Non-Pharm Finance – Part III

Welcome to part three of Non-Pharm Finance. Within this section, we discuss how to start investing by recommending where to put your money and how to diversify your portfolio.

First thing’s first, addressing 401(k), Roth IRA and HSA accounts are a must. 

The 401(k) Plan – If your company provides a 401(k) plan, an employer-sponsored retirement plan, with a match/non-elective contributions, start here! If your employer provides a match/non-elective contribution, you’re getting free money. Also, with a 401(k) plan, the money you put into the plan is before tax and it decreases your taxable income. However, there is a limit to how much you can contribute to this plan. The 401(k) contribution limit is $19,000 for 2019. However, people 50 or older who expect to hit this 401(k) elective deferral limit can contribute an additional sum of up to $6,000 for a total of $25,000. This is known as the catch-up contribution limit. The table below gives you a good gist of the 401(k) plan.

The Roth IRA – Within this retirement account, you invest your after-tax dollar to grow without paying taxes on its growth. In a brokerage account, you pay for the capital gains (the growth of your invested dollar). Within a Roth IRA, you are able to withdraw the amount your contributed into the account since you have already paid taxes on this amount. However, you’re unable to withdraw the investment earnings without a penalty/tax.  Once you’re 59½ and have held the account for at least five years, you can take distributions, including the earnings, without paying federal taxes. The contribution limit is $6,000 or $7,000 if you’re 50 or older for 2019.

Health Savings Account (HSA) – An HSA is a tax-advantaged savings accounts available for people who are enrolled in high-deductible health insurance plans. You’re able to contribute pre-tax dollars to the HSA and can then withdraw the tax-free money for qualified medical expenses. However, once you turn 65, you can withdraw the money without incurring any penalties. In 2019, you’re able to contribute $3,500/year for individuals and $7,000 for families. If you contribute the maximum amount, you would be able to reduce your taxable income by $3,500. That means you contributed tax-free money AND withdraw tax-free money at 65 AND you have effectively lowered your taxed income over those years by what you contributed.

How to Diversify
Now that you have a general understanding of different tax-advantage accounts, you’re able to mix and match with/without a brokerage account to start investing. The key to success is diversification. 

It is important to diversify within stocks, but it’s even more important to allocate across the different asset classes. The major classes are:

Stocks and Funds (“equities”) – When owning a company’s stock, you own part of that company. Since these are known to have higher risk, you can diversify that risk by owning mutual funds, index funds, and/or exchange-traded funds. Click here to read more.

  • Large Cap – Market caps that are >$10 billion
  • Mid Cap – Market caps that are between $2 billion-$10 billion
  • Small Cap – Market caps that are >$2 billion

Bonds – You’re lending the bank money in exchange for interest over a fixed amount of time. These are generally considered “safer” because they have a fixed rate of return.

Cash – This includes liquid money and the money that you have in your checking and savings accounts.

Investing in the important concept of asset allocation comes into play because investing in only a single category is very dangerous. You should own a variety of assets in your portfolio. If you put all your money in one category and it doesn’t perform well for a decade, you’re going to have a bad time. Instead, if you owned a variety of assets and included small-cap, large-cap, with a variety of bonds, you’re more insured against one investment dragging you down.

General Rule of Investing in Stocks by Age
The old rule of thumb used to be that you should subtract your age from 100 – and that’s the percentage of your portfolio that you should keep in stocks. For example, if you’re 20, you should keep 80% of your portfolio in stocks. If you’re 60, you should keep 40% of your portfolio in stocks.

However, life expectancy has increased and many financial planners are now recommending that the rule should be closer to 110 or 120 minus your age. That’s because if you need to make your money last longer, you’ll need the extra growth that stocks can provide.

PillPicks Recommendation
Utilize automation and allow a robo-investor to diversify your portfolio. Wealthfront is currently my robo-investor of choice. You are able to view exactly how Wealthfront allocated your money and base any additional investing decisions with this information. By utilizing the code from Non-Pharm Finance Part 1, Wealthfront will manage up to $5,000 without any fees. Click here to read more about Wealthfront.

Another passive route of investing is utilizing a Life-Cycle Fund/Target Date Fund. If you plan to retire in about 30 years, a good target date fund for you might be the Vanguard Target Retirement 2050 Fund (VFIFX). The 2050 represents the year in which you’ll likely retire.

After utilization of the above, use a percentage to invest in individual stocks in an attempt to beat the market. This is where you’re able to learn the market and prove to yourself that you are able to profit from the stock market. 

A rule of thumb I believe in is to still have a 6 month emergency fund in a high-interest (APY) savings account. I have recently moved my savings account from Discover Online Banking (2.04%) to Wealthfront’s Cash Account (APY 2.54%). I believe it is always important to have something to fall back on if the rug is pulled beneath your feet and you need time to get back up.

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