Should I invest excess income in stocks or contribute to a 401(k)/IRA?

I just graduated college. Would it be better to invest my excess income in stocks, to have access to the money if needed, or put money into a 401(k) or IRA to store the money away for retirement?

401(k), IRAs, Stocks
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December 2016
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Congratulations on graduating. The answer to your about both!

But, before you do either one, make sure you have something built up in your emergency fund in case of unexpected financial events. Not planning enough for the short term could leave you cash poor and reaching for the credit card if an unexpected expense pops up. After you have 3-6 months of living expenses in the bank, I would also urge you to consider what major purchases you might be making in the next 3-7 years, like maybe a down payment on a house or a vehicle. It's important to start saving for these things now so you have enough time to build up your savings. This will help you keep your liabilities down when you go to make those purchases. People get into financial trouble when they are highly leveraged, have no emergency fund, and then something goes wrong. That's when they have nowhere to turn for financial relief.

After getting a comfortable emergency fund in place, i would assess your company's 401(k) benefits to see if they are willing to match your contributions. If so, it is generally a good idea to contribute enough to maximize their matching contribution. After all, that is like getting free money toward your retirement.

After your short-term risks are covered and after you are maximizing your employer match in your 401(k), then take a look at what your goals are. Chances are you have some that are short-term and some that are long-term (like retirement). This is where you will likely do "both" when it comes to stocks vs. a 401(k). However, I will say that I would not advise you to go into stock investing blindly. There is a fundamental way to investing and there is a speculative way. Things like proper allocation, minimizing concentration, and diversification will help you avoid major and expensive mistakes when investing in stocks. So, if you're not experienced with stock investing, then you can enlist the help of an advisor or stick with ETFs and mutual funds, which already come diversified and are not concentrated in a small amount of stocks. This is typical for younger investors with a small amount in their portfolio and there is nothing wrong with using these tools.

Taking a chance on a stock here and there with no overall strategy is no different than gambling and I would never recommend gambling over contributing to your 401(k). However, if done correctly, you could invest in stocks, ETFs, or mutual funds outside of your 401(k) in a brokerage account that is more liquid and accessible, if that is important to you.

Good luck

Joe Allaria, CFP®

December 2016
December 2016
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