Updated: Jan 28
There are many different tools one can use to begin to invest money. Two common investment accounts are IRAs and 401Ks. Both of these can be broken down further, but we will divide both into Roth and Traditional for simplicity. Typical brokerage accounts are also popular, but have been challenged recently by commission free platforms, such as Robinhood.
To begin, we will look at typical brokerage accounts. Brokerage accounts are commonly opened with banks and Wall Street firms. One can buy and sell a variety of investments: stocks, bonds, ETFs, alternatives, etc. There is no restriction on account contributions. One may invest as much money as they please. There are no withdrawal limitations or penalties either. One can remove money any time they please.
There is however, a capital gains tax. Gains from selling investments for more than one bought in for are taxable income. By holding assets for longer than a year, the higher short-term capital gains tax can be avoided, by paying the long term rate of 15%.
Alternatively, one can also earn a tax break from selling a losing position. However, a brokerage account holder is likely to incur either a portfolio management fee or transaction fees. Management fees land somewhere in the range of 0.5-1.5% yearly.
Transaction fees are incurred every time the account owner makes a trade, regardless of the advisor’s advice or performance of the trade. The cost structure is undergoing change however as some brokerage companies, such as Charles Schwab and E*TRADE, have cut their transaction fees (except on options) as a result of increased competition from fee-less online brokers and discount brokerages.
An Individual Retirement Account (IRA) is an account where one may invest and save for retirement while getting tax advantages for doing so. IRAs can be opened with brokerages, banks, or robo-advisors.
Like brokerage accounts, IRAs offer investment in stocks, bonds, and alternative assets. The maximum yearly contributions for traditional and Roth IRAs is $6,000, and $7,000 if the account holder is 50+ years old. Other types of IRAs exist as well, such as SEP IRAs and SIMPLE IRAs, but for simplicity we will show traditional IRAs and Roth IRAs, the two most common.
A 401k plan is an account where both an individual (the employee) and the employer make contributions to the plan. The contribution limit cannot exceed what is set by the IRS (Internal Revenue Service, those pesky buggers that collect your taxes). If one is under 50 years of age the maximum contribution is $19,500 per year, and if over 50, $26,000.
Withdrawals before age 59.5 are subject to a 10% federal penalty tax, similar to traditional IRAs. After the account holder is past the age of 72, they must withdraw at least a certain percentage from their account each year, varying with age. As with IRAs, there are two common versions: Traditional and Roth.
Speaking of commission and brokerage fees, ETFication doesn't charge based on how much money you have. Our app, Portfolio Shepherd, simply takes into consideration your assets and investing preferences in order to suggest a ETF-based portfolio utilizing the same math as robs-advisors. By utilizing the app, you can take back ownership of your finances and increase your knowledge.