Understanding Your New Investment Accounts

Posted on February 12th, 2021
Investment Account

How do you know what new investment accounts you should open when you’re a beginner? Investing is a topic that many find stressful. Especially when you are just getting started. There is always the advice of “talk to a financial advisor!” but when advisors are often looking for clients that have a minimum of $250,000 of investable assets that they can charge 1% on, is that always a feasible choice? As someone who used to be a financial advisor, I’d like to say that investing without a financial advisor has actually never been easier. 

Big, well-known firms have all dropped trading fees to $0 to compete for your business. New companies are opening that are strictly online or on mobile apps. Account balances and your net worth update instantly. We can literally handle all of our finances on the rectangle that fits in our pocket!

It’s easy to get overwhelmed with all of the options available. So, what investment accounts should beginners look at opening first?

The before-you-invest account

Whether you are a beginner to investment accounts or not, you should make sure to have one account checked off before starting. An emergency fund. How big your emergency fund needs to be is up to you and your needs, but there should be some savings set aside for the inevitable.

When you are investing your money, it is no longer “liquid”. This means it is more difficult to pull out cash to buy an item or pay for an expense. It’s not impossible- it just takes the transaction time of selling your investment position, then moving the cash from your investment account to your checking account. This process can take several days and may incur taxes along the way, depending on which account the money is taken from.

To avoid unnecessary taxes or potentially selling your positions at a loss, you should have an emergency fund in place to cover expenses that pop up. Yes, your investment accounts are there, and your money if you need it, but they should not be your first line of defense!

Two Types of Investment Accounts

There are many, many different investment account options out there. However, all of the different accounts you see can really boil down into two categories. Those categories are retirement and non-retirement.

One big mistake beginners make with investing is thinking they are too young to worry about saving for retirement. But investing and retirement planning actually go hand-in-hand! Investing is a tool to build wealth. Retirement is an inevitable phase of life that requires wealth

To make the most out of your investing experience, you should start saving for both short and long-term goals. While retirement is a crucial thing to be saving for, it’s not normally your only financial goal. There are inevitable expenses in the short to medium term that investing can also help fund. 

Understanding the type of account that will best fit your goals is key. Then, knowing that life will throw you all types of expenses, put your investments to work to help fund them.

Retirement Accounts

You should understand that ‘retirement accounts’ is actually a huge umbrella! While they all have the same objective: money saved for your future, their ways to get there are all different. Each account has a slightly different set of rules, limitations, and tax situations. This is why you might be more comfortable talking to a financial or tax advisor about your unique situation. 

Start investing in your 401k or 403b

The first investment account that beginners should consider is, hands-down, a 401k or 403b through an employer. This is because of ease of entry, not because of any other investing perks! If you don’t have an employer 401k or 403b through work, don’t panic. There are still plenty of great investment account options for you.

If you do have access to a retirement plan at work, use it! Saving your money can be a difficult habit to get into. It will make saving a whole lot easier when a portion can automatically be taken from your paycheck.

Money that is coming directly from your paycheck also gets the perk of not being taxed. Your 401k or 403b contributions get deducted from your taxable income when you file your taxes. This means your seeing some tax savings on your saved money!

What about the “employer match”?

An “employer match” is a deal you don’t want to leave on the table. This is money that your employer will put into your account, for free, based on an amount you are putting in. It’s common to hear of employer matching of 3-6%, but I’ve witnessed matches as high as 10%. Yeah, I was jealous too. 

This percentage could be based on your income, or it could be based on a dollar amount you contribute. But, regardless of the formula, you don’t get the match unless you are also contributing to your account!

Ask questions about employer matches and keep asking questions until you understand how it works! In the best-case scenario, you should be shooting to contribute enough to get the full employer match that’s available.

How to start investing when you don’t have a 401k

While saving in a 401k and employer matching is nice, not everyone has access to it. If you don’t have a 401k or 403b option at work, you’re going to have to be a little more involved in your finances. This is not a bad thing! This means you have a LOT more freedom as far as your investment options. Having access to all options means you can choose investments with lower fees, which is a common complaint in 401k and 403b plans.

For those that don’t have employer plans, or for those that do but who want to be doing more saving, there are Individual Retirement Accounts, or IRA’s. Make sure you understand the IRS’s rules on these accounts! While there are perks, there are also limitations. The most common one is not being able to withdraw your savings until age 59.5, the deemed “retirement age”.

These accounts can be invested, just like employer plans. Being able to invest inside your retirement account is the key ingredient to having enough money to retire. 

IRAs beginners should start with

The first investment accounts beginners without 401k’s should consider are the Traditional and Roth IRA. These accounts can be funded up by anyone with earned income, which is income from a job or self-employment. Things that don’t qualify as earned income are interest, dividends, alimony, child support, and social security.

Opening up a traditional or Roth IRA is not difficult, and it isn’t something that should intimidate you! You open your account with a custodian, like Vanguard, Fidelity, or Charles Schwab. Most custodians offer free account opening, no minimums, and free trading. Most accounts can be opened online, in less than 15 minutes. Remember when I said investing without an advisor has never been easier?

Traditional or Roth IRA?

Should you start investing in a traditional or Roth IRA? This is one of the biggest questions for new investors. Both accounts will help you save for your retirement years, but they have a very big difference when it comes to how they are taxed.

When you are saving in a traditional IRA your contributions will be deducted from your taxable income. This is how 401k’s and 403b’s work as well. When you put money into your traditional IRA, it will get subtracted from your income when you file your taxes. This makes the amount of money you owe taxes on smaller, and gives you tax savings today. For those who are looking to replace not having a 401k at work- the traditional IRA is a closer comparison.

Note: there are Roth 401k and 403b’s that exist, to which the above does not apply!

The Roth IRA works differently. In the Roth IRA, you do not deduct your contributions when you do your taxes. This means you are not taking any tax savings today. Instead, you most likely already paid income taxes on the money that went in. I know, this doesn’t seem like a great tax perk right now, but bear with me…

Taxes on withdrawals

There are key differences to these accounts when you are withdrawing money from your IRA. This is when the Roth IRA’s perks begin to show! Because you already paid taxes on the money you put into your Roth IRA, in the IRS’s eyes, you’re done paying taxes. Your entire account balance is yours. Imagine… 20, 30, 40, 50 years down the road when you are withdrawing your money from these accounts. Now imagine never having to worry about paying taxes on it. Doesn’t that make you want to plan your retirement vacations right now?

The traditional IRA had better tax perks in our saving years, but now, they aren’t looking as nice. In the traditional IRA, since you were deducting your contributions, you technically haven’t paid any taxes yet. The money you withdraw from traditional IRA’s get taxed as income. This means you will have to pay income taxes on every single withdrawal. How much in taxes? Well, that depends on whatever tax system you’re in at that time.

Many people agree that already paying their taxes provides a special peace of mind. Especially for those who think taxes will increase in the future. This makes the Roth IRA a favorite for many. However, you will want to make sure you do not exceed the annual income threshold for making contributions. 

It’s likely you will need to use both accounts in your lifetime, so don’t get hung up on which is “better”. If you are just beginning in one of these investment accounts, getting started is the important part. 

Traditional and Roth Annual Limits

The annual limit for contributions to these accounts in 2020 and 2021 is $6,000 or $7,000 if you are over age 50. Note that is the combined limit, not individually! If you put $6,000/$7,000 in a Roth IRA in a given year, you could not put any in a Traditional IRA that same year. You could put $3,000 in each, or any combination that adds up to the limit, but not more than.

This is an area where 401k’s and 403b’s show more benefit. The annual contribution for those accounts is much higher at $19,500. People trying to save a significant amount for retirement are capped by the much smaller limit of the traditional and Roth in comparison. 

However, those just getting started might benefit from a lower annual limit, as it makes a great goal. Having a $6,000 max on this investment account when you’re a beginner could mean setting an investment goal of $500 a month. This would max out an account, and could add up to a large sum of money by retirement time!

Other IRA Options

When you are self-employed there are even more IRA options for you to start investing. But if you don’t expect to be investing more than $6,000 a year, there is nothing wrong with sticking with the Traditional or Roth. 

If you are hoping to put away more than that for your future, you should consider opening a SEP or SIMPLE IRA. Which one you choose will depend on your business and the number of employees.

When you are a beginner to investment accounts, don’t feel like you need to open multiple IRA’s at once! Decide which one makes the most sense for your current situation. You might want to read more about the differences in tax perks and see which account is most useful given your current situation.

Non-Retirement Accounts

Once you have some money being regularly invested for your future, you should consider other financial goals. If you know you have big expenses coming up in the next 5-20 years, things like homes, weddings, or college tuition, investing could help you out. But keep in mind, It’s not a good idea to start investing for short-term goals. The market could be down when you are in need of your funds, and you could risk having less money than you put in. The longer the time-frame, the greater your chances of a balanced out, positive return.

Setting up non-retirement investment accounts can also prevent you from tapping into retirement funds early if you need money for an emergency. This is also why you should have an emergency fund established before you start investing.

Non-retirement investment accounts do not see the same tax savings as retirement accounts. You will not write off any of the money you put in, and when you sell out of a position, you will owe taxes on any gains. You should get familiar with short-term and long-term capital gains taxes when you are investing in these accounts. Always consult a financial or tax professional if you are unsure about your tax situation!

Individual brokerage accounts

This is probably the most common investment account in the non-retirement category. Beginners who opened investment accounts through apps like Robinhood and Acorns most likely opened up an individual brokerage account. As the title suggests, this account is for individuals, so only one person can be listed on the account. 

Again, the biggest perk is inside this account is being able to invest. Unlike money in your savings account, you can invest the cash you move to these accounts into companies or commodities. You can buy stocks, exchange-traded funds, mutual funds, index funds, and more. There is no guarantee your money will grow. Remember, you should always be doing your own research before you start investing, and understand the risks involved.

You should also be aware of the tax happenings inside of your new investment account. You will pay short-term capital gains tax on positions held for less than a year. If you hold your position for over a year, you will be taxed at the lesser, long-term capital gains tax rate.

Don’t let tax fears prevent you from starting your investing journey! Your custodian will send you tax forms in January or February with any tax information you’ll need for filing your taxes. You only owe taxes on the growth of your money. Paying taxes on your growth is better than not growing at all!

Joint brokerage accounts

If you have a spouse, you might be considering a joint brokerage account for your money goals. You can open joint accounts with non-spouses too, just use caution, as both account owners will have full access! Joint accounts might be considered for business partners or family members, just make sure all of the terms are understood by all parties.

Joint brokerage accounts are treated the same as individual accounts, except they allow more than one account owner. You should anticipate the same investment options and tax rules when it comes to this account! 

If you open a joint investment account, make sure you are clear on what will happen to the account in the event of an account owner’s death. In most cases, the account will remain intact for the surviving party. This is normally fine when your joint owner is your spouse, but might not be ideal in other situations.

Investing for your children

Common non-retirement goals that people open investment accounts for are college or savings for their children’s future. If you know helping out your kids is something you want to do, consider setting up an investment account to start saving in on their behalf. Investing to help reach these pricey goals might mean you reach them more quickly than saving in a bank account would. 

529 Plans

529 Plans are investment accounts specifically designed for saving for education. The money you contribute does not see a tax deduction as a qualified retirement account would, but there are other tax savings. You do not have to pay any capital gains tax on the growth inside this account if the money is used for qualifying education expenses.

You will have to pay taxes if money is taken out for non-education expenses. Plus an additional 10% penalty. If you are unsure if your kids will use this money for education, make sure you understand the tax rules on this account before saving in one!

UGMA/UTMA Accounts

Opening a custodial account is another way to invest for minors, or to help your children learn about investing their own money. You will still be responsible for taxes on gains, and there will be no tax perks for education expenses, but there aren’t penalties on withdrawals either. The UGMA (Universal Gift to Minors Act) and UTMA (Uniform Transfer to Minors Act) are both ways to invest on behalf of your children. Both accounts are very similar but you will want to do your research or talk to a professional to see which is best for you. 

You would list yourself, or another guardian, as custodian of the minor’s account. The custodian must act as a fiduciary, or with the child’s best interest when it comes to account management. Once the minor reaches a certain age, they become the full account owner. 

If going to college is in the future, make sure you understand the rules with financial aid and different accounts!

Recap: Investment accounts for beginners

Understanding investment accounts as a beginner can be a lot to navigate! Don’t let the huge variety of investment options overwhelm you. There is an account that can help you with just about any life goal. Commit to learning more with time, and investing could become an exciting part of your life!

The first investment account beginners should open is one for retirement. Make sure you are considering your future and putting money aside for it. If you have a 401k or 403b at work, start there. If not, look into Roth and traditional IRA’s. 

Be realistic about upcoming expenses for your future. Consider investing in non-retirement accounts to meet your goals. Remember to stay educated and diversified! Understand the tax implications of different accounts, and consider talking to a professional before you make expensive decisions. 

Enjoy the process

Above all, enjoy the process! If you are new to the world of investing, try reading or listening to audiobooks on the subject in your free time. Listen to podcasts and find groups on social media. Make the learning process enjoyable! Be wary of your neighbor’s hot stock tips, and try not to let the news headlines about the stock market dictate your decisions. Educate yourself, stay diversified, and grow your wealth!

Alicia Dion

Alicia Dion

Alicia Dion is a personal finance expert, financial coach, and founder of Friend of Finance. She loves creating content that helps people understand and overcome their fears around investing, and helping others unlock their potential to build wealth. She was formerly a financial advisor for retirees and is now sharing her industry insight through writing, coaching, and financial courses!

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