It has often been said that the sooner you begin saving and investing, the more you can grow your wealth over time. But for young investors, the wide range of available financial accounts and options can be somewhat overwhelming. So, how do you know which ones will be right for you?
While you don’t need to have an in-depth understanding of each and every type of investment and savings account available, it is important that you are familiar with where you are now financially, and where you would like to be in the future. Getting you to your destination starts with having the proper accounts in place.
When You’re Just Getting Started
There are many types of savings and investment accounts that are used by investors. But because everyone’s goals are unique, the reality is that the “best” portfolio for you is the one that is set up to move you closer to your specific financial objectives.
With that in mind, the first step in deciding which type(s) of accounts you should have is to determine your short-, medium-, and long-term financial goals, as well as how accessible your money will be when you need or want it.
Money for Now, Money for Later
It’s important to have a plan that works for a wide range of time frames throughout your life. For instance, you may want to purchase a home within the next several years. So having an account to build up funds for a downpayment is typically recommended. Likewise, in looking ahead to retirement, you may have a certain monetary goal, such as $1 million, that you would like to have available by the time you turn age 65.
Because your financial goals will typically have different time frames, it is important to allocate funds for each goal into different types of accounts, as well as into various investments that will allow you to grow and protect your principal.
Given the wide range of goals that many young investors have, some or all of the following accounts may be recommended, based on your specific situation:
Short-Term Financial Goals
Short-term financial goals are those that
you want to achieve within the next 12 months or less. Some examples here would be purchasing a new computer, making minor home improvements, or saving for the downpayment on a new car. You may also need money to pay for emergencies, such as repairing your car after a fender bender or replacing a broken refrigerator.
For short-term goals, then, it is important to have money available that you can easily get to in a base account, as well as in an emergency fund:
• Base Account – One of the most important types of financial accounts to have is a base checking account. This is where you can deposit income from your paycheck and other sources. You can also pay your regular living expenses, such as rent or mortgage, utility bills, groceries, and transportation costs from your base account. Banks usually offer a variety of checking accounts to choose from. Some may pay you a small amount of interest (typically if you maintain a minimum balance), and others offer free accounts where your
average balance can fluctuate without
you having to keep a certain dollar amount in it.
• Emergency Fund – Having an emergency fund is recommended for people of all ages. It goes without saying that items can—and do—break (including expensive items like appliances, cars, and computers). Having a repair bill can oftentimes set you back by hundreds, or even thousands, of dollars. So by having an emergency fund already in place, you will be much better prepared to pay the tab, and you can avoid putting the expense on a high-interest credit card. It will also allow you to continue paying your regular monthly bills without having to struggle. Because you want your emergency money to be there when you need it, you should consider keeping these funds in “safe” and liquid alternatives like a money market. Many financial experts agree that having 6–12 months of living expenses in an emergency fund is sufficient. But when you’re just getting started, any amount is better than nothing.
• Fun Account – Another way to help keep yourself on track financially is to set up an account for “fun” items, like buying a new TV or a nice outfit. Having a slush fund available for these types of items allows you to use some of your money to make non-essential purchases without impacting your other financial goals. It can also keep you from running up a large credit-card balance by instead paying for these things with cash up front.
These types of accounts would preferably be in money-market or cash alternatives, for easy access.
Medium-Term Financial Goals
Medium-term financial goals are those that you would like to accomplish within five to ten years. These could include a long vacation abroad or the downpayment on a new home. It can be helpful to keep these funds in an account that is separate from your base account where you access the money on a regular basis. Otherwise, you run the risk of depleting the funds you need for meeting these medium-term goals. In this case, it can be beneficial to have the following type(s) of accounts:
• Specific Item or Event Account – If you’re saving for a specific item or event, such as a wedding, a new car, or a long-awaited dream vacation, you could open a separate account for this goal. Contributing to the account can help you get in the habit of making payments on a regular basis, too. For instance, if you estimate your future car payment to be $450 per month, you could contribute $450 into your account each month. Then, when you purchase the car, you will already be in the habit of paying that amount. Depending on your time frame (i.e., when you plan to take the money out), you may opt to grow the funds.
Long-Term Financial Goals
Long-term financial goals are those that have a timeline of ten years or more. One of the
biggest long-term financial goals that people have is saving for college and retirement. If your goal here is still quite a few years out, going with options like stocks or mutual funds could provide you with some added growth—although these financial vehicles could also lose value in a down market. So, as you get closer to your goal, it may be necessary to readjust your investment options in this type of account.
There are several types of accounts that you could have for meeting your long-term financial goals, including a(n):
• College Fund – If you (and your partner) have children, you may also want to set up a separate college fund so that funds can be available for paying tuition, room and board, and other related needs.
• IRA (Individual Retirement Account) – There are two primary types of IRAs: Traditional and Roth. Both types of IRAs allow for tax-deferred (or tax-free) growth, so your money can compound exponentially. If you have a Traditional IRA, you can typically deduct some or all of your annual contribution. The withdrawals from a Traditional IRA are taxable. With a Roth IRA, contributions go into the account after-tax, but you can make tax-free withdrawals provided they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 or prior to the account being opened for five years, whichever is later, may result in a 10 percent IRS penalty. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
• Employer-Sponsored Retirement Account – Depending on where you work, your employer may offer retirement savings options such as a 401(k), 403(b), or a SEP IRA. These accounts will also usually allow for tax-deferred growth that can help your money compound over time. As a younger investor, equities could provide you with the opportunity to increase your return, although there is also some risk involved. As you get closer to retirement, reallocating to more stable investment options is recommended.
It can be beneficial to contribute regularly to these longer-term accounts. If you participate in an employer-sponsored retirement plan, you can usually have money deducted directly from your paycheck. With personal accounts such as an IRA, the bank or financial-services company that manages the account can typically set up monthly contributions that are automatically moved over from your checking or savings account.
Making Sure the Bases Are Covered
Although there are some guidelines that help in determining how many accounts young investors should have, and what types of investments should ideally go in them, there is no such thing as a one-size-fits-all solution.
Because all situations and financial goals can differ, it is best to discuss your short- and long-term objectives with an experienced financial professional who can narrow down what works best for you.
In addition, those in the LGBTQ community should consider working with an advisor who is LGBTQ-friendly. That way, the advisor is more likely to be informed on financial regulations and laws that pertain to domestic partners and same-sex married couples, and can guide you in the proper direction for your specific goals.
This article appears in the March 2020 edition of OutSmart magazine.