The Foundations of Investing in the Stock Market- Part 2
Last week, we talked about how compounding works for us when we invest in the stock market. When we invest, we are on the right side of interest- the ones collecting the interest, not paying it! Today, I’d like to dive further into retirement investing.
Let’s get into how to get money working for us in the stock market.
Just a reminder that I’m not a financial professional. I’m just a medical professional trying to figure this stuff out along with you.
But, I’m happy to share what I’ve learned so far from several years of reading about this stuff.
The information below has largely been gathered from books such as A Simple Path to Wealth, by J. L. Collins, The Little Book of Common Sense Investing by John C. Bogle, and various financial podcasts and blogs.
Where Should I Invest?
Ok. So, you’ve got some money and want to start investing. Where do you invest?
To start, we need to evaluate our goals- is this investing for the short term (1-3 years) or long term (10-50 years).
First, let’s talk about long term investing for retirement.
In comes the alphanumeric soup- 401k, 403b, 457, Roth IRA, Backdoor Roth IRA, i401k, etc.
Why should I invest in my 401k?
There are many accounts out there to save for retirement- the employer sponsored plans (401k, 403b, 457, TSP, etc), the individual retirement plans (IRA’s, solo/individual 401k’s, etc), Health Savings Accounts, high yield savings accounts, the taxable brokerage accounts, and more.
All of these accounts are just buckets where you can put money and choose what you want to invest in. If I had a chunk of change and I wanted to save for retirement, I’d contribute to whichever employer sponsored plan with a match was available to me first.
Why these first? Because these accounts have tax advantages. The U.S. government encourages saving for retirement because financially prepared retirees are better for the economy, of course. They do this by giving us a break on taxes in these accounts. Sweet! Why not take it?
Also, employers often provide a match to our contributions- they will contribute a certain percentage of our contributions to OUR 401k. More compensation? Yes, please.
For more info on the individual plans, check out Physician on FIRE’s breakdown.
The Nitty Gritty
Pre-tax contributions can be directly withdrawn from your paycheck if you’re an employee- that makes these accounts really easy to contribute to.
Now for the cool tax incentives: Your pre-tax contributions are not counted as income (they reduce your taxable income), so you owe less taxes that that year. Neat! Once you invest in these accounts and your money grows, you’re also not taxed on the growth UNTIL you withdraw the money in your retirement.
If you don’t want to pay taxes in retirement, you can choose to pay taxes now and make ROTH contributions. Roth or Not is a whole different and long conversation, but suffice it to say either is fine- you’re just choosing when to pay taxes on your contributions- now or later, in retirement.
For the year 2020: A 401k has a limit of $19,500 for the year (+$6,500 for catch up contributions for those over 50). Once you max the 401k, you can contribute to an IRA (Individual retirement account, limit $6000), as well. Income limits for the Roth IRA generally limit doctors from contributing directly, but we can still do a Backdoor Roth– it just involves a few extra steps. You can add an HSA (Limit $7,100 for families) to this lineup as a stealth IRA, if you like and have an eligible high deductible health insurance plan.
The Retirement Plan
If I just maxed out these three accounts – the 401k, the Backdoor Roth IRA, and the family HSA every year (total $32,600) for 30 years, I would have $6.5 million to retire on, given 10% average returns, or $3.5 million given 7% average return (those 3% points make a big difference!). If a couple maxed two 401ks, two backdoor Roth IRA’s, and 1 family HSA every year for 30 years, they’d have $5.9 mil at 7% average returns or $10.5 mil at 10% average returns. Either way, that’s plenty to retire comfortably.
If we want to retire early, we’ll have to step up our game a little- we can do that by contributing to a taxable brokerage account or investing in real estate.
Choosing Investments: Coming up...
Now, let’s say we have our buckets set up. For example, let’s say I have a 401k, a backdoor Roth IRA, and an HSA. Now what? How do I get those 7-10% average returns? We’ll need to understand our investment options and we’ll need to choose investments.
Check out Part 3!
Stay Frugal, ya’ll!
Standard Disclaimer: Not meant as individualized financial or medical advice. This post contains affiliate links.