When I first started investing with an app at 21, I thought I was doing the right thing. Ive since learned I had it all backward. – Business Insider

When I first started investing with an app at 21, I thought I was doing the right thing. Ive since learned I had it all backward. – Business Insider
  • I started out investing simply to grow wealth over time, but using an app that only offered one type of account meant I ended up investing out of order. 
  • After several years, I realized that I wasn’t actually investing in the best type of account for my goal.
  • For long-term wealth building, a tax-advantaged retirement account like a Roth IRA is a better option.
  • I’ll be able to keep more money in the future by switching my focus from my individual taxable investment account to an Roth IRA. 
  • Use Blooom to analyze your 401(k) today and see how you can grow your retirement savings »

When I started out investing at 21, I did so somewhat blindly: I opened an account with a buzzy investment app on my phone and started an automatic deposit of $30 per week. But, what I didn’t realize was that I should be prioritizing where I invest.

My main goal was really to just build long-term wealth for the future. I wanted to let compound interest work its magic for as many years as possible. I started out investing with an individual taxable brokerage account — the only account type offered by the app I used at the time.

What should I have been using for my long-term wealth building goal? A Roth IRA.

A Roth IRA is a tax-advantaged retirement account that allows money to grow over time. You pay taxes up front, when you contribute, so you don’t have to pay them later, when you withdraw. Anyone earning less than $139,000 per year is eligible ($206,000 for married couples).

I didn’t think of retirement savings as investing at the time, and I hadn’t opened any sort of retirement account before I started investing on my phone. I didn’t know at the time was that investing in a retirement account would have so many more benefits I wouldn’t see with my taxable brokerage account: mostly in the form of tax benefits later on, after the money has grown.

When I realized that using a Roth IRA would allow me to keep more of my money in the future, switching was a no-brainer.

There’s an order to smart investing — and I was doing it backward

That’s not to say that no one should use a taxable brokerage account. For most people, it just shouldn’t be your first priority, and it probably shouldn’t come before retirement savings.

Financial expert Ramit Sethi, author of “I Will Teach You to Be Rich,” lays out the order of the best accounts to invest in for building long-term wealth in his book. It should go like this: 

  1. Invest enough in a 401(k) to get your company’s full match (or skip if you don’t have a match)
  2. Then, contribute to a Roth IRA up to the yearly limit (in 2020, the limit is $6,000 for anyone under 55, and $7,000 for anyone over 55)
  3. Max out your 401(k) (up to $19,500 in 2020)
  4. Invest in an HSA to put away tax-advantaged money for health costs before or in retirement
  5. Invest in an individual taxable investment account

“After your 401(k) match, the next best place to invest is your Roth IRA,” Sethi writes.

I had essentially flipped that script. There’s a reason for doing things this way. Quite simply, it’s because you’ll keep more money, since this order prioritizes tax-advantaged investment accounts.

In an individual taxable account, I’ll eventually have to pay taxes on what that money earns, generally in the form of capital gains tax. For most Americans (anyone earning between $39,376 and $434,550), that means paying 15% on what you earn, if you keep your investments for a year or longer.

In a Roth IRA, I can keep whatever I put in, and whatever I earn, totally tax-free. Roth IRAs have many more tax perks than other brokerage accounts — you won’t owe any taxes on growth or money you put in when you withdraw it. Instead, you pay taxes up front, contributing to a Roth IRA with money that’s already been taxed.

While money can’t be withdrawn without a fee until age 59 and a half from a Roth IRA, it will eventually be available tax-free. Once I realized this, and that my financial goals don’t have me withdrawing investments anytime soon, where I should be saving was a no-brainer. 

For my goal of building long-term wealth, investing in an individual taxable investment account should probably be the last step on my financial priorities list. There’s a time and a place for individual taxable investment accounts. But, while I’m saving for the long run, a Roth IRA has too many advantages to pass up. 

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