Open Your Investment Account(s)

Roth? Traditional? IRA? 401(k)? WTF?

Now that you've decided how much you're going to invest, we have to figure out what kind of account you're going to put the money in. This is usually where people's eyes glaze over and they give up on investing. Don't worry. We're going to make this as easy as possible.

The government has created special investment accounts to help people invest to get to Assets & Chill. This is a bit of a good-news-bad-news situation. It's good news because the government lets you skip out on some taxes when you use these accounts. Who doesn't love lowering their tax bill? The bad news is that it means you're presented with options and will have to make a decision between them, which can be overwhelming.

It can be a bit confusing, but we'll figure it out together.

A Normal Investment Account

Let's start by talking about an account that doesn't have any tax benefits. This is normally called a brokerage account. Let's think through all the times you have to pay taxes with this type of account.

• You first have to earn money from your job before you can put it into this account. Taxes are taken out of your paycheck and then you invest part of what's leftover.
• You periodically earn dividends in your account. You owe taxes on those dividends each year.
• When you want to withdraw money from the account, you'll owe taxes based on how much your investments have appreciated.

That's a lot of taxes!

The Government's Special Investment Accounts

Good news about all those taxes: the government wants to help you achieve Assets & Chill! So they allow you to open two types of investment accounts that have sweet tax deals.

The I'll Pay My Taxes Later Account

This is known as a Traditional account and has the following tax treatment.

• You first have to earn money from your job before you can put it into this account. But the government allows you to skip the taxes on the money you put into the account!
• You periodically earn dividends in your account. But you won't owe taxes on those dividends each year!
• When you want to withdraw money from the account, you'll owe taxes based on how much you withdraw each year.

The I'll Pay My Taxes Now Account

This is known as a Roth account and has the following tax treatment.

• You first have to earn money from your job before you can put it into this account. Taxes are taken out of your paycheck and then you invest part of what's leftover.
• You periodically earn dividends in your account. But you won't owe taxes on those dividends each year!
• When you want to withdraw money from the account, you won't owe any taxes!

So how do I choose?

Hopefully you can see that the Traditional and Roth accounts offer some serious tax advantages. The calculator below let's you enter your monthly investment and investing time horizon from the previous project to see how much you can withdraw each month from each of the account types.

If you read the fine print, you can see there are a lot of assumptions that go into these calculations. People debate Traditional versus Roth endlessly, but at the end of the day you have to make a lot of predictions about the future (a notoriously difficult task) to say which one is definitively better.

But there a couple lessons we can learn from this.

• If your income will be higher in the future, Roth may perform better; if you're in your highest earning years now, Traditional may perform better.
• Traditional and Roth will beat brokerage accounts in virtually any situation.

So now it's time to choose. Will you go with Traditional, Roth, or a brokerage account?

Where Do I Open My Account?

We're not here just to learn about different types of accounts. This is an Assets & Chill project to take action! So this is exactly the right question to be asking. Let's get into it!

Retirement Accounts At Work

Many employers offer retirement accounts to their employees. There are lots of different types of these workplace retirement accounts. You've probably heard of the 401(k), but there's also the 403b, the 457b, the TSP, and several even more obscure ones. They all generally work the same way for the stuff we care about, with just a few small differences. Most of the differences boil down to who you work for: a company, a nonprofit, or the government.

If your employer offers a retirement account, then you don't have to worry about where to open your account – they're going to do it for you! All you need to do is talk to your human resources or benefits person about how to get the ball rolling.

Accounts Outside Work

If you're going to open an account outside of work, you'll have to decide where to open the account. I personally recommend and use an investment company called Vanguard . There are lots of other good investment companies out there too. The only thing you need to watch out for is that they have low fees and offer index funds. We'll talk about that more in the next project. But if you don't have any strong reason to go elsewhere, just go with Vanguard.

If you want a brokerage account you're good to go. You just need to go open it.

Retirement Accounts

If you want a Traditional or Roth account, you'll need to open an IRA account (which stands for Individual Retirement Account). Again, you can do this at Vanguard or any other investment company.

Up Next

Great! Now you've decided what type of account to open and where you're going to open it. Your homework is to actually go open it. In the next lesson we'll figure out what investments to buy in your account!