In my last post I told you what stocks I invest in, now I will tell you where I recommend investing them. When you go to buy a stock, your broker or your online account will ask you what kind of account you want to put it in.
Step 1. let's talk about a 401k. Many jobs offer 401ks to employees and it is super simple to get started with this account. They will give you a list of funds you can choose (I would recommend an index fund, an S&P500 fund is what I personally use in my 401k since my favorite Vanguard funds are not an option) and you tell them how much of your pay you want being saved every paycheck. This money has great tax benefits and is a super powerful retirement account in a world where pensions are becoming a thing of the past. If you have a 401 k with your employer, step one is to contribute up to the match.
Step 2. You should set up a Roth IRA account (or Traditional IRA- check out the differences and benefits of each one here) with a brokerage that allows contributions to low cost index funds. I use Vanguard because it has the lowest fees in the industry. You can use whatever you want. Your goal should be to max out your IRA each year ($5,500). I use a Roth IRA because I am currently in a low tax income bracket and it will be the most beneficial for me. Your situation might be different. Plenty of early retirees use traditional IRAs, the reasons can be read about here. Really it's a choice between two good options, so don't worry about your choice between Roth-IRA and T-IRA too much. Just get started today!
Step 3. If you have access to a Health Savings Account (HSA) you should max that out to its potential of $3450 annually. Not everyone has this option but ask your employer if you do, because this is an amazing savings/investment account. The money that goes in is tax free, it grows in the stock market, and if you use the money to pay for any healthcare costs (dental work, glasses, prescriptions, emergencies, what have you) then the money is NOT taxed when it comes out. This is great for everyone, especially since medical costs are a huge reason that Americans have to claim bankruptcy. Plus as you age you don't have to be as worried about crazy medical costs since you have a dedicated savings account ready to go. But it's ESPECIALLY great for early retirees. The great thing for an early retiree is that if you pay out of pocket today while you are working, but keep the money in your HSA and KEEP YOUR RECEIPTS for the medical bills, you can reimburse yourself later (even 15, 20, or 30 years later, it doesn't matter). This means that the money goes in tax free, you capture all the benefits of compounding and THEN you can take the money out tax free. Once you reach age 65, any money inside is treated like a traditional IRA with money pulled out taxed at your current income bracket but with a continued benefit of tax free medical withdrawals.
Step 4. If you have any money left over after you pay your bills and live your life, it should go toward maxing out your 401k, up to the $18,000 limit.
Step 5. If you are maxed out on your available retirement accounts, and still have extra money to invest you can open a regular non-retirement account through Vanguard.
A great benefit of saving with these retirement accounts is that your 401k and HSA and traditional IRAs aren't taxed until you pull the money out later, which means you will be saving TONS of money on taxes right now. If you make $50,000 per year, this will easily drop you into the lowest tax bracket in the US and will help stretch your dollars even further. If you invest in a normal, non-retirement account (step 5) there are no tax advantages for you, compared to the retirement accounts which have HUGE tax advantages. BUT the main benefit to this account is that it is 100% liquid with no penalties for pulling money out, and no loopholes to jump through with age requirements or income requirements. In fact this is an excellent account to build and tap into for an emergency, or if you are an early retiree since there is no age requirements or penalties for withdrawal.
To find a good chunk of money to plunk into these magical money-growing accounts, get yourself on a budget.Take a look at your outgoing funds and see what you can cut to make room for more contributions to these investments. Do you really need cable TV, amazon prime, AND Netflix? Do you really need $100 a month just for alcohol plus another $100 for eating out at restaurants, plus another $300 for normal groceries? Is that car payment bothering you enough that you would be willing to sell the car and get something more reasonable? Watch out for lifestyle creep, stick to your budget, and save those dollars so you can get them working for you!
If you are indeed able to save $26,950 for 10 years, you would put in $269,500 and it would grow to $400,000 in that time period (assuming 7% interest. Check my math here). Let's say at this point you decide to quit your job because you have been working hard and are burned out, and you want to pursue a passion. Lets say your passion happens to produce around $25,000, or $13/hr. Well you were already the Budgeting Master who lived on less than $25,000, so it's no problem for you! Maybe you love to grow microgreens, or write books, or start a band, become a photographer, or work in a ski lodge, or at a nonprofit...there are tons of interesting and awesome jobs and hobbies that bring at least $13 per hour! I suggest finding a passion of yours and going from there.
Meanwhile you have that $400,000 nest egg gathered from the hardcore 10 years of work that you're not even tapping into. Let's say you don't touch it for another 20 years because you're having so much fun pursuing your passions that it turns out your $13 per hour path has blossomed into a cool $30 an hour since you are now an expert in your field and people pay for your expertise. At that point your initial investment of $239,500 will have grown to about $1.5 million dollars. If you wanted to start living off 4% of that, you could withdrawal about $60,000 per year and it wouldn't even touch your principle.
It's a pretty freaking cool system...and it's why I get so excited by something as boring sounding as "retirement accounts"