What even is a 401(k)?
<div class="user-question">what’s the best way to make money/ make my money make money, when you’re younger? like i see so many tiktoks about 401 Roth ira & stocks but i literally know almost nothing & google doesn’t help much. should i already be investing? is digital marketing real & something i should look into, where do i start? how do i set myself up for the best possible success?</div>
So you’re 19, in college and super excited to get a hold on investing and your finances - that's amazing! When I was 19, the most important thing on my mind was getting into my sorority and making the cheer team, so you are way ahead of where I was!
🌱 Investing at 19 - The Earlier You Start, The Better
A lot of buzz words can be thrown around (including 401(k) and IRA), but just keep in mind that you need money to make money! If you don't have an emergency fund or don't have a stable income, it may not be the best to start investing just yet.
However, once you do have some disposable income (let's say even $20 a month), investing in your future early can have a massive impact on your financial success. The sooner you begin, the more time your money has to grow.
🌱 Make Your Money Work For You Through Compound Interest
Now that you have some disposable income to invest, let's talk about compound interest! The magic behind compound interest is that it applies, not only to the initial investment, but also to the accumulated interest over time.
Imagine two people: one starts investing $200 per month at 19, and the other waits until they’re 30 to start with the same amount. If both aim to retire at 65, the 19-year-old investor will have significantly more money, even though they invested the same monthly amount. This is the magic of compound interest, where your money earns interest, and then that interest earns more interest. This is what people usually refer to, when they say "make my money make money" or "make my money work for me".
Here’s a simple visual of how this works if you started investing $200/month at the age of 19. By the time you're 65, you'll have $1.1M, however, you would've only put in about $110k. The remaining $1M is your "money working for you" through compound interest!
Now compare this to the person that starts investing $200/month at the age of 30. By the time they're 65, they'll have $462K. That's still a lot of money, however, you can see that by starting 11 years earlier, you can earn an additional $690K!
🌱 401(k), Roth IRA, Traditional IRA
You also asked about retirement accounts, so it is important to understand some of the definitions here.
Understanding the different types of retirement accounts—401(k), Roth IRA, and traditional IRA —is essential for building a solid financial future for retirement.
Each of these accounts has unique benefits and tax implications, making it important to know which might be the best fit for you based on your financial goals and income. Keep in mind though that these are for retirement preparation, meaning you won't be able to access this money until after you're 60 years old, so it may not be the most relevant for you right now, but it is still a definition for you to understand.
🌱 401(k) - a 401(k) is a retirement savings plan offered by many employers. If you don’t have an employer, you probably won't have to worry about this. Contributions are made pre-tax, meaning the money goes into your 401(k) before income taxes are taken out, reducing your taxable income for the year. The money in your 401(k) grows tax-deferred, which means you don’t pay taxes on investment gains until you start making withdrawals in retirement. Many employers also offer matching contributions, essentially giving you "free money" as you save. However, withdrawals in retirement are taxed as regular income, and there are penalties for withdrawing funds before age 59½.
🌱 Roth IRA - A Roth IRA is a retirement account that allows for tax-free withdrawals in retirement. Unlike a 401(k), contributions to a Roth IRA are made with after-tax dollars, meaning you've already paid taxes on the money you contribute. The biggest advantage of a Roth IRA is that your money grows tax-free, and you won’t pay taxes on withdrawals in retirement, as long as you meet the requirements. This can be particularly beneficial if you expect to be in a higher tax bracket when you retire. I wouldn't suggest opening this until you have a steady income.
🌱 Traditional IRA - a Traditional IRA is similar to a 401(k) since contributions typically are tax-deductible, and the investments grow tax-deferred. You only pay taxes when you withdraw the funds in retirement. This can be a good option if you want to lower your taxable income now and expect to be in a lower tax bracket in retirement. However, unlike a Roth IRA, traditional IRAs do have RMDs starting at age 73, meaning you are required to start taking withdrawals whether you need the money or not.
Just wanted to remind you again that these are for retirement, meaning you won't be able to access this money until after 60 you're years old or you will face tax penalties.
🌱 The 100 Rule: How Much Should You Invest in Stocks vs Bonds?
One simple rule for investing is the 100 Rule.
Subtract your age from 100, and the result is the percentage of your portfolio that should be in stocks. So, if you're 19, you might allocate 81% of your investments into stocks and the rest into bonds or more stable assets. Stocks have higher potential returns over time, but they also come with higher risk, so this rule helps balance growth with safety as you get older.
🌱 Short(er) Term Investing - Your Plan of Action
You're 19, not 60 so don’t focus too much on the retirement details just yet. Instead, let's focus on your plan of action and short term goals and next steps:
1️⃣ Build an emergency fund worth 1-3 months of expenses.
<div class="frich-tip">Frich tip: Here are our favorite tools for building an emergency fund!</div>
2️⃣ Pay off credit card debt. There is no point in investing if you have high yield credit card debt because you will be losing money over time.
<div class="frich-tip">If you've accumulated a lot of debt, take a look here if you qualify for any debt relief options.</div>
3️⃣ Once you get some cash flow, you can start investing little by little. I always auto-invest every two weeks so I don’t have to make a conscious effort.
4️⃣ Keep in mind that platforms like Acorns are not structured like retirement funds, which means you have much more flexibility. With these platforms, you can buy and sell your investments at any time without worrying about the restrictions or penalties that typically come with retirement accounts. Unlike a 401(k) or IRA, where early withdrawals before a certain age can trigger hefty tax penalties; you can access your money whenever you need it, giving you more control over your investments.
However, it's important to note that if you sell your investments within less than a year of holding them, the profits will be subject to short-term capital gains tax, which is typically taxed at a higher rate than long-term capital gains. So while you have the freedom to cash out, it’s often smarter to hold your investments for more than a year to take advantage of the lower long-term capital gains tax rates, which can help maximize your profits over time.
🌱 Long(er) Term Investing - Your Plan of Action
Once you get a job, take advantage of 401(k) and contribute the amount you need to get the matching from your employer. Sometimes employees will contribute to your retirement up to a percentage, so hit that max and have your employer basically give you free money.
1️⃣ If you are getting your health insurance, you can opt in for a High Deductible health insurance. Open up an HSA (health savings account) and max out your contribution (typically around $2,500 a year). Once this account reaches over $1,000, you can invest within it and it's all tax-free.
2️⃣ Max out your Roth IRA. Don’t forget to auto invest the yield you earn!
Btw - here's how others are doing👀
What percent of your income do you invest?
💸 Average answer: 15.5%
Hope this helped! And trust me, as intimidating as this all sounds, all you really have to do, is figure out your financial priorities and then set up recurring transfers to your investment accounts.
xx,
Kristina
