By Anthony Lupo, CFP, Rob Tilson, CFP, and Eric Tilson
These days, young people looking to invest have more options and platforms than ever before. Starting to invest at a young age is paramount to building long-term wealth, as the power of compounding works its magic over the years.
The easy thing to do would be to tell any person under 30 to invest in an ETF or basket of diversified stocks in a brokerage account and let the market work for them. While this is still a great option, there are other investment vehicles that may prove even more beneficial over the short or long term. While there are many options for investing extra savings, we want to touch on a few places that young people, or really people of all ages, can put extra money: namely, paying down debt, utilizing retirement plans through an employer, and fully utilizing an HSA (if available).
Pay Down Debt
The first item, paying down debt, is a fairly obvious one. We should point out here that we are talking about extra savings – it’s very important to have an emergency fund built up that can cover 3-6 months of living expenses if you were fired or have a medical emergency and are unable to work for some time.
Debt can mean anything from student loans to credit cards, car loans, etc. Interest rates vary from product to product, but typically credit cards have high interest rates and student loans and car loans have lower rates. For example, if a person had a $5,000 credit card balance at 20% and paid it off over 18 months at $325 per month, they would have paid about $720 in interest.
High interest debt accumulates quickly. One of the best strategies people can utilize is to look at all their debt and prioritize extra money going toward the high interest rate item down to the lowest interest rate item, in that order. This leads to an efficient paydown of all debt and minimizes the interest paid.
Keep in mind though, that not all debt is bad debt. If you think you can earn an investment return higher than the interest rate on said debt, it could be worth investing over paying down debt.
Utilize Employer Plans
One important investment vehicle for all workers to utilize is a 401(k) plan (or a 403(b) plan for those employed by public schools and certain 501(c)(3) tax-exempt organizations). Contributing to a pre-tax, traditional 401(k) plan (up to $19,500 for 2021) gives workers a tax deduction for the current tax year and allows the investments to grow tax free until withdrawal. The money is fully taxable upon withdrawal, which is allowed once the employee turns age 59 ½, but withdrawing before that age subjects you to a 10% penalty plus taxes. There are hardship withdrawals and early withdrawals allowed in certain circumstances without penalty, but always taxable.
Another type of 401(k) that many employers now offer is a Roth 401(k). While the traditional 401(k) offers a tax deduction now, the Roth 401k is the opposite. With a Roth 401(k) you do not get a tax deduction today, but the account grows tax free and withdrawals are tax free as well. This makes the Roth 401(k) very valuable for younger workers who have the ability to invest over a 35+ year period, especially those who are in a lower marginal income tax bracket now and expect to be in a higher one in retirement, as all growth is completely tax free.
Many companies also offer a matching contribution for employees contributing to a 401(k) (traditional or Roth), but that will vary by employer. For those workers who have money in the bank, a better option may be to start contributing or increase the amount contributed to a 401(k) or Roth 401(k) instead.
Health Savings Account
An often-overlooked investment vehicle is the health savings account (HSA). Many health insurance plans offer HSA plans as a supplemental option. With these plans, participants are allowed to contribute funds to an HSA, receive a tax deduction for the current year, and have the investments grow tax free with tax free withdrawals for health-related expenses.
This type of account is very valuable for those people who are young and healthy and who probably will not need to tap into the funds for a very long time. For example, someone who invests just $100 per month (well short of the current $3,600 annual maximum) starting at age 25 and gets a 7% return annually, will have over $257,000 at age 65. That amount can be withdrawn tax free for things like vision and dental expenses, Medicare premiums, and long-term care costs. An HSA plan thus offers a triple tax advantage.
While this is by no means an exhaustive list, these are a few of the strategies and investment vehicles that we see being underutilized. Prioritizing the paying down of your highest interest debt, followed by lower interest debt, is a great way to help your credit score and cash flow over the shorter term, while taking full advantage of things like 401(k), Roth 401(k), and an HSA are some of the best long term moves a younger person can make to put them on solid financial footing later in life.
About the authors: Anthony Lupo, CFP®, Rob Tilson, CFP®, and Eric Tilson
Anthony has been with Tilson Financial Group since 2010. As a financial analyst, Anthony’s responsibilities include research and analysis, portfolio rebalancing and development of financial plans for clients. He is a member of the firm’s financial planning and investment committees. Anthony holds the CERTIFIED FINANCIAL PLANNER™ (CFP®) certification and is a cum laude graduate of Rutgers University where he earned a Bachelor of Arts degree in Economics and Psychology.
Prior to joining the Tilson Financial team in 2016, Rob spent six years at Gabelli & Partners, LLC, a money management firm in Rye, NY. As a financial planner, Rob’s primary responsibilities include investment analysis and business development. He is also a member of the firm’s financial planning and investment committees. Rob holds the CERTIFIED FINANCIAL PLANNER™ (CFP®) certification and is a graduate of Boston College where he earned a Bachelor of Science in Finance and a Bachelor of Arts in Philosophy.
Eric joined Tilson Financial Group in mid-2021. Eric spent the last six years working for Prudential Financial, Inc., most recently as a portfolio administration specialist in the hedge fund area at their Newark headquarters. Eric’s primary responsibilities are investment analysis, financial planning, and operations. He is a member of the firm’s investment and financial planning committees. He is a graduate of Lafayette College where he earned an undergraduate degree in Economics and he has an MBA from New York University’s Stern School of Business with a specialization in Quantitative Finance and Strategy.