Tuesday, 7 July 2020

The Best Way To Invest Into A 401k, HSA, IRA


If you eventually want to achieve financial freedom or even financial independence, then you need to know how to invest your money properly. You know how there's a certain order that you need to go through when you want to wash dishes in a dishwasher? Rinse the dishes off so there's no food on them,  load them into the dishwasher, add dishwasher soap, run the dishwasher, unload the dishes. If you skip the steps of rinsing off the dishes or, I don't know, forgetting to add soap, then you will end up with plates and silverware that are not clean. It is the same thing with investing your money if you do it wrong. 

There is a certain order that you need to follow with investing, just like there are certain steps that you need to go through to have clean dishes. If you skip one of those steps without knowing why you are skipping a step, then you are going to pay for it later down the line. Unfortunately, your investments are not as forgiving as your dirty dishes are. In this article, I am going to go through the order that you should be investing to ensure that you have the maximal amount of money so you can achieve financial freedom or even financial independence in the future. 

If you don't have access to any of these on the list, then just skip that step and move onto the next one. Don't completely ignore it, though, because at some point it may be available to you so you should at least be aware of what you are going to do. Other than that you should not jump around from step to step. Think of this process as a row of buckets that you need to fill up. Once the first one is filled up, then you move onto the next one, and then the next one, and so on. At some point in this article, I will go through how I am personally working through this whole process. 


  • Disclaimer: Obviously nothing in this article should be taken as investment advice. Stick figure drawings are what I do professionally, so this article is for informational and entertainment, entertainment purposes only. Please do your own research and don't listen to a stick figure guy like me. 


Let's get started



Step 1. Build Up An Emergency Fund

This should technically be done as early in the process as possible, but it can be built up while you are still investing and going through the following process. It's tough for me to give you any sort of timing because it's smart to start investing as quickly as possible, but that emergency fund is going to save your butt more often than you know. This is one of those gray areas that you will have to decide for yourself. The stability of your job and whether or not you have a family will give you an idea of how much you need to carry. If you have a steady job like a teacher, then you might be fine with, we will say three to six months worth of expenses. Now if you have a sales job where income can drastically change throughout the year, then a six to the 12-month emergency fund would work best for your situation. 


Keep Money In High Yield Saving Account

All of this money should be put into a high-yield savings account. Do not, under any circumstances, invest this money. I know it's going to be extremely tempting because the stock market has done nothing but go up over the past 10 or 11 years and you feel like you could be earning so much more if it was invested in the market. But playing the stock market in the short term is a loser's game. You have no clue when you will need the money since it's there for emergencies. So, you have to assume it will be invested in the short term. 


Step 2. 401k Up To Match

Invest up to your employer's match. There is no gray area with this one. Under all circumstances, you should be doing this no matter what people like Dave Ramsey tell you. Let's say your employer gave you 30 days vacation, every single year, and if you did not use that vacation by January 1st, then you would lose it. Would you make sure that you used it all by January 1st? Of course, you would. Those are free days that you can't get back once the option is off the table after January 1st. It is the exact same thing as a 401K match. If you don't invest enough for them to match today, then you can't go back and get that free money from them later down the line. A $3,000 per year employer 401K match invested for 30 years at a 7% return comes out to over $280,382.36. This is a part of your compensation, just like your salary and all of the other benefits you receive from them. So, take advantage of that free money. 


Employer Match Money Goes Into Traditional 401k

One thing to note is that all of the money an employer contributes to you goes into a traditional 401K. So for example, if you are currently investing in a Roth 401K, then they will still match your contributions but, it will go into a traditional 401K. This is how it is everywhere, so you can't change it, you just gotta deal with it and be happy with the fact that they are giving you free money. 


Step 3. HSA (Health Savings Account)

This is the ideal bucket, especially if you treat it like it's a tax-free retirement account. Not many people think about it in this way, because on the surface, it looks like it's for medical expenses, which is technically true, but how you interact with it changes everything and leave you with insane amounts of money in retirement. The way to do this is to contribute to your HSA every year and avoid touching that money until you are retired. That means that you'd pay all of your medical expenses out of pocket instead of withdrawing money from your HSA account to pay for them right now. 

To take advantage of this, you will need to make sure that the money in your HSA account is actually invested so it has a chance to grow. If you are single, maxing out your HSA for just one year, letting it stay invested for 30 years, assuming a 7% return and never investing another dime would turn that $3,550 into over $27,000 of tax-free money. You save on paying taxes three different times. So, it's a triple tax saving.


  1. You don't pay taxes on the money when it's going into the account,
  2. You don't pay taxes on the investment gains, so in our example, that we just talked about,
  3. You don't pay taxes on the $23,000 gains 
  4. You don't pay taxes when you withdraw money from the account. For medical expenses.

It's very rare that the IRS gives you a chance to legally skip out on paying taxes once, let alone three different times. So, that's why this is such a powerful account if you use it properly. There's more you need to know before doing this,


Step 4. IRA (Individual Retirement Accounts)

It was honestly tough for me to put an HSA before a Roth IRA because I love everything about a Roth IRA, but that triple tax savings you get with an HSA is just too good to pass up and not contribute to first. If your income is over the Roth IRA limit, then this would be the time for you to look into contributing to a traditional IRA and converting it to a Roth IRA using a backdoor Roth IRA. If you are eligible to invest in a Roth IRA, then go for it. The reason I say that is because none of us have any idea of what the tax rate is going to be in the future, so I always say to put the tax, pay the taxes now so the money can grow tax-free forever. But once again, that's just my opinion, do your own research and do what you want. Plus, dealing with required minimum distributions from a traditional IRA is a little annoying.


More Control Over Your Money

The reason that IRA is the next best thing to max out before you go back to investing in something like your 401K, is because you have full control over everything. You choose where you want to invest and there are a lot more options for you to choose from when it comes to equities to invest in. With a 401K, you are locked into having to use the platform your employer sets up for you, you have to deal with the fees that they charge you and your investment options are limited to only the ones that they offer. The one major problem with investing in an IRA is the fact that it is self-directed. So, you have to take all of the initial steps to set one up and most people don't do this. And I think that's either because they don't know about it or even know how to do it. Now, this could be a little bit intimidating if you don't know what you are doing.



Step 5. It Depends

Now we're heading into the territory of, it depends. Which one of these four you choose is all going to depend on you. 


  1. Build Up An Emergency Fund
  2. 401k Up To Match
  3. HSA (Health Savings Account)
  4. IRA (Individual Retirement Accounts)


You could potentially do all four at the same time or do a little bit of each, or just do one. But I would put them all on the same level just in case someone wants to choose one.


Step 5a. 401k Up To Current Limit

The first of the three is going to be maxing out your 401K up to the limit allowed which is right now, $19,500 per year. You would deduct $19,500 from whatever you contributed up to your employer match and that's what you would contribute in this portion or this bucket. Whether you invest in a traditional or a Roth 401K is going to be up to you. Now some people who are pursuing financial independence will contribute to a traditional 401K, then roll it into a traditional IRA, then convert it to a Roth IRA. 

Now that level of detail is way beyond the scope of this article, so just have an idea of which type of 401K that you will put money into. If you are not sure, then don't let that stop you from moving through this step. Just contribute to one while you spend a few weeks or a few months figuring it out. You are not going to make or break your future one way or the other while you gather more information, but you will if you are not investing at all.


Step 5b.  Real Estate Investing

Invest in real estate or start putting money aside to invest in real estate at some point in the future. I have friends who are bypassing their 401K just to buy real estate because that's how they want to generate money for themselves in retirement. And I don't see an issue with this at all. The people I know who have had a lot of success with real estate investing do it two ways. 


House Flipping

The first way is that they buy, make improvements on, then sell that property to make a profit. Now there's a lot more that goes into this sort of thing, so you might want to talk to someone who successfully does it, before giving it a go.


Rental Properties 

The second way is you could also think about investing in real estate through the buy and hold method, where you purchase an investment property, then rent it out as a way to build a consistent stream of cash.

If investing in physical real estate on your own is not something you are interested in, but you still want some of your money invested into real estate for diversification purposes, then you could always go the route of using a crowdfunded real estate platform. I personally recommend and currently invest in Fundrise. 


Step 5c. Invest Into Your Business 

Invest money into a current business you have or start setting money aside to start a business. I love it when people build a business on the side with a full-time job. I honestly wish that everyone did this because there are so many benefits. The tax benefits alone are insane and make me wonder why everyone does not start a business. Having additional income outside of your full-time job also gives you a little safety net in case something happens where you got laid off. It's a great way to ensure that you at least have a little bit of money coming in just to get you by. Another benefit a lot of people don't mention is that it gives you something to do that's more productive than just sitting around and watching television or YouTube videos all the time. If you enjoy what you do, then it starts to become your entertainment as opposed to work.


Step 5d. Pay Down Mortgage

Starting to pay down your mortgage or start saving for a home. Some people have the desire to pay off their mortgage because it helps them sleep better at night and there's nothing wrong with that. I, personally, have no desire to do this because my money is better invested somewhere else where I can get a higher return. If you want to do this, then absolutely go for it, I wouldn't call you stupid for doing it. 







Conclusion

Think of this like anything we didn't talk about already. They are going to be very specific to you and what you know, so I can't necessarily name any of them off right now. Maybe you know something about, we'll say, investing in art, or jewelry or something obscure like that. Hopefully, you enjoy reading this article and I hope you learn something from it

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