Money and Wealth (Part 11) - Investing (Part B) - Retirement Accounts, Where and How to Invest

---

 

Money and Wealth (Part 11) - Investing (Part B) - Retirement Accounts, Where and How to Invest 1. Different types of retirement accounts A. There are different types of retirement accounts which have tax and other advantages. B. 401(k) i. 401(k) plans are offered by employers to their employees. ii. Most employers offer a Traditional 401(k). (i) With a Traditional 401(k), the employee can make contributions tax- free up to $23,500 per year (2025), and the employer often matches a percentage of the amount the employee contributes (e.g. 50% of the first $5,000). (ii) Both the contributions and the account earnings grow tax-free until distributions are taken after age 59½, at which time they are taxed as regular income. iii. Some employers also offer a Roth 401(k). (i) A Roth 401(k) works similarly to a Traditional 401(k) except that the contributions are made with after-tax income. (ii) Account earnings are tax-free as long as the withdrawal rules are met (must be at least 59½ and have been contributing to the Roth account for 5 years). (iii)Contributions can be taken out tax-free at any time since they were already taxed. C. One-Participant 401(k) ― (also called, self-employed 401(k), solo 401(k), or individual 401(k)) i. A One-Participant 401(k) is for self-employed business owners with no employees. ii. It works like a regular 401(k), except the business owner can contribute as both the employee and the employer, which means he can contribute up to a maximum of $70,000 per year (2025), depending on his income. D. IRA i. IRA stands for Individual Retirement Account. ii. IRAs can be Traditional (pre-tax contributions) or Roth (after-tax contributions). iii. They are setup by the account holder, not an employer. iv. They work similarly to 401(k)s except there is not employer matching funds and the contribution limits are much lower ($7,000 per year in 2025). v. They offer more investment options than 401(k)s often do. 2. Where to invest your money A. Invest 15% of your gross income (before taxes) into retirement accounts. B. Take advantage of your company’s 401(k) plan if they have one, especially if they do a match. i. Nearly half of millionaires rank investing in an employer-sponsored 401(k) first among financial vehicles to build wealth. ii. “A Table 22c indicates, 47% of millionaires in the study [The National Study of Millionaires] ranked the employer-sponsored retirement plan first,  while another 30% ranked it second. As a result, this tool ended up with the largest importance factor on the list at 6.17. When combined with information from Figure 22a, the research indicates that a vast majority of millionaires used a company plan to build wealth and believe it is the primary tool for reaching financial independence. Likewise, the millionaires also see the importance of investing outside of the company. Nearly two- thirds of respondents ranked this as either first or second, which produced a weighted importance score of 5.84. In the research interviews, millionaires mentioned taking advantage of IRAs and ETFs (specifically low-cost index funds) as some of the keys to growing their wealth.” (Dave Ramsey, Baby Steps Millionaires, p. 195) C. If your employer offers a Roth 401(k), consider going with it because it will likely cause you to have more in the end after all taxes are paid. i. Your contributions are made with after-tax dollars. ii. The contributions and the earnings then grow tax-free, so when you begin to take distributions, they are not taxed. iii. This assumes that the government will not change the rules someday and tax the distributions of a Roth. iv. For those with high incomes, a Traditional 401(k) will save a lot of money in taxes up front which could be invested in a Roth IRA. (i) For instance, if a man has an effective tax rate of 25% and is contributing the maximum of $23,500/year in his Traditional 401(k), he would save $5,875/year in taxes. (ii) He could then invest that $5,875 into a Roth IRA. 1. Using this strategy, he could invest $29,375/year and have the same out-of-pocket expense as if he had invested $23,500 in a Roth 401(k). 2. If he used this strategy for 30 years (age 30-60, for example), the extra $5,875/year that was saved on taxes and invested in a Roth IRA would be worth $1,106,689 million, assuming a 10% average rate of return. 3. His investments in his Traditional 401(k) would be worth $4,426,781 after 30 years, assuming a 10% average rate of return. 4. His total investments (Traditional 401(k) and Roth IRA) would be worth $5,533,470 ($4,426,781 + $1,106,689). (iii)However, the $4,426,781 in his Traditional 401(k) would be taxed when he took distributions at age 60. 1. If the $4.4M was taxed at 30% over the course of 20 years, he would only have $3,098,746 left after taxes, which means that his investments would be worth a total of $4,205,436 after taxes ($3.1M + $1.1M). 2. If his effective tax rate was 35%, he would have at total of $3,984,097 after taxes. 3. If his effective tax rate was 40%, he would have at total of $3,762,758 after taxes.  v. Despite the taxes saved up front, it appears that investing in only a Roth 401(k) would still be the most profitable after taxes are paid in the end. (i) If the same man invested the max of $23,500/year in his Roth 401(k), his investment would have grown to $4,426,781 over 30 years, assuming a 10% average rate of return. (ii) This would all be tax-free money when he starts taking distributions at age 60. (iii)By using only the Roth 401(k), after all taxes are paid, he would end up with between $221,345 to $664,023 more money than if he used the Traditional 401(k) and invested the money saved in taxes in a Roth IRA. D. If your employer doesn’t offer a Roth 401(k), then open a Roth IRA for you, and another one for your spouse, if need be, in order to invest 15% of your gross income (Roth IRA contribution limits are $7,000 per year in 2025). E. Here’s what Dave Ramsey recommends. i. First, contribute the minimum percentage of your gross income into your company’s 401(k) that is required to get the full employer match (6%, for instance) because the match is free money. ii. Next, max out both your and your spouse’s Roth IRAs until you are contributing 15% of your gross income. iii. If you were not able to get to 15% of your gross income using the Roth IRAs, then go back and fund your 401(k) with enough to get to 15% of your gross income. iv. Inside your 401(k) and IRA, invest in good mutual funds averaging 12% per year over the long term. v. Put 25% into each of these four categories of mutual funds: growth (mid- cap), growth and income (large-cap), aggressive growth (small-cap), and international. F. Here’s what Carlton Moore, founder of Kingdom Wealth Building, recommends. i. Like Ramsey, he recommends contributing the minimum percentage of your gross income into your 401(k) that is required to get the full employer match because the match is free money. ii. Inquire with your 401(k) provider to see if you can have your account “unlocked” which will allow you to invest in whatever stocks or funds you choose instead of the limited options they offer. (i) Do the same thing before opening a Traditional IRA and/or a Roth IRA. (ii) Only open an IRA (traditional or Roth) if you can “unlock” it. iii. Inside your unlocked 401(k) or IRA, or your individual brokerage account (i.e. Charles Schwab, Fidelity, E*Trade, etc.), buy the S&P 500. (i) “The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 leading companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices and includes approximately 80% of the total market capitalization of U.S. public  companies, with an aggregate market cap of more than $49.8 trillion as of March 31, 2025.” (Wikipedia, S&P 500, 4-7-2025) (ii) The S&P 500 has averaged about a 10-12% return over its history since 1926. 1. “Since its inception in 1926, the index's compound annual growth rate—including dividends—has been approximately 9.8% (6% after inflation), with the standard deviation of the return over the same time period being 20.81%. While the index has declined in several years by over 30%, it has posted annual increases 70% of the time, with 5% of all trading days resulting in record highs.” (Wikipedia, S&P 500, 4-7-2025) 2. “Historically, the 30-year return of the S&P 500 has been roughly 10–12%.” (Investment Calculator, RamseySolutions.com) 3. Here is a chart showing the historical returns of the S&P compared to some other stocks, bonds, and gold. (Historical Returns on Stocks, Bonds and Bills: 1928-2024) (iii)It is very easy to “buy the S&P” today using index funds such as mutual funds and exchange traded funds (ETFs). 1. “Index funds, including mutual funds and exchange-traded funds (ETFs), can replicate, before fees and expenses, the performance of the index by holding the same stocks as the index in the same proportions. ETFs that replicate the performance of the index are issued by The Vanguard Group (NYSE Arca: VOO), iShares (NYSE Arca: IVV), and State Street Corporation (SPDR S&P 500 ETF Trust, NYSE Arca: SPY and NYSE Arca: SPLG). The most liquid based on average daily volume is (NYSE Arca: SPY), although SPY has a higher annual expense ratio of 0.09% compared to 0.03% for VOO and IVV, and 0.02% for SPLG. Mutual funds that track the index are offered by Fidelity Investments, T. Rowe Price, and Charles Schwab Corporation.” (Wikipedia, S&P 500, 4-7-2025) 2. You can buy the S&P 500 by simply buying shares of one of the ETFs that replicate it such as VOO, IVV, SPY. iv. Warren Buffett, considered by many to be the greatest investor of all time, recommends that people should just buy the S&P 500. (i) “‘Consistently buy an S&P 500 low-cost index fund,’ Buffett said in 2017. ‘Keep buying it through thick and thin and especially through thin.’” (Warren Buffett's Golden Advice: S&P 500 Index Funds Reign Supreme For Retirement Success, Yahoo Finance, 1-16-2024) (ii) “‘I recommend the S&P 500 index fund and have for a long, long time to people,’ billionaire investor Warren Buffett said at Berkshire Hathaway’s annual shareholders meeting last May.” (Warren Buffett's simple investing advice that's beaten most pros for 12 straight years: Morning Brief, Yahoo Finance, 4-27-2022)  v. Carlton says that 90% of money managers fail to “beat the market”, i.e. get a better return over the long run than the S&P 500. (i) Yahoo Finance reports close to the same thing. (ii) “In a report published last month, S&P Dow Jones Indices (SPDJI) analysts found that 85.1% of U.S. large-cap equity fund managers underperformed the S&P 500 in 2021. It was the 12th straight year that more than half of the managers in this category lagged the index. In other words, investors following Buffett’s advice have outperformed most professional money managers every year for more than a decade.” (Ibid) (iii)Before choosing a mutual fund in your 401(k) or IRA, go to Google Finance (finance.google.com) and enter the ticker symbol of the mutual fund and then do a “compare to” with the S&P 500 index to see how it has performed against it. vi. Buying the S&P and holding for the long term is the easiest way to invest your retirement money. vii. If the S&P continues to do what it has done historically, then you will do well over time. viii. If you think that the US stock market and economy are going to crash and never recover, then buying the S&P or mutual funds in the US stock market will probably not be your choice.