As you just get started with making smarter money moves, you might be a bit confused and overwhelmed as to what types of investment accounts you should open.
After all, each account type may have various rules, offer unique benefits, and only allow you to choose certain assets.
But having these numerous options when it comes to making a decision with your money is also a good thing.
Since your finances and goals are personal to you, it’s imperative that you are making the right choices for you and your family.
This simple guide below will cover the various types of investment accounts you should understand and consider in order to boost your wealth, financial goals, and why it’s important to diversify accounts and assets.
Five Common Types of Investment Accounts
So what are the common types of investment accounts? Previously, there were four that you would need to know.
However, since there have been updated rules by the SEC and new Fintech products looking to change the game for investors, I’ve included another investment account type that is necessary to understand.
The Five Common Types of Investment Accounts:
- Brokerage Account
- 401k Account
- IRA Account
- 529 Account
Certainly this list can be extended when it comes to account options and investing strategies, but this will cover a majority of what you need to get started successfully.
A standard brokerage account is also sometimes called a taxable account or non-retirement account. This is because a brokerage account offers access to several different investments such as stocks, bonds and ETFs. But, anything you earn from these investments are then subject to taxes in that specific tax year.
With a brokerage account, you won’t have a limit to how much you can contribute and you’ll be able to withdraw your money at all times. And additionally, there are a few different types of brokerage accounts too.
The individual brokerage account is an account that is opened by one person who will own the account and be responsible to pay taxes from any income producing assets. As an individual, you’ll be able to hold all kinds of financial assets like different types of bonds, individual stocks, index funds, and ETFs.
The joint brokerage account is just like an individual brokerage account, but instead you will be sharing it with two or more people. This could be an account you open with your spouse or with relatives or friends. Different account holders may be subject to different types of taxes and tax brackets.
A custodial brokerage account is an account that you would set up for a minor. This is usually an account that a parent opens for their child — but really anyone can act as a custodian, including grandparents, family friends or even professionals.
If you open a custodial account, you won’t have unlimited control over the assets in the account and will need to plan wisely on what you invest in. Once the child reaches the age of 18 or 21, they will be in control of the assets (depending on your state laws).
A 401k is a well-known and common type of investment account. It’s a retirement account that allows employees to contribute a percentage of their income into their investment account that is run by the employer. The employer usually picks the financial institution they will work with (and sometimes the asset options too), but the employee decides how much to contribute.
And there are a few types of 401k accounts as well, which will depend on your type of job you have like employed, self-employed, government, etc.
The employer sponsored 401k is the most popular type of 401k. In this investment account, employers may offer a match to the contribution of the employee. An employer may, for example, match up to 3% of an employee’s salary if they contribute at least 5%. Usually, the employee must have worked at the company for a certain period of time.
A solo 401k is similar to the employer sponsored 401k, but is instead designed for small business owners who don’t have employees. With a solo 401k, there are various contribution rule sets, so make sure you read them carefully.
The 403B plan is similar to a 401k, but is instead offered to employees who work at public schools or non-profit organizations. The employee can contribute a certain amount of their salary, and the employer may also match the contribution themselves.
The 457 investment account is another tax-advantaged account for government employees and civil servants, such as police officers and firefighters. With this plan, your employer provides the plan and then as an employee you defer compensation into it on a pretax or after-tax basis. The annual maximum contribution in 2020 is $19,500, but this will change over time so check the limits each year to see if they have increased.
The IRA (Individual Retirement Account) is a separate retirement account to help you save more and invest in your retirement, in addition to your 401k or employer sponsored plan. This can also be a good option if your company does not offer a sponsored plan, but you’d stii like to boost your retirement savings.
Like the other investment account types above, there are some variations of IRAs too.
The Roth IRA is an account where you would put after-tax income and then withdraw tax-free once you retire. You get taxed now, and can then benefit later once you are retired. The benefit of the Roth IRA is that you can withdraw your contributions at any time, but you may have to pay taxes and penalties on earnings in your Roth IRA.
The Traditional IRA is another IRA account where you put pre-tax income, and then get taxed once you withdraw later on in life. It works in reverse to the Roth IRA: you benefit from not paying taxes now, and will need to pay taxes once you withdraw in retirement.
An SEP IRA is similar to a traditional IRA, but is instead designed for business owners. Contributions are tax-deductible and investments can grow until they are withdrawn, and then are taxed at withdrawal.
A 529 savings account is a tax-advantage account that is specifically for individuals who want to save for a beneficiary’s (usually their child) higher education. The 529 can be used at most schools throughout the U.S., and the investments are only taxed on the way in. Some states even offer a match to 529 contributions.
The 529 plan can be used across any state, and at more than 6,000 US colleges. The investment earnings on your 529 are tax-free and so are withdrawals.
And the 529 can be used to pay for tuition fees as well as other college related expenses such as books, supplies, computers and more. The tax-free withdrawals can also be used to pay off federal and private student loans.
There is plenty of info and things to know, so definitely read further about 529 plans on the SEC website.
Crowdfunding is a new kind of investment strategy that encourages several people to come together to raise money and invest in specific assets. Crowdfunding can be used to invest in companies, real estate, and many other types of financial assets that may have a high barrier to entry.
And in many of the crowdfunding investment platforms, you’ll have options to open an IRA as well. Technically, some will consider the account a brokerage account, but crowdfunding in itself is a completely different (and new) type of investment account.
Real Estate Crowdfunding
Real estate crowdfunding is pretty straightforward: investors contribute a certain amount of money to a pool of funds, and then these funds are used to invest in properties and return a profit.
Since real estate usually requires a large down payment, crowdfunding makes real estate investing more accessible; some crowdfunding sites allow users to invest with as little as $10.
Real estate crowdfunding is commonly processed through REITs (Real Estate Investment Trusts) — these are platforms that own and manage real estate such as hotels, warehouses and residential apartments, and then redistribute profits amongst the shareholders.
It’s still a growing phenomena, but it can be a great way to diversify your money into actual properties with less money and not having to manage properties or maintenance yourself.
- Fundrise – Invest in commercial real estate for as low as $500.
- Roofstock – Buy investment rental properties online (accredited investors only)
- Groundfloor – Invest in single-family homes via short-term loans, for as low as $10.
While real estate crowdfunding is by far the most popular in this space, it has expanded beyond properties. Fine art is another asset class that has a high barrier to entry and requires a lot of specialised knowledge.
For this reason, crowdfunding platforms to help people invest in fine art have appeared to make it a more accessible investment.
Platforms such as Masterworks allow anyone to own a “share” in a piece of well-known artwork — and then trade and sell them, just like on the stock market.
There are many different ways to invest in gold: buying physical gold bullion, investing in gold mining stocks and buying gold ETFs (if you financial institution offers them). Yet, crowdfunding is another option to dabble in gold investments.
For example, one way to invest in gold is through Vaulted — where you can buy physical gold but never have to store it if you elect not to. You can purchase gold bars, have them store it safely and securely, or elect to have gold shipped to you.
Collectibles and antique objects are another way to diversify your investments in assets that are outside the international monetary system. Collectibles can range from baseball cards, to old cars, to comic books.
Flipping and searching for collectibles does require expertise, time in the market and knowledge – for this reason, putting your money into crowdfunding is a good alternative to educating yourself on the collectible market.
Diversifying Your Investment Account Types
When you first start investing, it’s likely you’ll first start with safer investments like a 401k, IRA or taxable brokerage. These are the most common types of investment accounts and are easy to understand and get started with.
If your employer offers a match with a 401k, it’s highly recommended to maximize contributions and take advantage of the free money for your retirement.
Once you are contributing regularly to the main types of investment account, you may want to start looking into diversifying between the different types of accounts you have.
The main advantage of investing in different account types is that you can benefit from all the tax breaks offered by the government: free money from your employer sponsored 401k, tax-free money for your children and tax-free money for your retirement.
Having various accounts is also a good way to make sure you always have money in case of emergencies: you won’t want to withdraw from your 401k because of the penalty, so it’s always worth having a taxable brokerage account where you can withdraw at any time without paying any fees.
Finally, having several types of investment accounts means you’ll always have money invested somewhere in case something happens to the other accounts. Diversification reduces risk and over exposure, plus it can help you give peace of mind.
Where Should You Open Your Investment Account?
If you are just getting started, then I’d look at your employer first to get set up with their potential employer sponsored retirement account.
You can also look into micro investing apps, which can be a great additional way to start investing with little money.
From there, you can start to expand your investments and diversify your wealth. However, the type of investment accounts you need will depend on your goals, what interests you, and the amount of money you can afford to risk (as there are always risks involved with investing!).
Additionally, you can consult a financial advisor and/or talk to your CPA about ensuring you maximize your money and lower your tax burden at the same time.