Where do I invest my money? (Part 2 – Stocks and Bonds)

This will be a 4 part series of articles and this is the second part.

In part 1 of this series, we talked about defining your investment strategy. If you have not read that, I encourage you to read that before you get to this article. Once you have defined your investment strategy, now it’s time to get into the nuts and bolts of how and where to invest. This article will focus on stocks and bonds and different ways to invest in the market. It’s very likely that you are already invested in the market through some of these vehicles. 

Lets begin with looking at the asset location strategy with the 3 different types of accounts. Most people want to just jump to item 3 and if you are already well invested in items 1 and 2, then you can skip to 3. But if not, I encourage you to read those because before in my opinion, investing in 1 and 2 is going to support and diversify your asset location strategy. 

Tax Deferred Accounts

The most common example of this is the 401K or the equivalents (403b etc) and traditional IRAs. These are the vehicles you use to sock away money for your retirement and the government does not tax you on these $ today. But when you do withdraw them at a later date, you will be taxed at the prevailing rate. 

1. 401Ks: For W-2 employees, a lot of companies have company matches that match a certain % of money you invest. Lot of people call it ‘free’ money. So at the minimum, you should look to invest that amount. If you have high enough savings, I would strongly encourage you to max out the 401K. If you withdraw from this account before the age of 59.5 with the exception of some very specific circumstances, you will be charged a 10% penalty.  In 2021, the max contribution limits are $19,500 per person with an additional $6500 per person for people above the age of 50. 
2. Investing into a 401K – A lot of people end up choosing target date funds to invest the money, which is generally OK assuming they have low expense ratios and the funds are giving you the right exposures to different markets. If you don’t like the idea of a target date fund but need help picking funds offered by your plan, you should ask your financial advisor to guide you or use a robo-advisor service like Blooom that specializes in 401Ks (I use Blooom to invest my money in my 401K). 

Tax-free or tax exempt accounts 

Not all of these are technically tax free. I would like to highlight 2 classic examples here – the Roth IRAs and the HSAs (Health Savings Accounts). 

1. Roth IRA – In a Roth IRA, you pay taxes upfront and then the contributions grow tax free and can be withdrawn after the age of 59.5 tax free (Contributions can be withdrawn anytime tax free). Money in a Roth can be withdrawn before the 59.5 if you have had it for at least 5 years and they are used for some specific qualified purposes, including for education expenses (some people love using this instead of a 529 college fund for that reason). There are income limitations to directly invest in a Roth IRA.  However, even if you make too much money to qualify to invest in a Roth IRA, the IRS has this option where you can invest after tax money in a traditional IRA and then, immediately convert it to a Roth IRA (this is called a backdoor Roth IRA). In 2021, the contribution limit is $6000 per person for Roth IRAs. The general advice is to invest in a Roth IRA if you are currently in a low tax bracket only but I strongly feel that irrespective of the tax bracket you are in, you should do this. We don’t know where tax rates are going to go in the future and the money in a Roth is not subject to RMDs (Required Minimum Distributions) at a later age. There is something called a Mega Backdoor Roth for the super savers and geeks. I won’t cover that here because that gets more advanced.

2. HSA (Health Savings Accounts) – this is the most tax advantaged account out there and I personally love these and strongly recommend everyone to take advantage of these. Now, in order for you to be able to have an HSA, you need to have through your employer what is called a High deductible health plan. HSAs combine the tax benefit of both the 401K and the Roth IRA. Your contributions are tax exempt, the money grows tax free and if you withdraw it for qualified health expenses, it can be withdrawn tax free. There are ways to do this in a very smart manner and I will write a separate article on this. In 2021, the contribution limits are $7200 per family (for ages 55 and older, you can invest an additional $1000). I have personally invested in an HSA and I am considering this a retirement account dedicated to healthcare expenses.  

I will note that College fund 529 accounts are very similar to the Roth IRA and funds including the growth can be withdrawn tax free for qualified education expenses too. 

Taxable accounts

These are accounts where you can own stocks and bonds through a trading platform and you will contribute after tax dollars into it, the dividends and interest you get, will get taxed and when you withdraw (sell), you will pay capital gains taxes. However, these accounts offer you the most amount of flexibility and don’t come with any strings attached like the previous two types of accounts.  You have basically 3 approaches here:

1. DIY approach – you can open your own trading account via Schwab, E-trade or Robinhood or any of those trading platforms out there and invest directly in stocks or bonds or funds/ETFs. I personally have a Robinhood account where I have invested a small portion of our funds directly into low-cost broad based market ETFs. I picked them based on my asset allocation strategy. These days costs of doing trades have become $0 and if you buy ETFs or funds, you will pay whatever is the expense ratio. So this is the least expensive way of buying stocks and bonds.
2. Robo-advisors – there are a whole breed of robo-advisors including stand-alone ones like Betterment, Wealthfront or robo-advisor versions of the larger trading platforms like Vanguard and Fidelity. Essentially they ask you a few questions to understand your risk tolerance and a computer algorithm will recommend a portfolio of low cost index funds to invest in typically. These robo-advisors will also automatically rebalance the portfolio to meet your targeted asset allocation at all times. Since a human is not involved, these tend to be low cost too. These will come at a cost of around 0.3% of the overall invested portfolio (and can go lower as you invest more money). I personally have a small portion of money invested through Wealthfront and they are invested in low cost broad market index funds. For someone who wants to be hands-off but keep their costs low, I recommend using a robo-advisor.  
3. Active assets under management (AUM) – this is the most traditional and common way of investing where you take a completely hands-off approach and give your money to a financial advisor who actively invests it for you for typically a fee that is around 1% of the overall invested portfolio. I am personally not a fan of this model and I am a strong believer of passively managed index funds which don’t require paying a financial advisor 1% of the portfolio. There are however fiduciary financial advisors who I am a big fan of, who will simply take a fixed fee for providing you advice and don’t charge you based on how much they invest. I use a fixed-fee fiduciary financial advisor personally to help validate what I am doing and if we are on track for retirement. Note: financial advisors will also guide you on your overall investments not just within your taxable accounts – so don’t think of them narrowly.

That concludes my high level framework on investing in stocks and bonds and the second article in this series. I hope that gives you an idea of how to think about investing your money in stocks and bonds. In order to dig deeper into the tactics of investing in real estate, I encourage you to read the last parts of this series. Thank you for reading and I wish you success in your financial journey. 

Disclaimer: I am not a financial advisor and all the information in my articles are from my personal experience and are for informational and educational purposes only. Please consult with a financial advisor or CPA for professional advice.