Meaningful growth and the security that entails for your long-term savings requires investment.

Saving and Investing for Retirement in One Sentence

It’s easy to be confused about how saving and investing for retirement works. In one sentence, here’s how it works: You find a brokerage company, open an account, put money in that account, and use that money to purchase shares of an investment product. That wasn’t so bad, right? Now let’s break it down a little further.

Brokerage Company

This is simply an institution that is authorized to offer different types of accounts that have money invested in different investment products. So, just like a bank is authorized to offer checking and savings accounts, a brokerage company is authorized to offer retirement accounts, company stock plan accounts, and more. (Many banks also offer brokerage services.)

Common examples include Vanguard, Fidelity, Schwab, E*TRADE etc.

Retirement Accounts

You can invest for your retirement using any type of brokerage account. But an account designed specifically for “retirement” offers tax advantages. Because of these advantages, there may also be limitations (like how much you can invest each year, a maximum amount of annual income you can have and still be allowed to invest in it, a time when you must make withdrawals from the account etc.).

The tax advantages generally fall into one of two buckets (and a few account types, like HSAs, fall into both buckets!):

1. Pre-Tax Accounts: You contribute to this type of retirement account before income tax is taken out. This reduces the tax you pay now because your income is reduced by the amount you contribute to your retirement account. However when you withdraw the contributions and investment earnings in retirement, you’ll pay taxes then.
   
   Common examples of pre-tax accounts include a 401(k), 403(b) (offered at tax exempt organizations like non-profits, public sector jobs etc.), Solo 401k etc.
   
   Note that many pre-tax plans are “sponsored” by employers. This means a few things but the most significant is that when you’re enrolled, your pre-tax contributions come directly out of your paycheck. This is nice because once you’re signed up, you don’t have to do anything extra to make regular contributions.
2. Post Tax Accounts: You pay income taxes as you normally would, but with whatever is left over (i.e. the “net” amount on a paycheck) you can use to contribute money to the retirement account. While this doesn’t reduce your taxes now, when you withdraw the contributions and investment earnings in retirement, you don’t have to pay any additional taxes.
   
   Common examples include a Roth IRA, Roth 401(k), Roth 403(b) etc.

Investment Products

When you invest in “the market” you purchase shares. Each share represents a percentage of ownership. Common examples of investment products include:

• Company Stocks: Publicly traded companies like Apple, Target, Netflix allow you to purchase a (very small) percentage of ownership every time you purchase a share of their stock.
• Index, Mutual, Exchange-traded, Target-date Funds etc.: “Funds” are simply a grouping of different assets (e.g. company stocks, bonds etc.). Purchasing a single share of an S&P 500 Index Fund for example, gives you a tiny percentage ownership of all the stocks in the S&P 500. All “funds” will be more diversified than individual stocks because a share of a fund is a grouping of many stocks.
• Bonds: Bonds are a way of loaning money (it could be to a company, municipality or other government entity). Essentially, you are the lender and the borrower is the issuer of the bond. In this case the borrower agrees to pay you back at a set time and a set rate for the money you have lent them, i.e. “the bond.” Bonds are often sold as part of some kind of fund (i.e. a grouping of bonds) since that reduces risk that any one individual borrower won’t be able to pay you back. However, through a broker or government entity it is possible to buy individual bonds and gain the predictability of return for the specified time frame that that bond offers.
  
  Important: Simply putting money into a retirement account is not the same as investing that money. For the money to have the opportunity to grow, you must make the final step of purchasing a specific investment product.

Balancing Your Priorities

In the Growth stage, we understand you may be working to increase the size of your emergency fund and to pay off medium-interest debt. But as we’ve previously discussed, the best thing you can do to ensure positive and high growth of your investments is to start as early as you can.

If you’re contributing something to your emergency fund each month, and you are paying off your medium-interest debt at the required pace, and you also have a few hundred extra dollars (or any amount), it’s the perfect time to use that money for long-term investments for your retirement.

The extra medium-level interest you’ll be paying on loans, or an emergency fund that doesn’t grow quite as fast as you’d like it to, are worthwhile short-term sacrifices to ensure you’re setting yourself up for success with your long-term savings.

In the next steps, we’ll dive into helping you determine how to choose a brokerage company, retirement account type, and investments. And we’ll give you several specific suggestions to make the whole process as simple as possible.