When we run in to people on the street, we are typically asked 2 different types of questions. Some ask us where they should put their money, searching for stock tips or economic advice. Others ask us where they should put their money, speaking from a structure standpoint. It is frustrating as a financial professional that our junior highs and high schools teach students all of the science and mathematics fundamentals while ignoring investment fundamentals. This week we wanted to provide a short outline of the difference between numerous investment structures. As a note, this is a simple, brief outline and we suggest that anyone with questions consult a professional before making a decision.
The most simplistic investment vehicle that one can have is a checking account. Checking accounts allow owners to store their wealth and allow them instant access to cash. The downside is that while you will not lose money in your checking account, that money is not being put to work for you either, you will not earn on it. Checking accounts are best suited for when you need money at a moment’s notice for bills, groceries, etc.
Savings accounts are also liquid investments and will pay a small interest rate on your balance. These deposits allow banks to supply capital to businesses or individuals seeking loans. Much like checking accounts, money in savings accounts will not provide you with market exposure. These accounts are best suited for money that you will need in the near future for larger expenses, such as purchasing a car or a down payment on a home.
Personal Investment Accounts
Otherwise known as a non-qualified account, these accounts allow you to contribute money and invest in stocks, mutual funds, CDs, etc. Invesmtents in this structure provide you with the opportunity to put your money to work for you and earn a rate of return. Depending on the investment, some assets held in personal accounts may not be immediately liquid, however stocks and mutual funds are liquid investments. These accounts are also subject to market risk.
Joint Tenants with Rights of Survivorship
Commonly referred to as Joint Accounts, these accounts function identically to personal investment accounts, however they are intended for 2 adults to share ownership in the account. The only downside is that as an owner of a Joint Account, you legally only own half of the assets in the account, which can make splitting the account up in the event of a divorce or separation a messy proposition.
Individual Retirement Accounts allow for employed individuals with earned income to invest for their retirement. While Traditional IRAs provide an immediate tax write off, Roth IRAs allow earnings to grow tax-free (the purpose of this section is not to debate Traditional and Roths as each has their own benefits and downsides). While these investments provide a great means to save, a tax benefit and market exposure, they are an illiquid investment and cannot be withdrawan until age 59 ½ without penalties (unless for special circumstances such as health needs).
401(k) plans operate much like IRAs, the difference being that these plans are sponsored by an employer and subject to various different levels of regulation and scrutiny. Some 401(k) plans even provide matching provisions for employees who choose to participate. One unique facet of 401(k) plans that differs from IRAs is that some 401(k) plans allow the participant to borrow against the balance of the account. While this may be viewed as a benefit, we suggest avoiding this option. In the event of termination of employment, those loan balances must be repaid with 90 days or will be taxed as ordinary income and may face early withdrawal penalties.
Annuities are an investment that allows owners to lock in a guaranteed rate of return. Variable annuities also allow investors the possibility to earn more than their guaranteed rate of return, depending on market conditions. While many investors feel comfortable with the guarantee, there is certainly a high price tag in the form of fees (comparative to other investments) that one pays for such a guarantee.
Life insurance provides a protection against loss of income due to death. Think of buying car insurance as a protection against your car being totaled in an accident; the same logic applies to life insurance. While life policies can provide income for wife, kids, family, etc. in the event of death, individuals with no spouse and no children likely do not need a policy, much like individuals who do not own a car do not need car insurance.
We hope that this brief crash course provided some basic insight on different investment options. One of our mottos is that there is no right choice and there is no wrong choice, only options. We highly recommend utilizing several of these options to help ensure a fulfilling and successful retirement.