starting out because they are diversified and you can buy fractional shares, versus having to buy the whole stock.
CERTIFICATES OF DEPOSIT (CDS)
CDs are a type of savings account where you keep your money for a specific length of time, earning a fixed interest rate, which is generally higher than a savings account.
These are a good option to earn a bit more money and a safer investment, but they have lower growth opportunity.
Most financial institutions offer these accounts, as do online brokers and trading platforms like Charles Schwab and E*TRADE.
