Investors are faced with a variety of choices on where to invest their money; for example, a taxable account, a 401(k), or an IRA. Knowing which accounts to invest in first will maximize return with a minimum of taxes. Prioritizing investments indicates the appropriate order in which investments go into these accounts.
Take care to ensure that any investment priority decision aligns with your Investment Policy Statement.
- 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.
- Contribute to an employer retirement plan (for example, 401(k) or 403b) enough to get the full employer match (the match is like free money, your best possible investment).
- Pay off high-interest debt (a guaranteed high return, the next best thing to free money).
- Contribute to a Health Savings Account (HSA) if a high deductible health plan is appropriate for your needs (you can think of HSA contributions as also getting a match, from the IRS).[note 1]
- Contribute the maximum to an IRA, traditional or Roth (or backdoor Roth technique), depending on eligibility[note 2] and personal circumstances. (See below for situations where you may prefer to swap steps 5 and 6.)
- Contribute the remainder of the maximum employee contribution to the work-based plan.
- If your plan supports it, employ the mega-backdoor Roth strategy.[note 3]
- Pay off medium-interest debt (for example, student loans, car loans, and personal loans), especially if the interest is not tax-deductible.
- Invest inside a taxable account.
- Pay off low-interest debt (for example, most mortgages, and some car loans).
It is important to realize that these steps are not cast in stone. The above list should be considered with some flexibility for your needs and personal preferences.
Choosing between an employer retirement plan and an IRA
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.
Also, your marginal tax rate may influence the decision: those subject to higher marginal tax rates should consider higher contributions to a tax-deferred plan (for example, traditional 401(k) or IRA) rather than a post-tax plan (for example, Roth 401(k) or IRA). See Traditional versus Roth for more guidance.
If you prefer traditional to Roth, and traditional contributions to the employer's plan are needed to reduce your Modified Adjusted Gross Income (MAGI) for traditional IRA purposes enough to allow a full or partial IRA deduction (see IRA Deduction Limits), consider swapping steps 5 and 6.
Rationale for funding priority
Table 1 describes the rationale for investing in the order shown above.
|Step||Funding priority||Approx. after-tax return|
|1||Start building an emergency fund||N/A|
|Have enough cash on hand to cover unplanned expenses. While the exact amount depends on your risk tolerance, a common rule of thumb is to start with one month of expenses, and as you satisfy other financial priorities, grow it over time to around 3-12 months of expenses. (See: Emergency fund.)|
|2||Contribute to a work-based retirement plan (eg. 401(k) or 403(b)) enough to get the full employer match||50-100% immediately|
|Not getting an employer match is like letting your employer keep part of your salary.|
|3||Pay off high-interest debt||8-30%|
|Typically these include credit cards and other unsecured loans. Paying off a high-interest debt is a guaranteed high return on your investment, the next best thing to free money.|
|4||Contribute to a Health Savings Account (HSA) if a high deductible health plan is right for your needs||8-10%|
HSAs offer tax-free contributions, growth, and withdrawals when used for qualified medical expenses. You can view HSA contributions as being matched by the IRS. If you are in a 25% tax bracket, it costs you $750 to put $1000 in your HSA, and once it is there, it will not be taxed at all as long as you spend it for medical care, so this is as good as $1000 in a Roth IRA.
After age 65, the HSA can also be used for non-medical expenses, with such withdrawals taxed at your regular tax rate. So if you are unlucky and are too healthy after 65, the HSA is still as good as a pre-tax retirement account. Unlike pre-tax retirement accounts, HSA contributions made through an employer are also payroll tax-deductible.
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.
|5/6/7||Contribute to available retirement accounts (eg. IRA, 401(k), 403(b), 457(b)) without a match||8%|
|Retirement accounts offer either an immediate tax deduction and tax-deferred growth (traditional) or life-long tax-free growth (Roth), plus asset protection and estate planning benefits. These accounts have annual contribution limits which are lost if not used.
Deductible IRA contributions are subject to income limits, but the income limit for contributing to a Roth IRA may be circumvented by the Backdoor Roth process. Employer plans may also offer mega-backdoor Roth contributions, but these should be made only after normal contributions.
|8||Pay off medium-interest debt||3-8%|
|Typically these include student loans, car loans, personal loans, and Home Equity Lines of Credit (HELOCs). 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.|
|9||Invest in a taxable account||0.5-7%|
|As you consider all these steps, keep in mind that your asset allocation (ratio of stocks to bonds), which sets your portfolio's level of acceptable risk, is the single most influential decision you can make on your portfolio's performance. Your chosen asset allocation (% stocks / % bonds) may direct you to skip some of these steps.|
|10||Pay off low-interest debt||1.5-3%|
|Typically these include mortgages and other secured debt. Paying off low-interest debt on good terms should be a lower priority than most other funding options, but a higher priority than investing in low-return investments with no tax advantages.|
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 is 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.
- If you are in a 25% tax bracket, it costs you $750 to put $1000 in your HSA, and once it is there, it will not be taxed at all as along as you spend it for medical care. This means the deductible also gets discounted by your tax rate: this should be taken into account when comparing deductibles with non-HSA plans. Note that health plans with a Flexible Spending Arrangement (FSA) also offer tax deductions; however, the FSA is a use-it-or-lose-it plan, with balances normally zeroed out at the end of every year.
- You should verify eligibility before making traditional IRA contributions: in particular, check the tax-deduction limit. For Roth IRAs, the backdoor Roth is a technique for making contributions when your income exceeds the eligibility 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.
- This technique is only available through select employer plans; it is complicated in nature and may not be for everyone. Read the Mega-backdoor Roth article to determine if your plan supports it, and ask in the forum if you are unsure.
- Employer matching contributions
- Principles of tax-efficient fund placement
- Asset allocation in multiple accounts
- Paying down loans versus investing
- "Investment order". Mr. Money Mustache Forum. December 8, 2016. Retrieved June 5, 2023.
- "What order should I fund my investing accounts in?". White Coat Investor. May 5, 2017. Retrieved June 5, 2023.
- "401(k), Roth IRA, then Back at 401(k)". The Finance Buff. October 22, 2006. Retrieved June 5, 2023.
- Bogleheads forum post: , grabiner. February 16, 2014.
- Saving: review - bogle.tools. An open-source tool created by forum member Rob Relyea to help readers prioritize their investments. For support, see Bogleheads forum topic: .
- Bogleheads forum topic: , okwriter. July 9, 2021.