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Three things to keep in mind when you are starting to invest in your 401K

In the book Building Wealth on a Dime, Tanya Diaz is a 34-year old project manager living in Chicago that didn’t start investing in her 401k till she was 28, after she learned about its importance from a graduate school classmate – but her story isn’t unusual.

According to the U.S. Census Bureau, only 41% of workers that have access to a 401(k), about 68%, actually use them. According to another study by MagnifyMoney, approximately 45% of Americans wish they would have invested more.

All that said, here are three things you need to know when learning or starting to invest more heavily.

Tax-advantaged accounts, like your 401k, can help you build wealth faster than a standard brokerage account

Today, there are more ways than ever to start investing, with some as simple as downloading an app on your phone. That said, regardless of which company you use, it’s important to consider the type of account you contribute to. For example, a 401(k) and IRA are both considered “tax-advantaged accounts”, which are different from standard brokerage accounts because they save you money in taxes while you invest. This means they help you build wealth faster because, unlike a standard taxable account, you won’t have to pay capital gains tax as they grow.

Tax-advantaged accounts will be at least one of the following:

  • They might be tax-deferred, meaning you don’t pay taxes now but will pay taxes when you withdraw in retirement
  • They might be tax-exempt, meaning the funds in your account won’t be subject to taxes
  • They might carry another tax benefit, for example, the ability to invest using pre-tax funds, giving you more money to invest upfront

Some types of accounts may even offer a combination of the above.

For example, you invest within a Traditional 401(k) using pre-tax dollars, and your earnings also grow tax-deferred. This allows more money to stay in your account and grow over time. While you will pay taxes when you withdraw in retirement, your wealth will grow a lot quicker than it would have using a taxable brokerage account.

Using another example, a Roth IRA involves contributing post-tax funds, but your earnings still grow tax-deferred and are exempt from taxes in retirement. This makes it a great choice for someone who doesn’t want to worry about taxes in retirement or thinks they’ll be in a higher tax bracket by then (so they rather pay their taxes upfront now).

There are several types of tax-advantaged accounts to consider before opening a standard brokerage account. For example, in addition to a 401k, you can also contribute to a Traditional or Roth IRA. There are also IRAs for entrepreneurs and business owners too!

Learn about them all and get Tanya’s full story in Chapter 8 of Building Wealth on a Dime.

Remember the Rule of 72

In Building Wealth on a Dime, Tanya learns one rule of thumb that helps underscore just how quickly her investments can grow over time, called the Rule of 72. The Rule of 72 is a formula that divides the amount of money you invest by the anticipated rate or return on your investment. For example, if you invest $10,000 today and anticipate a 7% annualized rate of return, then it would take approximately 10 years to double that investment to $20,000. Now, while most people will invest smaller amounts of money over time, for example, $500 every month instead of $10,000 all at once, the rule still demonstrates why it’s so important to start investing as soon as possible – because you have the potential to double or triple your investments over long periods of time.

Don’t stop at your employer match.

If you’ve ever had access to a workplace retirement plan like a 401(k) or 403(b), then you’ve probably heard about the importance of “meeting your employer match”. This refers to money that your employer agrees to contribute to your investment account, so long as you also contribute funds, known as “meeting your match”.

For example, an employer might agree to match 100% of your investment contributions up to 3% of your total salary. If your salary is $60,000 and 3% of that is $1,800, then so long as you contribute up to that amount, your employer would also put in up to $1,800, doubling your investment (in this example). While employer matches will vary from employer to employer, the important part is you don’t want to leave money on the table – but that doesn’t mean you should stop there either!

Because any money you invest now will work harder for you than money invested 5, 10, or 20 years from now, you should strive to invest as much as you can, as early as possible. The maximum amount you can contribute as an employee to a 401(k), 403(b), 457, or Thrift Savings Plan is $22,500 in 2023 – likely well above any employer match. So, while an employer match is an incredible benefit (that you should definitely take advantage of) strive to increase contributions above it even if it’s only by 1-2% of your income per year. 1% may not sound like a lot, but it can make a huge difference in your investments over time.

About the Author

Kimberly Hamilton is a Latina financial educator, author of Building Wealth on a Dime, and Founder of Beworth Finance where she helps women make smart money moves through online courses and coaching. As a Certified Financial Education Instructor, her advice has been featured in Forbes, Yahoo Finance, Health magazine and others, and you can follow her on Instagram @BeworthFinance.

Want to read the full story and learn more about how you can start building wealth, even if you’re starting small? Check out Building Wealth on a Dime to learn more about investing and how you can start creating generational wealth today.

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