I feel like the discussion is a little bit too in the weeds for an OP that doesn’t yet grasp index funds. Spending 10 or 20 hours reading up on all these things would be a help. However, in the absence of that, I have very easy and specific advice:
Can one do better tax-wise with Roth IRAs and other investment vehicles? Possibly. But the worst thing is for the OP to look at these things, conclude that it’s all way too complicated, and then do nothing. Actually, I take that back–the worst thing would be to listen to someone that sounds like they’re saying the same complicated words, but is really a scammer that will walk away with all their money. Therefore, for a newbie I recommend starting with well-regarded firms and simple investment vehicles.
My observation is based on personal experience with friends and acquaintances. Information overload leads to inaction. Specific advice is more helpful. The OP is of course free to take or ignore it.
Um…don’t tell people this. That would be 10 years of IRS audits. That fund has a very low, very efficient 4% turnover rate, but it’s not 0%.
Inaction is the absolute wrong course of action here. But blindly jumping in without understanding the waters is just as bad.
You are right about one thing, though - the discussion is in the weeds. These discussions ALWAYS get in the weeds on this board (no thanks to my participation, either). The OP (and anyone else in a similar position) is far better suited working with an advisor.
I did make an absolute statement, so that is a fair critique. To amend: Please do not ignore the notices labeled “Important Tax Information” that Vanguard will helpfully send you once a year. It will contain a 1099-DIV statement that you need to use for your taxes.
Not that I suggest jumping in completely blind, but if one were to do so, I’d give the same advice. A Vanguard account and VFIAX shares (spoiler alert: it’s an S&P 500 index fund) is almost impossible to go wrong with. It may not be a perfect investment vehicle for any particular person, but it is a very good one for almost anyone.
But do pay off any credit card debt first, in case that wasn’t understood.
As someone else who is new to non retirement investments, do you have to report money you invest in index funds when you just let it sit, or only when you take it out?
If you put the money in index funds and you reinvest the dividends, do you need to file taxes on that every year or only on the year when you take money out?
You’ll have to pay taxes on the dividends yearly. It’s a pretty nominal amount: under 1% is typically paid as dividends. That is reported as ordinary income.
There will likely also be a capital gains distribution, I believe due to the mutual fund selling stock to rebalance their portfolio. These will be taxed as long-term capital gains. That’s a rate of 0% for up to $40,000 currently.
The bulk of the gains will only be taxed when you finally sell.
All of this will show up on a 1099-DIV they send you.
This is exactly what we did when we had some inheritances. At a minimum, if you are NOT putting in enough to get the employer’s full matching contributions, then use it to help you bump that up.
At age 34, that 25K will have a LOT of time to compound.
I can’t speak to fees on employer-sponsored funds versus going direct through Fidelity, Vanguard etc., but large-enough employers may well be able to negotiate lower fees.
If you do leverage the money to fund your 401(k), look into whether the employer offers a Roth option on their 401(k). If so, you have access to larger annual contributions than a regular Roth IRA.
If you don’t want to do it that way, then you can put it in your own IRA (though, subject to contribution limits of 5,000 or so). The advantage of an IRA (regular or Roth) is that you are not limited to your employer’s choice of investments, and if it’s a Roth, you can withdraw the principle after a few years, without penalty.
Obviously if you are thinking the money might be useful sooner than retirement age, that affects how you’d invest it. If you think you might want to save up for the down payment on a house in a year or two, then put it in something much lower risk like a certificate of deposit. You won’t be making any significant income on it, but it won’t have any market risk.
So 34 years old, with a paying job that presumably pays the bills and leaves a little left over. You say you want to generate income. Do you understand the difference between “income,” “capital gains,” and “total return”? At that age, I was seeking total return. I didn’t need income (and I still don’t, I’m not that much older than you). I was and am trying to accumulate wealth.
My general recommendation is low-cost index mutual funds. They are simple to understand, minimize fees, and tend to outperform active investments. I would also get in the habit of investing regularly. “Pay yourself first” is how some people phrase it.
I mostly invested in Vanguard Total Stock Market Index (VTSAX). I’m happy with my decision and it’s still a good general purpose core investment. I recommend it to you too. If you wanted to diversify a bit more, you could add Vanguard Total International Stock Market (VTIAX). These two funds have been the core of my portfolio for over 20 years (I started investing in my freshman year of college).
Bond yields are currently very low and rising. Although my market timing prowess is terrible, this is probably not a great time to start investing in bonds. When bond rates go up, the value of bonds drops. (That seems counterintuitive at first but what you have to realize is that when you buy bonds, you are buying a fixed interest payment. If the bond you buy today promised you a 5% interest rate for 20 years but interest rates are rising, it makes more sense to wait until tomorrow to collect a 6% interest rate instead. And if tomorrow you want to sell the bond that has a 5% interest rate, no one will buy it from you at the price you paid because they can now get another bond that is paying 6% instead To sell, you will have to lower the price until the interest it pays equals the 6% people can get on other bonds).
If you are buying a stock, bond, mutual fund, ETF, or nearly any other investment that ordinary people would make, this is actually the least important thing to consider. Generally, your investment cannot go negative. There are some options strategies that some regular people can choose that can go negative (notably, selling put options) but I wouldn’t recommend doing that. As a practical matter, if you have a well-diversified portfolio, the risk of going to zero is pretty darn low. If the value of a portfolio like the the Vanguard Total Stock Market ever goes to zero, it’s because all the largest 5000 or so public companies in the US have all lost any value. There are some conceivable things that could cause that (armed communist takeover of America, enslavement of the human race by aliens, nuclear winter, planet-killing asteroid bound to strike Earth in a few days) but they would all give you bigger things to worry about than your investment portfolio. I would say that many apocalypses (like prolonged drought in America or pandemic that kills 50% of the population in a few months) still wouldn’t be enough to drive Vanguard Total Stock Market to zero even if it got pretty hairy there for a while.
This is a gross oversimplification of REITs, which can make lots of different real-estate related investments. Some are rental properties. Some are homebuilders. Some are mortgage loans. Some are commercial properties. There are investment risks in all of these things but there is no such thing as perfect safety. If you look for the safest investment, with the lowest volatility, it will have a very low rate of return and any returns you make will be swallowed up by inflation (7.5% last month!). That’s it’s own form of risk.
Buying individual stocks is way more risky than buying a diversified mutual fund that invests in many blue chip stocks at the same time.
This is good advice if the plan offers a matching contribution. If you don’t have a work retirement plan, think about an IRA, or if you are eligible, a Roth IRA invested in low-cost mutual funds.
He’s 34. The first part seems to describe him.
If you have a large balance in tax deferred accounts, your taxable income might be higher than you expect due to required minimum distributions that kick in at age 72. At the rate things are going with my portfolio, there is a very good chance I will have RMDs that roughly equal my real income now. If tax rates go up, I will be much better off with a sizeable Roth IRA, which isn’t subject to RMDs or income tax.
At some point, arguing about tax consequences on a $25,000 portfolio is like asking how many angels can dance on the head of a pin. The OP should probably start investing. When he or she learns a bit more and has a bit more, they can continue to refine their portfolio and tax strategy.