What are the best investment accounts for young investors? Though encouraged to invest for their future, which is good advice, the big question for young investors is how to get started. The types of investment accounts to consider can be particularly confusing.
Best Investment Accounts for Young Investors Include Tax-Deferred Accounts
Retirement accounts can be tax-deferred. This means that the money invested in the account grows and compounds free of taxation year to year. Individual retirement accounts (IRAs) and company-sponsored retirement accounts, such as a 401(k), 403(b) and 457 plans, are examples of tax-deferred retirement accounts, meaning that the money is not taxed until it is withdrawn for retirement. Remember that the money has to be from employment; you can't invest other money you might have, from an inheritance perhaps, into a retirement account.
In many cases there is a tax break upfront when the money is contributed to these accounts. Workplace retirement plans allow you to make contributions from each paycheck. The amount contributed is not subject to federal and state income taxes, though Social Security and Medicare taxes are still due.
In the case of an IRA the contributions may or may not be tax deductible, depending upon your income and whether or not you have access to a retirement plan via your employer. Even if you contribute to an IRA with after-tax dollars, the money in the account grows tax-deferred until withdrawn. The funds contributed on an after-tax basis are not subject to taxes, but you will need to keep good records of your contributions. An IRA or a 401(k) contribution might be one of the few tax breaks available for a younger worker, an added benefit for doing something you should do anyway.
...Also Roth Accounts
A contribution to a Roth IRA or 401(k) account is made with after-tax employment income – in other words, money on which you've already paid taxes. As with a traditional IRA or 401(k), the money grows free of taxes while invested. However, at retirement the money can be withdrawn completely tax-free if certain rules are followed. Note that you can only open a Roth IRA account if your income is below a certain level. That makes these a good option for younger investors, as their income may be lower and the benefit of the current-year tax breaks is not as valuable as it will be down the road when their income rises.
...And Taxable Accounts
Taxable accounts can include brokerage accounts, certificates of deposit (CDs) and other types of higher-interest depository accounts and accounts with mutual fund companies. Gains and interest from these accounts are taxable each year as incurred. Losses can also be deducted in many cases. With a taxable account you generally have greater access to your money without worrying about the taxes and potential penalties that can come with a tax-deferred or Roth account. (For more, see A Mutual Funds Guide for Young Investors.)
So Where Can You Open an Account?
Your 401(k) plan will not offer you a choice of where to open an account and will come with a set investment menu. As for other types of accounts, you have a lot of choices.
Taxable accounts and IRAs can be opened at many popular investment custodians, such as Charles Schwab, Fidelity, Vanguard, TD Ameritrade and a host of others. Additionally, many mutual fund companies offer account options as well. Robo advisors such as Betterment can also be an option. These advisors invest your money in low-cost investment options, such as exchange-traded funds (ETFs), based on a computer algorithm tied to your specific needs. This can be a great option for someone just starting out.
In today’s online world there are many new types of accounts and account providers. There is even an app called Acorns that rounds up the amount from purchases from linked accounts and saves your “spare change.” Technology can enable many wonderful twists on basic savings and brokerage accounts, for example by using personal finance apps to manage your accounts. As with any type of financial account or transaction, be sure you understand how the account and its technology work, who is behind it and if it is right for you.
CDs and other vehicles for saving are available at banks and many brokerage firms. In fact, the traditional lines separating financial services providers are blurring as more firms attempt to offer a full range of accounts and services.
The Bottom Line
Investing is a lifelong activity, and getting started is sometimes the hardest part. Understanding the different types of accounts available to you is a good first step in this process. (For more, see The Best Investments for Young People and 5 Common Mistakes Young Investors Make.)