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Step 4: Open and Fund Your Accounts

Pardon us for interrupting your illustrious investing career for this very important public service announcement: Any money you need in the next month, five months, or five years does not belong in the stock market.*

Go ahead and read that sentence again. It is the key to avoiding heartache, headache, and a lifetime of Pepto addiction.

Got it? If so, please continue reading. For those into footnotes, we've provided this one:

*The last place for your short-term savings is anyplace where it is at risk of being worth less when you need it most. That rules out the stock market, which is prone to roller-coaster-like ups and downs, as is evident on any chart that tracks its month-to-month performance. Now, we don't want to scare you away from stocks. Over five- and 10-year periods, that squiggly line on the chart that resembles a ride on the Great American Scream Machine morphs into a gently rising upward slope. The key is time -- giving your money time to ride through the stock market's bumps and tumbles and reap the rewards of long-term investing.

With that important bit of business out of the way, we're ready to find proper accommodations for all of your savings needs and devise a strategy for funding your long-term financial goals.

The best places for your short- and mid-term savings
There's a vast array of appropriate places to stash the money you may need to access soon, including basic checking and savings accounts, high-yield savings accounts, money market accounts and funds, certificates of deposit, Treasury bills, and all sorts of bonds. These types of accounts are safe harbors: They won't provide killer rates of return (and may not even keep up with inflation), but they do provide a guarantee that the money you deposit will all be there when you need it.

Keep in mind that one type of account may not best serve all of your short-term savings needs. For example, cash earmarked for a home down payment that you plan to make in a few years is ideal for a CD. Junior's summer camp tuition is better off in a high-yield savings account. (Elsewhere on Fool.com we go into more detail on finding the best place for your short- and medium-term savings.)

Once you've deployed your funds for near-term needs, it's time to find the right spot for the money you'll need to cover Saturday date nights … in the year 2041.

Long-term parking
Your long-term cash stash (specifically, money designated for your retirement years) belongs in accounts set up solely for that purpose -- we're talking IRAs and employer-sponsored retirement accounts (such as 401(k)s). Now, sit back while we guide you through this savings maze.

Long-Term Parking, Lot A: Your 401(k) (or other workplace plan)
What if you could invest your money in a place where at least a portion of your contribution was guaranteed to double?

Well, if you work full-time, chances are you have that opportunity through your employer-sponsored retirement account -- your 401(k), 403(b), or 457. If your company offers one of these plans -- with a company match -- for goodness sake (and your sake), don't pass up the free money! We typically recommend that you put your first long-term investment dollars into this type of account if it's available. Ask your friendly HR department how to get started.

These plans allow you to contribute pre-taxed money directly from your paycheck (within limits; see the IRS's website at IRS.gov for this year's allowable contribution amounts). That way your money grows tax-free, and (added bonus alert!) your contributions lower your taxable income for the year (which means a lower tax tab come April). You pay the piper (in this case, Uncle Sam), only after you retire and begin to withdraw the money.

Unfortunately, not all plans are created Foolishly. Some employers don't offer a match, and some plans provide horrid investment choices and charge high fees. Plus, it's not always easy to figure out if your plan is one of the lemons. Don't worry, we've got your back. "Save Your 401(k)" shows you how to assess your plan, and what to do if it's a stinker. We can even help you identify the best investment alternatives in your 401(k) plan.

Long-Term Parking, Lot B: An IRA
Once you've maxed out your workplace retirement account (or, if it's an atrocious plan, invested enough to get your employer match), divert your next retirement dollars into an IRA.

IRAs have one big advantage over workplace retirement accounts: They typically offer more investment options. However, Uncle Sam won't let you contribute as much money to these accounts each year (again, check with the IRS for this year's limits). And, depending on your income, you may not be eligible to contribute to one fully -- or at all.

IRAs come in two garden varieties -- Roth and traditional -- and they offer different tax advantages:

  • Traditional IRA: Tax-wise, this account works just like a 401(k) -- the money you put into it is not taxed until you make withdrawals during retirement. Also, like a 401(k), you can deduct the money you contribute from your income, lowering your tax bill in the year you make the contribution.
  • Roth IRA: This account gives Future You a tax break. The money you sock away here is never deductible. However, come retirement you get off scot-free -- you pay no taxes on the gains or the principal when you withdraw the money. A Roth IRA also allows you to withdraw your contributions tax-free at any time for certain things, such as a first-time home purchase or education expenses, whereas with a traditional IRA (and 401(k)), you'd not only pay taxes, but you'd also get hit with penalties.

Which one is right for you? We like the flexibility of the Roth -- and the fact that the earnings grow tax-free. That said, the Roth is not necessarily the best choice for everyone. Read "Roth vs. Traditional IRA" for a rundown of the choices, and then use our calculators to crunch the numbers. When you're ready to open an account, our three-step article will show you how to get one set up.

Long-Term Parking, Lot C: Taxable accounts
If, after maxing out the tax-advantaged retirement accounts above, you still have money to sock away, we have just two things to say: (1) Huzzah!, and (2) watch out for Uncle Sam!

The only real difference between retirement accounts (IRAs and 401(k)s) and regular (taxable) accounts is, you guessed it, how the investments are taxed. Follow these two basic guidelines to (legally) dodge the taxman (as much as possible):

  • Fill your tax-favored retirement accounts with the most tax-inefficient investments. Those are the investments that generate the biggest tax bills -- bonds, real estate investment trusts (REITs), high-turnover stock mutual funds (if you must, though we're not fans). The payouts from these investments are taxed at ordinary income tax rates, so shelter them within your plan for as long as possible.
  • Use non-retirement accounts for investments that are already tax-efficient. That includes long-term, buy-and-hold vehicles like stocks that pay little or no dividends, or tax-managed stock funds. Since you won't pay taxes on these investments until you sell, they have a built-in tax-deferred benefit -- as long as you hold for many years. When ultimately cashed in, the gains will be taxed at the long-term capital gains rate, which is lower than ordinary income tax rates.

Setting up a taxable account is as easy to do as opening an IRA. Compare fees and special deals in our Discount Broker Center, and you'll be off and investing in no time. Once you set up your accounts, just three things are left on your "to do" list: Lather. Rinse. Repeat.

Put your savings on auto-pilot
OK, now you know that saving and investing your money is good for you -- just like eating right and exercise. Fortunately, discount brokers and fund companies make it a whole lot easier than counting calories and doing your cardio -- through dollar-cost averaging. That's just another name for automatic investing. It works just like your 401(k): Money is taken out of your account before you can even think about spending it.

What are you waiting for? The sooner you get your short- and long-term savings accounts set up, the sooner you can get to the fun stuff -- investing.

Action: Take the free money! If you haven't signed up for your workplace retirement plan yet, consider this your friendly Fool nudge to go talk to HR. You may be passing up a guaranteed way to instantly double your money -- and all it requires is 7.3 minutes to fill out a few forms. Go ahead, we'll wait.

Fantastic. Next, get ready to put your investing dollars to work outside of your employer-sponsored retirement account. You'll need a discount brokerage account for either an IRA or a taxable account, which are even easier to set up than your 401(k). Check out the brokers we like in our Discount Broker Center.


Read/Post Comments (28) | Recommend This Article (546)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 20, 2010, at 2:55 PM, ljones61 wrote:

    Loved the article. No fool am I? There is a lot of great advice here. I think everyone concerned with their finances should read and heed.

  • Report this Comment On September 23, 2010, at 11:40 PM, acchaladka wrote:

    I realize that most here are working in the US but I'm an expat in Canada. I have RRSPs, not IRAs, and no employer-contribution plan...so what's up for me?

  • Report this Comment On February 06, 2011, at 11:50 AM, ggentle13 wrote:

    This is great advice, particularly the section "nudging" you to access and utilize the employer match. I started a new job and jumped on this opportunity. Unfortunately I did not budget well and had to pull out the matching funds for living expenses while my wife searched for a new job. I let a year and half past before I realized that I could be contributing again, missing out on $900 a year from my employer in addition to the $1800 I was planning to throw at it through a simple $150/month payroll deduction.

  • Report this Comment On February 21, 2011, at 12:30 AM, brownknight wrote:

    I should have been here years ago!!! I guess it is not too late. I am new to investing and I stayed away from this topic since other sites make it sound so daunting. This site gives it in bite-size-easy-to-digest topics. Thanks guys!

  • Report this Comment On March 29, 2011, at 12:44 AM, pryan37bb wrote:

    Two things:

    I think you should've also mentioned the possibility of selling any investments that may have lost value and/or fallen out of favor in the investing world, and writing off the capital loss against any gains/dividends for a tax benefit for that year.

    And wouldn't the Trad IRA be better for the long-term because of....I'm having trouble describing it, but I can visualize it perfectly. Okay, scenario. This year, your AGI is $5,000, so you deposit $2,500 in a Trad IRA and $2,500 in a Roth IRA. A bit unrealistic, I know, but just pretend you didn't eat or anything this year for the sake of the example. Now, assuming a 25% tax rate, the money now available for your Roth IRA is $1,875 after taxes, whereas your Trad IRA still has $2,500. The extra $625 in the Trad will now grow at the same rate the principal will, until it gets taxed (at the same 25% rate as before if I'm not mistaken) when you start withdrawing. So wouldn't that extra money, which was able to harness the magic of compounding, outweigh the tax-free status of Roth IRA withdrawals?

  • Report this Comment On May 18, 2011, at 3:19 PM, davidandlis wrote:

    Wasted 20 mins on an extended, really wordy sales pitch.

    Please you guys. You're smart and you know your biz; you don't need a long script with ten times the necessary words to get me interested, especially in such an overblown narrative. Get a new writer.

  • Report this Comment On June 27, 2011, at 11:09 PM, dp23peace wrote:

    I just left my company and converted to an IRA. I was looking over the 401k stats and saw that of my 60,000, 23,000 was from employer matching.

    You simply HAVE TO take that money!

    Then, use any extra for an IRA, and invest FOOLISHLY, of course. :)

  • Report this Comment On August 05, 2011, at 12:01 PM, GoatRoper2011 wrote:

    Ok. I'm 47 y.o., have no investments due to numerous divorces and I'm self employed. How do I best grow my money given my late start?

  • Report this Comment On September 29, 2011, at 11:55 AM, Jazzcake wrote:

    I am also late to the stock party, but I am anxious to learn. What can you do with a limited or very small amount of investment capital?

  • Report this Comment On April 02, 2012, at 3:09 AM, Giorghio wrote:

    I'm 49 years old I live in Cyprus and I have 250 thousands euro in debt for mortgage and business.

    My income is 3000/month and I have to pay more than 2000/month for my debt. How can I invest foolishly to get out of this bad financial situation. I have to kids ( girls, 10 & 5 years old ) and I do not want to leave to then such a big debt to live with.

    Please help me with your right advises for a financial freedom.

    Sincerely,

    Giorghios

  • Report this Comment On March 11, 2013, at 4:20 PM, Judintx wrote:

    To all of you late comers don't be discouraged. My husband and I didn't start until we were in our middle to late 50's. We both contribute the max to our 401K 22500.00 yearly and have built quite a nest egg which thanks to Fools is doing well. but, according to this article we shouldn't have in the stock market? We have 3 more yearts until we can retire age wise. He only has 1 year but if Momma's working everyone is working!

  • Report this Comment On March 22, 2013, at 9:11 AM, rcsmith1957mf wrote:

    i,m on disability and i have $500.00 dollars can I start investing with this small amount with David Gardner’s “No Choice Revolution

  • Report this Comment On August 03, 2013, at 6:32 PM, igiveupandthen wrote:

    I would love to invest in the Fool Mutual Fund but my ira is in TDAmeritrade and I don't want to take it out so is there any way I can do it?

  • Report this Comment On October 05, 2013, at 7:06 PM, Desjarlais wrote:

    Is it wise to invest in the stock market at this point October 2013 or should I wait until a full correction sometime but year from now

  • Report this Comment On October 06, 2013, at 12:14 PM, sunny2045 wrote:

    to Desjarlais, There is no possible way to time the market. If you have done your research and all the fundamentals are good - buy the stock. Move on, find another stock, research it and buy it. The secret to the market is good companies and time. A caveat, even good companies go bad, but if you have done your homework (which you can learn almost anywhere on the web) more companies will be good than bad.

    Good Luck, Fool on. .

  • Report this Comment On January 12, 2014, at 11:00 AM, markgil1964 wrote:

    All this negativity makes me look at you like u don't believe in your market strategies and ur just saying if ur not already rich then don't try it...

  • Report this Comment On January 14, 2014, at 6:59 PM, sexonthebeach wrote:

    I don't know of a time when I WON'T need my money in the next five years. I'll need money in the next five years… this sounds like you already should be making the fat-pimp-cash.

    Since I'm a young poor person, I shouldn't be in the stock market? Isn't this like saying, "You'll never be fully be ready to be a parent, so you should never have kids

    By the way, if you've made it this far, if you were in my position, why would you continue to use Montley Fool if the only useful advice regarding the stock market is don't get involved with the stock market (which I'm starting to believe is better and better advice… maybe it was worth the money!)

  • Report this Comment On February 04, 2014, at 7:37 PM, divingfool62 wrote:

    what is this "Bank on yourself" thing I keep hearing about? Is that a good short term investment?

  • Report this Comment On February 08, 2014, at 2:37 PM, Strider316 wrote:

    @ pryan37bb The similarity between Roth IRA vs trad IRA is the fact that you are maxing out both every year to receive the full benefits down the line. So the principal invested is the same. Taking your example you receive $5000 of which 2500 is removed at source in a trad IRA but not taxed. In Roth you are taxed for the 5000 and say receive $4500. You are still investing the maxed allowable 2500 principle into the IRA account but now you don't have to pay taxes at retirement since you already paid it. The nice part about the Roth is that if you feel that tax prices will be increased in the future which normally it will due to growing budget deficit and money needed to pay for social security then paying the tax right now is smarter than paying a future higher interest rate. If however you feel tax will be lower in future then trad IRA is a better choice.

  • Report this Comment On February 13, 2014, at 2:47 PM, WILLIAMMORGAN77 wrote:

    Quick question,, I have a ROTH IRA thru Primerica that Ire paid into while I was in the Navy. I paid $100 a month into it and I also had a THIFT SAVINGS PLAN (TSP) through the government as well that if I recall I paid like $25.00/$50.00 in every month as well. I am looking to taking both of these accounts and removing the money from them and start investing in Dividend-Paying stocks, is this a good idea or what advice can anyone offer as a smart extra income for myself and my daughter for the future?

  • Report this Comment On March 21, 2014, at 11:48 PM, NanaFool wrote:

    @WILLIAMMORGAN77

    Having been a gov't employee and invested in the TSP, I would advise you to leave the funds in the TSP for as long as possible. The growth rate/return is very, very good and fees are quite low.

    I had mostly C fund, followed by the S & I funds… your match is always in the F or G fund…. can't remember which. I did not want an annuity, so I rolled over all monies to a Traditional IRA when I was required by age to start withdrawing the Required Distribution.

    Now I'm in the process of investing that money… hence, The Motley Fool for a little help. And to serve as a security blanket. haha

  • Report this Comment On April 06, 2014, at 4:08 PM, ldf454 wrote:

    I don't have the money cushion of six months, the short-term money to buy a house or make any of the other short-term purchases we have, but I have started a 401K, and I have a Roth.

    Would it be wise to buy stocks with a small percentage of income I have budgeted for savings, and then take gains of that money and put it away into short/long-term savings?

  • Report this Comment On April 06, 2014, at 4:09 PM, ldf454 wrote:

    I meant would it be "Foolish"

  • Report this Comment On April 16, 2014, at 11:23 AM, ellebno4 wrote:

    i see many questions on how a later starter can get started; NO ANSWERS.. what amount of money is considered a 'good' DISPOSABLE amount to start investing?

  • Report this Comment On June 05, 2014, at 4:33 PM, LaughingRaven wrote:

    ellebno4: You can start investing with almost anything, assuming you've already taken care of the first steps (reducing debt and accumulating short-term savings). For example, some Schwab funds require only a $100 initial investment. TD Ameritrade has no minimum to open an account, and like most brokerages these days, they offer a stable of mutual funds or Exchange-Traded Funds (ETFs) that you can buy into without a fee.

    Speaking of fees, until you've amassed a decent amount of investment funds (your threshold may vary, but for me it was about $5,000), you may be better off with a mutual fund than individual stocks. Each time you buy or sell a stock, you incur a fee, and those fees can really eat you up. Suppose you have $1,000 to invest; because you want a diverse portfolio, you spread that out among seven stocks. Even at a modest $7 per trade, that's $49 lost to fees, or almost 5% of your portfolio. It could take months just to get back to where you started. With a $5,000 portfolio, that's only a 1% loss. Better yet, with a larger balance you might qualify for a sign-up bonus or free trades.

  • Report this Comment On July 13, 2014, at 12:35 PM, carolyoyo wrote:

    I grew up with "Depression Era" parents. They were afraid of the Stock Market, but very frugal. I inherited that attitude.

    I am now self employed with no debt and a modest income and lifestyle. I have used financial advisors that got me in expensive mutual funds that lost me money. I am in the process of picking my own funds and DRIP stocks. I have about 10 years to retirement. I was saving for a bigger house, but decided to stay in my older small one. I have about $111K invested in CDs and mutual funds and a few dividend producing stocks. I have about 80K in a saving account. I know I need to invest more of my savings, but that fear of a market crash coupled with my bad experience with financial advisors causes me to hesitate.

    I don't want to be like a couple of my older single lady friends and still working at age 67. I'm 57 and a childrens entertainer. I'm running out of steam.

    I feel like I can learn to make my own investing choices if I keep learning. I opened up a individual 401K at Vanguard last year and I'm trying to move money into it on a regular basis.

    I guess I'm going to use this forum for feedback and encouragement.

  • Report this Comment On July 15, 2014, at 11:41 PM, nwfl890 wrote:

    Keep at it, carolyoyo. We're all here to learn.

  • Report this Comment On August 20, 2014, at 10:04 AM, SCross35 wrote:

    I wanted to point out a slight inaccuracy in the article here. The author claims that "A Roth IRA also allows you to withdraw your contributions tax-free at any time for certain things, such as a first-time home purchase or education expenses, whereas with a traditional IRA (and 401(k)), you'd not only pay taxes, but you'd also get hit with penalties."

    Roth IRA contributions do not require a certain circumstance to be distributed tax-free, as they have already been taxed. According to the IRS Pub 590: "You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s)."

    Conversion amounts can be subject to a penalty if distributed within 5 years of the conversion if no exception applies, but otherwise the penalty would only apply to taxable distributions, which does not apply to contribution amounts.

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