The priority of investing
JUST LIFE
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“You should save and invest as early as you can. The longer you wait, the harder it is to catch up.”
You have likely heard some version of the above statement, whether from a parent, grandparent, financial pundit, or co-worker who won’t stop talking about personal finance. While this statement is true, it does not answer the question: “How do I save and invest for the future?”
Yes, putting aside a certain amount of income each month for the future is an accomplishment in and of itself that should be celebrated. However, once you earmark those dollars for investing, the important next step is determining what you will do with that money.
“Should I start investing with the 401(k)?” “When should I put money in an IRA?” “Should I open a brokerage account so the investments aren’t tied up until retirement?” “And what about an HSA? How does this fit in with the other options?”
These are just a few of the many questions when considering how to save and invest for the future. The myriad of options and questions can damper the excitement of investing with feelings of overwhelm and confusion. Whether you are saving $100 or $1,000 per month, you should consider: “How do I determine the priority of my investing?”
But before I answer that question, let’s establish a couple of important disclaimers.First, there is no “right” way to save and invest for the future. Everyone’s situation is different regarding income, expenses, timeline to retirement, other financial priorities, tax situation, etc. Each of these is an important variable to consider, and this is why a one-size-fits-all approach doesn’t work. Second, the prioritization framework below does not represent all investment options. Real estate and digital assets are two notable examples missing from the list.
With that said, let’s look at a framework for prioritizing your savings.
Priority #1: The “Match” for a 401(k)1
Does your organization offer a match for a 401(k)? If so, this is essentially free money. For example, assume you make $100,000 annually, and your employer offers a dollar-for-dollar match of up to 3% of your contributions. Therefore, if you contribute $3,000, the employer will match that for a total savings of $6,000. Before you take advantage of the “The Match,” one important consideration is knowing your vesting schedule. Many employers require a minimum amount of time (such as 1 year or more) before you are vested with your employer match. Said another way, if you leave your employer before the defined vesting timeline, you can always take your contributions, but your employer contributions may not come along. This is especially noteworthy for those doing residency or fellowship, who are likely to be with the employer for a short period of time.
Priority #2: Health Savings Account (HSA)
If you are enrolled in a high-deductible health plan (HDHP), you can contribute to an HSA. An HSA is high on the investment priority list because it has a triple tax benefit (tax-free contributions, tax-free growth on investments, and tax-free distributions for qualified healthcare expenses). Unlike a Flexible Savings Account (FSA), funds in an HSA can be rolled over from one year to the next. Furthermore, monies inside an HSA can be invested like those within a 401(k), IRA, or brokerage account. In 2024, the HSA contribution limits are $4,150 for individuals with self-only coverage, and $8,300 for those with family coverage.
Priority #3: Individual Retirement Account (IRA)
As the name suggests, an IRA is associated with the individual and is not dependent upon working for an employer. Anyone with earned income can contribute to an IRA. Furthermore, a nonworking spouse can contribute up to the maximum using a spousal IRA. Similar to a 401(k), an IRA has a “Roth” (post-tax contributions) and “Traditional” (pre-tax contributions) flavor. In 2024, the contribution limit for an IRA is $7,000 for those under the age of 50.
Priority #4: Maxing out employer-sponsored retirement accounts
Taking your 401(k) contributions to the limit can allow you to invest a huge chunk of cash in a tax-favored way. In 2024, the contribution limit for a 401(k) plan is $23,000 for employees under the age of 50. This limit does not include the employer match portion. This is prioritized after IRA contributions (#3) because most individuals will find a greater selection of funds and flexibility with an IRA than with a 401(k).
Priority #5: SEP IRA
Got a side gig that’s generating money? The good news is you can sock away a ton of cash beyond the 401(k) and IRA limits. The key here is that your maximum contribution in 2024 is the lesser of 25% of earnings or $69,000.
Priority #6: Brokerage account
Even if you have maxed out all retirement and HSA accounts, you can still invest more by setting up a brokerage account (sometimes called an investment account). The main advantage of a brokerage account is flexibility (you don’t have to wait until retirement age to withdraw funds penalty-free). The main disadvantage is that the dollars going in will be post-tax dollars, and any withdrawals will incur short- or long-term capital gains tax.
For more financial tips and information, check out Your Financial Pharmacist’s (YFP) book Seven Figure Pharmacist (use coupon code APhA for 15% off), visit the YFP website, and listen to the YFP Podcast.
Tim Ulbrich, PharmD, is the co-Founder and CEO of Your Financial Pharmacist. Founded in 2015, Your Financial Pharmacist is on a mission to help pharmacists achieve financial freedom through fee-only, virtual comprehensive financial planning services via YFP Planning, as well as three weekly podcasts including the Your Financial Pharmacist Podcast, books, webinars, and numerous online resources.
1For the purpose of this article, 401(k) is being used as an umbrella term for “employer sponsored retirement plans,” which also includes a 403(b) for those that work for a non-profit organization, and a TSP for those that work for the federal government.