The Simple Dollar is running a series in which we re-evaluate Money Magazine’s “25 Rules To Grow Rich By”. One “rule” will be re-evaluated each weekday until the series concludes; you can keep tabs on the action at the 25 Rules index.
Rule #6: All else being equal, the best place to invest is a 401(k). Once you’ve earned the full company match, max out a Roth IRA. Still have money to invest? Put more in your 401(k) or a traditional IRA.
First of all, many places of employment don’t offer 401(k) plans. I have never worked in an environment that has offered a 401(k) plan. So, upon first reading, I would be led to believe that I should be maxing out a Roth IRA every year.
The actual truth of the matter is that you should simply look for an individual retirement plan at work of any kind that provides company matching. For me, this has varied among 403(b)s, government-run individual retirement plans, and other situations. The key here is company matching; it’s essentially an enlargement of your salary that they give you for behaving responsibly. By not doing this, you’re turning down an immediate 50% to 100% return on your investment.
A Roth IRA is another good place to sock away some extra money because of the tax shielding. Even if you don’t earn as much through the IRA as you do elsewhere, you never have to pay taxes on a dime of it provided you wait until retirement to withdraw from it. If you do this early in life, you’re going to earn a lot of money that you never have to pay a dime of taxes on, which is a big leg up over other investments. This part of the rule makes a good deal of sense.
Where I begin to disagree is with dumping more money into individual retirement plans once you’ve maxed out your matched retirement plan and your Roth IRA. If you are doing both the full matched retirement plan and the full Roth IRA and you’re starting young with it, you’re going to have retirement in the bag.
Instead, you should use remaining investment money to look at a slightly less long term future. Wouldn’t you like to buy that dream home when you’re 45 or 50 and you can still enjoy it for thirty or forty years? To avoid penalties for withdrawal, you need to put it in a high-earning place that you can access in ten or fifteen years, even if you have to pay taxes on the earnings. This way, you enable the possibility of buying some great things for your family when you reach the forties and your children are starting to grow up.
Of course, if you’re already approaching retirement age, put it in the tax-sheltered options, but if you’re young, this often is not the best option. Let’s rewrite that rule:
Rewritten Rule #6: All else being equal, the best place to invest is in an investment plan through your work benefits up to the full company match. After this, invest in a Roth IRA. Still have money to invest? Put it in a place that you can easily access in ten or fifteen years, like an index fund.