Difference between revisions of "Prioritizing investments"

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{{Bogleheads_Investing_Start-Up_Kit}}
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Investors who are able to place their investments in several different kinds of accounts (such as taxable accounts, 401k, or [[IRA]]) need to decide which ones to prioritize.  In order to maximize the [[Principles_of_Tax-Efficient_Fund_Placement|tax efficiency]] of a portfolio, the ''general'' rule for investing priority is:
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Investors who are able to place their investments in several different kinds of accounts (such as taxable accounts, 401(k), or an IRA) need to decide which ones to '''prioritize'''.
  
#Company plan ([[401k]], [[403-b|403b]], etc.) up to the company match
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Investing in a prioritized order will maximize the [[Principles_of_Tax-Efficient_Fund_Placement|tax efficiency]] of a portfolio (pay the minimum amount of taxes).
#[[Roth IRA]] up to maximum contribution limit
 
#Company plan up to maximum contribution limit
 
#Taxable Investing
 
  
If the company plan offers good, low-cost funds, it may be preferable to contribute to the company plan ''before'' contributing to the Roth IRA.
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==Funding priority==
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Here is a general account funding priority that often works well for many people (not all points will apply to everyone):
  
An investor's tax bracket may influence the decision as well: those in higher tax brackets should consider higher contributions to a tax-deferred plan (e.g. traditional 401k) rather than a post-tax plan (e.g. Roth 401k).
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# Establish an [[Emergency fund|emergency fund]] to your satisfaction. If you have many other high financial priorities (like paying off high-interest debt), start with a smaller emergency fund, and grow it later over time, as those other priorities are satisfied.
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# Contribute to a [[Employer retirement plans overview|work-based plan]] (eg. [[401(k)]] or [[403(b)|403b]]) enough to get the full [[Employer matching contributions|employer match]] (the match is like free money, your best possible investment).
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# Pay off high-interest debt (a guaranteed high return, the next best thing to free money).
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# Contribute to a [[Health savings account|Health Savings Account]] (HSA) if available (unlike many other tax deductions, there are no income restrictions to contribute to an HSA).<ref>{{Forum post|t=133142|title=Prioritizing investments- HSA goes where?}}, 16 Feb 2014</ref><ref group="note">Investor should determine if enrolling in a [[high deductible health plan]] and possibly gaining access to a HSA is appropriate for their personal circumstances and health care needs. If so, then using the HSA as an investment account can be advantageous and is therefore included in this list.</ref>
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# Contribute the maximum to an IRA, [[Traditional IRA|traditional]] or [[Roth IRA|Roth]] (or [[Backdoor Roth IRA| backdoor Roth technique]]<ref group="note">This is a technique for contributing to a Roth IRA when your income exceeds the contribution limit. It is complicated in nature and may not be for everyone. Read the [[Backdoor Roth IRA#Cautions| Cautions]] section of the article before proceeding and ask in the forum if you are unsure.</ref>), depending on eligibility and personal circumstances.
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# Contribute the remainder of the maximum employee contribution to the work-based plan, including an [[After-tax 401(k)]] (Mega Backdoor Roth), if available.
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# Pay off medium-interest debt (eg. student loans, car loans, personal loans), especially if the interest is not tax-deductible.
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# Invest inside a [[Taxable account|taxable investing account]]. In [[Taxable account#Comparison to non-deductible IRAs and variable annuities|certain circumstances]], a [[Non-deductible traditional IRA]] and/or [[Variable annuity|variable annuity]] may be better than a taxable account.
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# Pay off low-interest debt (eg. most mortgages, some car loans).
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# Invest in low-return assets (eg. [[Money markets|money markets]], [[Certificate of deposit|Certificates of Deposit (CDs)]]).
  
Many company plans contain high-cost funds which make them unattractive. If you have such a plan, look for one or two index funds or a bond fund that can be used.  If your company offers matching funds up to a certain contribution level, it's '''always''' wise to use the company plan.  If there is no match, the power of tax-deferred compounding and automatic contributions still favors using the plan with limited contributions.  Also, if you leave your current employer you will most likely be able to rollover the assets in your poor-quality company plan to either a better company plan, or to an IRA.
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If the company plan offers good, low-cost funds, it may be preferable to contribute to the company plan ''before'' contributing to an IRA; see: [[IRA#Comparison to employer accounts|Comparison between IRAs and employer plans]].
  
== Paying off debts ==
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An investor's tax bracket may influence the decision as well: those in higher tax brackets should consider higher contributions to a tax-deferred plan (e.g. traditional 401(k) or IRA) rather than a post-tax plan (e.g. Roth 401(k) or IRA); see [[Traditional versus Roth]] for more guidance.
  
Another order discussed in the [[:Bogleheads' Guide to Retirement Planning]] considers investors who have [[debt]]s that may need to be paid off.
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The choice to pay off debt or invest is based mostly on the [[Marginal_tax_rate#After-tax value of investments|expected after-tax rate of return]]. When the returns are similar, secondary factors sway the decision; see: [[Paying down loans versus investing]].
  
#Invest up to the match
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'''Health savings accounts:''' Use of an HSA requires participation in an IRS qualified [[High deductible health plan| high deductible health plan]] (HDHP) at work. Look at your particular health care needs to decide if you may be better off with a traditional health care plan or an HDHP plus HSA. If the latter, then using the HSA as an investment account can be advantageous.
#Pay Off high Interest Debt
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#[[Traditional IRA | Tax-Deductible Retirement Accounts]]
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==401(k) plans with high cost funds==
#Roth IRA
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{{See also |401(k)#Expensive or mediocre choices|l1=Expensive or mediocre choices}}
#Taxable Accounts
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#[[Non-deductible Traditional IRA |Nondeductible IRAs]] and [[:Category:Annuities | Annuities]]
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Many company plans contain high-cost funds which make them unattractive. If you have such a plan, look for one or two index funds or a bond fund that can be used. If your company offers matching funds up to a certain contribution level, it's '''always''' wise to use the company plan. If there is no match, the power of tax-deferred compounding and automatic contributions still favors using the plan with limited contributions. 
 +
 
 +
Also, if you leave your current employer you will most likely be able to rollover the assets in your poor-quality company plan to either a better company plan, or to an IRA.
  
 
==See also==
 
==See also==
*[[Principles of Tax-Efficient Fund Placement]]
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*[[Employer matching contributions]]
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*[[Principles of tax-efficient fund placement]]
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*[[Asset allocation in multiple accounts]]
 
*[[Paying down loans versus investing]]
 
*[[Paying down loans versus investing]]
  
[[Category:Investing]]
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==Notes==
[[Category:Retirement Planning]]
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<references group="note"/>
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==References==
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{{Reflist}}
  
{{Footer}}
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{{Bogleheads investing start-up kit}}
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{{Portfolios}}
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[[Category:Portfolios]]

Latest revision as of 06:17, 7 February 2021

Flag of the United States.svg.png This article contains details specific to United States (US) investors. It does not apply to non-US investors.

Investors who are able to place their investments in several different kinds of accounts (such as taxable accounts, 401(k), or an IRA) need to decide which ones to prioritize.

Investing in a prioritized order will maximize the tax efficiency of a portfolio (pay the minimum amount of taxes).

Funding priority

Here is a general account funding priority that often works well for many people (not all points will apply to everyone):

  1. Establish an emergency fund to your satisfaction. If you have many other high financial priorities (like paying off high-interest debt), start with a smaller emergency fund, and grow it later over time, as those other priorities are satisfied.
  2. Contribute to a work-based plan (eg. 401(k) or 403b) enough to get the full employer match (the match is like free money, your best possible investment).
  3. Pay off high-interest debt (a guaranteed high return, the next best thing to free money).
  4. Contribute to a Health Savings Account (HSA) if available (unlike many other tax deductions, there are no income restrictions to contribute to an HSA).[1][note 1]
  5. Contribute the maximum to an IRA, traditional or Roth (or backdoor Roth technique[note 2]), depending on eligibility and personal circumstances.
  6. Contribute the remainder of the maximum employee contribution to the work-based plan, including an After-tax 401(k) (Mega Backdoor Roth), if available.
  7. Pay off medium-interest debt (eg. student loans, car loans, personal loans), especially if the interest is not tax-deductible.
  8. Invest inside a taxable investing account. In certain circumstances, a Non-deductible traditional IRA and/or variable annuity may be better than a taxable account.
  9. Pay off low-interest debt (eg. most mortgages, some car loans).
  10. Invest in low-return assets (eg. money markets, Certificates of Deposit (CDs)).

If the company plan offers good, low-cost funds, it may be preferable to contribute to the company plan before contributing to an IRA; see: Comparison between IRAs and employer plans.

An investor's tax bracket may influence the decision as well: those in higher tax brackets should consider higher contributions to a tax-deferred plan (e.g. traditional 401(k) or IRA) rather than a post-tax plan (e.g. Roth 401(k) or IRA); see Traditional versus Roth for more guidance.

The choice to pay off debt or invest is based mostly on the expected after-tax rate of return. When the returns are similar, secondary factors sway the decision; see: Paying down loans versus investing.

Health savings accounts: Use of an HSA requires participation in an IRS qualified high deductible health plan (HDHP) at work. Look at your particular health care needs to decide if you may be better off with a traditional health care plan or an HDHP plus HSA. If the latter, then using the HSA as an investment account can be advantageous.

401(k) plans with high cost funds

Many company plans contain high-cost funds which make them unattractive. If you have such a plan, look for one or two index funds or a bond fund that can be used. If your company offers matching funds up to a certain contribution level, it's always wise to use the company plan. If there is no match, the power of tax-deferred compounding and automatic contributions still favors using the plan with limited contributions.

Also, if you leave your current employer you will most likely be able to rollover the assets in your poor-quality company plan to either a better company plan, or to an IRA.

See also

Notes

  1. Investor should determine if enrolling in a high deductible health plan and possibly gaining access to a HSA is appropriate for their personal circumstances and health care needs. If so, then using the HSA as an investment account can be advantageous and is therefore included in this list.
  2. This is a technique for contributing to a Roth IRA when your income exceeds the contribution limit. It is complicated in nature and may not be for everyone. Read the Cautions section of the article before proceeding and ask in the forum if you are unsure.

References

  1. Bogleheads® forum topic: Prioritizing investments- HSA goes where?, 16 Feb 2014