The rich invest to make their money grow. Unfortunately, too few of us follow their example. We put off investing because we think we’ll be in a better financial place in the future. We tell ourselves that later on we’ll have more money to invest.
Unfortunately, later never arrives as we inherit more obligations. A spouse and kids cause expenses to skyrocket, while your income struggles to keep pace. Lifestyle inflation has the potential to sap any extra income.
That’s exactly why the best strategy is to start investing early, regardless of how little you have to invest. Use time as your ally. Small sums invested now, snowball over time to create a sizable nest egg in the future.
Consider investing just 1% or 2% of your income on a consistent basis. As your income grows the amount you invest grows as well. In addition, you may find yourself able to invest a larger percentage of your income as your financial situation improves. But don’t be afraid to start off small.
What should you invest in?
Forget the stock symbols, Mad Money style TV shows or the money magazines hyping the latest and greatest stocks. As we discussed previously, the simplest way to take advantage of the wealth building power of the stock market is by purchasing a low cost index fund.
Where should you invest?
Once you decide to invest and what to invest in (low cost index funds of course), the next question is where to invest. Two of the first places for investment should be your employer’s 401(k) or 403(b) plan and a Roth IRA.
A 401(k) plan is an employer sponsored retirement account. You direct a portion of your salary to be placed directly into your 401(k) plan for investing. Non-profits have a similar plan for employees called a 403(b) plan.
Unfortunately, not all employers offer a 401(k) or 403(b) plan, but if they do, this could be one of the smartest places to invest your money because you fund your account with pre-tax dollars. This reduces the amount of income tax you’ll pay at the end of the year. The downside is that you’ll pay taxes on your earnings as they are withdrawn after retirement.
One particular feature that makes a 401(k) or 403(b) attractive is that many employers will match the amount of money you place into your retirement account, usually up to 3-6% of your salary. If you place 3% of your salary into a 401(k) retirement account, for instance, your employer will place an equivalent amount of money into your retirement account. This is basically free money and doubles your investment immediately.
Best of all, with a 401(k) or 403(b) plan you select the percentage of your salary you want directed to the plan and it is automatically deducted from your paycheck. You can simply set it and forget it, putting your wealth creation on autopilot.
A Roth IRA is an individual retirement account that you set up with an online broker. Unlike a 401(k), with a Roth IRA you invest money that you’ve already paid taxes on. You can have money directly transferred from your checking account to your IRA account. Remember, you’ll want to invest your Roth IRA contributions in a low cost index fund to reduce risk while maximizing the long-term growth of your money.
Put your investment accounts on autopilot then ride the long, lazy road to wealth creation.
The advantage of a Roth IRA is that your investments then grow tax-free. You can withdraw your contributions from your Roth IRA anytime, tax free. You don’t pay taxes when you withdraw your contributions and earnings from your Roth IRA after the age of 59 1/2 (assuming you’ve held your account for at least 5 years). Generally, you’re only allowed to contribute $5,500 to your Roth IRA each year and if your income exceeds $133,000 as an individual or $196,000 a year as a married couple, you are not allowed to contribute to a Roth IRA at all.
Many experts suggest that if your employer offers a 401(k) or 403(b) and matches your contributions, that you should first consider contributing up to the amount of the match, before investing in a Roth IRA. This is so you can take advantage of the “free” money your employer is offering you.
Whether you chose to invest in a 401(k)/403(b), a Roth IRA, or both, the key is to start early and invest consistently in low-cost index funds, even if you don’t have much money to begin with. Put your investment accounts on autopilot then ride the long, lazy road to wealth creation.
BMWK, have you put a 401(k)/403(b) or Roth IRA to work for you?