Drill Down: How to Invest Other Assets
Two issues are important with regards to other investment assets: the order in which you fill your various investment buckets and what you put into each bucket.
Your various buckets include your 401k and possibly an IRA, a brokerage or direct mutual fund account, and maybe a college savings account. In this book, I’m focusing solely on retirement money, so I’ll ignore the college savings issue.
Generally speaking, fill up the 401k first if your employer provides you with a match. If the employer does not provide a match, your 401k is equivalent to an IRA. The IRA gives you a little more flexibility with respect to how you invest your money, but with a lower limit on how much you can save annually.
After you’ve saved the maximum yearly amount allowed in your 401k and IRA, it’s time to open a taxable account. You can do this at a full service brokerage firm (example: Merrill Lynch), a discount brokerage firm (example: Charles Schwab) or a mutual fund company (example: Vanguard). You can set up an account at one of these companies by yourself or with the help of a financial planner, but the financial planner will also help you make the investment decisions. If you have a hankering to buy individual stocks, you need a stock broker, either full service or discount. If your interest leans toward buying mutual funds, any of them can help you, or you can go directly to a company that specializes in mutual funds.
Now that you have money in your 401k, IRA, and a taxable account, how should you invest it? The key point to remember is that the asset allocation I recommend in Chapters 3 and 4 should apply to your assets as a whole. It does not have to apply to every particular account.
In a taxable account, interest and dividends are taxed every year, but capital gains are not taxed until you sell the asset. The assets in a 401k (or IRA) are not taxed at all until you withdraw the money, and then it’s all taxed at regular income tax rates (unless you have Roth IRA or Roth 401k).
These tax laws are not too bad on stocks held outside a 401k or IRA, but they are very harsh on bonds and REITs held outside a 401k or IRA. As a result, you should have stocks in your taxable account and bonds in your 401k. (If you own any REITs, they should be lumped with bonds and placed into your 401k.)
Examples:
Jane has $100,000 in her 401k, and $50,000 in her taxable account. Her target asset allocation is 60% stocks and 40% bonds. Here’s how she could invest the money to reach her target allocation percentages.
Her total investment assets are $150,000 (adding together the $100,000 in her 401k and the $50,000 in her taxable account).
She wants $90,000 worth of stocks (60% of $150,000) and $60,000 worth of bonds (40% of $150,000) to reach her asset allocation goals.
To get the right percentages, she invests the $50,000 in her taxable account entirely in stocks. She then splits the remaining $100,000 in her 401k by allocating $40,000 to stocks and $60,000 to bonds.
Jack is in a slightly different position. He has $40,000 in his 401k and $60,000 in his taxable account. His target asset allocation is 30% stocks and 70% bonds. Here’s how he allocates his money.
His total assets are $100,000 (the $40,000 in his 401k and the $60,000 in his taxable account). His target allocation is $30,000 in stocks and $70,000 in bonds.
In his taxable account, Jack should buy $30,000 of stocks and $30,000 in bonds. His 401k should hold $40,000 in bonds.
In both cases, they get as close as possible to the goal of having all the stocks in the taxable account and all the bonds in the 401k.
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Lesson 1: What the Heck is a 401k, and What’s So Great About It?
Lesson 2: Contributions to Your 401k
Lesson 3: Investments “Cook Book” Approach
Lesson 4: Investments: How Investments Work
Lesson 5: Loans and Hardship Withdrawals from Your 401k
» Lesson 9: Your 401k, Your Other Assets, and Your Life
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