Investing 101: Investing for Beginners

Individual "Non-Qualified" Accounts

Non-qualified accounts are accounts that don't receive any special tax treatment. Contributions are made with after-tax dollars and any investment gains are taxed at either short or long-term capital gains rates, which are determined by income levels and length of time the investment was held.

However, because there is no specialized tax treatment for this type of account there are also no contribution or withdrawal rules or limits. You can buy or sell investments within the account and use the money whenever and however you want.

These types of accounts may be more appropriate for people who want to invest larger amounts of money or have short-term investment goals.

Retirement Accounts

Retirement accounts, more commonly known as Individual Retirement Accounts or IRAs, are accounts that can hold investments specifically for retirement purposes. These types of accounts have special tax treatment and rules that the account holder must follow. If you withdraw the money before you reach that age, you will be charged income tax on the money you withdraw, as well as a 10% early withdrawal penalty. These types of accounts may be suitable for people who are looking to save for retirement, would like tax advantages and have low liquidity (short-term) needs. There are two types of IRAs, each with its own tax rules and incentives.

Traditional IRA

Traditional IRAs are a type of tax-deferred vehicle, meaning that investment returns and gains are not taxed until you sell the investment and take money out of the account. Withdrawals from the account are taxed at your marginal interest rate at the time of withdrawal.

Contributions to the account are also tax-deductible, however, contributions to an employer-sponsored retirement plan like a 401(k) may affect how much of your IRA contributions you can deduct (check with your CPA or tax preparer).

Traditional IRAs are also subject to Required Minimum Distributions (RMD's) which stipulate that a person must withdraw a calculated amount every year from their traditional IRA once they hit 72 years old. If a person fails to withdraw their RMD, they will be taxed at 50% of the amount not withdrawn. RMD's are calculated based on the amount of money you have in the account and life expectancy.

Roth IRA

Roth IRAs are a type of retirement account that provides tax-free gains. Contributions are made with after-tax dollars, and any investment returns can be taken tax-free after the age of 59.5 years old. Roth IRA accounts must be five years old before distributions can be taken tax-free (if you opened the account at 58 years old, you could start tax-free distributions at 63 years old). Since the investment gains come out tax-free, contributions to Roth IRAs are not tax-deductible.

Another provision of Roth IRAs that makes them a popular choice is that a person can withdraw their contributions (not investment gains) from their account before they're 59.5 years old without any penalties. This may offer flexibility and liquidity in the event of a financial hardship or emergency. Gains in a Roth IRA may also be accessed without penalty under a few exemptions including a higher education exemption and a first-time homebuyer exemption. Be sure to check the rules and limits of these exemptions before using them and remember that gains withdrawn, although not penalized, will still be taxed at ordinary income levels.

Another benefit to Roth IRAs is that they do not have RMDs which may give you more flexibility when retirement income planning. Roth IRAs have an income limit, meaning that you can't contribute directly to the account if you are making more than $139,000 (single) or $206,000 (joint) per year.

Employer Plans

One of the primary opportunities for people to invest in an employer-sponsored retirement plan. It's been reported that 40% of the Colorado workforce has access to a retirement plan through an employer. If you have access to a company-sponsored retirement plan be sure to take advantage of it. Many companies offer an incentive match plan which means the employer will match a certain percentage of your contributions. This is essentially free money and a great way to boost your retirement investment savings.

Larger employers may offer plans like a 401(k), 457(b) or 403(b) if you're a government or non-profit employee. Smaller businesses may offer plans like a SIMPLE IRA. Whichever type of plan you have, they are all a type of qualified retirement account. These types of accounts refer to the type of tax treatment of the contributions, not the investment choice.

If you have access to a company 401(k), you probably have access to traditional and Roth 401(k) options. Like IRAs, traditional 401(k) contributions are funded with pre-tax dollars and are not counted towards taxable income. This means that money goes into the account before normal employer deductions for things like Social Security, Medicare, and other State and Federal taxes. Roth 401(k)s, like their IRA counterpart, are funded with after-tax dollars and are tax-free upon withdrawal. A difference between a Roth 401(k) and IRA is that Roth 401(k)s have RMD's starting at age 72. These can be avoided by rolling over the money from your Roth 401(k) to a Roth IRA. This can be done without any fees or penalties however, the employer contribution or match portion will be taxed at ordinary income levels.

Money contributed to a retirement plan is invested in one of the plan's many options. The investment choice is usually selected based on age and the investor's risk tolerance, and if the employee doesn't make a specific selection, a qualified default option is selected for them. Investment options will differ between different plan providers and the details of the investment options can be provided at enrollment, or by the plan administrator.

Pros

• Incentive Match Plan – Employers may provide a contribution match to help boost your retirement savings
• Qualified Default Investment Alternative (QDIA) – A default investment option that reduces the need for an investor to do extensive research on the different investments in the plan.
• Fiduciary Regulations – The Employee Retirement Income Security Act (ERISA) act means that the retirement plan managers have a legal obligation to make sure investment options are suitable for the employees and that decisions are made with the best interest of the employee in mind.

Cons

• Vesting Schedules – Vesting schedules may reduce the amount of employer match you can keep if you don't work for the company for a certain amount of time (varies from company to company).
• Portability – Because 401(k)s and other similar plans are employer-sponsored, you will lose the ability to make plan changes and contributions if you leave the company. Leaving the company and/or withdrawing funds may cause a taxable event. Contact your plan administrator to hear your options soon after leaving a company.
• Retirement Plan Regulations – Like other retirement plans, there are certain rules or limits that come with the tax benefits these plans provide. You can only contribute $19,500 per year* (for a 401(k)) and can't withdraw the money before you're 59.5 years old without penalties. If you need access to money, employer plans may have loan options you can utilize.

Online Brokerages

Online brokerages have evolved into platforms that give individual investors access to many different types of investment opportunities and research resources. These types of platforms give a person the power to invest in almost all public investments and build their own portfolios of stocks, bonds and other more complicated investments. Popular online brokerages often have low fees, no trading commissions and low minimum requirements to fund the account and get started.

These types of platforms are great for people that are D.I.Y. investors because of the breadth of investment and research options that are available on the platforms. The investor is at the helm of all decisions, but many brokerages have FAQs, chat functions and call centers that can be used to help with account management and in certain cases, investment decisions (may require higher account balances). Online brokerages can be accessed through web and mobile devices and can be connected to bank accounts to make deposits and withdrawals a seamless digital experience.

Pros

• Investment and Research Options – Whether you prefer stocks, bonds, mutual funds, exchange-traded funds (ETF's) or other investment types, you can find them all on online brokerages.
• Low Fees and Minimums – Sometimes referred to as "discount brokers", this moniker reflects the low cost of using the platform, making it a suitable choice for people who are fee conscious or are new to investing.

Cons

• Complexity – These platforms were made to provide comprehensive investing services. With different investment options, account types, automation features and more, it can be confusing to the new investor and take time to learn and be comfortable with the various features.

Mobile Apps

As technology trends more towards mobile devices, investing apps have become more commonplace. With the surge of new investing apps, the barriers to entry are lower than ever and almost anyone with a phone or mobile device can get started.

The low barrier to entry has caused a growing shift in the demographics of investors. In the past, investing was relegated to people with higher incomes who were more advanced in their careers. Now, younger people who are starting in their careers can experience investing in funds and stocks of well-known companies.

Apps give investors options to trade individual stocks, ETF's and options with no trading fees. No trading fees have spurred many people to get into "day trading" or short-term investing. The goal of short-term trading is to look for opportunities to accrue gains by timing the market and taking advantage of the volatility of stock prices. This strategy can be risky and is more suitable for experienced investors or investors with high-risk tolerances.

Other investing apps have a personal finance component built-in, helping users invest and improve spending and saving habits. These types of investing apps are also a good way to get started investing if you're a beginner and are risk averse. The additional personal finance features can also be attractive for people who use other types of financial technology for budgeting and banking.

Overall mobile apps can be a good starting point in your investment journey however, they have their limitations which include customer support, research capabilities and no access to retirement accounts on some platforms.

Pros

• Low Barrier to Entry – Anyone with a phone and bank account can get started using these platforms. You can start with small amounts of money to learn the ropes and get comfortable before investing more.
• Low Fees and Commissions – Low costs help investors compound their money over time.

Cons

• "Too Easy" to Trade – One of the biggest challenges faced by investors has to do with investor behavior. Namely, the action of panicking and selling their investments in response to short-term fluctuations. Investing apps may not be the best option for people who have strong emotional responses to financial decisions.
• Limited Functions - Investing apps were designed to simplify the investing experience. As a result, you may not have the same functions for trading and automation available on other platforms.
• Advice and Customer Support – Their digital-first experience may lend to less access to customer support and personalized advice.

Financial Advisors

If you're not that familiar with using technology, or if you prefer higher levels of service and face-to-face interactions, a financial advisor may be a good fit for you. Financial advisors are professionals that can help you create a financial plan, invest, recommend financial products and plan for other scenarios that might affect your finances.

There are a lot of different financial advisors out there, but generally, they are either independent (owns their practice) or representatives of a larger financial organization (credit unions, investment companies, insurance companies, etc.). Regardless of the type, you should ask any prospective advisor if there are any proprietary financial products their company offers and if that will affect their recommendations to you.

Different financial advisors may specialize in different areas of planning depending on their background and company. For example, Advisor "A" might specialize in strategies for retirement planning while Advisor "B" might be more proficient at college planning. When looking for a financial advisor, it is important to learn what areas they specialize in and find advisors who can best help you reach your goals. If you have multiple goals in different areas, you could have multiple financial advisors that are "best of breed" in their respective practices.

If possible, find an advisor who follows fiduciary standards, which means they are required to make recommendations that are not just suitable for your situation, but also have your overall best interest in mind.

Pros

• Personalized Advice – Financial advisors will spend time to figure out your financial and lifestyle goals and how you can get there.

Cons

• Fees – Financial advisors don't work for free, and there is an associated cost to their services and advice. Investing through an advisor may be more expensive than using an online platform.
• May Have a Barrier to Entry – Depending on the firm, some advisors have a minimum investible asset requirement. This means you may need a certain amount of money for them to take you on as a client.

Robo-Advisors

Robo-advisors have been around for a handful of years now and are some of the latest iterations of investment technology. Robo-advisors give the everyday investor access to professional investment management but at a fraction of the cost. These types of platforms utilize algorithms and software to actively manage your investments. The algorithms seek opportunities in the market and analyze financial data in an attempt to minimize risk and capture investment returns. While all of this seems complicated, these companies have done a good job of making it simple for users to navigate the platform and can be suitable for new investors.

Pros

• Tax Harvesting – Most Robo-advisors have features that help make your investments more tax-efficient that you otherwise would have to do manually.
• Automated Management – The algorithms will automatically rebalance your investments to keep on track with your goals and risk tolerances.
• Technology Tools – Some platforms have additional features to help manage and track your goals and finances.

Cons

• Limited Advice – Being an automated platform, you may not be able to get personalized advice if you have specific financial questions.
• Less Control Over Individual Investments – If you like to pick certain stocks and companies this may not be the platform for you. Investment options are usually limited to indices, funds and pre-made portfolios.

Credit Unions and Banks

As credit unions and banks continue to grow, many have added financial advisors and investments to their service lineup. Investing through your credit union or bank has many of the same benefits as working with a financial advisor and then some. Along with investment products, they also have access to auto and business loans, mortgages, CDs and other deposit products. Working with a financial advisor through your credit union or bank may also allow for a more cohesive plan because your other financial accounts would already be linked. This may also make transfers between your banking accounts and investment accounts more streamlined.

Pros

• Wide Variety of Services – You would have access to investment and banking products all under the same roof.

Cons

• Diversification – Banking and investing at the same institution may be a case of putting all of your eggs in one financial basket. If you tend to switch your banking institution often, it may be easier to keep your investments at a separate entity.