Is now a good time to invest in the stock market? I get asked that question a lot.
My answer is always the same. Anytime is a good time to invest in the stock market when you’re investing for a longer-term goal. Of course, everyone dreams of buying low and selling high. Successfully timing the market is difficult if not impossible to do time after time and year after year.
Maybe you’re new to the investing world and don’t know how to start. Or are you a more seasoned investor paying high fees for below-average results? Consider my one-stop-shop investment plan, which consists of just two elements:
• The best tax-advantaged account available
• An indexed all-in-one target fund
It’s simple to set up yet incredibly effective. Best of all, there are no ongoing management duties. Set it and forget it!
Your Best Tax-Advantaged Account
When investing for longer-term goals like financial independence and retirement, you must be all-in on tax-advantaged accounts. You’re guaranteed a higher after-tax rate of return versus a regular taxable brokerage account (given the same investing results) because of the tax advantages.
Love Those Restrictions!
I also favor tax-advantaged accounts because they have restrictions. Most bar you from tapping the money in the account without penalty until later. That’s a good thing. Everyone has temptations. Those restrictions force you into investing for the longer term, allowing the power of compounding to work its magic.
Easier at Tax Time
In the spirit of this newsletter’s theme of one-stop-shopping and simplicity, there’s also less paperwork to do in a tax-advantaged account compared to a regular taxable account come tax time. There’s no need to keep track of the basis of your contributions nor your reinvested dividends, capital gains, and interest when investing in a tax-advantaged account as you must in a regular taxable one. Qualified withdrawals are either tax-free (Roth contributions) or taxable as ordinary income (traditional contributions).
Top 3 tax-advantaged accounts:
1. Your Employer’s Plan
If you or your spouse have an employer-sponsored 401(k)-type plan available (including 403bs, 401as, 457s, and TSPs), I want you to look there first. 401(k) -type plans have much higher contribution limits than other tax-advantaged accounts. Your company’s plan could be different, so be sure to double-check the documentation.
If you’ve got a 401(k)-type plan with a match, you’ve got the best wealth-building account on the planet. At the bare minimum, always contribute enough to get your full match no matter what. Don’t be afraid to save past your match.
If your employer’s plan doesn’t offer index fund options, you have my sympathies. Worse, your employer may offer what I call a dog plan. If that’s your scenario, contribute just enough to get any match, then invest the extra into a Roth IRA or Health Savings Account.
Confused as to what type of contributions you should be making? Visit traditional vs Roth.
2. Roth IRA
Everyone should have a Roth IRA, even if you have a Roth option at work. If you’ve got kids, encourage them to open and fund a Roth IRA the first year they have earned income. The gift of tax-free earnings keeps giving and giving and they’ll love you for it.
Did you know the money you’ve contributed to your Roth IRA over the years (the principal) can be withdrawn tax and penalty-free at any time? Let me repeat. At any time, for any reason, you can withdraw the principal. You don’t have to be age 59 1/2 or even have a good reason.
With 401(k)-type plans, your employer chooses the custodian. When opening a Roth IRA, you get to pick. I favor custodians who offer free trading and index mutual funds and Exchange Traded Funds (ETFs) with super-low expense ratios.
Blackrock Investments would be a great place to open a Roth IRA. Check out their iShares Lifepath Target ETF series.
Roth IRAs have income limits. If you’re over you can’t contribute, unless you perform what I’ve always called the ‘Ole Roth IRA Switcheroo. It sounds sneaky and underhanded but it’s currently perfectly legal and cool with Uncle Sam. The Switcheroo is just one way higher wage earners can contribute to a Roth IRA and get bypass the income limits.
3. Health Savings Account
A health savings account (HSA) is an intriguing wealth-building option. The reason it’s not higher on my list is because it’s not for everyone. However, if it’s the right choice for you, you’ll earn a higher after-tax rate of return in your HSA with up to 4 tax breaks, more than any other tax-advantaged account. See Become an HSA Millionaire! (last month’s newsletter topic) for details and review.
Indexed All-In-One Target Fund
Now that you’ve chosen your best tax-advantaged account, you must decide what to invest in. Don’t let Wall Street fool you into investing in actively managed funds. Most have bloated expense ratios with inferior rates of return.
Skip right to the index funds. For the one-stop-shop investment plan, look for indexed all-in-one target-date funds, which go by many names:
• Target Funds
• Lifecycle Funds
• Target Retirement Funds
• Freedom Funds
All are set up as “fund of funds,” meaning the target fund’s investment plan is created using multiple index funds representing the fund’s diversity.
Read the Instructions
You’re to estimate your retirement or target date, the day you want to start withdrawals, and then choose the appropriate target fund with that date (or close to it) in its title.
Unfortunately, following those instructions to the letter can be disastrous. Instead, do a little research. Find the current stock-to-bond ratios, what I call your risky to not-so-risky ratios, for your age-appropriate fund plus the target funds on “both sides” of the list.
TSP Example
For example, assume you’re age 45, in the military, and want to contribute to your 401(k)-type plan. The federal government calls their 401(k)-type plan a thrift savings plan or TSP. I uncovered the following information at tsp.gov to use as an example. Your custodian’s website will have similar information:
For most 45-year-olds, the age-appropriate fund, assuming a retirement age of 65, is a good choice. The fund is mostly invested in the stock market (77%) now but that’s OK given the 20-year time horizon. As our 45-year-old gets closer and closer to age 65 that percentage of risky assets will proportionately decrease.
Conservative Investors
If you’re a very conservative investor, 77% invested in risky investments might prove too much, especially if you’re inclined to bail out of the fund after a big stock market downturn. Conservative investors should consider the 2040 Lifestyle Fund (72% risky) or even the 2035 Lifestyle Fund (66% risky).
Aggressive Investors
More aggressive investors seeking a higher rate of return can get frustrated with the lower returns of the age-appropriate fund. Consider the riskier and higher-yielding 2050 or 2055 Lifestyle Funds.
Set it and Forget It
Once you’ve chosen the perfect fund, be sure and put all your money in that one fund and have future contributions go there too. One more thing. Be sure all earnings (interest, dividends, and capital gains) generated by the fund are reinvested to buy more shares.
All you need to do is keep feeding that super-charged beast of an investment plan more money. The manager of your chosen all-in-one does the heavy lifting for you.
Your 250-Page Stock Investing Guidebook
Maybe you want to find the “why” behind my stock investing recommendations, learn more about the One Stop Shop Investment Plan, my 5 tenets and risk management strategies, or are finally ready to get serious about investing for the future.
DIY Stock and Securities Investing
Keep the book with its detailed table of contents handy to help answer all your questions along your journey to financial independence.