These are definitions of some investment vehicles related to health, retirement, college, and fun:
Roth IRA: An individual can contribute $5,500 a year into a retirement account which will grow tax free and can be accessed at age 59 1/2. Unlike a Traditional IRA, you don’t get a tax deduction when you contribute but if you contribute $20/mo for 30 years your total contributions would be $7,200 and your tax free earnings would be $17,500 (assuming a safe interest rate of 7%). Meaning when you turn 59 ½ you could have $24,700 to buy a few four-wheelers. There also is an exception where you can take both contributions and earnings out tax-free prior to retirement in order to pay for your first home purchase.
Employer 401k Match: In the past employers often used defined benefit (i.e. pension) plans as incentive to attract workers. Modern companies, and even government organizations, are now moving towards defined contribution (i.e. 401k) plans. Often companies will automatically put a particular amount of money into your 401k (retirement plan which can be accessed penalty free at age 59 ½). In addition you can divert more of your own money towards that same account and often employers will match 100% of your contributions up to 3-5% of your income. So say you file the paperwork to get 4% of your $2,000 paycheck put into your 401k ($80)…the company will put $80 more into the account for you (80+80=160). That’s what we call doubling your money, a 100% return, and/or a pay increase. 401k’s usually function like Traditional IRA’s where you get a tax deduction in the year you contribute but have to pay taxes on the money when you withdraw it, but they can also be set up as Roth 401k’s.
Emergency Fund: Usually it is best to save 3-6 months of living expenses in a safe place such as a normal bank account, a bond focused mutual fund, or under the mattress. Three to six months of living expenses could be upwards of $10,000 so that’s a big thing to build up to. Putting just $1,000 into an account which is separate from the accounts you normally access but still available if the car breaks down, you lose your job and need groceries, or someone gets cancer… will provide A LOT of peace of mind (not for Christmas shopping, taking your parents on a trip, or buying a nice new phone).
College Savings 529 Plans: Like a Roth IRA, you don’t get a tax deduction for money contributed to a 529 plan but you do get completely tax free growth (as long as you use the money for tuition, housing while a student, books, etc.). What if your kid decides they don’t want to go to school? You can transfer the money to another kid or grandkid or go get yourself another degree. Most 529 Plans require a $1,000-$3,000 initial contribution but after that you (or your kid) can contribute as little as $20 a month.
Term Life Insurance: Most companies provide a life insurance component for their benefits package. Often they supplement the cost so it is very cheap or even free. Typically the amount they provide leaves you underinsured and also makes you rely on their employment. This is one of those “sleep at night” products which is more critical to have when you have kids, a mortgage, and not very much money in savings/retirement accounts. Having $400,000 in term insurance would cost a 35 year old around $30/mo.
Health Savings Account: HSA’s are a double whammy investment because you don’t pay taxes on the amount you contribute and you also don’t pay taxes on growth or withdrawal amounts. The money does have to be spent on copays, medical emergencies, insurance premiums, and medical expenses like crutches and the like. HAS companies have convenient debit cards which you can use or you can pay yourself back later for medical expenses you incur. The money is usually invested in a mutual fund of your choice: heavier stocks if you don’t mind risk, heavier bonds if you are risk adverse.
Mutual Fund: A passive instrument that leaves the actual investing choices up to either managers or a specific formula (i.e. a formula which just invests in all big American companies or mid-level energy companies etc.). The return on a mutual fund will vary depending on the sector of companies it is invested in (manufacturing, health care, entertainment, etc.), the type of instruments it is invested in (stocks, bonds, etc.), and the management cost of the fund (are you paying a person to manage or is a machine/formula doing it). The amount of risk which you can take when choosing a fund to invest in depends on when you will need the money and how much growth you need to occur. If you are saving to buy a new car in 5 years then you will pay taxes on any dividends paid out while invested and then pay capital gains taxes (typically much lower than regular income tax rates) on earnings when you withdraw. Mutual funds are an investment which can be inside a tax-sheltered retirement account or just a normal investment account. Investing in something like a Vanguard S&P 500 Fund would require $1,000 initial investment and could fluctuate up or down by 10-20% on any given year but over the long run averages about an 8% return.
Credit Card’s: Many credit card companies have good reward incentives for making purchases with their cards. They provide these rewards because whenever you use their card, businesses running your transaction have to pay the credit card company a fee. Using around 5-25% of your credit limit will report positively on your credit score report. It is not wise to spend more than you have readily available in your checking account because missing credit card payments gives the credit card company the right to charge you interest. That interest gives them a nice 6-25% investment return and steals your hard earned money. That 6-25% interest you are paying them could be put into an investment of your own which could make you 6-25% (that’s another example of doubling your money).
