There are numerous ways to invest for college students, including using brokerage accounts, or even retirement accounts like individual retirement accounts (IRAs) or 401(k)s. But there are many other things that college students should take into account before or while investing, too.
For college students, it’s never too early to start investing your money. In fact, the earlier you start, the faster you may be able to meet long-term goals such as a graduate degree, buying a house, or even retirement.
Why You Should Start Investing Early
There are a number of reasons to start investing early. Chief among them is potential return. The average annual return offered by the S&P 500 — a market-capitalization-weighted index of the 500 largest companies in the U.S. – is around 10%.
That’s considerably more than you’re likely to generate from putting your money in a savings account – even a high-yield savings account. That means that while money in a savings account is accruing interest, it’s actually losing value at the same time. Investing may help you outpace inflation and give you an extra boost towards your long term goals. 💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.
3 Ways to Invest While in College
There are numerous ways for college students to invest their money, including the use of tax-advantaged retirement accounts, and traditional brokerage accounts.
IRA
Traditional and Roth IRAs are a type of retirement account that almost anyone can open up and start contributing to. There are rules regarding how much you can contribute every year, and when you can take withdrawals (depending on the type of IRA you open), but they can be relatively easy ways to kick-start a college students’ investment portfolio.
Brokerage Account
A brokerage account allows you to make investments through a brokerage firm by depositing funds with them. Your bank may already have brokerage options, or you may consider other outside firms.
A brokerage account allows students to buy and sell stocks, bonds, mutual funds, and other assets through a brokerage firm. Be aware that selling assets can trigger short-term or long-term capital gains taxes. Short-term taxes are charged at your regular income tax rate, and long-term rates are either 0%, 15%, or 20% depending on your tax bracket.
401(k)
A 401(k) is a type of retirement account offered through an employer, though there are some versions, such as Solo 401(k)s, you can open yourself. Like IRAs, there are annual contribution limits, and traditional and Roth 401(k)s to choose from.
The money you put in the account is tax deductible and it grows tax-free while it’s invested. That said, generally, you can’t withdraw money from the account until you reach age 59 ½, or you’ll be subject to a 10% early withdrawal penalty.
Steps to Start Investing as a College Student
For college students getting started investing, there are several steps that they can take to find their footing. It starts by giving some thought to your overall financial goals, determining what you can afford to invest, and then building your portfolio.
Set Clear Financial Goals
It’s important, before you make your first investment as a college student, to give some serious thought and consideration to your financial goals. Do you want to hit a total net worth or dollar amount by a certain age, for instance? Or, do you want to save up enough to buy a home or start a family?
These are the types of financial goals you should think about. Having clear financial goals in mind before you start investing can help guide your decision-making in regard to what types of investments you make.
Determine How Much Money You Can Set Aside
With your goals in mind, you’ll want to think about how much money you realistically can set aside to invest. Odds are, you won’t be able to invest your entire paycheck – there’s rent to pay and groceries to buy, after all. But if you can free up some additional money in your budget for investing, that should help you get your portfolio started. Again, think about how much you can realistically use for investment purposes.
Choose the Right Investment Account
Knowing how much you have to invest and some end-goals in mind, you’ll need to decide what type of investment account will best help you reach those goals. As discussed, this might be a retirement account like an IRA or 401(k), or a brokerage account, which will allow you to buy and sell stocks, or even day trade, if you’d like – though most financial professionals may caution against it.
Understand Types of Investments
You’ll also want to review and deepen your understanding of the various types of investments out there. That can include a variety of asset types such as stocks, bonds, cash, real estate, commodities, precious metals, and more. Not all types will be best for each and every investor – again, it depends on your goals.
Fund Your Investments
The rubber is finally starting to meet the road! You’ll finally want to actually fund your chosen account (be it a brokerage account, etc.) and make your initial investments. This marks the start of your investment portfolio.
Tips for Investing as a College Student
Investing as a college student may seem relatively easy – particularly to get started – but it never hurts to accept some guidance. Here are a few tips for investing as a college student.
Stay Diversified
A good rule of thumb for investors of all stripes is to try and stay diversified by investing in many types of assets and asset classes. The basic idea of portfolio diversification is that the fewer investments you expose yourself to, the more risk you take on should they perform poorly.
Imagine you invest in only one stock and that company folds — if that happens, you’ve lost your entire investment. However, if you invested in 100 different stocks, one company failing would affect you far less. Diversification, however, does not eliminate all risks, including the risk of loss.
One way to stay diversified is by investing in mutual funds or exchange traded funds, which bundle groups of stocks together, essentially doing the work of diversification for you.
Avoid Emotional Investing
The market experiences natural ups and downs. As these fluctuations occur, it’s important to try to avoid letting your emotions impact your investing.
When the market makes a big dip, you may feel the urge to sell investments. However, by doing so you’re actually locking in your losses. Examine what is motivating you to sell, as it’s usually a good idea to let reason prevail so you don’t miss out on any future upturn that may take place. 💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.
Timing the Market vs Time in the Market
When the market is doing well, you may find yourself tempted to get in on the action and end up buying investments that are too expensive. This type of buying and selling is known as timing the market. You may want to avoid checking the market multiple times a day to help keep your emotions in check and avoid the temptation to time the market.
It might help to think of investing as a long-term proposition. The longer you allow your investments to stay in the market, the more opportunity they have to ride out downturns — and the more opportunity you have to take advantage of an upswing.
Balancing Investing With Academic Responsibilities
As a college student, you should keep your studies in mind, first and foremost. Your academic responsibilities, in most cases, should probably take precedence over your investing activity – though you should keep an eye on your portfolio and learn as much as you can about the markets, too. Everyone is different, but the main point is to not ignore your studies in lieu of watching the market fluctuate.
Investing with SoFi Invest®
Investing as a college student isn’t necessarily difficult, and there are many ways to get started. But given that college students are often working with a limited budget, there may be constraints. Even so, it’s important for relatively young investors to take advantage of the time they have on their side, as the market tends to rise over the years.
College students can look at various retirement accounts, or even a simple brokerage account to get started investing. Investing involves risk, however, which is something students should keep in mind, too. It never hurts to consult with a financial professional, either.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.
SoFi Invest® The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results. Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below. 1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Claw Promotion: Customer must fund their Active Invest account with at least $10 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.
Day trading is a type of active trading where an investor buys and sells stocks or other assets based on short-term price movements. Day trading is often thought to differ from a buy-and-hold strategy typically used by long-term investors.
With day trading, the investor is not necessarily looking for assets that will make money over the long-term. Instead, a day trader seeks to generate short-term gains.
Investors should know, though, that day trading is an incredibly risky strategy and there’s a high chance of losing money.
What Is Day Trading?
Day trading incorporates short-term trades on a daily or weekly basis in an effort to generate returns. The Securities and Exchange Commission (SEC) says that “day traders buy, sell and short-sell stocks throughout the day in the hope that the stocks continue climbing or falling in value for the seconds or minutes they hold the shares, allowing them to lock in quick profits.”
A long-term investor, conversely, may buy a stock because they think that the company will grow its revenue and earnings, creating value for itself and the economy. Long-term investors believe that that growth will ultimately benefit shareholders, whether through share-price appreciation or dividend payouts.
A day trader, on the other hand, likely gives little credence to whether a company represents “good” or “bad” value. Instead, they are concerned with how price volatility will push an asset like a stock higher in the near-term.
Day trading is a form of self-directed active investing, whereby an investor attempts to manage their investments and outperform or “beat” the stock market.
Recommended: A User’s Guide to Day Trading Terminology
Best Securities For Day Trading
Day traders can work across asset classes and securities: company stocks, fractional shares, ETFs, bonds, fiat currencies, cryptocurrencies, or commodities like oil and precious metals. They can also trade options or futures — different types of derivatives contracts.
But there are some commonalities that day-trading markets tend to have, including liquidity, volatility, and volume.
Liquidity
Liquidity refers to how quickly an asset can be bought and sold without causing a significant change in its price. In other words, how smoothly can a trader make a trade?
Liquidity is important to day traders because they need to move in and out of positions quickly without having prices move against them. That means prices don’t move higher when day traders are buying, or move down when they’re starting to sell.
Volatility
Market volatility can often be considered a negative thing in investing. However, for day traders, volatility can be essential because they need big price swings to potentially capture profits.
Of course, volatility could mean big losses for day traders too, but a slow-moving market typically doesn’t offer much opportunity for day traders.
Volume
High stock volume may indicate that there is a lot of interest in a security, while low volume can indicate the opposite. Elevated interest means there’s a greater likelihood of more liquidity and volatility — which are, as discussed, two other characteristics that day traders look for. 💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.
Day Trading Basics — How to Get Started
Before starting to day trade, some investors set aside a dollar amount they’re comfortable investing — and potentially losing. They need to figure out their personal risk tolerance, in other words.
Getting the hang of day trading can take some time, so newbie day traders may want to start with a small handful of stocks. This will be more manageable and give traders time to hone their skills.
Recommended: How Many Stocks Should I Own?
Good day traders can benefit from staying informed about events that may cause big price shifts. These can range from economic and geopolitical news to specific company developments.
Here’s also a list of important concepts or terms every prospective day trader should know.
1. Trading Costs
If you’re utilizing day trading strategies, it’s wise to consider the cost. Many major brokerage firms accommodate day trading, but some charge a fee for each trade. This is called a transaction cost, commission, mark up, mark down, or a trading fee. Some firms also charge various other fees for day trading or trading penny stocks.
Some platforms are specifically designed for day trading, offering low-cost or even zero-cost trades and a variety of features to help traders research and track markets.
2. Pattern Day Trader
A pattern day trader is a designation created by the Financial Industry Regulatory Authority (FINRA). A brokerage or investing platform will classify investors as pattern day traders if they day trade a security four or more times in five business days, and the number of day trades accounts for more than 6% of their total trading activity for that same five-day period.
When investors get identified as pattern day traders, they must have at least $25,000 in their trading account. Otherwise, the account could get restricted per FINRA’s day-trading margin requirement rules.
3. Freeriding
In a cash account, an investor must pay for the purchase of a security before selling it. Freeriding occurs when an investor buys and then sells a security without first paying for it.
This is not allowed under the Federal Reserve Board’s Regulation T. In cases where freeriding occurs, the investor’s account may be frozen by the broker for a 90-day period. During the freeze, an investor is still able to make trades or purchases but must pay for them fully on the date of the trade.
4. Tax Implications of Trader vs Investor
The IRS makes a distinction between a trader and an investor. Generally, an investor is someone who buys and sells securities for personal investment. A trader on the other hand is considered by the law to be in business. The tax implications are different for each.
According to the IRS, a trader must meet the following requirements below. If an individual does not meet these guidelines, they are considered an investor.
• “You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation;
• Your activity must be substantial; and
• You must carry on the activity with continuity and regularity.”
5. Capital Gains Taxes
Another important tax implication to note is that the IRS differentiates between short-term and long-term investments for capital gains tax rates. Generally, investments held for over a year are considered long-term and those held for under a year are short-term.
While long-term capital gains may benefit from a lower tax rate, short-term capital gains are taxed at the same rate as ordinary income.
A capital loss occurs when an investment loses value. In certain circumstances, when a capital loss exceeds a capital gain, the difference could potentially be applied as a tax deduction. Some brokerages may also offer automated tax loss harvesting as a way to strategically offset investment profits.
6. Wash Sale Rule
While capital losses can sometimes be taken as a tax deduction, there are certain regulations in place to prevent investors from abusing those benefits. One such regulation is the wash sale rule, which says that investors cannot benefit from selling a security at a loss and then buy a substantially identical security within the next 30 days.
A wash sale also occurs if you sell a security and then your spouse or a corporation you control buys a substantially identical security within the next 30 days.
Get up to $1,000 in stock when you fund a new Active Invest account.**
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**Customer must fund their Active Invest account with at least $10 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.
7 Common Day Trading Strategies
Some common types of day trading strategies that you may want to research include technical analysis, scalping, momentum, swing trading, margin and so on. Here’s a closer look at them.
1. Technical Analysis
Technical analysis is a type of trading method that uses price patterns to forecast future movement. A general rule of thumb in investing is that past performance never guarantees future results. However, technical analysts believe that because of market psychology, history tends to repeat itself.
Support and resistance are price levels that traders look at when they’re applying technical analysis. “Support” is where the price of an asset tends to stop falling and “resistance” is where the price tends to stop climbing. So, for instance, if an asset falls to a support level, some may believe that buyers are likely to swoop in at that point.
2. Swing Trading
Swing trading is a type of stock market trading that attempts to capitalize on short-term price momentum in the market. The swings can be to the upside or to the downside and typically from a couple days to roughly two weeks.
Generally, a swing trader uses a mix of fundamental and technical analysis to identify short- and mid-term trends in the market. They can go both long and short in market positions, and use stocks, ETFs, and other market instruments that exhibit volatility.
3. Momentum Trading
Momentum trading is a type of short-term, high-risk trading strategy. While momentum trades can be held for longer periods when trends continue, the term generally refers to trades that are held for a day or several days, on average.
Momentum traders strive to chase the market by identifying the trend in price action of a specific security and extract profit by predicting its near-term future movement. Looking for a good entry point when prices fall and then determining a profitable exit point is the method to momentum trading.
4. Scalp Trading
In scalp trading, or scalping, the goal of this trading style is to make profits off of small changes in asset prices. Generally, this means buying a stock, waiting for it to increase in value by a small amount, then selling it. The theory behind it is that many small gains can add up to a significant profit over time.
5. Penny Stocks
Penny stocks — shares priced at pennies to up to $5 apiece — are often popular among day traders. However, they can be difficult to trade because many are illiquid. Penny stocks aren’t typically traded on the major exchanges, further increasing potential difficulties with trading. Typically, penny stocks sell in over-the-counter (OTC) markets.
6. Limit and Market Orders
There are types of orders that day traders quickly become familiar with. A limit order is when an investor sets the price at which they’d like to buy or sell a stock. For example, you only want to buy a stock if it falls below $40 per share, or sell it if the price rises to over $60. A limit order guarantees a particular price but does not guarantee execution.
With a market order, you are guaranteed execution but not necessarily price. Investors get the next price available at that time. This price may be slightly different than what is quoted, as the price of that underlying security changes while the order goes through.
7. Margin Trading
Margin accounts are a type of brokerage account that allows the investor to borrow money from the broker-dealer to purchase securities. The account acts as collateral for the loan. The interest rate on the borrowed money is determined by the brokerage firm.
Trading with this borrowed money — called margin trading — increases an investor’s purchasing power, but comes with much higher risk. If the securities lose value, an investor could be left losing more cash than they originally invested.
In the case that the investor’s holdings decline, the brokerage firm might require them to deposit additional cash or securities into their account, or sell the securities to cover the loss. This is known as a margin call. A brokerage firm can deliver a margin call without advance notice and can even decide which of the investor’s holdings are sold.
Which Day Trading Strategy Is Best for Beginners?
There’s no single answer that’s going to be correct for every trader. But investors might want to stick to the simpler strategies to get a hang of day trading. For instance, they could take a try at technical analysis to try and determine which trades may end up being profitable. Or, they could stick with swing trades to test the waters, too.
Perhaps the most important thing to keep in mind is that day trading is, as mentioned, incredibly risky. 💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.
Best Times to Day Trade
As mentioned, day traders seek high liquidity, volatility and volumes. That’s why when it comes to stocks, the first 15 minutes of the trading day, after the equity market opens at 9:30am, may be one of the active stretches for day traders.
The stock market tends to be more volatile during this time, as traders and investors try to figure out the market’s direction and prices react to company reports or economic data that was released before the opening bell. Volume also tends to pick up before the closing bell at 4pm.
For futures, commodities and currencies trading, markets are open 24 hours so day traders can be active around the clock. However, they may find less liquidity at night when most investors and traders in the U.S. aren’t as active.
Day Trading Risk Management
The SEC issued a stern warning regarding day trading in 2005, and that message still holds value today. They noted that most people do not have the wealth, time, or temperament to be successful in day trading.
If an individual isn’t comfortable with the risks associated with day trading, they shouldn’t delve into the practice. But if someone is curious, here are some steps they can take to manage the risks that stem from day trading:
1. Try not to invest more than you can afford. This is particularly important with options and margin trading. It’s crucial for investors to understand how leverage works in such trading accounts and that they can lose more than they originally invested.
2. Investors and traders often benefit from tracking and monitoring volatility. One way to do this is by finding one’s portfolio beta, or the sensitivity to swings in the broader market. Adjusting one’s portfolio so it’s not too sensitive to sweeping volatility may be helpful.
3. Day traders often benefit from picking a trading strategy and sticking with it. One struggle many day traders contend with is avoiding getting swept up by the moment and deviating from a plan, only to lock in losses.
4. Don’t let your emotions take the driver’s seat. Fear and greed can dominate investing and sway decisions. But in investing, it can be better to keep a cool head and avoid reactionary behavior.
Is It Difficult To Make Money Day Trading?
While it may feel like it’s easy to make a couple of lucky moves and turn a profit from some trades, it isn’t easy to make money day trading. Again, it’s very, very risky, and new traders would do well not to assume they’re going to make any money at all. That said, there are professional traders out there, but they use professional-grade tools and experience to help inform their decisions. New traders shouldn’t expect to emulate a professional trader’s success.
The Takeaway
Day trading involves making short-term stock trades in an effort to generate returns. It can be lucrative, but is extremely risky, and prospective traders would likely do well to practice and learn some tools of the trade before giving it a shot. They’ll also want to closely consider their risk tolerance, too.
Again, while stock investing can be an important way to build wealth for individuals, it’s crucial however to know that the consequences of risky day trading can be catastrophic. Investors need to be disciplined, cautious and put in the time and effort before delving into day trading strategies.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.
FAQ
What is day trading and how does it differ from other trading strategies?
Day trading involves making short-term trades with stocks or other securities in an effort to make a profit. Other strategies may involve longer-term investments, which are not bought and sold on a daily or weekly (or monthly) basis.
Are there any risk management techniques specific to day trading strategies?
Traders can do many things to try and limit their risks, and that can include working with different brokers or platforms, incorporating thinking patterns or rituals before making trades, setting up stop-losses, and diversifying their portfolios.
Are day trading strategies suitable for all types of markets, such as stocks, forex, or cryptocurrencies?
Day trading can be done in many asset classes and markets, which can include stocks, forex, and even crypto. But each asset is different, and the markets may not behave the same ways, either. As such, traders may want to do some homework before jumping in.
How much capital is typically required to implement day trading strategies?
It’s generally recommended that traders start with at least $25,000 in their brokerage accounts before day trading.
Are there any specific timeframes or market conditions that are more favorable for day trading strategies?
Perhaps the best times of the day for day traders are immediately after the markets open, and shortly before they close. There may also be more market action on certain days of the week (Mondays, for instance) which create good conditions for day traders.
SoFi Invest® The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results. Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below. 1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Claw Promotion: Customer must fund their Active Invest account with at least $10 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.
If you find yourself with $100,000 to invest your first job is to decide what you need from this money – income or growth. You will also need to determine your risk tolerance, time horizon, and the level of involvement you want to have with your investment.
If you want long-term growth with little to no involvement, then index funds or mutual funds might be your speed.
If you are looking for income then you might consider bonds or real estate, depending on how much involvement you want to have.
But no matter what you decide, make sure that your financial house is in order before you start and ensure that you are well diversified as you invest.
Before You Start Investing
If you’ve received a $100,000 windfall you’ll want to make sure your financial house is in order before you begin investing it. First, ensure that you have an emergency fund in place. The last thing you want is to invest this money and then need to sell an investment because you have an emergency. Next, you’ll want to consider paying off any debts you have.
Emergency Fund
Having an emergency fund is an important part of a solid financial plan. It can provide a safety net during difficult times and help you stay on track to achieve your long-term financial goals. If you don’t already, you’ll want to have six months of living expenses saved up. Having to dip into your investments unexpectedly can disrupt your plans to save for the future and may result in penalties, taxes, or just poor investment timing.
You’ll want this money in a safe and easy-to-access place. A high interest savings account is likely your best option.
Here are our favorite high yield savings accounts.
Pay off debt
Before you start investing consider paying off your debts. The interest rates on most consumer debts, such as credit cards and personal loans, are typically higher than the returns you can expect to earn from most investments. By paying off high-interest debt first, you are effectively earning a guaranteed return on your money equal to the interest rate on the debt.
Paying off debt also reduces risk and frees up cash flow, which can put you in a better position to invest for the long term, as it makes it less likely you will need to access your investments for emergencies.
Determine Your Investment Needs and Risk Tolerance
The best way for you to invest $100k will be different than how someone else should invest $100k. What you want to use the money for, how soon you’ll need it, and your risk tolerance are all factors in determining the best way to invest.
What are Your Investment Goals
You’ll first want to determine your investment goals. Ask yourself what you want to achieve with your investments. For example, do you want to save for retirement, build a college fund for your children, or save for a down payment on a house?
Each of these goals would require different investment vehicles. Also, keep in mind that you don’t need to use all the money for one thing. You can work towards several goals at once.
If your goal is to use the money to provide income, you would consider different investments than you would if your goal was to grow the balance of the account.
What is Your Risk Tolerance?
How much risk you are willing to take? This really means – how comfortable are you with the potential for losing money.
In general, the more risk you are willing to take the more potential growth there is. For example, if you have a very high risk tolerance you could consider investing in emerging markets. If your tolerance for risk is low, you’ll want to consider more stable investments such as bonds or real estate.
The longer your time horizon the more risk you can take since you will have longer for the markets to recover before you need the money. This is why you’ll want to have a robust emergency fund – so you don’t need to access the funds before it’s time.
When Will You Need the Money?
Consider the time frame you have to achieve your financial goals. Are they short-term goals that you want to achieve within the next few years, or are they long-term goals that you want to achieve over the next several decades?
If you are investing for the long term (over 5 years) then depending on your risk tolerance you can afford to be more aggressive, consider a portfolio of well-diversified stocks and bonds. If you are saving for retirement you’ll want to consider a tax-advantaged account such as an IRA.
If you are saving for a short-term goal (less than 5 years) such as a down payment on a house, you’ll want something with less risk and easier access, such as a CD.
How to Invest $100k
Stocks
If you have $100,000 to invest, stocks will likely be a part of your portfolio. You have several options on how to buy stocks.
Index funds
If you are new to investing in stocks, or just don’t have a lot of time to research and manage a portfolio, then index funds, mutual funds, and ETFs are great options. These investments are mostly hands-off, yet allow you to get access to a diversified portfolio.
Index funds aim to match a particular index that tracks the market. For example, you could invest in a fund that tracks the S&P500 or the Dow. You could even buy a fund that tracks the stock market as a whole.
The benefits of index funds are that it’s easy to get a lot of diversification and they often have very low fees as they require very minimal human research and management.
The drawbacks of index funds are that they aim to match the returns of the index they track, so you will never outperform the index – however, they also aren’t likely to underperform.
Also, with index funds you can become over-invested in a particular sector without realizing it as there can be an overlap of companies across different indices.
Mutual funds
Mutual funds are similar to index funds in that they pool together funds from multiple investors to buy a collection of stocks. The difference is that they are run by professional managers who follow the investment objectives of the fund, rather than following a specific index.
The benefits of mutual funds are good diversification and professional management. Unlike index funds, mutual funds are not limited to a set selection of investments. As long as the investments follow the stated objectives of the fund the manager is allowed to invest as she thinks best based on her knowledge of the markets and investment experience.
The drawbacks of mutual funds are fees and the possibility of underperformance. Since mutual funds are managed by a real person they have higher expenses than index funds, which are managed by a computer. This will reduce your returns.
Mutual funds also have the potential to underperform the market. While index funds aim to track a sector of the market they typically won’t under or overperform. Mutual funds have a lot more flexibility, so while they may overperform some years, they also risk underperforming as well.
ETFs
Exchange-Traded Funds, are a type of investment vehicle that allows investors to buy and sell a diversified portfolio of stocks or bonds in a single transaction, similar to an index fund. However, ETFs are traded on stock exchanges like individual stocks, and their prices fluctuate throughout the day as investors buy and sell shares.
ETFs are designed to track the performance of a specific index or benchmark, such as the S&P 500, and their holdings are usually disclosed on a daily basis. This allows investors to gain exposure to a broad market or sector with a single investment.
The benefits of ETFs are low expenses and diversification. Because they are managed by computers, like index funds, they tend to have very low expense ratios. They also allow you access to a broad range of investments.
The drawbacks of exchange traded funds are trading costs and the potential for underperformance. ETFs have the potential to be actively traded – if you partake in this activity you will likely have fees when you buy and sell shares. Also, if you actively trade shares you have the potential to underperform (or overperform if you are luck) the market.
Individual Stocks
Rather than buy collections of stocks via a mutual fund or ETF you could invest in individual stocks, if you have the time, knowledge, and inclination to do so.
Investing in individual stocks has more risks due to the fact that it’s difficult to build a diversified portfolio. Plus, you are also limited by your own knowledge and research abilities.
However, some people love to research stocks and investing strategies. If that’s you, and your risk tolerance is high enough you may find a lot of satisfaction in choosing your own investments. You could potentially beat the market – although you could also underperform the market as well.
Even if this appeals to you, I recommend investing in individual stocks with only a small percentage of your portfolio, while the bulk of your money remains in index funds or mutual funds.
Here are our favorite stock trading apps.
Dividend Stocks
If income is your goal you may want to consider dividend stocks. These are stocks that pay out a portion of their earnings to shareholders in the form of dividends. Dividends are typically paid out quarterly, and the amount of the dividend can vary depending on the company’s earnings and dividend policy.
Dividend stocks are typically issued by established, mature companies that have a history of stable earnings and strong cash flow. These companies may not offer high growth potential, but they are often viewed as more stable and less volatile than growth stocks.
The benefits are that they can provide investors with a regular stream of income and lower volatility than growth stocks.
The drawbacks are they have limited growth potential and can make dividend cuts at any time.
Here is how to find the best dividend paying stocks.
Real Estate
If you are looking to invest $100k you’ve probably thought of real estate. You have a lot of options when it comes to owning property. You could buy an individual property to rent or you could be more hands off with REITs or crowdfunding.
Buying Rental Property
Buying individual rental properties can be an attractive investment option for individuals seeking to generate passive income and build long-term wealth through real estate.
The benefits of real estate is passive income and appreciation potential. When you have a rental property you get rent each month from your tenants and the value of the property will likely go up over time. If the rent is high enough to cover all your expenses you could have a fairly passive income stream.
The drawbacks of real estate are that there are high upfront costs as well as ongoing costs. There is also market risk and tenant risk.
Plus, real estate is illiquid. If you want to sell it will take weeks, even in a strong market. If the market is weak at the time of the sale it could potentially take years to find a buyer and make a sale.
REITs
REIT stands for Real Estate Investment Trust, which is a company that owns or operates income-producing real estate properties, such as apartments, shopping centers, office buildings, hotels, and warehouses.
REITs allow individual investors to invest in real estate without having to purchase, manage, or finance the properties themselves. Instead, investors can buy shares of a REIT, which represent ownership in the underlying real estate portfolio.
This eliminates many of the drawbacks of individual real estate. You can participate in the rental income and price appreciation of a property without having to deal with tenants or broken hot water heaters.
They are also more liquid than individual properties. Shares of Real Estate Investment Trusts are traded like stocks, so if you want to sell a portion of your holdings you can easily do so.
REITs are the only way to get in and out of real estate quickly.
Real Estate Crowdfunding
Real estate crowdfunding is a relatively new form of investment that allows multiple real estate investors to pool their money together to invest in real estate projects. Crowdfunding platforms provide a digital marketplace where investors can browse and select from a range of real estate investment opportunities, typically offered by developers, sponsors, or real estate companies.
Crowdfunding is like a cross between buying an individual property and REITs. Like REITs, it allows you to invest in real estate for a lower entry amount and avoid having to be a landlord.
However, unlike REITs (and more like owning an individual property) your money is invested in a particular property, rather than in a fund that has multiple properties. The rent you receive and property appreciation is linked to your specific property.
Also, crowdfunding is typically not very liquid. Crowdfunding platforms usually have a set amount of time, often five years or more, before you are allowed to draw your funds out of the investment.
Here’s more information on real estate crowdfunding.
Bonds
Bonds are a type of fixed-income security that represents a loan made by an investor to a government, corporation, or other entity. In essence, an investor who buys a bond is lending money to the bond issuer in exchange for regular interest payments and the promise of a the return of their principal investment at the bond’s maturity date.
If your goal is to generate income, then bonds are worth considering. They can provide a regular stream of income in the form of interest payments, which can be particularly attractive for investors who are looking for steady, predictable income.
Bonds can provide diversification in an investment portfolio, as they tend to have a lower correlation with stocks and other assets. This can help to reduce overall portfolio risk and volatility.
However, bond prices and yields are inversely related, meaning that when interest rates rise, bond prices tend to fall. This can result in capital losses for bond investors. Also, bond issuers may default on their payments, which can result in capital losses for investors. You can lessen credit risk by only buying bonds from governments and large stable companies.
Here’s how to invest in bonds.
Certificates of Deposit
Certificates of Deposit similar to a savings account except that your money is locked away for a set period of time in exchange for a higher interest rate. They are good investments when your primary goal is safety of principal but don’t need access to the money for a fixed period of time.
The benefits of CDs are that they are very low risk. Your money is insured and not invested in any market so you have no risk of losing your principal. They also offer CDs offer a fixed rate of return, which is nice if you are looking for a predictable source of income.
However, they also have fairly low returns. Depending on the interest rate environment the returns may not even keep up with inflation – so you may even be actually losing purchasing power over the long term.
Here are the best CD rates.
Taxes
Investing means dealing with taxes – even investing in a retirement account will have some sort of tax implications.
Capital Gains Tax
If you are investing outside of retirement accounts you will want to consider capital gains taxes. Capital gains occur anytime you sell an investment for more than you paid. If you’ve held the asset for less than a year when you sell, then you will be taxed at your ordinary income tax rate.
However, if you’ve held the asset for more than year you will be taxed at your capital gains rate, which is likely 15% (and likely lower than your ordinary income tax rate).
Capital losses can also occur. If you sell at a loss you can use your losses to offset any other capital gains you had that year. If your losses exceed your gains you can carry them over indefinitely.
Income
If you are receiving income from your investments, for example, rent, dividends, or interest payments you will likely pay your ordinary income tax rate on this income.
An exception is some dividends are tax advantaged. Dividends can be “qualified” or “non-qualified” which will affect their tax status. Here is some information from the TurboTax on this.
Also income from government issued bonds may be tax advantaged as well. Income payments from municipal bonds are exempt from federal taxes and state taxes if the issuing state is also the state where you live.
Income from federal bonds are exempt from state taxes and local taxes.
Retirement Accounts
If you are investing for retirement then using a tax advantaged retirement account is your best bet.
Common accounts are Traditional and Roth IRAs. Both are individual retirement accounts but they are taxed differently.
Traditional IRAs give you a tax break when you contribute to the account but withdrawals in retirement are considered taxable income and you’ll pay taxes as your ordinary income tax rate.
Roth IRAs do not receive a tax break when you contribute but withdrawals in retirement are tax free. Meaning the growth is actually never taxed.
IRAs have annual contribution limits. You can find out more about that here.
Diversify
As you start investing, keep in mind that you don’t have to invest your money all in one place. If you like the idea of long-term growth but feel nervous about putting it all in the stock market, that’s ok. You can split it up between an index fund and a real estate investment trust.
Maybe you sock most away in a well-diversified index fund but want to keep a little bit set aside to trade in individual stocks and try your hand at individual stocks.
It’s your money and ultimately you get to decide what to do.
Hire a Financial Advisor
If you don’t feel confident enough to invest $100k on your own you can always ask for help from a financial advisor. They typically have expertise in various areas of finance, such as investments, retirement planning, tax planning, and estate planning.
Financial advisors get paid in a few different ways:
Commission-based: Some earn commissions on the products they sell, such as mutual funds, insurance policies, or annuities. This model can create a conflict of interest, as advisors may be incentivized to recommend products that may not be in the client’s best interest.
Fee-only: Fee-only advisors charge clients a fee for their services, typically based on a percentage of the assets they manage. This model eliminates the potential conflict of interest associated with commissions, as advisors are not incentivized to recommend specific products.
Fee-based: Fee-based advisors charge both a fee for their services and may also receive commissions for the products they sell. This model can also create a conflict of interest, as advisors may be incentivized to recommend products that generate higher commissions.
Hourly or project-based: Some financial advisors charge clients an hourly rate or a flat fee for specific projects or services, such as creating a financial plan or reviewing investment portfolios.
It’s essential to understand how a financial planner is compensated before working with them, as their compensation structure can influence the advice they provide. Fee-only financial advisors are often considered the most transparent and unbiased, as they are not incentivized to recommend specific products.
It’s important to find an investment advisor that you trust. They will be helping you make some of the most important financial decisions of your life.
How to find a financial advisor.
Summary of How to Invest $100k
Investing $100,000 can be an overwhelming task, but with the right approach and mindset, it can be a fruitful one. The first step is to create an emergency fund/ savings account and pay off high-interest debt to ensure financial stability.
Ultimately, the key to successful investing is to develop a diversified portfolio that aligns with your investment goals, risk tolerance, and financial objectives. With the right strategy and mindset, investing $100,000 can be a smart move towards securing a better financial future.
Betterment and Betterment are not only two of the most popular robo advisors in the industry, but they may very well be the most innovative in the field. Though they represent two of the first robo advisors, both have built out their platforms and now offer robust portfolio options and other services to their clients.
Though they each have their own nuances–and specializations–you really can’t go wrong with either platform. Each will take complete control of your portfolio, managing every aspect of it for a very low annual fee. When you sign up with either service, your only responsibility will be to fund your account on a regular basis.
But what if you’re either new to robo advisors or you’re considering a switch from another one? If you’re researching robo advisors, the information will inevitably lead to Betterment and Wealthfront. So let’s take a look at the two heavyweights in the robo advisor space and see which might be a better fit for your portfolio. Listen to the Podcast of this Article
About Betterment
Betterment is not only the original robo advisor, but its also the largest independent robo (along with Wealthfront), with $21 billion in assets under management. The company is based in New York City and began operations in 2008.
As a robo advisor, Betterment is an automated, online investment platform that handles all aspects of investment management for you. When you sign up for the service, you complete a questionnaire that will help determine your investment goals, time horizon, and investment risk tolerance. From that information, Betterment creates a portfolio of stocks and bonds to meet your investor profile.
They dont actually invest your money in individual securities, but instead through exchange-traded funds (ETFs), each representing a specific asset class. They can build an entire portfolio for you through about a dozen funds that will give you exposure to the entire global financial markets.
All this is done for a low annual management fee. Your only responsibility will be to fund that your account on a regular basis and let Betterment handle all the management details for you.
Better Business Bureau rates Betterment as A+, which is the highest rating in a range from A+ to F. The company also scores 4.8 stars out of 5 by more than 20,000 users on the App Store, and 4.5 stars out of 5 by more than 4,500 users on Google Play.
About Wealthfront
Wealthfront is, with Betterment, the largest independent robo advisor, and Betterment’s primary competitor. In fact, with over $24 billion in assets under management, its now slightly larger than Betterment. The company is based in Redwood City, California, and launched operations in 2011.
As a robo advisor, it works much the same as Betterment, creating a portfolio for you based on your answers to a questionnaire when you open your account. Wealthfront will also manage your account using a small number of ETFs spread across various asset classes. But on larger accounts, they’ll also add individual stocks to get greater benefit from tax-loss harvesting.
Like Betterment and virtually all robo advisors, Wealthfronts basic investment strategy is based on Modern Portfolio Theory (MPT), which emphasizes asset allocation over individual security selection.
Similar to Betterment, and really all robo advisors, your account will receive full investment management for a very low annual fee. Your only responsibility will be to fund your account on a regular basis.
Unfortunately, Wealthfront has a Better Business Bureau rating of F, due to unanswered complaints. However, the company gets 4.9 stars out of 5 from more than 9,000 users on the App Store, and 4.8 stars out of 5 by more than 2,700 users on Google Play.
Investment Strategies Betterment vs Wealthfront
Betterment Investment Strategy
Betterment offers two plan levels, Digital and Premium. Premium is available for minimum account balances of $100,000, while Digital is open to all account balances. Like many robo advisors, Betterment has evolved past building and managing a basic portfolio comprised of a mix of stocks and bonds.
For example, if you choose the Premium Plan, you’ll have access to live financial advisors. But there are many other services and plans to choose from.
Read More: Betterment Promotions
Basic portfolio mix
Your portfolio will be invested in as many as six stock asset classes/ETFs and eight bond asset classes/EFTs.
Stocks:
US Total Stock Market
US Value Stocks Large Cap
US Value Stocks Mid Cap
US Value Stocks Small Cap
International Developed Markets Stocks
International Emerging Markets Stocks
Bonds:
US High-quality Bonds
US Municipal Bonds
US Inflation-Protected Bonds
US High-Yield Corporate Bonds
US Short-term Treasury Bonds
US Short-term Investment-Grade Bonds
International Developed Markets Bonds
International Emerging Markets Bonds
Use of value stocks
Notice that three of the six stock asset classes involve value stocks. This is a specialization of Betterment and represents a time-honored stock market investment strategy. Value stocks are investments in companies with stock prices that are low in relation to their competitors by various standard measurements. But the companies are deemed to be fundamentally sound, and therefore likely to outperform the general market once the investment community realizes the true value of the stocks.
In this way, Betterment makes an attempt to outperform the general market, such as the S&P 500 or even some broader indices.
Smart Beta
This is another investment strategy Betterment uses with the potential to outperform the general market. This specific portfolio is managed by Goldman Sachs. Smart Beta is a form of active portfolio management, which seeks high-quality companies with low volatility, strong momentum, and good value.
Since its a higher risk/high reward type of investing, it requires a minimum portfolio of $100,000.
Socially responsible investing (SRI)
This is an investment option increasingly being offered by robo advisors. However, with Betterment only a portion of your portfolio will be invested in SRI. They replace the ETFs in the International Emerging Market Stocks and US Value Stocks Large Cap with ETFs that specialize in socially responsible investing in those sectors.
Learn More: The Pros and Cons of Socially Responsible Investing
Flexible Portfolios
If you want more control over your investment portfolio, you can choose this option. It allows you to adjust the individual asset class weights in your portfolio allocation. Its also designed for more advanced investors and gives you an opportunity to increase allocations in asset classes you believe are likely to outperform the market.
BlackRock Target Income
For investors looking for income and safety of principal, Betterment offers this portfolio, which consists of 100% of bonds. There is some risk of principal in this portfolio but it’s designed to be minimal. You can even choose the level of risk and return you want. It won’t provide the type of long-term gains you’ll get from a stock portfolio, but it will offer the kind of steady income that will work especially well for retirees.
Tax-loss Harvesting
Tax-loss harvesting is a year-end strategy in which asset classes with losses are sold (and later replaced with comparable ones) to offset gains in winning asset classes. The strategy helps to defer taxable capital gains on growing asset classes.
Betterment makes this strategy available on all account balances. However, it’s only offered on taxable accounts since it’s completely unnecessary for tax-sheltered retirement plans.
Betterment Everyday Cash Reserve
If you’re looking to add a cash option to your investment portfolio, you can do it through Betterment Cash Reserve. The account is eligible for FDIC insurance up to $1 million. The minimum deposit is $10, and offers unlimited transfers, both in and out of your account.
Betterment Checking
The Betterment Checking account gives you the flexibility to manage your money in a way that best fits your financial goals. You’ll get this account with a debit card and you can use it to pay in person or online. You’ll also get FDIC insurance on your money.
The Betterment Checking account is an innovative way to manage your money. It’s faster, more secure, and requires zero minimum balance requirements. You can now deposit checks using their streamlined mobile app. Just take a picture and deposit checks will be there for you on the other side.
Wealthfront Investment Strategy
Unlike Betterment, Wealthfront has a single plan for all investors, with an annual management fee of 0.25% on all account balances. And like Betterment, Wealthfront has expanded its investment options menu in many different directions.
Basic Portfolio Mix
Wealthfront uses 11 asset classes in the construction of its portfolios, including four stock funds, five bond funds, plus real estate and natural resources.
The allocation looks like this:
Stocks:
US Stocks
Foreign Stocks
Emerging Market Stocks
Dividend Stocks
Bonds:
Treasury Inflation-Protected Securities (TIPS)
Municipal Bonds (on taxable investment accounts only)
Corporate Bonds
U.S. Government Bonds
Emerging Market Bonds
Alternatives:
Real Estate
Natural Resources
Use of Alternative Investments
Wealthfront includes real estate and natural resources in its portfolio composition. The real estate sector invests in companies that provide exposure to commercial property, apartment complexes, and retail space. Natural resources are held in ETFs representing that sector.
The combination of the two offers a stronger diversification away from a portfolio comprised entirely of stocks and bonds, largely because they offer protection in an inflationary environment. It’s possible for these sectors to perform well when the general financial markets are not.
Smart Beta
The Smart Beta option attempts to outperform the general financial markets. The strategy deemphasizes market capitalization in the creation of a portfolio. For example, rather than using the capitalization allocations of certain companies within the S&P 500, the strategy might increase some allocations and decrease others. It’s more of an active investment strategy and requires a minimum investment portfolio of $500,000.
Wealthfront Risk Parity
This is another investment strategy for investors with larger accounts and a greater appetite for risk. Its been shown to provide higher long-term returns, but it may use leverage to increase those returns.
Stock-level Tax-loss Harvesting
Tax-loss harvesting is available on all taxable investment accounts. But Stock-level Tax-loss Harvesting is available to larger accounts to provide more aggressive tax deferral.
This is a fairly complex investment strategy, but it involves the use of individual stocks to take greater advantage of tax-loss harvesting. The use of individual stocks will make it easier to buy and sell securities to minimize capital gains taxes. Depending on the specific plan, the required minimum investment ranges between $100,000 and $500,000.
Wealthfront Path
This is a software-based financial advisory, providing you with financial planning tools. They can help you plan for retirement or saving for the down payment on a house or a college education for one or more of your children. The apps run what-if scenarios, that can make projections based on various savings levels for each of your specific goals.
Though it doesn’t offer live financial advice, the service is free to use.
Wealthfront Cash
You can open an interest-bearing cash account with Wealthfront Cash Account with just $1. There’s no market risk, no fees, unlimited free transfers, and your account is FDIC insured for up to $5 million. The account currently pays 4.30% APY and provides a safe, cash investment to go with your stock portfolios.
And now, Wealthfront Cash allows you to get your paycheck up to two days early when you set up a direct deposit. They’ve also implemented the ability for you to invest directly into the market within minutes, straight from your Wealthfront Cash account. That means you can get paid early and immediately invest – giving you about extra days of investing each year.
Read more: Wealthfront Cash Account review
Wealthfront Portfolio Line of Credit
Much like a home equity line of credit, the Wealthfront Portfolio Line of Credit is secured by your investment account. You can borrow up to 30% of the value of your account for any purpose. There’s no prequalification since the line of credit is completely secured by your investment account.
The line of credit is automatic if you have a non-retirement account balance of at least $25,000. You can request funds against the line on your smartphone and receive them in as little as one business day.
Current interest rates paid on the line range between 2.45% and 3.70% APR, depending on the size of your account.
Retirement Planning Betterment vs. Wealthfront
One of the most common uses of robo advisors is the management of retirement accounts. Both Betterment and Wealthfront can manage all types of IRA accounts, similar to the way they do with taxable accounts. But each also offers some level of retirement planning.
Read More: Best Robo Advisors Find out which one matches your investment needs.
Betterment Retirement Planning
Betterment is strong in this category because in addition to their regular portfolios, they also offer income-specific investment options, like their BlackRock Target Income and Everyday Cash Reserve. The Target Income option in particular focuses on maximizing interest income, which is exactly what most people are looking for in retirement.
One of the advantages Betterment offers is that you can connect your 401(k) with your investment account. Betterment cant manage the 401(k) (unless chosen to do so by your employer through their 401(k) management plan), but they can coordinate your Betterment retirement account(s) with the activity in your employer plan.
And of course, if you have at least $100,000 in your Betterment account, you can enroll in the Premium plan and have access to live financial advisors.
But Betterment also offers its Retirement Savings Calculator to help you know if you’re on track for your retirement. By answering just four questions, they’ll be able to determine if your current retirement plan will provide the income you’ll need in retirement, taking your projected Social Security income into consideration. If it isn’t, it’ll let you know how much more you need to invest on a regular basis.
Wealthfront Retirement Planning
You can take advantage of Wealthfront Path to help you with retirement planning. You’ll start by linking your financial accounts so the program can get a better understanding of your finances. Recommendations to help you reach your goals are made based on the amount of regular contributions you’re making and the income you will need in retirement.
Path will analyze your spending patterns, your average annual savings rate, the interest you’re earning on those savings, as well as your investment and retirement contributions. It will also analyze the fees you’re paying on your investment and retirement accounts. Loan accounts are analyzed as well.
The information is assembled, and future projections are made. You’ll be given advice on any needed increases in savings for retirement contributions, as well as asset allocations. And perhaps best of all, since all your financial accounts are linked to the service, it will provide continuous updates on your progress toward your retirement goals.
Betterment Pros & Cons
No minimum initial investment or account balance requirement.
Reduced fee structure on larger account balances.
Use of value stocks seeks to outperform the general market.
Unlimited access to certified financial planners on account balances over $100,000.
Comprehensive retirement planning package.
Limited investment diversification, excluding alternative asset classes, like real estate and natural resources.
The annual management fee rises from 0.25% to 0.40% if you select the Premium plan.
The reduced fee structure on large account balances doesn’t kick in until you reach a minimum of $2 million.
Wealthfront Pros & Cons
Your account includes alternative investments, like real estate and natural resources. This offers greater diversification than a portfolio invested only in stocks and bonds.
The minimum initial investment is just $500. That’s not zero, but it’s an amount most small investors can comfortably start with.
Flat-rate fee of 0.25% on all account balances.
Larger accounts get the benefit of more efficient tax-loss harvesting strategies through Wealthfront Risk Parity.
The Wealthfront Portfolio Line of Credit lets you borrow up to 30% of the value of your non-retirement accounts at very low interest and with no credit check.
There’s no reduced management fee for larger account balances.
The retirement planning tool (Path) is an automated system and does not provide advice from live financial advisors.
Poor rating from the Better Business Bureau.
Bottom Line
We’ve covered a lot of territory and details in this side-by-side comparison of Betterment vs Wealthfront. The summary table below should help you to be able to compare the various services each offers with a quick glance.
Category
Betterment
Wealthfront
Minimum initial investment
Digital: $0 Premium: $100,000
$500
Promotions
Up To 1 Year Free
First $5,000 Managed Free
Management fees
Digital: 0.25% up to $2 million, then 0.15% above Premium: 0.40% to $2 million, then 0.30%
0.25%
Available accounts
Individual and joint taxable accounts; traditional, Roth, rollover and SEP IRAs; trusts and nonprofit accounts
Individual and joint taxable accounts; traditional, Roth, rollover and SEP IRAs; trusts and 529 accounts
Rebalancing
Yes
Yes
Dividend reinvestment
Yes
Yes
Tax-loss harvesting – on taxable accounts only
Yes
Yes
Socially-responsible investing
Yes
Available through Smart Beta ($500,000 minimum) and Stock-level Tax-Loss Harvesting ($100,000 minimum)
Smart Beta investing
Yes
Yes, minimum $500,000
Interest bearing cash account
Yes
Yes
Line of credit
No
Yes
Financial advice
Yes, on Premium Plan only
Automated only
Mobile app
Yes
Yes
Customer service
Phone and email, Monday through Friday, 9:00 am to 6:00 pm Eastern time
Phone and email, Monday through Friday, 10:00 am to 8:00 pm Eastern time
You’ve probably already guessed were not declaring a winner between these two popular roboadvisors. Both are first rate and you can’t go wrong with either. More than anything, your decision will likely come down to specific details–what features and benefits one offers that better suits your own personal preferences and investment style.
But one advantage that’s undeniable with both Betterment and Wealthfront is that not only is each a first-rate service, but they provide enough investment options and related services that they can accommodate your growing financial capabilities and needs well into the future.
For example, while you may start out with a basic managed portfolio, you’ll eventually want to get into higher risk/higher reward options as your wealth grows. As well, you’ll like the flexibility of having high-interest cash investment options, as well as low-cost or free financial or retirement advice.
We like both these services and are certain you can’t go wrong with whichever one you choose.
Betterment Cash Reserve Disclosure – Betterment Cash Reserve (“Cash Reserve”) is offered by Betterment LLC. Clients of Betterment LLC participate in Cash Reserve through their brokerage account held at Betterment Securities. Neither Betterment LLC nor any of its affiliates is a bank. Through Cash Reserve, clients’ funds are deposited into one or more banks (“Program Banks“) where the funds earn a variable interest rate and are eligible for FDIC insurance. Cash Reserve provides Betterment clients with the opportunity to earn interest on cash intended to purchase securities through Betterment LLC and Betterment Securities. Cash Reserve should not be viewed as a long-term investment option.
Funds held in your brokerage accounts are not FDIC‐insured but are protected by SIPC. Funds in transit to or from Program Banks are generally not FDIC‐insured but are protected by SIPC, except when those funds are held in a sweep account following a deposit or prior to a withdrawal, at which time funds are eligible for FDIC insurance but are not protected by SIPC. See Betterment Client Agreements for further details. Funds deposited into Cash Reserve are eligible for up to $1,000,000.00 (or $2,000,000.00 for joint accounts) of FDIC insurance once the funds reach one or more Program Banks (up to $250,000 for each insurable capacity—e.g., individual or joint—at up to four Program Banks). Even if there are more than four Program Banks, clients will not necessarily have deposits allocated in a manner that will provide FDIC insurance above $1,000,000.00 (or $2,000,000.00 for joint accounts). The FDIC calculates the insurance limits based on all accounts held in the same insurable capacity at a bank, not just cash in Cash Reserve. If clients elect to exclude one or more Program Banks from receiving deposits the amount of FDIC insurance available through Cash Reserve may be lower. Clients are responsible for monitoring their total assets at each Program Bank, including existing deposits held at Program Banks outside of Cash Reserve, to ensure FDIC insurance limits are not exceeded, which could result in some funds being uninsured. For more information on FDIC insurance please visit www.FDIC.gov. Deposits held in Program Banks are not protected by SIPC. For more information see the full terms and conditions and Betterment LLC’s Form ADV Part II.
DoughRoller receives cash compensation from Wealthfront Advisers LLC (“Wealthfront Advisers”) for each new client that applies for a Wealthfront Automated Investing Account through our links. This creates an incentive that results in a material conflict of interest. DoughRoller is not a Wealthfront Advisers client, and this is a paid endorsement. More information is available via our links to Wealthfront Advisers.
Robo-advisors have barely been around for 10 years, but in the past couple of years several have been steadily expanding their investment menus, and even offering valuable add-on services. One of the leaders in this regard is Wealthfront. The robo-advisor has been growing its investment capability in every direction but is now even offering financial planning. The platform now bills itself as offering High-Interest Cash, Financial Planning & Robo-Investing for Millennials. If you’re looking for more than just investing, Wealthfront has it. And as has become their trademark, it’s all available at a low cost.
What is Wealthfront?
Based in Palo Alto, California, and founded in 2011, Wealthfront has about $25 billion in assets under management. It’s the second-largest independent robo-advisor, after Betterment. And while dozens of robo-advisors have arrived in recent years, Wealthfront stands out as one of the very best. There isn’t any one thing Wealthfront does especially well, but many. And they’re adding to their menu of services all the time.
Their primary business of course is automated online investing. You can open an account with as little as $500, and the platform will design a portfolio for you, then manage it continuously. Your money will be invested in a globally diversified portfolio of ETFs–just like most other robo-advisors. But Wealthfront takes it a step further, and also adds real estate and natural resources.
Like other robo-advisors, Wealthfront uses Modern Portfolio Theory (MPT) in the creation of portfolios. They first determine your investment goals, time horizon, and risk tolerance, then build a portfolio designed to work within those parameters. MPT emphasizes proper asset allocation to both maximize returns, and minimize losses.
But in a major departure from other robo-advisors, Wealthfront now offers the ability to customize your portfolio and get access to a variety of investment methodologies and portfolios, including Smart Beta, Risk Parity and Stock-Level Tax-Loss Harvesting. And more recently, they’ve also stepped into the financial planning arena. They now offer several financial planning packages, customized to very specific needs, including retirement planning and college planning.
If you haven’t checked out Wealthfront in the past year or so, you definitely need to give it a second look. This is a robo-advisor platform where things are happening–fast!
How Wealthfront Works
When you sign up with Wealthfront, they first have you complete a questionnaire. Your answers will determine your investment goals, time horizon, and risk tolerance. A portfolio invested in multiple asset classes will be constructed, with an exchange-traded fund (ETF) representing each.
The advantage of ETFs is that they are low-cost, and enable the platform to expose your portfolio to literally hundreds of different companies in each asset class. With your portfolio invested in multiple asset classes, it will literally contain the stocks and bonds of thousands of companies and institutions, both here in the U.S. and abroad.
Wealthfront offers tax-loss harvesting on all portfolio levels. But they’ve also added portfolio options for larger investors, that include stocks as well as ETFs. The inclusion of stocks gives Wealthfront the ability to be more precise and aggressive with tax-loss harvesting.
Each portfolio also comes with periodic rebalancing, to maintain target asset allocations, as well as automatic dividend reinvestment. As is typical with robo-advisors, all you need to do is fund your account–Wealthfront handles 100% of the investment management for you.
More recently, Wealthfront has also added external account support. The platform can now incorporate investment accounts that are not directly managed by the robo-advisor. This will provide a high-altitude view of your entire financial situation, helping you explore what’s possible and providing guidance to optimize your finances.
And much like many large investment brokers, Wealthfront now offers a portfolio line of credit. It’s available only to investors with $25,000 or more in a taxable account, but if you qualify you can borrow money against your investment account and set your own repayment terms in the process
Wealthfront Features and Benefits
Minimum initial investment: $500
Account types offered: Individual and joint taxable accounts; traditional, Roth, rollover and SEP IRAs; trusts and 529 college accounts
Account access: Available in web and mobile apps. Compatible with Android devices (5.0 and up), and available for download at Google Play. Also compatible with iOS (11.0 and later) devices at The App Store. Compatible with iPhone, iPad and iPod touch devices.
Account custodian: Account funds are held in a brokerage account in your name through Wealthfront Brokerage Corporation, which has partnered with RBC Correspondent Services for clearing functions, such as trade settlement. IRA accounts are held with Forge Trust.
Customer service: Available by phone and email, Monday through Friday, from 7:00 AM to 5:00 PM, Pacific time.
Wealthfront security: Your funds invested with Wealthfront are covered by SIPC, which insures your account against broker failure for up to $500,000 in cash and securities, including up to $250,000 in cash.
Wealthfront uses third-party providers to maintain secure, read-only links to your account. The providers specialize in tracking financial data, as well as employ robust, bank-grade security, and in general, they follow data protection best practices. In addition, Wealthfront does not store your account password.
Wealthfront Investment Methodology
For regular investment accounts, Wealthfront constructs portfolios from a combination of 10 different specific asset classes. This includes four stock funds, four bond funds, a real estate fund, and a natural resources fund.
Each portfolio will contain various allocations of each asset class, based on your investor profile as determined by your answers to the questionnaire. The one exception is municipal bonds. That allocation will appear only in taxable accounts. IRAs don’t include them since the accounts are already tax-sheltered.
Notice in the table below that most asset classes have two ETFs listed. This is part of Wealthfront’s tax-loss harvesting strategy. In each case, the two ETFs are very similar. To facilitate tax-loss harvesting, one fund position will be sold, then the second will be purchased at least 30 days later, to restore the asset class. (We’ll cover tax-loss harvesting in a bit more detail a little further down.)
The ETFs used for each asset class are as follows, as of December 29, 2018:
Specific Asset ClassGeneral Asset ClassPrimary ETFSecondary ETF
US Stocks
Stocks
Vanguard CRSP US Total Market Index (VTI)
Schwab DJ Broad US Market (SCHB)
Foreign Stocks
Stocks
Vanguard FTSE Developed All Cap ex-US Index (VEA)
Schwab FTSE Dev ex-US (SCHF)
Emerging Markets
Stocks
Vanguard FTSE Emerging Markets All Cap China A Inclusion Index (VWO)
iShares MSCI EM (IEMG)
Real Estate
Real Estate
Vanguard MSCI US REIT (VNQ)
Schwab DJ REIT (SCHH)
Natural Resources
Natural Resources
State Street S&P Energy Select Sector Index (XLE)
Vanguard MSCI Energy (VDE)
US Government Bonds
Bonds
Vanguard Barclays Aggregate Bonds (BND)
Vanguard Barclays 5-10 Gov/Credit (BIV)
TIPS
Bonds
Schwab Barclays Capital US TIPS (SCHP)
Vanguard Barclays Capital US TIPS 0-5 Years (VTIP)
Municipal Bonds (taxable accounts only)
Bonds
Vanguard S&P National Municipal (VTEB)
State Street Barclays Capital Municipal (TFI)
Dividend Stocks
Bonds
Vanguard Dividend Achievers Select (VIG)
Schwab Dow Jones US Dividend 100 (SCHD)
Wealthfront’s historical returns are as follows (through 1/31/2019). But keep in mind these numbers are general. Since the portfolios designed for each investor are unique, your returns will vary.
Specialized Wealthfront Portfolios
As mentioned in the introduction, Wealthfront has rolled out several different investment options, in addition to its regular robo-advisor portfolios. Each represents a specific, and generally more specialized investment strategy, and is typically available to those with larger investment accounts.
Smart Beta: You’ll need at least $500,000 to be eligible for this portfolio. Smart beta departs from traditional index-based investing, which relies on market capitalization. For example, since Apple is one of the most highly capitalized S&P 500 stocks, it has a disproportionate weight in strict S&P 500 index funds. In a smart beta portfolio, the position in Apple will be reduced based on other factors.
In general, under smart beta, the weighing of stocks in the fund uses a variety of factors that are less dependent on market capitalization. There’s some evidence this investment methodology produces higher returns. This portfolio is available at no additional fee.
Wealthfront Risk Parity Fund: This is actually a mutual fund–the first offered by Wealthfront. It involves the use of leverage with some positions within the portfolio. It attempts to achieve higher long-term returns by equalizing the risk contributions of each asset class. It’s based on the Bridgewater Hedge Fund, and requires a minimum of $100,000, with an additional annual fee of 0.25% (0.50% total). This is the only Wealthfront portfolio that charges a fee over and above the regular advisory fee.
Socially responsible investing (SRI): Wealthfront just recently began to offer a specific SRI portfolio option. Once you sign up, you’ll be able to customize your portfolio and add socially responsible ETFs.
Sector-specific ETFs: If you want to invest in a particular portion of the market, such as technology or healthcare, Wealthfront gives you the option to build a portfolio that focuses on certain industries to portions of the stock market.
Customized Wealthfront Portfolios:
Wealthfront also lets investors build their own portfolios, which is somewhat uncommon among robo-advisors.
Most robo-advisors will build your portfolio automatically based on your risk tolerance and goals. If you like that service, Wealthfront can do it. However, more hands-on investors are free to make tweaks to the automatically designed portfolio by adding or removing ETFs.
You can also build a portfolio entirely from scratch if you’d rather. You can choose which ETFs to invest in and how much you want to invest in them. You can then let Wealthfront handle things like rebalancing and tax-loss harvesting while maintaining the portfolio you desire.
Wealthfront Tax-loss Harvesting
If there’s one investment category where Wealthfront stands above other robo-advisors, it’s tax-loss harvesting. Not only do they offer it on all regular taxable accounts (but not IRAs, since they’re already tax-sheltered), but they also offer specialized portfolios that take it to an even higher degree.
Wealthfront starts with a tax location strategy. That involves holding interest and dividend-earning asset classes in IRA accounts, where the predictable returns will be sheltered from income tax. Capital appreciation assets, like stocks, are held in taxable accounts, where they can get the benefit of lower long-term capital gains tax rates.
But for larger portfolios, Wealthfront offers Stock-level Tax-Loss Harvesting. Three specialized portfolios are available, using a mix of both ETFs and individual stocks. The purpose of the stocks is to provide more specific tax-loss harvesting opportunities. For example, it may be more advantageous to sell a handful of stocks to generate tax losses, than to close out an entire ETF.
Given that Wealthfront puts such heavy emphasis on tax-loss harvesting, it’s not surprising they’ve published one of the most respected white papers on the subject on the internet. If you want to know more about this topic, it’s well worth a read. The paper concludes that tax-loss harvesting can significantly increase the return on investment of a typical portfolio.
US Direct Indexing
US Direct Indexing is an enhanced level of tax-loss harvesting that Wealthfront offers to people with account balances exceeding $100,000.
Instead of building a portfolio of ETFs, Wealthfront will use your money to directly purchase shares in 100, 500, or 1,000 US companies. By buying shares in so many companies, Wealthfront can emulate an index fund in your portfolio while owning individual shares in the businesses.
Owning individual shares in hundreds of companies makes tax-loss harvesting easier as it lets Wealthfront’s algorithm trade based on movements in individual stocks rather than in funds. This can increase the number of tax losses that Wealthfront harvests each year, reducing your income tax bill.
Other Wealthfront Features
Wealthfront Cash Account
Wealthfront offers acash account where you can safely and securely store your money for anything–emergencies, a down payment for a home, or to later invest. By working with what they call Program Banks, Wealthfront has quadrupled the normal FDIC insurance on this account, so you’re protected for up to $5 million.
There’s also no market risk since it’s not an investment account and the money isn’t being invested anywhere. You can make as many transfers in and out of the account as you’d like, and it only takes $1 to start.
So what’s the catch?
There really isn’t one. Wealthfront will skim a little off the top to make some money before giving you an industry-leading 4.30% APY, but other than that, you’re just giving them more financial data. Since we’re doing this all the time with technology anyway, it shouldn’t make that big of a difference.
I see no downside, especially if you’re already a client of Wealthfront.
They’re really making a play to be your all-in-one financial services provider, too.
A new feature, just launched, is the ability to use your cash account as a checking account. This includes the ability to access your paycheck up to two days early when you set up a direct deposit. Additionally, you can invest in the market within minutes using your Wealthfront Cash account. Put the two together and you give yourself the ability to invest more than 100 days more in the market. The account also allows you to auto-pay bills and use apps like Venmo and PayPal to send money to friends or family. Account-holders also get a debit card to make purchases and get cash from ATMs. And you can use the account to organize your cash into savings buckets – like an emergency fund, down payment on a house, or other large purchase – and use Wealthfront’s Self-Driving Money offering to automate your savings into those buckets.
If you have cash that’s getting rusty in a traditional bank account and you want to earn more, the Wealthfront Cash Accountis a great place to keep it.
Read more about the cash account in our Wealthfront Cash Account full review.
Wealthfront Portfolio Line of Credit
This feature is available if you have at least $25,000 in your Wealthfront account. It allows you to borrow up to 30% of your account value, and currently charges interest rates between 3.15% and 4.40% APR depending on account size. You can make repayments on your own timetable, since you’re essentially borrowing from yourself. And since the credit line is secured by your account, you don’t need to credit qualify to access it.
Wealthfront Free Financial Planning
This is Wealthfront’s entry into financial planning. But like everything else with Wealthfront, this is an automated service. There are no in-person meetings or phone calls with a certified financial planner. Instead, technology is used to help you explore your financial goals, and to provide guidance to help you reach them. And since the service is technology-based, there is no fee for using it.
The service can be used to help you plan for homeownership, college, early retirement, or even to help you plan to take some time off to travel, like an entire year!
Simply choose your financial objective, enter your financial information, and Wealthfront will direct you on how to plan and prepare.
Self-Driving Money
One of the biggest and largely unrecognized obstacles for most investors is something known as cash drag. That’s when you have too much of your portfolio sitting in cash, which may earn interest, but it doesn’t provide the investment returns you can get in a diversified investment portfolio.
Wealthfront has addressed the cash drag dilemma with their newly released Self-Driving Money features. It’s a free service offered by the robo-advisor that essentially automates your savings strategy. It does this by automatically moving excess cash to help meet your goals, including into investment accounts where it will earn higher returns. And in the process, it eliminates the need to make manual cash transfers, and the judgment needed to decide exactly when to make that happen.
Our vision of Self-Driving Money is going to be a complete game-changer for people’s finances, said Chris Hutchins, Head of Financial Automation at Wealthfront. We want to completely remove the burden of managing your money so you can focus on your career, your family or whatever is most important to you.
You can take advantage of Self-Driving Money from the Wealthfront Cash Account. You’ll set a maximum balance for the connected account, which should be an amount that’s more than you expect to spend or withdraw on a monthly basis.
How It Works
When Wealthfront determines you’re over your maximum balance by at least $100 it will schedule an automatic transfer of the excess cash based on your goals. For example, you can tell Wealthfront you want to save $10,000 in an emergency fund, then max out your Roth IRA, then put the rest toward saving for a down payment on a house. Once you set the strategy, Wealthfront will automate the rest.
And before it happens, you’ll receive an email alert, then always have 24 hours to cancel the transfer if you need to cover unexpected expenses. You’ll also be able to turn on and off your Self-Driving Money plan at any time.
It’s usually possible to set up automated transfers from external accounts into most investment accounts. But what sets Wealthfront apart is the fact that it will make those transfers automatically. They will make sure you always have enough cash to pay your bills, then automatically transfer any excess into your savings buckets or investment accounts to improve the return on your money.
The strategy is designed to optimize your money across spending, savings, and investments, and to make it all flow with no effort on your part. You can simply have your paycheck direct deposited into your external checking account or Wealthfront Cash Account, cover your expected monthly spending, then have excess funds automatically transferred into the Wealthfront account of your choice.
By delivering on its Self-Driving Money vision, Wealthfront is taking the robo-advisor concept to a whole new level. Not only do you not need to concern yourself with managing your investments, but now even funding those investments will happen automatically. The result will be near complete freedom from the financial stresses that plague so many individuals.
Wealthfront Fees
Wealthfront has a single fee structure of just 0.25% per year for their advisory fee. That means you can have a $100,000 portfolio managed for just $250, or only a little bit more than $20 per month.
The one exception is the Wealthfront Risk Parity Fund, which has a total fee of 0.50% per year.
How to Sign Up with Wealthfront
To open an account with Wealthfront, you’ll need to be at least 18 years old, and a U.S. citizen.
You’ll need to provide the following information:
Your name
Address
Email address
Social Security number
Date of birth
Citizenship/residency status
Employment status
As is the case with all investment accounts, you’ll also be required to supply documentation verifying your identity. This is usually accomplished by supplying a driver’s license or other state-issued identification.
As mentioned earlier, you complete a questionnaire that will be used to determine your investment goals, time horizon, and risk tolerance. Your portfolio will be based on your answers to that questionnaire, and will be presented to you upon completion of the questionnaire.
For funding, you can use ACH transfers from a linked bank account. You will also have the option to schedule recurring deposits, on a weekly, biweekly, or monthly basis. The platform can even enable you to set up dollar-cost averaging deposits.
If you already have a brokerage account with another company, Wealthfront makes it easy to transfer your funds to your new account. If you’re invested in ETFs that Wealthfront supports, Wealthfront will assist with an in-kind transfer.
That means that you won’t have to sell your shares before transferring funds, which lets you avoid capital gains taxes that would be triggered by a sale.
Wealthfront Alternatives
Wealthfront’s closest competitor, and the robo-advisor that offers the most comparable services, is Betterment. They also have an annual advisory fee of 0.25%, but require no minimum initial investment. That could make it the perfect robo-advisor for someone with no money, who plans to fund their account with monthly deposits. Read the full Betterment review here.
Related: Wealthfront vs. Betterment
Another alternative is M1. Also a robo-advisor, M1 enables you to invest your money in what they call “pies”. These are miniature investment portfolios comprised of both stocks and ETFs. You can invest in existing pies, or create and populate pies of your own design. Once you invest in one or more pies, the platform will automatically manage it going forward. What’s more, M1 is free to use. Read more about M1 here.
Related: Wealthfront vs. Vanguard
Read More: The Best Robo Advisors – Find out which one matches your investment needs.
Wealthfront Pros and Cons
Investment options: Wealthfront offers more investment options than just about any other robo-advisor, particularly for investors with at least $100,000.
Reasonably priced: The annual fee of 0.25% is extremely reasonable, especially when you consider the degree of sophistication offered by Wealthfront’s investment methodology.
Tax-loss harvesting: This is available on all accounts, and Wealthfront is probably better at this investment strategy than any other robo-advisor.
Portfolio credit line: Gives you the ability to borrow against your portfolio with ease, and represents a form of margin investing.
Financial planning feature: The financial planning service is free to use and is available to all investors.
Limited access for smaller investors: Some of the more advanced investment portfolios and services are available only to investors with $100,000 or more to invest.
$500 minimum initial investment: It’s a minor issue, though some competitors require no funds to open an account.
FAQs
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Should You Sign Up for Wealthfront?
In a word, absolutely! Wealthfront is one of the very top robo-advisors, and you can’t go wrong with this one. Not only do they offer far more services than most other robo-advisors, but they also allow you to grow along the way. For example, as your account increases in value, you can take advantage of more sophisticated investment strategies, including advanced tax-loss harvesting.
That Wealthfront offers its portfolio line of credit and free financial planning services only makes the platform a bit more attractive, But the real benefit is the actual investment service. Wealthfront’s investment service comes extremely close to that of traditional human investment advisors, but at only a fraction of the annual cost.
This article originally appeared on The Financially Independent Millennial and was republished with permission.
If investing is of interest to you, then you’ve probably heard about stocks vs. options. How can you make the best choice when deciding which investment strategy to use?
After all, investing comes with risk attached – learning how to navigate that risk and make sound investment decisions is the key to building a good investment portfolio.
Knowing as much as you can about options and stocks will mean you can make better investment choices. In this comprehensive guide, I’ll explain the differences between stocks vs. options in detail. Armed with this knowledge, you should be better prepared to achieve your financial targets.
What Are Stocks?
A stock means you own part of a company that has sold shares on an exchange. These shares that you can buy are known as stocks. When you buy shares, you’re then a shareholder of that company.
Every company has a certain number of shares available on the stock market. Those stocks can be bought and sold on the stock exchange. Each company decides how many shares can get bought and can raise or lower how many shares are available on the exchange at any time.
The stock market can rapidly change from one moment to the next based on many factors. Anyone trading in stocks must remain aware of how their stock is performing to minimize the risk of a loss.
Benefits of Stocks
The first benefit of investing in blue chip stocks (unlike options) is that most investors will build wealth, as stocks nearly always rise over a long period. Individual stock prices fluctuate daily, but investing in companies with a proven track record of growth and investments means in the long-term, your wealth will grow.
Investing in stocks is extremely easy these days, thanks to modern technology. You can get started with just a mobile phone and an internet connection with many apps doing a lot of the hard work for you. This ease of access makes stock trading appealing for many beginner investors.
It also means you can often start trading using small amounts. Learning to trade for a few dollars a month is a great way to build confidence and understand how it all works. Once you’re established, then you can gradually invest more!
Stocks are good assets to have as they are considered liquid. Liquid means they can be converted to cash quickly, unlike other assets such as real estate. And, this may good if a situation arose that required you to get cash fast.
Drawbacks of Stocks
Investing in stocks comes with risk attached. The biggest one is that the price could drop dramatically, and you lose all your investment. Stocks can vary wildly from one day to another. Therefore, experts recommend stocks as a long-term investment strategy, and you should plan to keep the money invested for at least five years.
Another way to avoid losing all your investment is by diversifying your portfolio. Don’t put all your money into one stock. Invest in a variety of stocks to spread the risk.
Other drawbacks of trading in stocks include fees, capital gains taxes, and commissions. Commissions and fees vary. Some brokers don’t charge any at all. Make sure to shop around before opening a brokerage account to find the best deals for you.
While investors can’t avoid taxes, the rate you pay does vary depending on several factors. How much profit you’ve made, your income, and how long you’ve held the stock affects Rates. Generally, any investments held for less than a year attract a higher rate—another good reason to own stocks long-term.
What Are Options?
An option is when you purchase the right to buy or sell an asset (typically a stock) for an agreed price and at an agreed time. The seller has no choice but to allow you to exercise the option. The buyer pays for the right (but not the obligation) to have the option to buy or sell an underlying security for an agreed price on or before an agreed date.
There are two types of options – call options, and put options.
Call Options
Call options are the most common. Investors who buy call options expect the stock price to end up above the strike price before the expiration. Profit gets made when investors can either sell the stocks on the open market for a higher amount than they paid or sell the option they originally bought for a profit.
Call Option Example
An investor may buy a call option on AAPL with a $120 strike price that expires 9/17/2021. The investor pays $6 for the call option (Options get sold in lots of 100, so the total is $600). If at expiration (9/17/2021) AAPL is trading at $130, the investor can either:
1 – Exercise the option by buying 100 shares of AAPL for $120 each and then sell them to the open market for $130 each making a net profit of $400 ($10/share gross profit – $6 premium * 100).
2 – Sell “to close” the call option before expiration for a profit.
Put Options
Investors buy put options as a way to insure against a downturn. For example, investors can sell an asset at a specific price within an agreed time (expiration). These options work the opposite way to a call option. Investors buy put options hoping the stock price will drop. Profit gets made when investors sell the underlying security at a higher price than it’s worth.
Related read: How to Sell Covered Calls for Monthly Income
Put Option Example
You buy put option on AAPL with a strike price of $100, expiring 9/17/2021. The cost of this put option is $20 ($0.20 * 100 shares). On expiration, if AAPL is trading at $95:
You can exercise the option and sell AAPL to the Put option seller for $100 each. Doing so will earn you $5 minus the original $0.20 premium, times 100 (net total $480).
Or
You can sell the put option at a higher price than you originally paid for it.
Benefits of Options
Investing in options usually costs less upfront than stock trading. And, this can be appealing if you’re starting to invest and don’t have much capital. You could get more for your money trading in options.
Trading in options can be more flexible than stocks. That’s because you’ve got several moves you can make when deciding how to play out your investment strategy.
You can exercise the option and buy the shares to add to your investment portfolio. Another option is to exercise the option and either buy or sell the shares at a profit. There are also various points through the process where you could sell the options contract to another investor.
One of the critical benefits of options is that the underlying stocks strike price is fixed. For the agreed period, the stock price agreed is the price you can buy or sell the stocks for up to the expiration date.
Drawbacks of Options
Options trading can be much more time-consuming than investing in stocks. You might want to exercise the option before expiration, which means keeping a close eye on the stock price. To help with this, you can set up alerts with most online brokers.
Some options strategies carry more risk than others. Some strategies are so risky that only experienced traders should attempt them. You must understand what you’re doing before making the trade. Make sure to do your research and don’t trade in anything you don’t fully understand.
Commissions, fees, and capital gains taxes can also be higher than the cost of trading in stocks. Keep in mind that the more you trade, the more your costs are going to be. Taxes are also higher on investments held less than a year, in some countries.
Stocks vs. Options: Making a Decision
When thinking about stocks vs. options, it’s entirely your choice as to which you prefer. Everyone has their investing style and appetite for risk that will drive their decision.
For beginner investors, or anyone preferring straightforward investing, stocks are usually the best choice. Options may become more appealing as you become a more experienced investor or if you prefer an investment that requires more active participation.
Don’t forget that you don’t have to stick with one or the other. There is no reason you can’t invest in both stocks and options should you want to. Just make sure you have a thorough understanding of any investment before going ahead with it.
Stocks vs. Options: Further Considerations
When considering stocks vs. options, keep in mind that they are intricately linked. You can hold both stocks and options for the same company. Plus, option prices get calculated based on the difference of the strike price and the current stock price, the implied volatility (IV), and the amount of time before expiration.
When planning your investment strategy, there are some questions you should ask yourself to determine how to proceed. What is your appetite for risk? Do you want to make long-term or short-term investments? Do you want to make a mix of investments? Where will you get the best return for the money you have available to invest?
Think about your answers to these questions. Don’t forget to keep in mind your financial goals and your current situation when making your decisions.
Ultimately, only you can decide which investment opportunities are best for you.
Importance of a Balanced Portfolio
Having a diverse and balanced portfolio is essential for achieving your financial goals and, ultimately, growing your wealth.
The best strategy balances the need for long-term returns while absorbing any economic shocks. For example, if all your money is in bank stocks and there’s a financial crisis, you could lose all your money. However, having a balanced portfolio means that although the asset values diminished, your other investments can help balance that loss until the market recovers.
Conclusion
Now that you understand the difference between stocks vs. options, you can make better financial decisions. Making the right choices now makes it much easier to reach your financial goals in the future!
Buying a house with your partner? You’ll need to make many decisions during the process — like figuring out who gets to use that sweet spare room as a home office or what your landscaping will look like. But one of the most important choices is how the two of you hold the title of the house. It might sound like a no-brainer, but there are actually a few different legal ownership designations to know and understand.
Both joint tenancy and community property with right of survivorship are ownership structures that can be used by partners buying a home together. But community property with right of survivorship is specifically reserved for married couples, and is only available in certain states. Community property with right of survivorship offers certain tax benefits in the event that one spouse dies before the other, but both of these ownership structures confer joint ownership over the property to both people whose names are on the title.
Let’s take a closer look.
First-time homebuyers can prequalify for a SoFi mortgage loan, with as little as 3% down.
What Is Joint Tenancy?
In order to fully understand community property, it’s helpful to first understand joint tenancy, which is the ownership structure that came first. In fact, community property with right of survivorship is a fairly new legal designation; it was invented by the California legislature back in 2001.
Before that time, joint tenancy was one of the most common ways that couples — or other parties holding an asset together — designated their ownership. Joint tenancy basically states that everyone has equal ownership over the shared asset, be it a piece of real estate or a joint brokerage account. Conceptually, it helps to think about each person owning 100% of the asset, rather than each holding a proportional amount (50/50, 33/33/33, etc). If you and your spouse are first-time homebuyers on the market, understanding this legal jargon is an important step in the journey.
Joint tenancy could be shared between more than two people under certain circumstances — like if you and two friends bought a vacation home together. But because everyone in the agreement owns 100% of the asset, nobody can sell their share of it or will it to their heirs after their death. That’s the “right of survivorship” part: Any surviving parties automatically have ownership rights over the asset if one of the owners dies. 💡 Quick Tip: When house hunting, don’t forget to lock in your home mortgage loan rate so there are no surprises if your offer is accepted.
What Is Community Property?
Community property works very similarly to joint tenancy, but is reserved specifically for married couples. (That’s why it’s also sometimes known as marital property.) Community property is only a legal designation in a handful of U.S. states, including:
• Arizona
• California
• Idaho
• Louisiana
• Nevada
• New Mexico
• Texas
• Washington
• Wisconsin
Three additional states — Alaska, South Dakota, and Tennessee — allow couples to decide whether or not they’d like to opt into a community property ownership structure — whereas in the other states listed, community property is the default status for shared ownership of assets between married couples. It is, however, always possible to opt out of the community property system with a prenuptial agreement.
Under community property, each partner has equal joint ownership over shared assets — which, again, can range from a piece of real estate to bank accounts and even to debt (like a mortgage). This means that, in the event of a divorce, all assets are required to be split 50/50 — which is part of why some partners in those states might opt to sign a prenup ahead of time, if they want to hold onto an asset no matter what.
However, community property also comes with the added bonus of some tax incentives for spouses — which is part of why it was created in the first place.
Recommended: The Cost of Living By State
The Difference Between Joint Tenancy and Community Property With Right of Survivorship
The most salient difference between joint tenancy and community property with right of survivorship comes down to taxes.
That’s right: This ownership structure is really all about how much a surviving spouse stands to owe Uncle Sam if their partner passes away.
What Are the Tax Benefits for Surviving Spouses in Community Property States?
In a joint tenancy situation, even with right of survivorship, a property sold after the death of a spouse would be subject to capital gains taxes — taxes levied against earnings on an asset like a home or an investment.
Part of the reason buying a house is considered such a good financial move is because homes tend to appreciate, or grow in value, over time. With the capital gains tax, a surviving loved one would be required to pay taxes on that appreciated value if they chose to sell the home after their spouse’s death.
Community property with right of survivorship, however, allows these proceeds to be exempt from the capital gains tax — which can ease the overall financial burden in an already difficult time.
What Is the Right of Survivorship in Real Estate?
Now let’s take a look at the piece that both joint tenancy and this type of community property have in common: right of survivorship.
Right of survivorship in real estate pretty much does what it sounds like — it confers the surviving partner, in the event of the other party’s death, the right to continue to live in the house. Again, this can ease the burden for a surviving spouse in an incredibly difficult emotional time, when there are already other significant financial planning steps to take. However, it also means that couples under this ownership structure are unable to give the home to an heir, or anyone else, in their will. The property will instead automatically be under the ownership of the surviving spouse.
Recommended: How Home Ownership Can Help Build Generational Wealth
How Does a Right of Survivorship Work With a Will?
So what happens if a person sharing community property — or joint tenancy, for that matter — with right of survivorship tries to leave some or all of their property to an heir in a will?
While every legal case is different, in most cases, the right of survivorship will take precedence over wishes stated in a will. So if Rebecca and Ann share a home under community property with right of survivorship, and Rebecca writes into her will that she’d like to leave her share of the home to her grandson Pete, it’s very likely this wish will be superseded by Ann’s right to survivorship in the event of Rebecca’s death. 💡 Quick Tip: When house hunting, don’t forget to lock in your home mortgage loan rate so there are no surprises if your offer is accepted.
Community Property vs Community Property With Right of Survivorship
It’s important to understand that the right of survivorship part of this kind of agreement is separate from the community property part.
Community property basically states that assets acquired in a marriage are evenly shared between the partners, 50/50 — and must be distributed that way in the event of a divorce. But without the right of survivorship, a partner would still be able to will their 50% of the home to whomever they want, which may or may not be their surviving spouse. Those few extra words make a big difference!
The Takeaway
Community property with right of survivorship is a legal ownership structure that confers ownership rights and possible tax benefits to married couples, while also creating rules as to how assets are distributed in the event of a divorce. You’ll need to decide on your preferred ownership structure when purchasing a home, along with other important decisions you’ll make.
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FAQ
What is the difference between joint tenancy and community property with right of survivorship in California?
Although the designation of community property with right of survivorship was originally invented in California, couples can own property there under either ownership structure — and indeed, many maintain joint tenancy. Community property requires couples to split assets 50/50 in a divorce, which is not the case with joint tenancy. However, in both cases, right of survivorship confers the surviving spouse the right to ownership over the home, and other assets, in the event of one spouse’s death.
What is the difference between joint tenancy and community property in California?
In California, as in all states, the most salient difference between joint tenancy and community property is how a property is taxed in the event it is sold after one party’s death. In addition, community property is an ownership structure only available to married couples.
What are the disadvantages of community property with a right of survivorship?
While every type of shared ownership structure has both benefits and drawbacks, one drawback of community property with right of survivorship is that neither owner can choose to will their share of the property to an heir — instead, ownership is automatically conferred to the other party in the event of their death. Additionally, community property must, by law, be split 50/50 in the event the couple divorces, whereas in other cases there’s more flexibility about what constitutes an “equal” dispersal of assets.
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Before I delete the GRS forums, I’m moving the best posts here. Last month I shared Vintek’s introduction to mutual funds. Here he explains index funds.
In my previous discussion of mutual funds, I mentioned index funds:
Along came index funds, and this was hailed as the ultimate in investing. You’d invest not in just a basket of stocks, but in the entire market. Since the manager wasn’t required to do research and pick stocks (all he had to do was buy it all and hold it), his fee was reduced to a fraction of an actively managed fund’s fees (about 0.2%). Yes, you could have years of losses (2000, 2001 and 2002 were the most recent), but studies show that the market always recovered, even if some of the companies in the index didn’t. If you wanted put your investing on autopilot and be assured of a long-term (any 20 year period since the 1920s had an average gain of 10% per year) winner, this was the way to go.
That’s the basic introduction. Now let’s talk about what it all means.
What’s an index? In most cases, an index is just a group of financial instruments (mostly stocks, but also bonds, REITs and other things) designed to represent something. The index is typically used as a baseline against which a person’s investments can be measured. For example, the S&P 500 is supposed to be the 500 biggest stocks on the market, per Standard & Poor. The DOW is a collection of 30 stocks that are supposed to represent American industry as a whole. The Wilshire 5000 is supposed to represent all of the stocks currently being traded over the stock market. Ditto the Russell 3000. Interestingly enough, the Russell 3000 is broken into two parts: the Wilshire 1000 (kind of the Wilshire counterpart to the S&P 500), composed of the biggest 1000 stocks on the market, and the Wilshire 2000, composed of everything else.
What’s an index fund? An index fund is exactly what it sounds like. It’s a fund that’s designed to follow an index. For example, if you bought into an index fund that tracked the S&P 500, you’d be buying into every stock listed in the S&P 500. Because that fund covers the largest of the stocks (by capitalization) on the market, it would be considered a large-cap fund index fund. By contrast, a fund following the Russell 2000 would be considered a small-cap index fund. The really interesting thing is that the large caps stocks are so big that they overwhelm everything else by comparison. For example, if you singled out the companies that comprise the S&P 500, they would comprise about 70% of the Wilshire 5000! 70%!
What makes an index fund such a good choice? Good question. Well, we know that the market always recovers from downturns and goes up in the long term. Stocks and (managed) funds don’t always recover. We know that if we hold an index fund, there won’t be a lot of trading because a manager won’t be jockeying for the best performing stocks. He’d just hold stocks according to the index. As a result, this keeps trading costs (and therefore expenses) on the fund low. Furthermore, an index fund is tax-efficient because it doesn’t trade much. If it doesn’t trade much, you won’t have to pay very much in capital gains taxes. Still, there is a small amount of trading every year, as most indexes are re-evaluated on an annual basis.
That’s it for now. In the future, I’ll talk a bit about market capitalization (big cap vs. mid-cap vs. small cap) and why it’s important to know the difference. I’ll also talk about what index funds I own and why I own them.
Thanks to Vintek for allowing me to repost this information.
News that Amazon.com is reconsidering putting a second headquarters in New York City has dealmakers wobbling their heads. According to the news, a wave of public outcry and political maneuvering may well force the company to look elsewhere.
Amazon’s highly publicized search for a second headquarters appeared to be over as billionaire Jeff Bezos’ company seemed all set to create 25,000 jobs at a new campus in New York City. Real estate professionals close to the potential deal were anticipating new life being breathed into the stagnant NY market. Then a 29-year old congresswoman named Alexandria Ocasio-Cortez (above) pointed out what should have been obvious from the start. The subsidies and sweet offers New York offered Amazon were just too sweet. A political firestorm ensued, and the community lashed out at local politicians and dealmakers.
Governor Andrew M. Cuomo (D) and Mayor Bill de Blasio (D) have been singing the praises of the Amazon deal, calling it an economic triumph. At the end of the day, citizens of the state do not feel like giving giant subsidies to the world’s most valuable company at this moment in time is a good idea. Amazon has now hired an independent PR firm to try and sooth the deal over, but Ocasio-Cortez’s support base is solid. Sen. Michael N. Gianaris (D-Queens), appointed recently to the Public Authorities Control Board that will decide on the deal, has accused Amazon of extortion the past. The deputy senior majority leader was cited by the Washington Post commenting:
“Amazon has extorted New York from the start, and this seems to be their next effort to do just that. If their view is, ‘We won’t come unless we get three billion of your dollars,’ then they shouldn’t come.”
Many see this Amazon-NY struggle as one of populism versus the corporate elites, some calling the deal a “tipping point” in a kind of class struggle. Back in November Amazon dangled a huge carrot in front of New Yorkers and Long Island City residents by promising salaries of $150,000 a year to as many as 50,000 workers. The Jeff Bezos run company had originally planned a single headquarters but instead split the new development in two in between New York and Long Island. Now Amazon is threatening to pull out.
At the end of the day Amazon and supporters of the new HQ deal are claiming a $3 billion dollar subsidies package taxpayers will have to deal with. However, an Intercept report recently shows the actual amount of the subsidies is closer to $5 billion. And this does not include a Federal tax loophole that will save Amazon and cost truckloads of revenue. It turns out the Amazon location in Long Island City, in the New York City borough of Queens, puts the new Amazon HQ in a tax zone that lets the company defer income tax until many residents are dead or in old folks homes. The so-called “Tax Landing” zones let companies defer their taxes until 2026. Under the tax overhaul signed into effect by President Donald Trump last year, investors in opportunity zones can defer payments of capital gains taxes until 2026, and exclude 15 percent of the gains from taxation if they hold them for 7 years.
Alexandria Ocasio-Cortez and her constituents are bringing to light much of the hyperbole the Amazon PR teams have set in motion to create this deal. This Good Jobs First report also reveals Amazon PR people shorting potential workers by almost $40,000 a year. The “rabbit hole” of Amazon’s deal seems endless now that Freedom of Information Act disclosures show the under the table maneuvers of Amazon. One big question opponents of the deal have is, “What else is underneath?” Not much publicity has been given to the fact that the cities making the biggest known subsidy offers did not win the deal. Few people realize that Montgomery County, Maryland offered an $8.5 billion subsidies package or the St. Louis wagered $7.3 billion. Some say Amazon owner Jeff Bezos wants the HQs close to his three listed residences, and other experts contend the Virginia HQ is close to the Pentagon, a big customer for Bezos’ company. Whatever the case is, odds seem good the New York deal will turn sour fast as more revelations are brought into the limelight.
In conclusion, big companies taking huge subsidies for dangling the carrot of more jobs has cost Americans untold billions in potential revenue. Companies like Apple, Amazon, Facebook, Google, and Foxconn promise jobs, but those jobs end up costing taxpayers more than they are worth. This The Guardian story peels back the veil on this aspect of corporate dealmaking. The companies typically overstate the positive impacts like the number of jobs and the overall community aspects, and they end up paying little or no tax at all. The Guardian report shows that local schools and other infrastructure in need of financial help, suffer an inestimable loss on account of the long tail of corporate subsidies. No wonder some experts are calling this high profile Amazon case a battle between populism and the corporate elites.
Phil Butler is a former engineer, contractor, and telecommunications professional who is editor of several influential online media outlets including part owner of Pamil Visions with wife Mihaela. Phil began his digital ramblings via several of the world’s most noted tech blogs, at the advent of blogging as a form of journalistic license. Phil is currently top interviewer, and journalist at Realty Biz News.
There are many uncertainties on the road to financial independence. You can’t know what rate of return your investments will earn over the coming decades. And you certainly don’t know exactly how long you’ll live.
That old cliché is true: the only certainties in life are death and taxes.
So, we control what we can. And we try not to worry about the things we can’t control. From experience, this is easier said than done.
Tax is one variable over which we have a modicum of control. No, we cannot control how the government changes the tax code. But we can plan our lives and investments in ways that will affect how much tax we owe – both now, and in the future.
Strategic tax planning isn’t just for the wealthy. Unfortunately, it’s true that billionaires seem to benefit most from it. But, in fact, there are some simple things nearly everyone can do that may end up saving you tens of thousands of dollars in taxes – or more – over your lifetime.
Here, I’m going to show you what they are. I’ll begin with tax moves that will be available to most people. Some of the strategies that come later will only be relevant once you’ve taken advantage of the basics or earn a certain amount of income.
What’s Ahead:
Take advantage of retirement accounts
Are you tired of hearing about the importance of saving for retirement using a 401(k) or IRA? Well, there’s a reason that guys like me go on and on about them. These accounts represent a huge gift from Uncle Sam to taxpayers including you and me.
In a traditional IRA or 401(k), contributions are tax-free. Then, your earnings grow tax-deferred until retirement.
Every year, investments generate dividends, interest, and – if you sell investments at a profit – capital gains. In a traditional taxable investment account, you pay taxes on that investment income every year.
With a traditional 401(k) or IRA, you can invest pre-tax dollars now and you don’t pay taxes on any of that investment income until you begin withdrawing money in retirement. With a Roth IRA, you must invest after-tax dollars now, but all of the investment income you earn over the years is tax-free. With either type of account, the money you save by not paying taxes on investment income each year can continue compound growth. The earlier you start putting money in these accounts, the more you’ll save.
A modest example – consider the following situation
A 29-year-old in the 25% tax bracket contributes $5,000 every year to an IRA for 30 years and retires at age 65. She earns an average of 6% annual interest. At retirement, her IRA is worth $631,341 before taxes. If the money had been invested in a taxable account, it would be worth only $337,655. That’s a significant difference! But, since this is a traditional IRA, she still has to pay taxes on withdrawals.
After paying taxes on the IRA, she’s left with $473,505. That’s still a savings of $135,850 over investing in a taxable account!
Everybody needs to put as much money as they can afford into these kinds of retirement accounts. Not only is it smart planning for your future; it’ll save you a bundle on your taxes.
If you need help managing your 401(k) or IRA, I’d highly recommend checking out blooom. They can manage your account for you, taking into consideration your retirement goals, and rebalance your portfolio as needed.
Get an HSA or FSA
Flexible spending arrangements (FSAs) and health savings accounts (HSAs) are accounts that allow you to use tax-free dollars for medical expenses. The largest difference between them is that FSAs are owned by employers while HSAs are controlled by individuals.
HSAs are the better option, in my opinion. But to qualify for an HSA, you need to be enrolled in a qualifying high-deductible health plan.
What are health savings accounts (HSAs)?
You can contribute up to $3,450 pre-tax dollars per year ($7,750 per household) to an HSA. These funds can be withdrawn at any time to pay for qualifying medical expenses tax-free. There’s no need to “use or lose” HSA dollars, as unused funds roll over every year.
Like traditional IRAs and 401(k)s, early withdrawals that aren’t used for medical expenses are subject to a 20% penalty and income taxes. After you turn 65, however, you can withdraw HSA funds for any purpose (not just medical expenses) penalty-free. (You will owe income taxes on withdrawals not used for medical expenses).
HSAs are great for saving on medical expenses now. But they’re even better if you invest dollars in HSAs and let them grow to pay for medical expenses later in life. If you invest the funds in your HSA, the money will grow tax-free (just like an IRA.)
But when you withdraw money later in life to pay for medical expenses, you pay no taxes at all on both the dollars you contributed and your earnings. No IRA is truly tax-free. With a traditional IRA, you pay taxes on withdrawals but not deposits. With a Roth IRA, you pay taxes on deposits but not withdrawals. When used for medical expenses, you don’t have to pay any taxes on the money you put into or take out of an HSA.
Whare are flexible spending arrangements (FSAs)?
Flexible spending arrangements are another type of account that provides tax-free dollars for medical expenses. FSAs are set up by your employer and go away when you change jobs unless you contribute your health insurance through COBRA.
FSAs have lower contribution maximums ($3,050 for individuals and $5,000 for households).
The trickiest part of FSAs is that they are “use it or lose it” accounts. You can roll over up to $550 every year, but all other funds in an FSA expire at the end of the year (with a two-and-a-half-month grace period). This can lead employees to scramble at year-end to line up routine doctor appointments and even stock up on prescriptions or qualifying OTC pharmacy purchases!
Since you can’t usually have access to both an HSA and an FSA at the same time, take advantage of either if you can. If you find yourself in the unusual position of having the option between the two, choose the HSA.
Avoid tax penalties and interest
It should go without saying, but I’ve seen enough to know that it needs to be said: pay your taxes! Equally as important, do not ignore or procrastinate on any tax problems that arise.
The IRS charges penalties and interest any time you don’t pay enough tax by the relevant deadline. This can occur for lots of reasons, but most commonly it happens when:
You don’t have enough taxes withheld from your paycheck (W4 error).
You earn money through a business or self-employment and do not make or underpay quarterly estimated payments.
You file a tax return extension and fail to pay any estimated amount due. (An extension to file is not an extension to pay).
You simply pay late!
The longer you go with a balance due to the IRS, the more interest accrues. And a tax debt is the worst kind of debt to have. The IRS has the power to garnish your wages, seize future tax refunds, attach your assets, and even reduce Social Security benefits when you retire.
Donate to charity smartly
You probably know that donations to qualified charities are tax-deductible.
But you can only claim the tax benefits of charitable donations if it makes sense for you to itemize your deductions. With the standard deduction standing at $13,850 for individuals and $27,700 for couples, a minority of taxpayers itemize.
Does this mean charitable donations can’t help you if you don’t itemize? No! Keep reading…
If you do itemize deductions, charitable donations made in cash can reduce your taxable income dollar-for-dollar by up to 60%. Go ahead and make them every year.
You can also donate appreciated stock to charity can be a win-win. The charity gets its donation and you get a tax deduction equal to the stock’s fair market value (not its cost basis). You can deduct up to 30% of your income this way.
If you don’t regularly exceed the itemized deduction amounts, you can still make charitable donations work for you by either grouping your deductions in certain years or, better yet, making occasional large gifts to a donor-advised fund.
Donor-advised funds
A donor-advised fund is an investment account to which contributions are tax-deductible in the year you make them. You can contribute cash, appreciated assets, or investments held for more than a year. Then, you can make donations from the fund whenever you want. Donor-advised funds are a great way to give because you can give your money a chance to grow and yourself years to choose the best way (and time) to allocate your charitable funds.
To give you an example of how this might work, let’s say you give $1,000 to charity a year, on average. Your total tax deductions, not including your donations, total about $10,000. Even adding the donation will keep you under the standard deduction.
So, rather than donating $1,000 every year, you set $1,000 aside in a savings account every year for five years. In the fifth year, you put that money into a donor-advised fund and add $5,000 to your itemized deductions. This gets you a $1,150 additional deduction ($15,0000 itemized – $13,850 standard) in your taxes that year.
Be tax-savvy about where you live
If you’re serious about paying fewer taxes, you’ll want to consider living in a low-tax state.
When it comes to state and local taxes, not all states are created equal. Far from it. According to data from the Tax Policy Center, the difference in tax burden between the state with the highest burden (New York) and the state with the lowest burden (Alaska) is 7.12%. If you’re a New Yorker, you might be thinking about what you could do with an extra 7% of your income right now!
A handful of states attract an outsized share of entrepreneurs and other wealthy residents because of their 0% income tax rate. Although I personally can’t imagine moving across the country solely for tax purposes, I do know people who’ve done it. There is an argument to be made that a lifetime of state tax payments invested is an amount of money too significant to ignore.
For example, let’s say you will earn an average of $100,000 a year over 50 years (not that you have to work 50 years…income can include other sources like dividends). Over those years, you pay an average state income tax rate of 5%. If you could skip the tax payments and instead invest that money in the stock market at an average annual return of 7%, you would be sitting on just over $2 million ($2,032,660 to be precise).
And, now, seeing those numbers, I’m about to call my realtor.
Be a tax-efficient investor
When you own stocks and bonds outside of a retirement account like a 401(k) or IRA, you will owe taxes on the interest, dividends, and capital gains earned from those investments.
Although you do not need to not pay capital gains taxes until you sell an investment at a profit, most investments will pay you interest and dividends each year. Whether you spend that money or reinvest it, you will owe taxes on it.
There are two schools of thought when it comes to taxes and investing. Most investors try to minimize the tax consequences of their investments whenever possible. Some, however, argue that taxes should take the backseat to whatever investing strategy will get the best return. I think the answer lies somewhere in between.
Whatever your view, some of these ways to reduce taxes on your investments just make sense.
Take credit investment losses
If you own investments (stocks and bonds or even real estate) and sell them at a loss, you can write-off your losses.This can be an incentive to exit a losing investment if you suspect it’s never going to recover its value. But this tactic can also be used strategically as a part of routine portfolio re-allocation. When used in this way it is called “tax-loss harvesting”.
You can deduct up to $3,000 per year for stock investment losses, but you can carry-forward losses to future tax years. For example, if you had a $9,000 capital loss, you could deduct $3,000 a year for three years.
You may also be able to deduct up to $25,000 of rental real estate losses if your adjusted gross income is $100,000 or less (or a portion of that amount if your AGI is up to $150,000).
Hold bonds and dividend-paying stocks in retirement accounts
Bonds and dividend stocks will generate taxable investment income every year. Growth stocks that do not pay dividends, however, do not. If you have a taxable investment account and want to own both kinds of investments in your portfolio, put the income-generating investments in your IRA or 401(k) and buy non-dividend stocks with your taxable account.
Use ETFs instead of mutual funds
Exchange-traded funds can be more tax-efficient than traditional mutual funds. Both can generate capital gains and dividends, but ETFs are structured in a way that minimizes tax liability for the investor.
Invest in municipal bonds
If want to pay even fewer taxes on your investment income, consider tax-exempt municipal bonds. Municipal bond earnings are exempt from federal income taxes. The government makes interest on these bonds tax-free to encourage investment in local and state projects.
These bonds (called munis) yield less than corporate bonds before taxes but are competitive, and sometimes better when you compare after-tax returns.
Use a business to reduce your tax bill
Starting a business takes you to the next level of tax breaks. You don’t even need to create an entity like an LLC. If you earn money outside of a salary (W-2), you can call yourself a sole proprietor.
To deduct business expenses and take advantage of other business tax breaks, you’ll need to do two things:
Keep an accounting of your business income and expenses separate from your personal accounting.
File a Schedule C with your tax return.
In addition to deducting business expenses and, potentially, the use of part of your home as an office, you can also take advantage of some special retirement savings accounts.
The Solo 401(k) and SEP-IRA both allow much higher contributions than traditional 401(k)s and IRAs. For 2023, you can contribute up to the lesser of $66,000 or 25% of operating profits to a SEP-IRA. Otherwise, the SEP works like a traditional IRA: money in is tax-deductible and your money grows tax-deferred until retirement.
Summary
Nobody wants to pay more taxes than they have to. Everybody should take their taxes seriously and seek professional advice when they need it.
If you’re intent on achieving financial independence as quickly as possible, reducing taxes will likely be a large part of your plan. The methods described above will be invaluable.
As you begin implementing them, just remember not to let your life be dictated by paying as little tax as possible. At a certain point, the law of diminishing terms will apply. There are probably uses of time that will be more profitable in the long run!