Investing for Long Term Goals

Last week I introduced the concept of espousing certain financial truths that when applied in our daily lives, help guide us along the path to building wealth. The first truth examined was “invest early, invest often” and specifically the tactic of closing out those savings accounts and opening a taxable investment account to serve as “savings” for those shorter term (3-5 year) financial goals.

This week I’d like to share some thoughts on long term investing, but before I do, I think it’s important to address a burning question- how much should I invest? Although last week I disparaged the idea of the average American household being able to invest $50 a day, there is some credence to this approach.

The bottom line, to reach a million dollar net worth within a reasonable amount of time (20-25 years) you’ll need to invest as much as possible while still being able to cover your basic needs such as housing, transportation, utilities and nutrition. Note, I did not mention entertainment! We’ll talk about this more in next week’s blog on being frugal.  If the daily amount you can invest works out to be $50 dollars a day (or more) then great. If it’s something less, that’s ok too. Above all, never stop investing and gradually increasing over time the amount invested!

To keep honest people honest, setup automatic monthly investments to fund a few different types of investment accounts. This makes it a little more difficult to give in to the temptation to skip a month rather than stay on track.  We’ve already looked at the taxable investment account for shorter term goals, now let’s explore tax advantaged, long term accounts for life’s big milestones such as a child’s education or retirement.

If your employer has a 401k plan and you are not participating, shame on you! 401ks are “pretax dollars” and currently the best investment option for retirement. Let’s say you make $30k a year and invest $2k per year in a 401k account. The $2k is taken “off the top” and the government only taxes as if you made $28k! This may not matter as much when 20, but will become important when entering peak earning years later.

Best of all, many employers offer 401k contribution matching as an important part of benefits and compensation plans. Employer 401k matching has all but replaced the traditional “pension plans” that our parents and grandparents grew up with. It varies by employer, but a common “match” is 50% of employee contributions up to 4% of the employee’s annual pay.

In the event your employer does not have a 401k plan or if you want to be a super saver, open a Traditional or Roth IRA account. This can be with the same investment company as your short term taxable investment account or a different one but it is sometimes beneficial to stick with the same company.

Retirement planning and investing is where you may want to consider seeking the assistance of a financial advisor. IRA’s and 401ks are for the long haul, you can’t touch the funds (without penalty) until 59.5 years old. That’s nearly 40 years if the account is opened at age 20! It’s important to make good choices and continually monitor progress.

Roth IRAs are a great tax advantaged, long term investment account and offer the similar benefits of a 401k. I am just a little more partial to the Traditional IRA for the worker starting out who may not have access to a 401k or that is taking full advantage of an employer 401k but looking for an additional retirement investment opportunity.

Contributions to a Traditional IRA are “after tax” dollars. Once paid by an employer you can make a monthly investment into a Traditional IRA (not to exceed $6000 per year if you are under 50 in 2020). The dividends, interest and capital gains earned over the years won’t be taxed until you begin making withdraws, sometime after age 60 and presumably when in a lower tax bracket.

Additionally, Traditional IRAs offer what I think is a very good income tax adjustment for investors in the here and now. As long as you make less than $104K per year (for 2020, married filing jointly) you are eligible for a full deduction up to the amount of your contribution limit ($6000 for 2020, as you may recall).

Lastly, I like Traditional IRAs because most employer 401ks are easily rolled into a Traditional IRA (or vice versa). Think of your Traditional IRA as your old trustworthy friend that will be there till the end.

Regardless of whether you are participating in your employer’s 401k program, manage your own IRA or any combination thereof, the bottom line is establish retirement investment accounts now and start investing like crazy! These retirement accounts will inevitably make up the bulk of your million dollar net worth in midlife and could be an important part of any legacy left to heirs.

The last type of long term investment accounts for consideration is a 529 college savings plan. These plans and investment products vary by state but the basic premise remains the same. Contributions to 529 plans are “after tax” dollars, meaning after paid by an employer, you can use that income to invest into a 529 account.

The absolute best part of a 529 is the interest, dividends and capital gains on the account are never taxed as long as the withdrawals are used for specific educational expenses for the beneficiary. Let’s say you open a 529 account upon the birth of your child and over eighteen years contribute $20000 which grew to $30000 by the time the child entered college. You won’t pay any taxes on the $10k in growth as long as the money is used for education purposes!

Another cool feature is anyone can contribute to these accounts on behalf of the child. Grandma and Grampa can kick in $50 to the 529 instead of some useless toy at Christmas! Additionally, you can transfer between your offspring’s accounts. Let’s say one child wants to go to a trade school while another gets accepted into a four year college. No problem, just shift some funds from one child to the other.

Just as I mentioned last week, for either retirement or 529 investment accounts, expenses are an important consideration. Do the homework, seek advice as necessary but find the right long term investment options for you and set up those automatic investments!

I mentioned last week that living the financial truths to build wealth on a budget takes some sacrifice and discipline. Next week, I’ll take an initial look at the financial truth, being frugal. Join me next week as I offer some tips on how to live frugally without living cheap!

The commentary provided in this blog is for informational purposes only and is not intended to be a source of financial or investing advice.

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