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What are the best investment accounts for young investors? Though encouraging young investors to invest in their future is good advice, the big question for young investors is how to get started. The types of investment accounts to consider can be particularly confusing.
Tax-Deferred Accounts
Retirement accounts can be tax-deferred. This means that the money invested in the account grows and compounds free of taxation year to year. Individual retirement accounts (IRAs) and company-sponsored retirement accounts, such as 401(k), 403(b), and 457 plans, are examples of tax-deferred retirement accounts, meaning that the money is not taxed until it is withdrawn for retirement. Remember that the money has to be from employment. You can’t invest other money from an inheritance into a retirement account.
There is often a tax break upfront when the money is contributed to these accounts. Workplace retirement plans allow you to make contributions from each paycheck. The contribution amount is withdrawn, leaving less income to be taxed.
In the case of a traditional IRA, contributions are made similarly to a 401(k), with pre-tax dollars, and can be tax-deductible. An IRA or a 401(k) contribution might be one of the few tax breaks available for a younger worker, an added benefit for doing something you should do anyway.
Roth Accounts
A Roth IRA contribution is made with after-tax employment income—in other words, money on which you’ve already paid taxes. As with a traditional IRA or 401(k), the money grows free of taxes while invested. However, if certain rules are followed, the money can be withdrawn completely tax-free at retirement.
Note that you can only open a Roth IRA account if your income is below a certain level. That makes these a good option for younger investors, as their income may be lower, and the benefit of the current-year tax breaks is not as valuable as it will be down the road when their income rises.
Taxable Accounts
Taxable accounts include brokerage accounts, certificates of deposit (CD), higher-interest depository accounts, and accounts with mutual fund companies. Gains and interest from these accounts are taxable each year as incurred. Losses can also be deducted in many cases. With a taxable account, you generally have greater access to your money without worrying about the taxes and potential penalties that can come with a tax-deferred or Roth account.
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Where to Open an Account
Your 401(k) plan will not offer you a choice of where to open an account and will come with a set investment menu through your employer. As for other types of accounts, you have a lot of choices.
Taxable accounts and IRAs can be opened at many popular investment custodians, such as Charles Schwab, Fidelity, and Vanguard. Additionally, many mutual fund companies offer account options as well. Robo advisors such as Betterment, Ellevest, Titan, Acorns, SoFi, and Wealthfront are also options. These technology-based advisors invest your money in low-cost investment options, such as exchange-traded funds (ETFs), based on computer algorithms tied to your specific needs and goals. This can be a great option for someone just starting with little investment money and prefers a mobile-based service with no human interaction.
Many new types of accounts and providers exist in today’s online world. An app called Acorns even rounds up purchases from linked accounts and invests in your “spare change.” Technology can enable many wonderful twists on basic savings and brokerage accounts, such as using personal finance apps to manage your accounts. As with any financial account or transaction, understand how the account and its technology work, who is behind it, and if it is right for you.
CDs and other savings vehicles are available at banks and many brokerage firms. The lines separating traditional financial service providers are blurring as more firms attempt to offer a full range of accounts and services.
The Bottom Line
Investing is a lifelong activity; getting started is sometimes the hardest part. Understanding the different types of accounts available to you is a good first step in this process.
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