The Best Investment Order

A good investment strategy takes your current circumstances, long-term goals, and risk tolerance into account. Because all those considerations are personal, the best ways to invest vary from person to person. Deciding where and how to invest your money positions you for financial stability and success. With a wealth of options — stocks, bonds, annuities, retirement accounts, or real estate — choosing an investment order can seem like a daunting task. Read below for guidance on where to invest first.

Make Sure You’re Ready to Invest

Begin your investment strategy by starting and following an emergency savings plan. An emergency fund offers some financial security when unexpected expenses arise. By having emergency savings, you can avoid borrowing money and paying interest to cover costs like unanticipated car or home repairs. Aim to save enough for 3-6 months of expenses.

Next, focus on paying high-interest debts, like credit cards, before investing. Use interest rates for determining if you should put your money toward an investment or reducing debt. Consider paying off debts with interest exceeding the historic average stock market return of 7% first. At or above that interest rate, debt interest usually cancels out any potential financial gains. However, there is an exception to this rule. Continue investing in your 401(k) if your employer offers matching contributions. You lose potential compensation by not participating in a 401(k) with matching employer contributions.

Investment Order

Lay the groundwork for a sustainable financial future by creating and maintaining an emergency fund, and paying down high-interest debts. After that, consider starting your investment strategy in this order:

  • 1. A 401(k) plan is an easy first step into investing. These plans allow you to make tax-friendly retirement account contributions. Many employers offer partial matches to your 401(k) contributions. For example, an employer may offer a 50% match to your retirement contribution up to a certain percentage or dollar amount. Earnings remain untaxed until you withdraw the money. If you withdraw after age 59.5, you’ll pay taxes on the money but avoid a 10% early withdrawal penalty.

    Currently, the maximum annual contribution is $19,500. Anyone age 50 and up can contribute an additional $6,500 annually.

  • 2. A health savings account (HSA) allows individuals to save money for qualified healthcare expenses. Paying for healthcare-related deductibles and provider copayments with an HSA can lower your healthcare costs. The current maximum contribution is $3,600 for individuals, and $7,200 for families. These accounts also carry several tax benefits, such as tax-free withdrawals for qualified medical expenses. An HSA’s interest, dividends, and capital gains do not get taxed.

    However, you need a high deductible health insurance plan to open an HSA account. The question of if you should max out your HSA contribution depends on your situation. To determine what works best for you, start with determining when you will reach full investment in your 401(k) plan.

  • 3. An individual retirement account (IRA) allows you to save tax free and with tax deferrals. In contrast with employer-linked 401(k)s, individuals can open IRAs. However, that means that you decide when to contribute to the account. IRAs also feature lower contribution limits than 401(k)s. However, IRAs typically offer a variety of investment options. Currently, the maximum contribution to an IRA is $6,000. Anyone age 50 or older can contribute an additional $1,000.
  • 4. Maxing out your 401(k) contribution may significantly grow your wealth. However, not everyone can save $19,500 per year, which lowers this option in our ranking. But if you can max out your 401(k) contributions, it provides a huge, long-term boost to your portfolio, thanks to higher contribution limits for 401(k) accounts. Bankrate offers a 401(k) earnings calculator to help you visualize your potential earnings.

  • 5. Index funds try to match the performance of a specific stock market index, such as the S&P 500. By trading in all of a particular index’s stocks, gains and losses experience less volatility. As passive investments, less hands-on management typically means lower fees. You can invest in indexes based on a company’s market capitalization, business sector, or geographic location.

    However, as portfolio investments, you cannot pick and choose what comprises the investment. But that diversity makes index funds an investment worth considering.

  • 6. Additional investment options include high-yield savings accounts, certificates of deposit, treasury bonds, corporate bonds, and real estate. Every type of investment — including those considered low risk — has pros and cons. Certificates of deposit, for example, earn better returns than a regular savings account, and typically feature minimal risk of loss. However, they are not liquid assets. Accessing the money quickly may result in early withdrawal penalties.

Other Considerations

Develop your investing strategy around personal, short-term, and long-term goals. Once you have assessed your financial situation, decide how much risk you feel comfortable with. Next, consider a diverse mix of investment strategies to meet your goals. Diversification combines multiple types of assets in one portfolio.

Consider investing in a range of companies and industry sectors. An example of a diverse investment strategy may include stock investments in small and large companies, bonds, commodities, real estate, and cash equivalents. Or, consider simultaneously investing in a 529 education savings account and an index fund. The 529 account carries less risk but typically delivers less return. A more volatile index fund typically delivers higher returns.

If saving for retirement is your top priority, avoid investing too heavily in accounts that penalize early withdrawals. Finally, look for ways to keep your costs down. Some investment strategies incur trading, maintenance, or management costs. Monitoring and regularly adjusting your plan will maintain diversification as the markets change over time.

Questions About Investments

  • Is it better to invest in your 401(k) or stocks?

    The tax advantages and matching employer contributions typically make 401(k) investments a better long-term choice.

  • How much money can you invest in a 401(k)?

    You may contribute a maximum $19,500 per year in a 401(k). Individuals age 50 and older may contribute $26,000, according to the IRS.

  • What is the riskiest type of investment?

    Experts classify initial public offerings, penny stocks, and junk bonds as among the riskiest types of investments. Low risk investments include high-yield savings accounts and government-backed savings bonds.

  • When should I invest?

    Start investing now if you have enough money to cover day-to-day expenses, an emergency fund, and have paid off high-interest debts, like credit cards.

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