How to Invest Your Money

So far in the 15 Steps to More Money and Less Debt series, I’ve shown you how to track and trim your costs, pay off debt, and build up an emergency fund. There’s one critical aspect that you can’t miss out on: investing your money. Whether you are retiring in 2 years or 20, retirement investing is critically important to your financial future.

It can also be devastatingly confusing to the point that you make no decision at all. In reality you would be better off making a mediocre decision than avoiding the subject all together.

Before we get started breaking down all of your options, here’s a big win.

Get Free Money from Your Employer

Most places of employment offer a retirement option like a 401k. And most companies with a 401k provide an incentive for their employees to use the account. This is called an employer match.

How much your employer will give you is dependent upon your company, but it is free money. Ask your HR department about making sure you are putting enough in your account to get the employer match.

Here’s a simple example:

An employer might match your contributions up to 2% of your salary. If you put in 2% to the 401k plan, they’ll put 2% in on your behalf as well. You’ve just doubled your contribution. (If you put in 5%, they would match the first 2%, but it is still free money.)

If you don’t get anything else from this email, get your free employer match.

Understanding the Alphabet Soup of Retirement Investing

At first glance the various accounts you can use to save for retirement is baffling:

  • 401k
  • Roth IRA
  • Traditional IRA
  • Roth 401k
  • SEP IRA
  • Solo 401k
  • 403b
  • SIMPLE IRA
  • 457a

It’s a bunch of seemingly random letters and numbers pushed together. I’m supposed to use this to retire?

Here’s an easy breakdown of the accounts:

  • Accounts tied to your employer; money can be automatically taken from your check and put here:
    • 401k – most employers
    • Roth 401k – some employers
    • 403b – some employers
    • 457a – some employers
  • Accounts tied to being self-employed; money can be automatically taken from your check and put here:
    • SEP IRA
    • SIMPLE IRA
    • Solo 401k
  • Accounts you can set up on your own; money can be automatically taken from your bank account and put here:
    • Traditional IRA
    • Roth IRA

The average person should have a 401k or 403b tied to their employment plus either a Roth IRA or Traditional IRA that they set up on their own.

What’s the Difference Between Roth and Traditional Accounts?

You’ll notice on the above list there are some things that have the word Roth in front of them. What does that mean?

Roth is the namesake of the Senator that sponsored some legislation. That’s not important. What is important is the money you put into those accounts is after-tax money. Meaning you get your paycheck today and take some of that money to invest it for the future. That contribution, no matter how large it grows, is never taxed again by the government.

The rest of the accounts are pre-tax investments. What this means is you don’t pay taxes today, but you pay taxes on the contribution (and any associated growth) in the future.

This is important because $100,000 in a Roth IRA and $100,000 in a Traditional IRA are not the same amount of money. You could withdraw all $100k from the Roth in retirement. With the Traditional, you would have to pay income tax (let’s say 25%) and only end up with $75,000.

It’s a tradeoff: do you want to pay taxes now (Roth) or defer takes until later (Traditional)? The answer is dependent upon your specific situation, but one could argue there is wisdom in doing a little bit of both so you don’t have to guess about your future tax rate.

Find the Right Broker and Investments

After you decide which direction you want to go, you need to find a company to open an account with. There are a lot of options, and we have an article to help you choose the right investment broker for you, and how to set an IRA account.

In terms of finding the right investments there are literally thousands of options. The key aspect to watch with your investments is how much they cost you. In the investing world (at least of mutual funds and ETFs) this is called the expense ratio and it is shown in a percentage format like 0.50% or 0.07%. (All things equal, you want the 0.07% investment over the 0.50% because you just saved 0.43% in cost.)

The easiest path to get started with investing is:

  • A low cost index mutual fund for the Total Stock Market like Vanguard Total Stock Index (VTSMX); the expense ratio is only 0.18%
  • A low cost index mutual fund for the Total International Stock Market like Vanguard Total International Stock Index (VGTSX); the expense ratio is only 0.22%
  • A low cost index mutual fund for the Total Bond Market like Vanguard Total Bond Index (VBMFX); the expense ratio is only 0.22%

Investing isn’t something you can easily summarize in an article. Use this one as a primer, and check our other investing articles to learn more about investing your money.

Your To Do List

  • No matter what, get the company match on your retirement account at work. It’s free money.
  • Most people already have a 401k at work and can set up either a Roth IRA or Traditional IRA, based on their personal tax situation.
  • The key factor to watch in investing is expense ratio. Lower your ratio so you keep more of your money over the years.

About the Author

By , on Jul 14, 2012
Kevin Mulligan
Kevin Mulligan is a debt reduction champion with a passion for teaching people how to budget and stay out of debt. He's building a personal finance freelance writing career and has written for RothIRA.com, Discover Bank, and many others.

15 Steps Financial Success Plan

Leave Your Comment (3 Comments)

  1. Jonathan says:

    “Roth is the namesake of the Senator that sponsored some legislation.” I never knew this, I always wondered what it stood for. Great breakdown, very very useful

  2. An employer match benefit is great news to employees. Wish this was a “must-have” policy for all companies. Great info, by the way!

  3. Lance says:

    I love company matches. What is even better is when they don’t make you put money in but they auto contribute to your plan! I had this happen at a couple CPA firms but they also had long vesting schedules…

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