Investing Beyond Your 401(k): What You Need to Know
If you've been diligently contributing to your 401(k) and you're wondering, "What else can I do to grow my wealth?"—you're in the right place. Before we dive into investing outside your 401(k), let’s make sure we’ve got the basics covered.
First Things First: Financial Foundations
Before you start investing outside of your retirement accounts, two financial priorities need to be checked off:
1. Build Your Emergency Fund
Life happens. A job loss, medical bill, or unexpected home repair can throw a wrench in your finances. That’s why having an emergency fund is essential. A good rule of thumb? Save at least 6 months’ worth of living expenses in cash.
Where should you keep this money? Somewhere easily accessible but still earning a little interest. Look for high-yield savings accounts or money market accounts with competitive rates.
2. Maximize Retirement Savings
Investing for retirement should be a top priority. The general rule is to aim to save 15-20% of your income for retirement, including any employer match. If you’re not hitting this target yet, focus on increasing your contributions before looking at other investments.
Now, if your emergency fund is solid and you’re meeting your retirement savings goals, let’s talk about your next move.
The Next Step: Investing in a Taxable (Brokerage) Account
A taxable account—also called a brokerage account—is an investment account that gives you flexibility. Unlike retirement accounts, where you typically can’t access your money until age 59½ without penalties, a brokerage account allows you to withdraw funds at any time.
However, there’s a catch. You need to be clear on your time horizon—when you’ll need this money—because that determines how you invest it.
The Three-Bucket Strategy
Think of your money in three buckets:
Short-Term (0-3 years): This is money you’ll need soon, so keep it safe in a high-yield savings account. This is saving, not investing. Think of your emergency fund.
Mid-Term (3-10 years): Investments should be more conservative here, with a mix of stocks and bonds.
Long-Term (10+ years): If you won’t need this money for a decade or more, you can afford to take more risk and invest more aggressively.
If you need the money within the next three years, this blog post isn’t for you—stick with cash savings! I must drive this point home: I don’t want you to invest any money intended for a goal in the next three-ish years. One way of defining investment is “the risk that you’ll lose money.” The shorter the time frame, the higher the risk of loss.
But if you have goals that extend beyond the next three-ish years, or maybe you don’t have any specific goals in mind and just know you want something down the road, then a taxable account is for you.
How you invest your money in that account is going to be specific to you, your risk tolerance, and your life. Generally, the longer you have, the more aggressively you can invest.
How a Brokerage Account Works
A brokerage account is an account you open with an investment platform (such as Fidelity, Schwab, or Vanguard). It allows you to buy and sell stocks, bonds, ETFs, mutual funds, and other investments.
How to Open One:
Choose a brokerage firm.
Open an account online (it’s usually free and takes about 10 minutes).
Link your bank account and deposit funds. (You may even want to set up direct deposit straight from your paycheck—paying yourself first. Automation makes our life simpler, and this helps with the behavioral part of us all being human!)
Choose your investments—there are many to choose from. Remember, low cost and diversification are key here.
Taxable (brokerage) accounts work pretty much like retirement accounts but: your contributions aren’t tax-deductible now, and they won’t grow tax-free like in a Roth account.
And unlike retirement accounts, there are no limits to how much you can put into this account annually.
Understanding Taxes on a Brokerage Account
Why do we call it a taxable account? Because you’ll pay taxes on:
Dividends and interest: If your investments generate income, you’ll pay taxes on that each year.
Capital gains: If you sell an investment for more than you paid, you’ll owe taxes on the profit.
The good news? Long-term capital gains (on investments held for more than a year) are taxed at a lower rate—typically 15%,. If you sell an investment in under a year, you’ll pay ordinary income tax rates, which are higher.
Tax-Efficient Ways to Invest in a Brokerage Account
To keep taxes from eating into your gains, consider:
Investing in ETFs and index mutual funds: These have low turnover, meaning fewer taxable events.
Holding investments long-term: The less you buy and sell, the lower your tax bill.
Using tax-exempt bonds: Municipal bonds can provide tax-free income.
Tax-loss harvesting: If an investment loses value, you may be able to sell it and use the loss to offset taxable gains (a more advanced strategy, but worth noting!).
Final Thoughts: The Power of Flexibility
Yes, you’ll pay some taxes in a brokerage account, but that’s not a bad thing. If you’re paying taxes, it means your investments have grown—and that’s the goal!
If you’re ready to start investing beyond your 401(k) and want guidance on the best path forward, let’s chat! You can schedule a free consultation or send me an email.
Investing can feel overwhelming, but you don’t have to do it alone. I’m here to help you navigate it step by step!
Sign up for Redesign Wealth’s twice-monthly blog email to stay on top of our blog posts.
DISCLAIMER:
The information presented on this post is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. Comments should not be construed as an offer to buy or sell, or a solicitation of an offer to buy or sell the investments mentioned. This is for educational purposes only. A professional CPA, Financial Advisor or Attorney should be consulted before implementing any of the strategies discussed. Investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client's portfolio.