I love talking personal finance with people; whether friends, colleagues or readers on the blog. I love it because there’s always more to learn. Even someone like me who’s been quite into personal finance and investing for pretty much my whole life, is still learning. Whether it’s new strategies, new ways of thinking about investing or risks, or even different nuances of the very complex tax code that we have here in the US, I’m always learning. Often times when I chat with people, we start by each sharing a few new cool tips and tricks that we’ve learned. In an effort to do that virtually with you, I did want to share a few things I’ve learned and/or have been thinking about!

Roth vs Traditional 401k

If you’re saving for retirement (which I hope you are!), you’re probably quickly faced with two different options – either doing a Roth, or a Traditional retirement account. These two types are actually polar opposites, and both have nuances and pros/cons in terms of how you’ll save your money and how it’ll grow. There’s no right answer (in my opinion) as to which one is better, and I end up splitting my contributions fairly evenly between the two. Here’s the differences:

With a traditional plan, you don’t pay taxes now on the money, and you’ll pay taxes when you retire. Contributing to a traditional plan will lower you taxable income today but you’ll pay when you withdrawal. With a Roth, you pay taxes now, but don’t pay taxes when you withdrawal the money (i.e. at age 59.5).

It’s really about when you want to pay taxes. You can ask yourself questions like, “will taxes be higher or lower when I’m 59.5 years old?” or “will I be in a higher income tax bracket when I’m 59.5?” To be honest I don’t know the answers to either of those questions, and don’t really know if I could come up with an accurate prediction. On the one hand, having the ability to pay my taxes now and then letting my money grow and compound over the next 20-30 years tax-free is pretty ideal. On the other hand, I like reducing my taxable income now and worrying about tax later.

Me personally, I’m split pretty 50-50 in terms of how I contribute.

401k vs IRA

There are so many acronyms when it comes to retirement. Another set of acronyms is the 401(k) and an IRA. A 401(k) is an employer sponsored plan, meaning it might be offered through your company. Other industries (notably) education have different plans, like a 403(b). Same idea, different acronym. In a 401(k), you can contribute up to $19,500 (either Traditional or Roth) each year. This doesn’t include a match that you’d get, which many plans offer. Outside of that, your plan may offer a “post tax contribution” which seems a little next level to be honest but something I may start looking into more. 401(k)s are more tightly structured, meaning there might be fees, and there are likely only a handful of funds that you can invest in, chosen by your employer.

An IRA (individual retirement account) is your own plan. You’ll open and maintain this through your bank or brokerage account. Often it’s common to roll over a previous employer’s 401(k) plan either into an IRA or your new employer’s 401(k). An IRA comes with much more flexibility in terms of options of what you can invest in (including more advanced investments like real estate). You can contribute up to $6,000 each year into an IRA, but this is phased out the higher your income is (starts phasing out at $125K in income).

Depending on what your 401(k) offering looks like; whether you have it or not or what the fees look like, you may or may not decide to contribute as much to it and focus more on your IRA. Or you may find your 401(k) acceptable (I feel like most are) and contribute up to $19,500 there and then $6,000 to an IRA (assuming you’re not above the income level).

529

College isn’t cheap, as many of us young professionals vividly remember as many of us had student loans and some of us are still paying them off. I’m in a situation right now where I have kids (BabyMoneyFinance and SegundoMoneyFinance), and also where I have the ability to put a little aside for their college. My parents gifted me my college tuition, and I was able to graduate debt free. It was a huge blessing and allowed me to get a head start on my own financial independence post college. I realize that not everyone had that experience and that situations might change in my ability to save for college for them but I would like to try!

To do so, I’m saving through a 529 plan, which is a tax favorable plan that allows you to put aside money today and let it grow tax-free until it’s time for them to go to school. There are stipulations on how you can spend the money (college or schooling related) or who can spend it, so if one gets a huge scholarship, we can give it to Segundo, or a close family member. It’s not a perfect plan, as there are risks (scholarships, not going to college etc) but to me letting it grow tax free for the next 18 or so years seems worthwhile. Even more specifically, my state offers a state sponsored 529 plan, which allows me to also deduct my contributions from my state income taxes. Win-win!

I don’t know the right number to be saving right now but have committed to doing $4,000/year/kid which will be $72,000 saved by the time they are 18. I’m also hoping that number grows at about 5-10% each year, as I’m investing it in a mutual fund. To me that feels like the right amount now, college is about $20,000(ish) for public schools per year so hopefully that’ll be enough. I may increase or decrease as I learn more, or as I’m able (or not able to) save more.

Tax on stocks

There are only 2 certainties in life – death and taxes. A lot of things are taxed here in the US, but there are also a lot of strategies to minimize taxes (i.e. a 401(k) or a 529 plan as we just discussed). Stocks are a great way to grow your money, and although they are not without risk (but remember, no risk, no reward), they have historically grown at about 8% each year (that’s an average). When it comes to taxes, you will be responsible for paying taxes on both dividends and the profit from selling stock after it’s (hopefully) grown in value. Conversely, you can also deduct your losses if a stock you held went down in value.

Tax will come in two flavors depending on how long you’ve held it. If you’ve held it for 1 year or more, you’ll be taxed at the capital gains rate, which is something like 10, 15 or 20% depending on your tax bracket. If you’ve held it under a year, you’ll pay taxes at your regular income rate, which could be 20, 25, 30, 35%. The thinking here is that long-term investing keeps you safer, as day trading (or frequently trading) can be risky and also long-term investing is often better for companies as investors aren’t jumping around all the time.

So, if you’ve held a stock for 11 months and are thinking about selling it and taking profits, it could be worthwhile and save you money to hold it for another month. Of course there are other factors, like if you think the stock or the overall market is going to go down, or if you need the money now, but that one year mark is a good number to keep in mind.

Capital gains on houses

A house is probably one of the biggest investments and assets that many of us will have and it (in my opinion) is a great way to build long-term wealth. Houses typically appreciate each year, and although you’re most likely paying the bank back with interest, that interest is most likely deductible off your taxes. When it comes to sell a house, you’re hopefully going to have seen the price rise and the equity you have in the house grow and you’ll walk away with a nice chunk of change.

There’s a great little nugget that you might not realize but in the current tax law; as long as you’ve lived in your primary residence for 2 years, you don’t have to pay any capital gains tax on your profits. That’s huge. It used to be that you had to roll that profit into a new house but that’s actually changed. So if you buy a house, try as best you can to live in it for 2 years before selling and then all the gains will be tax-free! Even more intriguing, you can actually be out of the house for 3 years and still not pay capital gains taxes on it. So if you wanted to keep the house you moved out of and rent it, you could do it for 3 years and still avoid paying a tax on the profits when you sell.

High yield savings account

I’m a huge believer in making sure your money works hard for you. You work so hard to earn that money and then when you turn to save or invest it, the last thing you want is it getting hit with excessive fees or have it earn less (safely) than it could. One easy strategy I’ve found is high yield savings accounts. These are regular banks just like your local bank that you use, but they pay a lot more interest. There shouldn’t be fees and they’ll pay a lot more interest – like 5x or 10x what your local bank is paying. For example, I’m getting 0.05% from my Bank of America savings account. That is pennies, literal pennies that I earn each month. I also have 2 HYSAs (high yield savings accounts) – Capital One and American Express. Both are currently paying 0.4%, nearly 10x what Bank of America is paying. Why I have both types of accounts is a story for a different post but I try to keep most of my true savings in a high yield savings account. Sure it might only be the difference between earning a few dollars vs a few pennies, but to me that’s worth it. If my money is just sitting there, I’d rather earn a few dollars!

Not paying for fees

Fees seem to pop up everywhere in our daily lives, and the same applies true in our financial lives. Banks, brokerages, credit card companies are all trying to squeeze every dollar that they can in profit out of us and will often use fees to accomplish their goal of maximizing profit. Pretty much every financial institution you work with will have fees – late, account minimum, trading overdraft, excessive transfers, interest, and many more!

In my opinion, if you do it right (and I believe you can), you should not be paying fees to financial institutions. There are lots of options out there like online banks (Ally, Capital One etc), or local community banks that will have lower or no fees. Even the big banks often have ways around the fees by having a higher balance, or having additional services with them.

Stay on top of your accounts, shop around for the best institutions and set yourself up to avoid paying fees!

Picking stocks really doesn’t work

The last little tidbit I’d love to share is that in my opinion and experience; trading individual stocks may be fun, you might sometimes make money, but in the long-run it’s just better to pick a low-cost index fund. A low-cost index fund essentially is a basket of stocks that purchases most of the stocks in a specific sector or the entire market. Time and time again despite my hard work researching, picking and timing my buying/selling, I find that I barely or didn’t even get the same return that my index fund did (I invest in Vanguard’s $VTI). You might get lucky once or twice but even the best stock pickers aren’t right all the time. Instead I’ve learned to keep most of my money in index funds. Lower risk, generally better (or at least competitive) returns.

Summary

There is so much to learn about personal finance and even someone like myself is still learning! I hope a few of these tidbits helped out and I’d be curious to hear what are other tidbits or strategies that you’ve been learning!