- Before you invest, give some thought to the type of account that's best for you.
- Learn about tax-efficient investing to make sure Uncle Sam doesn't take more than his share.
- Once you're invested, stay in it for the long term -- but check in periodically to keep on track.
In the past two columns I've introduced investing concepts and terms that every investor should understand. For starters, you need to know why asset allocation (how you divide your money between stocks, bonds and cash) and diversification (not putting all your eggs in one basket) are crucial to your success. And you need to understand the differences between core investments, and how they can work together.
So let's say you've got the basics down. You've decided you're a moderately aggressive investor looking for growth, and you've researched and chosen a couple of initial investments. Are you ready to buy? Not quite. Because there are a few more topics you should explore: types of investment accounts, the impact of taxes, and how to keep your portfolio going -- and, hopefully, growing.
Why the type of account you open is important
When you're simply putting money aside, whether for a rainy day or for something special, a bank savings account will usually do. You'll make a bit of interest and you'll have easy access to your money.
An investment account is a different animal. It's offered through a broker and allows you to buy and sell investments. There is usually an initial minimum deposit and possibly account fees, which vary depending on where you open your account. You may also pay a commission to buy and sell certain investments. These commissions vary by brokerage, so best to do some comparison-shopping.
The financial institution is one decision, but you also have to decide what type of investment account best suits your goals: a taxable brokerage account, a tax-advantaged retirement account (IRA) -- or both. With a brokerage account, you can invest as much as you want at any time. With an IRA, you're limited to a yearly maximum contribution (much like you are if you have a 401(k) through your work).
Another important difference between account types is how earnings are taxed. You're probably already used to paying income taxes on the interest income you receive in a savings account. This is due whether or not you actually remove the funds from your account.
In a taxable brokerage account, the rules are different. In this case you'll pay either short-term or long-term capital gains tax on any money you make -- but only when you sell an investment that has gone up in value. Short-term capital gains are taxed at your ordinary income tax rate and apply to investments you've held for a year or less; long-term rates, currently 0, 15 or 20 percent depending on your income, apply to investments you've held for more than a year. These taxes are assessed at the end of the tax year when you file your income tax return.
Taxation of an IRA is different still. With a traditional tax-deferred IRA, your earnings grow tax-free until you withdraw them, at which time you'll pay income taxes on them at your ordinary tax rate (plus a 10 percent penalty before age 59½). Plus, you may get an upfront tax deduction on your traditional IRA contributions (if you're covered by an employer plan, IRA deductibility is limited by income level). With a tax-free Roth IRA, you don't get the upfront deduction, but both earnings and withdrawals are tax-free as long as you're at least 59 ½ and have held the Roth for five years. This can be a great choice for a young person in a lower tax bracket.
When starting out, it's important to begin putting money aside for retirement -- and the sooner the better. Begin in your 20s and you'll likely be in good shape saving just 10 to 15 percent of your annual salary for the rest of your working life. Start in your 30s and that goes up to 20 percent; in your 40s, 30 percent! Of course, there's no reason you can't have both a taxable and a tax-advantaged account. Which brings me to my next point.
What tax-efficient investing means
It's also smart to think about taxes. After all, it's not just what you gain, but what you keep after taxes, that matters. In general, investments that tend to lose less of their return to taxes (for example, stocks that you plan to hold for longer than a year) are good choices for taxable accounts. Investments that tend to lose more of their return to taxes (for example, stocks that you'll likely hold for less than a year) should go in your tax-deferred retirement accounts. Likewise, tax-free bonds would be redundant in a tax-free account.
How to stay on top of your investments
Making these initial decisions is part of the heavy lifting. Once you have your investments up and running, it's best to take a long-term view. That doesn't mean you can ignore them, however. You should check in at least quarterly to make sure your investments are on track. At the end of the year, you'll want to re-examine your asset allocation and possibly rebalance.
Basically, this means looking at the percentage of stocks, bonds and cash in your portfolio to make sure it still represents the allocation you want, then making changes if necessary. For instance, if stocks have done well, it might be time to sell some and use the proceeds to buy bonds. Or if bonds have had an exceptional year, it might be time to sell a few in favor of some stocks.
When to get help
Even when you understand investing, it pays to get help once in a while. A periodic consultation with a financial professional can help you deepen your knowledge and refine your decisions.
But whether you work with a financial advisor or go it alone, the main point of these last three columns is this: Don't be afraid to ask questions, get the information you need -- and get started.
Looking for answers to your retirement questions? Check out Carrie's new book, "The Charles Schwab Guide to Finances After Fifty: Answers to Your Most Important Money Questions."
This article originally appeared on Schwab.com You can e-mail Carrie at email@example.com, or click here for additional Ask Carrie columns. This column is no substitute for an individualized recommendation, tax, legal or personalized investment advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager.
COPYRIGHT 2015 CHARLES SCHWAB & CO., INC. (MEMBER SIPC.) (0415-2738)
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