Skip to Content

Chapter 9: Investing

Chapter 9: Investing

Arguably, the two pillars of obtaining FIRE are knowing how to save and invest.

When you’re just starting out, it can be a bit overwhelming. There are so many different types of investments to consider – Stock vs Bond, Roth vs Traditional IRA and 401k, just to name a couple. So many questions you may have – but don’t stress, we’re going to cover it all!

This page will lay out the basics and give you a solid foundation to kick-start your investing journey.

First, make sure you have checked out our budgeting chapter for more information on taking control of your income and expenses.  Without a budget, it will be very difficult to know how much money you have to invest.

With that… let’s get started!

What Investing Terms Should I Know?

Below are terms that are useful to know for investing

  • Active Management: A method of managing funds or portfolio that requires someone to actively manage it (Trading more frequently, or be monitored more regularly. This usually results in higher fees).
  • Balanced Fund: A fund that contains a balance of both stocks and bonds, example: 50% stocks, 50% bonds.
  • Bear Market: A market where the prices of stocks are falling, usually over a long period of time.
  • Benchmark: the standard that a mutual fund or ETF is measured against.
  • Bond: a loan to a company, government or municipality that pays back a fixed rate of return. Considered safer than stocks, but still has risk.
  • Bull Market: A market where the prices of stocks are rising, usually over a long period of time.
  • Capital Gains: Profit seen after the sale of a property or investment 
  • Capital Gains Tax: The amount of tax owed after an asset realizes capital gains.
  • Contribution: The amount of money you put into something.
  • Distribution: The amount of money you pull out of something.
  • Dividends: The amount of money paid regularly (usually quarterly) by a company to their shareholders.
  • ETF: Abbreviation for Exchange Traded Fund (a type of investment that usually follows a particular mutual fund, example: VTI & VTSAX
  • Index Fund: An investment type that tracks some segment or all of the market, example: or VITIX (Vanguard Information Technology Index Fund) or VTSAX (Vanguard Total Stock Market Index Fund, tracks the entire market) 
  • Money Market: Generally referred to as a short-term investment, high liquidity (cash) vehicle.
  • Mutual Fund: A fund that invests in a collection of companies, sometimes follows an a segment of the market. Example VWNDX (Vanguard Windsor Fund)
  • Passive Management: A method of managing funds or portfolio that requires someone to not be very involved. This is because the fund is designed to mirror a market segment or index (Less frequent trades, less monitored – hence the term passive).
  • Portfolio: The collection of all of your investments (stocks, bonds, cash, etc).
  • Pre-tax: Contributions made prior to paying any taxes are considered pre-tax, you will have to pay taxes upon withdrawal.
  • Roth: Contributions made after paying all taxes, distributions will be taken without paying any additional taxes.
  • Securities: Represents a position in a particular company or government. There are two types of securities, equities and debts. 
  • Stock: Represents your ownership of a company or corporation, usually referred to as shares of a company.
  • Target-date Fund: A type of mutual fund or ETF that allows an investor to select the year in which they plan to retire. These funds gradually adjust themselves over time to align with a safer stock to bond ratio. If you know nothing about investing, these are safe options but sometimes have slightly higher fees associated with them.
  • Tax-deferred: Similar to pre-tax, you’ve elected to make contributions to an account while deferring all taxes until later (at time of withdrawal).
  • Ticker Symbol: The characters (usually letters) that represent a particular fund that is listed on the stock exchange. Example: ‘AAPL’ is Apple Inc’s ticker symbol. 

When Should I Start Saving and Investing?

We’re sure you’ve heard your friends and family talk about their own investment strategies. You understand that you need to start investing at some point, but did you know that the earlier you start the sooner compounding interest will begin to work in your favor?

Think of the old scenario you may have heard in school. Would you rather have a penny doubled every day for a month, or a million dollars? By day 5, you’ll have a mere $0.16, and by day 15 only $163.84… but at day 30 you’ll be sitting on a cool $5,368,709.12!

This is the power of compounding interest. Be sure to check out our page – Visualizing The Power Of Compound Interest – for an interactive way to view the effects of compound interest over time.

So to answer the question – When should I start investing? We believe you should have paid off all of your high interest consumer debt (such as credit card debt) before you build an investment strategy.

We also think you should have some level of cash saved up in case of emergencies. On principle, you need at least one month of expenses saved. We would recommend, however, at least three months expenses saved. This is especially true if you’re at risk for being laid off or if your income fluctuates from month to month.

It’s important to understand why you should have some money saved up prior to dipping your feet into investing.

Let’s say you throw all of your available cash into an investment account, and suddenly you NEED $500 for a car repair, but you don’t have $500 anymore. Now you could potentially risk paying a penalty to withdraw it (especially in a tax-advantaged account). Not to mention, your money may have decreased in value if the markets are currently in decline.

That’s why it’s important to save some money liquid in a money market fund, or savings account, that’s easily accessible in the event that you may need to access those funds quickly.

How Much Should I Be Investing?

It’s important to analyze how much you have leftover in your budget each month to invest.

Ask yourself the question: How much can I afford to invest?  You want to make sure you’re saving as much as possible, but you don’t want to leave yourself short on living expenses.

As you saw in the previous section, the power of compounding is significant.  The more you can invest now, the more you will have later.  If you can make sacrifices now, such as not going out to dinner every week, it will pay off in the long run when you start to see those investments grow.

To compare how investing different amounts now will affect your FI date, check out our Ultimate FIRE Calculator here.

What are Some Ways to Increase the Amount I am Able to Invest?

  • Increase your Income – work more hours, consider a new job, get a second, part-time, job or side hustle, decrease your expenses.
  • Budget every month – know where your money is going and how much you are saving.
  • Realistic Car Selection – save for another car and pay in cash; if a car payment is unavoidable, choose wisely on a reliable, inexpensive vehicle.
  • Say No – plan ahead for fun in your budget, but avoid going overboard.
  • Avoid Lifestyle Creep – Get a raise?  Instead of upgrading your lifestyle (cars, houses, trips, or products), increase your savings rate instead!
  • Don’t Keep Up with the Joneses – Don’t worry about what other people have.  Stay focused on your goals.  More than likely, the Joneses will still be working much after you retire!

How Can I Balance Quality of Life with Investing?

While saving for your future should be a top priority, it’s also essential to live in the present.

If you feel like you’re depriving yourself, it will be really difficult to stick to your FIRE goals.  Make room in your budget for fun activities with family and friends, but don’t go overboard.

Stick to the plan you set, and remember, it’s ok to say “no” sometimes. Think of all the flexibility you will have when you’re financially independent.

What are some Valuable Investing Principles?

Goals

Determine why you are investing, and what your time horizon is.

Example: retirement, income, growth, savings goal, education, house down payment

Discipline

Stay the course! It’s easy to panic when the market is volatile, but selling your investments makes you realize any losses and miss out on any gains.

History shows that those who stayed in the market during downturns, like the 2008 market crash, came back to earn more than they had before the crash.

Asset Allocation

This is the percentage of investments in stock, bonds, or cash reserves. Typically, young people have more time to save, so they can consider a more aggressive portfolio

(Ex. 90/10; stocks-to-bonds ratio).

As someone gets closer to retirement, the need for conservation of capital becomes evident, as they need to be able to rely on the funds for retirement. A less aggressive portfolio should be considered (Ex. 60/40; stocks-to-bonds ratio).

Overall, these are just examples. How a portfolio is invested will depend on the person’s interests, their goals, and their risk tolerance.

Diversification

This principle involves investing in different asset classes (stocks vs. bonds vs. cash reserves) in an attempt to lower overall investment risk. You also have the option of investing in both domestic and international securities.

What Types of Accounts Should I Be Investing in?

Account TypeDescription2024 Contribution LimitsTaxable?Does employer match count towards the limit?
Traditional 401(k)Employer-Sponsored Plan$23,000 or $30,500 if age 50 or overTax-deferredNo
Roth 401(k)Employer-Sponsored Plan$23,000 or $30,500 if age 50 or overYes – contribute post tax dollars, and contributions/earnings grow tax freeNo
403(b)Employer-Sponsored Plan$23,000 or $30,500 if age 50 or overTax-deferredNo
457Employer-Sponsored Plan$23,000 or $30,500 if age 50 or overTax-deferredYes
i401(k) / Solo 401(k)A traditional or Roth 401(k) plan covering a business owner with no employees, or that person and his or her spouse$23,000 or $30,500 if age 50 or overTax-deferredNo; total contributions cannot exceed $56,000
SEP IRASimplified Employee Pension, used by business owners and their qualifying employeesUp to 25% of income or $69,000Tax-deferredCan only be employer funded
Simple IRASavings Incentive Match Plan for EmployeesAn employee can contribute up to $16,000; if you are age 50 or over, the catch up contribution limit is $19,500Tax-deferredNo
Traditional IRAIndividual Retirement Account$7,000 or $8,000 if age 50 or over (must have earned income that equals or exceeds your contribution)Tax-deferredN/A
Roth IRAIndividual Retirement Account$7,000 or $8,000 if age 50 or over (must have earned income that equals or exceeds your contribution)Yes – contribute post tax dollars, and contributions/earnings grow tax freeN/A
Flexible Spending Account (FSA)FSA’s are savings accounts that do NOT roll over every year; use it or lose it! (Some plans allow for a small roll over amount for 90 day period)$3,200Tax-deferredYes
Health Savings Account (HSA)Health care savings account that rolls over every year; Must be enrolled in an HDHP to be eligibleup to $4,150 for individuals, $8,300 for families (add +$1,000 for HSA holders age 55+)No – Triple tax benefits!Yes
Individual / Joint Brokerage AccountsNon-retirement investing accountsN/AYesN/A
529Education SavingsYearly and aggregate limits depend on state and past contributionsSeveral Tax Benefits / Varies by StateN/A
UGMA/UTMAGeneral Savings for MinorNo limit, but amounts above $18,000 per year ($36,000 for married couple filing jointly) will incur federal gift taxYesN/A

Should I be Investing in a Traditional or Roth?

To accurately determine which type of account you should invest in, consider your current income tax against what you anticipate it to be in the future.

If you have a low tax rate now and expect it to be higher in the future, it might make more sense to pay taxes now through contributing into a Roth IRA or Roth 401(k).

In addition to your main income, you should also consider if you are planning on a pension or passive income during retirement, like a business or rental property. This may also result in your income being higher in the future than it is now.

Down the road, when you have a higher tax rate, you can withdraw tax and penalty-free with your Roth IRA or 401(k), given that you are following all IRS rules.  You will want to keep in mind, however, that your eligibility for contributing to a Roth IRA depends on the IRS income limits.

If you expect your tax rate to be higher now than in retirement, it might make more sense to contribute to a tax-deferred traditional IRA or 401(k) and see if your accountant believes that you qualify for a tax deduction.  After age 59-1/2, you will pay regular income taxes with a withdrawal.  Your eligibility for tax deductions from a traditional IRA depends on IRS regulations regarding your tax filing status, income, and what retirement accounts you (and a spouse) may contribute to.

A downside to this method is that we don’t know what the future holds. Some people may find it beneficial to diversify their savings into both traditional and Roth accounts. For instance, someone may choose to have a traditional 401(k), but a Roth IRA.

2024 IRA Income Limits for Deductions

Filing StatusIncome Limits
SingleAny Amount * Varies by exception see publication 590-A
Single, Covered by Workplace Retirement PlanPhase Out $77,000 – $87,000
Married, Filing SeparatelyPhase Out $0 – $10,000
Married, Filing Jointly, Without Workplace PlanPhase Out $230,000 – $240,000
Married, Filing Jointly, With Workplace PlanPhase Out $123,000 – $143,000

What are the Tax Benefits of Investing in a Health Savings Account (HSA)?

An HSA is a way to save for current and future medical expenses, such as physician visits, medical supplies, and prescription drugs.

Eligibility to invest in an HSA include the following:

  1. You must be enrolled in a High Deductible Health Plan (HDHP) that does not cover all of your medical expenses
  2. You cannot be covered under another health insurance plan, including Medicare coverage, with certain exceptions.
  3. You cannot be claimed as a dependent on someone else’s tax return.

There are many benefits to investing in an HSA:

  1. They are triple tax-advantaged, meaning that your contributions are pre-tax or tax-deductible, all earnings and interest are tax-free, and any withdrawals for qualified medical expenses are tax-free.
  2. HSA funds do not expire annually.  They can continue to be saved and used for qualified medical expenses throughout your life, even in retirement.
  3. Once you reach age 65, if you need to complete a non-medical withdrawal, it is taxed at your current tax rate.

What is the Order of Operations for Investing?

Investing Order Of Operations

Without having a clear plan, investing can be very intimidating. We have developed an order of operations for achieving your goals below.

Step 1: Save in your Employer-Sponsored Plan up to the Match

Contributing to an employer-sponsored plan, like a 401(k) or 403(b), is a great way to save for retirement and obtain tax savings. Contributions can lower your taxable income and your investments grow tax-deferred. Even better, many companies offer a match to your contributions up to a certain percentage.

Example: Company A offers a 100% match of up to 4% of the employee’s contributions. For Step One, the employee would contribute 4% to their 401(k), and they would receive an additional 4% from their employer.

This extra savings can make a big difference over time, so it is important to take advantage of this benefit if it is offered. Don’t miss out on free money! Additionally, having your contribution

taken right out of your paycheck is an easy way to save because you won’t see the money in your bank account.

Step 2: Max an IRA

After contributing up to your company match, next you should contribute available funds into a traditional or Roth IRA. You learned earlier in this post how to decide which one to invest in, so now’s the time to take action!

Each year the IRS announces the contribution limits, so be sure to check and see what your age allows you to contribute. It may be helpful to have this contribution deducted automatically from your paycheck or to set up an automatic investment directly with your financial institution.

Step 3: Max an HSA

If you’re eligible, you should consider maxing out your HSA. We value this investing tool high in the list due to it’s triple-tax benefits, as discussed earlier. Additionally, we’ve found that many employers offer contributions to this type of account.

Step 4: Finish Maxing your Employer Plan

Next, you should work on maxing your 401(k). Make sure you know the contribution limits depicting how much you and your employer can contribute.

Step 5: Taxable & Education Savings

If you’ve gotten to this step, congratulations! You’ve done a great job in saving for retirement and investing, and you’re well on your way to being financially independent.

This next part is very customizable. You can choose to save in a taxable account for a variety of goals:

  • Emergency fund
  • Car fund
  • House fund
  • Big ticket items you and your family want

While this type of savings does not have tax benefits, it will still help you to put money away for future expected and unexpected expenses. You should continue to invest the money rather than put it into a savings account, allowing the funds to keep up with inflation.

Additionally, if you wish, you can use this as an opportunity to lock away money for your children’s education.

Where Should I Keep My Investments?

Where you hold your investments could affect your overall experience and returns over time. Do your research and find the right financial institution for you. Employer-sponsored plans will select the institution for you, but for personal accounts the choice is yours.

Keep these points in mind when deciding where to invest:

  • Costs (account service fees, commissions, expense ratios, loads, advisory fees, etc)
  • Investment selection
  • Technology (website & app capabilities)
  • Virtual vs. in-person firms

What Fees Should I be Charged?

There are so many different types of fees that are associated with investment and savings accounts. It’s important to understand the different types of fees, and which ones to avoid at all costs.

Account Service Fees

These fees could be charged for account maintenance or just to hold your account at an investment firm. Be sure to inquire and see if there are any options to waive the fee.

Expense Ratios

This is what it costs a mutual fund company to run a fund. It is calculated annually and includes management fees, administrative fees, and any marketing and distribution fees. It doesn’t include loads or purchase or redemption fees, if any.

Transaction Fees

This fee could be charged when investors buy or sell an investment.

Purchase Fees

Mutual funds may charge purchase fees to offset the costs of securities trades.

Redemption Fees

Mutual funds may charge redemption fees in an effort to discourage short-term trading.

Commission Fees

A fee charged by a broker for executing a security transaction, if applicable.

Load Fees

This is a sales fee charged on the purchase or sale of some mutual fund shares.

Front-end load: A one-time fee at the time the investor buys the fund shares.

Back-end load: A one-time fee at the time the investor sells the fund shares.

Advisory Fees

These are fees charged by a financial advisor to manage your portfolio. This could be done in many ways, such as a percentage of your managed assets or a one-time consultation fee. They could also be deducted annually, multiple times throughout the year, or when you purchase an investment.

*Please note that not all financial institutions and investments have these fees. Companies like Vanguard and Fidelity are known for their low-cost investments. That is why it is so important to vet your firm before opening an account. The consequences of not doing so could be detrimental to your savings.

What Investment Allocations Should I Consider?

Feeling overwhelmed? Have no fear! There are all-in-one funds, called balanced funds, that take care of your stock/bond allocation and fund selection for you.

Once you’ve chosen the fund that matches your goal, you can set it and forget it. These funds may have a slightly higher expense ratio, but it’s more important that you get your money invested than be overwhelmed and not invest at all.

Examples of balanced funds could be:

  • Vanguard Target Retirement Funds
  • Vanguard LifeStrategy Funds
  • Vanguard Star Fund
  • Vanguard Wellington Funds
  • Vanguard Wellesley Funds

If you plan on being an investor who is heavily involved with your portfolio, in order to determine which investments are appropriate for you start with the following steps:

  1. Choose a stock-to-bond ratio that you are comfortable with. Keep in mind that younger investors have more time to take risk, so their allocation may lean more toward stocks than bonds. On the other hand, investors nearing retirement may lean more toward bonds than stocks.
  2. Determine how you want to split your stock and bond allocations between domestic and international securities.
  3. Consider if you want to encompass a whole market or focus on small-cap, mid-cap, or large-cap funds. (This relates to the size of the companies you are invested in. Ex: Large-cap funds invest in large companies that take up a substantial portion of the market’s capitalization.)
  4. Decide if you are looking for value, growth, a blend, income, or inflation protection from your holdings.

We value the investment guidance of Jack Bogle, Vanguard’s beloved founder. A group of his followers, known as Bogleheads, have provided the following portfolios as sample recommendations.

How Can I Benefit from Automatic Investing?

Direct deposit and automatic investment options can make saving for your goals easier.

Direct Deposit allows you to have money taken out of your paycheck and sent to your 401(k), IRA, or other accounts immediately. This is helpful because the income never hits your bank, and you are not tempted to spend the money. Thus, keeping you on track with your goals.

Check with your employer and financial institution to see how you can set it up.

Additionally, many institutions have an option for automatic investing. While the money is taken directly from your bank account in this case, it still makes the process easier because you do not have to think about it.

Both investment types can be set up to split the assets into the asset allocation that you have selected.

Do I Need a Financial Advisor?

By educating yourself on investing, you will not need a financial advisor.

You may even find that you enjoy learning about many finance topics, turning investing into a new hobby. You will want to ensure that you reallocate your portfolio once it reaches 5% off target. Depending on the market, you could end up reallocating your investments once a quarter or less frequently.

For the sake of peace of mind, some people may feel more comfortable with meeting with one regardless. Here are a few ideas to consider when you are determining if you want to work with a financial advisor:

  • Time – Do you have the time to learn about investing, keep track of your investments and goals, and reallocate your portfolio as needed?
  • Willingness – Will you enjoy managing your own portfolio? What is the opportunity cost?
  • Ability – Do you understand investments and trust yourself to stay disciplined and allocate correctly?

If you decide to move forward with meeting with a financial advisor, please keep these questions in mind and be prepared to ask them at your first meeting:

  1. Will your financial advisor be acting as a fiduciary? (Are they working in your best interest?)
  2. Are they working on a salary or commission? (Will they make commission on selling certain products to you?)
  3. What fees will you be charged? (Are there any account maintenance fees, advising fees, or product fees that you should know about?)

If you don’t want an advisor to manage your portfolio permanently, you can consider consulting with one on an as needed basis. This would be considered a one-time fee based advisor. Life events like the following could need extra care:

  • First time investing
  • Planning for big expenses, like a house or car
  • Getting married
  • Having a family
  • Inheritances
  • Retirement planning
  • Retirement spending

Please take the time to consider if you really need an advisor, or if you can manage your portfolio yourself. In the end, the less fees you pay, the more savings you will have compounded over time.

Check out the investment opportunities below to get started.

Disclosure: This page is not intended as financial advice. Please consult with a financial advisor and tax professional to determine the best avenues for your unique situation.

Additionally, this information is not all-encompassing of IRS rules and regulations.  Please visit the IRS website for more information on your eligibility.

Joe H

Friday 9th of October 2020

So am I supposed to just pay the early withdrawal penalty on all of those retirement accounts? This post does nothing to talk about the bridge years between the RETIRE EARLY step and collecting Social Security or drawing from a retirement account. How much should be allocated into investments that can be drawn from prior to government retirement age?

John Hawrylack

Friday 9th of October 2020

Hi Joe, Thanks for checking out our website. Check out this post on the Roth Conversion Ladder.

Jason

Tuesday 15th of September 2020

Really good read! Thank you for the detailed examples on how to fire.