Investment accounts are so important on your journey to financial independence. The accounts Amon and I put our money into played a big part in how we achieved our own financial independence in less than eight years. So in this post, I’m going to talk about those accounts and our order of operations (i.e the process and order in which we funded each of our accounts).
And just to be clear: The accounts that you can invest in are important . . . but it’s also important to understand the order in which you invest in each of your accounts so that you can develop the most optimal investment strategy for you. In other words, instead of just thinking about specific accounts, you also need to think about your financial goals, tax advantages, and your overall timeline for investing.
This can be challenging because there are many types of accounts you can invest in, and you want to choose the ones that fit your situation best. Investment accounts can be classified into two major areas: Standard taxable accounts and tax-advantaged accounts. Some common types of investment accounts include 401ks, 403bs, 457s, solo 401ks, SEP IRAs, Roth IRAs, simple IRAs, traditional IRAs, health savings accounts, brokerage accounts, 529s, and custodial accounts. Of course, these are just some of the more common accounts. There are plenty of other investment accounts. But, the problem with having so many investment account options is that you generally can’t invest in all of them (unless you have an endless supply of money to invest). This is why it’s important to choose your investment accounts (and the order that you fund them) wisely.
For Amon and I, we wanted to invest in accounts that we felt could grow our money in the long-term while still keeping our short-term goals in mind. We also were mindful of the tax advantages we wanted to implement. Ultimately, on our FIRE journey, the accounts we chose to invest in included:
● 401k/TSP/Thrift Savings Plan
● Roth IRA
● Health Savings Account
● Custodial accounts for our daughters
● Standard brokerage accounts
● Emergency fund
Each account played a part in our plan for F.I.R.E. Similarly, the order that we chose to invest in these accounts also played a role in how we grow our stock portfolio. More specifically, our order of investing was key.
Order of Investing:
When it comes to the order that we invested in our accounts, we focused on the tax-advantaged accounts first. Why? Because tax-advantaged accounts grow so much faster than regular accounts without tax advantages. The earnings in tax-advantaged accounts aren’t eaten up by taxes, so there’s more room for money to grow with compound interest. Here’s a good example of why prioritizing tax-advantaged accounts makes sense:
If you invest the $20,500 every year into your 401k, after thirty years at a 10% return (not including employer matches), the account would be worth more than $3.5M! Alternatively, those same contributions to a taxable retirement account will only grow to $2.7M if you’re in the mid-tax bracket. That’s an $800K difference between investing in a tax-advantaged account and a standard brokerage account with no tax advantages. These are the kind of mind-blowing tax advantages you can get . . . which is why we started off by funding our 401k first.
This is the first account we funded, and we did so up to our employer match. Investing in this account was vital because it allowed our investments to grow tax-deferred, it lowered our taxable income, and our employer provided a 5% match.
Next up was the Roth IRA, and we both made our maximum contributions to this account. Roth IRAs are special because you can withdraw the principal amount in this fund if you really need it, so in a way, it can act as an emergency fund.
There are two major benefits of the Roth IRA: first, your earnings grow tax-free; and second, when you withdraw your earnings from your Roth IRA for retirement, you can withdraw the money tax-free as long as it is considered a qualified distribution.
We invested in our Health Savings Account (HSA) next. Health-Savings accounts are the granddaddy of retirement accounts, but most people don’t realize it. HSAs have a triple tax advantage, because:
● The money you contribute is tax-deductible;
● Earnings on the interest from your investments within your HSA are also tax-free; and
● When you withdraw money from your HSA, if you do so for qualified medical expenses, it is also tax-free (i.e., you’re not taxed on the money you withdraw)!
Another great thing about the HSA is it doesn't expire annually, so your money rolls over to the next year even if you don’t use it. Many people don’t use HSAs, and they’re missing out on a huge investment opportunity.
Healthcare costs are only likely to rise, so an HSA provides a great opportunity to offset those costs. Hence, our focus on our HSA!
Back to our 401k!
After we funded our HSA to the limit, our next step was to go back to our 401k and fund it to the max. And the reason why we invested the full amounts allowable into our Roth IRA and HSA before going back to max out our 401ks was because we had more low cost investment options with our Roth IRA and HSA.
With our tax-advantaged accounts fully funded, we then turned to our kids’ custodial accounts. We did not invest in 529s. Instead, we invested in custodial accounts. We funded these custodial accounts after the others because tax-advantaged accounts were (and are!) simply more advantageous for our family’s wealth overall. At the same time, we knew we wanted to put a certain amount in our girls’ custodial accounts to help them begin growing their wealth at a young age.
After funding our tax-advantaged and custodial accounts, we then put our remaining money into our brokerage accounts. Of course, we didn’t receive any tax breaks for investing in our standard brokerage accounts. But, by investing in our standard brokerage accounts, we were able to invest all of our additional money left over after maxing out our tax-advantaged accounts, which allowed us to grow our wealth even more.
Stock Market Crash Emergency Fund
This is the final account involved in our journey to financial independence, and it is different from a normal emergency fund. When you retire early and you’re not making a regular income, most of your money will be coming from the stock market. We made this account in the situation that the stock market crashes.
This fund holds an amount of money that we could live off for two years before we would have to access money from our stock accounts. We held off on building this fund until near the end of our F.I.R.E journey because we didn’t want a large sum of money that wasn’t growing in tax-deferred accounts. So we began building this emergency fund in the last two years of our journey.
The reason it will last us for two years is that bear markets historically last for 18-months on average, so we’ll be able to withstand that 18 months dip. In that amount of time we would probably make other financial changes, but having the flexibility and security of a 2-year fund is crucial.
So these are the accounts we’ve chosen to invest in, as well as the order that we chose to invest. They are the primary reason we’ve been able to retire early and move to Lisbon for the foreseeable future. Our plan may not work perfectly for you, but the idea I wanted to communicate is that you should build a strategy, choose the order of your accounts and take the appropriate actions. This is key to achieving financial independence further down the road.