Are you curious about options trading but don’t know where to start? Look no further!

This guide will break down the fundamentals of options trading for beginners, focusing on calls and puts with real-world examples to help you understand how it all works.

By the time you finish reading, you’ll be ready to start trading options with confidence.

What are Options?

Options are financial contracts that give you the right, but not the obligation, to buy or sell an asset at a set price before a certain date. In options trading, there are two main types: call options and put options. Understanding these basics is essential when starting options trading.

Difference Between Stocks and Options

When you buy a stock, you own a piece of a company. Your profit or loss is directly tied to the stock’s price movement.

Options, however, give you the right to buy (call options) or sell (put options) a stock at a specific price, known as the strike price, within a set period.

This distinction is key in options trading.

How Call Options Work

A call option gives you the right to buy a stock at a certain price before the option expires. Let’s walk through an example step-by-step:

1. Buying a Call Option:

Suppose you buy a call option for Apple with a strike price of $145, expiring in one month. The cost of this option, known as the premium, is $5.

2. Stock Price Rises:

If Apple’s stock price rises to $200, you can exercise your option to buy at $145 and sell at $200, making a profit. Your net profit would be $50 ($55 from the stock price increase minus the $5 option cost).

3. Stock Price Falls:

If Apple’s stock price falls to $100, your option expires worthless, and you lose the $5 you paid for the option.

What Happens to the Buyer of a Call Option if Stock Goes Up?

When the stock price goes up, the buyer of a call option benefits. For example, if you have a call option to buy Apple at $145 and the stock price rises to $200, you can exercise your option, buy at $145, and sell at $200, making a profit. After accounting for the $5 premium, your net profit would be $50.

What Happens to the Seller of a Call Option if Stock Goes Up?

If the stock price rises above the strike price, the seller of the call option incurs a loss. In our example, if Apple’s stock price rises to $200, the seller must sell the stock at $145, even though it’s worth $200. The seller’s net loss, after considering the $5 premium received, would be $50.

What Happens to the Buyer of a Call Option if Stock Goes Down?

If the stock price falls below the strike price, the call option expires worthless. The buyer loses the premium paid for the option. For instance, if Apple’s stock price falls to $100, the buyer wouldn’t exercise the option to buy at $145 and would lose the $5 paid for the option.

What Happens to the Seller of a Call Option if Stock Goes Down?

When the stock price falls below the strike price, the call option expires worthless, and the seller keeps the premium received. In our example, if Apple’s stock price drops to $100, the seller keeps the $5 premium without any obligation to sell the stock.

How Put Options Work

A put option gives you the right to sell a stock at a certain price before the option expires. Here’s how it works:

1. Buying a Put Option:

You buy a put option for Apple with a strike price of $145, expiring in one month, costing you $5.

2. Stock Price Falls

If Apple’s stock price falls to $100, you can exercise your option to sell at $145 and buy back at $100, making a profit. Your net profit would be $40 ($45 from the price difference minus the $5 option cost).

3. Stock Price Rises

If Apple’s stock price rises to $200, your option expires worthless, and you lose the $5 you paid for the option.

What Happens to the Buyer of a Put Option if Stock Goes Down?

If the stock price falls below the strike price, the buyer of a put option benefits. For instance, if you have a put option to sell Apple at $145 and the stock price falls to $100, you can exercise your option, sell at $145, and buy back at $100, making a net profit of $40 after the $5 premium.

What Happens to the Seller of a Put Option if Stock Goes Down?

If the stock price falls below the strike price, the seller of the put option incurs a loss. In our example, if Apple’s stock price falls to $100, the seller must buy the stock at $145, even though it’s worth only $100. The seller’s net loss, after considering the $5 premium received, would be $40.

What Happens to the Buyer of a Put Option if Stock Goes Up?

When the stock price rises above the strike price, the put option expires worthless. The buyer loses the premium paid for the option. For example, if Apple’s stock price rises to $200, the buyer wouldn’t exercise the option to sell at $145 and would lose the $5 paid for the option.

What Happens to the Seller of a Put Option if Stock Goes Up?

When the stock price rises above the strike price, the put option expires worthless, and the seller keeps the premium received. In our example, if Apple’s stock price rises to $200, the seller keeps the $5 premium without any obligation to buy the stock.

Summary of Calls vs. Puts

Understanding the differences between calls and puts is crucial for options trading:

• Call Options: Give you the right to buy a stock at a specific price before the option expires.
  • Buyer: Benefits if the stock price goes up.
  • Seller: Incurs a loss if the stock price goes up.
• Put Options: Give you the right to sell a stock at a specific price before the option expires.
  • Buyer: Benefits if the stock price goes down.
  • Seller: Incurs a loss if the stock price goes down.

The Contract Multiplier

Options contracts typically represent 100 shares of the underlying stock. This means that the premium you pay or receive must be multiplied by 100 to determine the total cost or revenue from the contract. For example, if an option premium is quoted at $5, the actual cost is $500.

How to Buy/Sell Options (The Options Chain)

When you decide to trade options, you’ll use something called the options chain. This is a list of all available options for a particular stock, including details such as the strike price, expiration date, and premium.

1. Finding the Options Chain

Let’s say you want to trade options on Apple. You would go to your trading platform and look up Apple’s options chain. Here, you’ll see a list of call and put options with various strike prices and expiration dates.

2. Selecting an Option

Suppose you choose a call option with a strike price of $145, expiring in one month. The options chain shows this option costs $1.41 per share. Since each contract represents 100 shares, the total cost would be $141.

3. Executing the Trade

If you decide to buy this call option, you’ll place an order on your trading platform. Conversely, if you choose to sell an option, you’ll receive the premium (in this case, $141) upfront.

Tips for Successful Options Trading

• Educate Yourself Continuously: Stay updated with market trends and learn from books, courses, and online resources. Here are the 5 best personal finance books that changed my life.
• Start Small: Begin with small trades to minimize risk and build your understanding. Check the Top 7 Beginner Investing Mistakes to Avoid at All Costs.
• Use Tools and Resources: Utilize resources like the Options Trading Starter Kit for practical tools and tips.
• Monitor the Market: Keep an eye on market conditions and news that could affect your trades.
• Maintain an Emergency Fund: Ensure you have a separate fund to cover unexpected expenses, so you don’t need to tap into your investments.

By following these steps, you can avoid common mistakes and increase your chances of success in options trading.

In my video My $400/Day Side Hustle, I share more insights on generating consistent income through strategic trading.

Ready to Start Trading?

Options trading can be a powerful tool for both generating income and managing risk. By mastering the basics of calls and puts and applying the strategies discussed in this guide, you’ll be well-equipped to start your options trading journey with confidence.

Don’t forget to download the Options Trading Starter Kit for additional resources to support your learning. Happy trading!

Recommended Reading to Enhance Your Investing Knowledge

• Unshakeable: This book gives you courage and blasts all the fears and misconceptions you have about investing.
• Think and Grow Rich: The ultimate book on money mindset and wealth consciousness.

The post Options Trading for Beginners (with Detailed Examples) appeared first on Rose Han.

The Fidelity’s Index Funds

I’m going to talk about which of Fidelity’s index funds are the best ones to invest in, and I’m also going to show you how and where to buy them.

Index funds are a great way to get started investing safely, without doing hours and hours of research on individual stocks. They’re the best way to create a diversified investment portfolio that grows your money big time over the long run. And Fidelity is known for being one of the most reputable, low-cost index fund providers in the industry. I also happen to be a long-time user of Fidelity, so not only do I know the platform inside out, but I’ll also take you on a tour of my account so that you can see what investing at Fidelity really looks like. So if you’re interested in buying some Fidelity index funds, then keep reading!

So let’s get right into it!

• First, I’m going to talk about the most important criteria to look for before investing in Fidelity index funds, or any index fund in general
• Then, I’m going to give you a list of the best Fidelity index funds that meet these criteria.
• And finally, I’m going to talk about how to buy them, including how much to buy and in what combination.

What is Index Fund?

First off, I don’t want to assume anything, so allow me to explain what an index fund is before I get into all the other stuff. An INDEX FUND is a pooled investment vehicle that gives you an instant slice of ownership in hundreds of different stocks, all in one easy purchase. It’s called an index fund because the stocks in the fund are chosen by an index, rather than by some super-smart, overpaid money manager. Indexes you might have heard of are the S&P 500, the Nasdaq, and the Dow Jones. So an S&P 500 index fund will have all the 500 stocks in the S&P 500 index. And a Dow Jones index fund will have all 30 stocks in the Dow Jones index.

Ok, now with that out of the way, let’s talk about what criteria to look for in Fidelity index funds.

IMPORTANT CRITERIA

First Criteria

There’s a couple of things you want to look at when buying an index fund, and the first thing is the expense ratio. The expense ratio is how much money is being skimmed off the top from your investment every year. In other words, it’s an annual fee for investing in the fund. If you want to avoid paying this fee, your only other alternative would be to go out and buy every single stock in the fund yourself. That’s obviously quite labor-intensive and not feasible, so I certainly don’t mind paying a fee to the index fund to do all that work for me. That being said, I want to keep that fee as low as possible. What can I say, I’m cheap!

A good rule of thumb is to look for an expense ratio of under 0.20%. For example, here’s a Fidelity index fund, the Fidelity Total Market Index Fund. If you invested $1000 in this fund, you’d pay an annual fee of only $0.15. Peanuts! However, if you invested in this fund, the Fidelity Women’s Leadership Fund, your annual fee would be 1.12% or $11.20 a year. It doesn’t sound like a huge difference, but compounded over time, a small difference in fees adds up to hundreds of thousands of dollars! Don’t believe me? Check this out:

This chart the difference that fees make in your investments. A difference of 1% in annual fees reduces your nest egg by $42k at the end of 30 years! Crazyyyyyy. So when you’re looking to invest in Fidelity index funds – or any index fund in general – the expense ratio is the #1 criteria. To find a fund’s expense ratio, just pull up the fund summary page, and look for the section that says “Gross Expense Ratio”. Again, you’re looking for funds with an expense ratio of 0.20% or less.

Second Criteria

The second criterion to look for is the automatic reinvestment of your dividends. Let me explain: When you invest in the stock market, you get dividends monthly or quarterly, and they look something like this. And every time you get a dividend deposit, you don’t want that cash to just sit there. You want to use that cash to buy more stocks. That way, you can make money on your money. Your dividends buy you more stocks, which in turn pays you more dividends, which you use to buy more stocks – and so on and so forth. That’s called compound interest, and omg, it’s like the best thing ever!

This chart shows you the difference between reinvesting your dividends and NOT reinvesting your dividends. If you invested $100k to start and you reinvest your dividends as I told you, you’d have $152,662.49 today. But if you didn’t reinvest your dividends, you’d have only $81,963.34. Moral of the story? Reinvest your dividends.

Two Forms of Index Funds

And the way to do that is by investing in Fidelity index funds that are MUTUAL FUNDS, not ETFs. Index funds can come in two forms –  mutual funds and ETFs. For example, you can invest in an S&P 500 mutual fund, or an S&P 500 ETF. The end result with either is that you’ll own a slice of the S&P 500 index. However, ETFs don’t do automatic reinvestment of your dividends. Only mutual funds do! So the second criteria to look for when buying Fidelity index funds is to make sure that it’s a MUTUAL FUND, not an ETF. The way to do that is by pulling up the ticker symbol for the fund, and confirming that it says “Mutual Funds” up here in the upper left corner.

Third Criteria

Ok, and now for the third criteria: transaction fees. Transaction fees are whatever the fund charges you to buy into the fund and to cash out of the fund. Some funds charge you for both, other funds don’t charge you for anything. Obviously, we’re going for the funds that don’t charge you anything. That’s right! We’re looking for free 99!

The good news is, if you have an account at Fidelity, you’re not going to pay any transaction fees to buy any of Fidelity’s mutual funds. But if you have an account at Vanguard, for example, they’ll probably charge you a transaction fee of like $50 or something crazy if you want to buy a Fidelity fund. So bottom line: if you have your brokerage account at Fidelity, you won’t have to worry about transaction fees.

The best fidelity index funds

Ok and now for the best Fidelity index funds! First of all, these are all mutual funds, no ETFs on this list, because I strongly believe that dividend reinvestment is a non-negotiable feature. Second of all, this list of funds is not an explicit recommendation to buy – it’s just a resource to help you jumpstart your research. So with that disclaimer out of the way, here we go!

For domestic stocks, Fidelity Total Market Index Fund or ticker symbol (FSKAX), the expense ratio of 0.015%

For international stocks, Fidelity International Index Fund (FSPSX), the expense ratio of 0.035%

For emerging market stocks, Fidelity Emerging Markets Index Fund (FPADX), the expense ratio of 0.075%

For U.S. government bonds, Fidelity Intermediate Treasury Bond Index Fund (FUAMX), the expense ratio of 0.03%

For U.S. government bonds, Fidelity Inflation-Protected Bond Index Fund (FIPDX), the expense ratio of 0.05%

For real estate, Fidelity® Real Estate Index Fund (FSRNX), expense ratio 0.07%

I made a handy PDF download for you with a list of all these funds, their ticker symbols, and expense ratios, and links to the Fidelity fund summary pages, so grab it HERE!

How to buy fidelity index funds

And now, let’s talk about how to buy these funds. Once you decide which fund you want to buy, the rest is super easy. You type in the ticker symbol in the search bar, pull up the fund summary page, and click BUY.

You’ll see that you need to specify a dollar amount. All of the funds I mentioned here have no investment minimums, so you can literally buy $1 if that’s all you have.

But assuming you have more than $1 to invest, the question you need to ask yourself is how much to buy of each fund – in other words, what asset allocation you want. Asset allocation is the particular mix of investments that you have in your portfolio, and it’s THE number one decision you need to make before you pull the trigger on any of these Fidelity index funds. For example, if you have $10k of investments and $5k of that is in stock funds, and $5k is in bond funds, then your asset allocation is 50% stocks / 50% bonds. Generally, the longer your time horizon, the more you want to have in stocks. It’s also a good idea to mix in other asset classes, like real estate, in order to make your portfolio as bulletproof as possible throughout any economic conditions.

The most basic asset allocation is doing a split between stocks and bonds. Jack Bogle, the founder of Vanguard and also considered by many to be the OG of index funds, recommends subtracting your age from 100 and owning that much in stocks. So if you’re 30 years old, you’d own 70% in stocks, and 30% in bonds. If you’re investing $10k into Fidelity index funds, then you could buy $7k of Fidelity Total Market Index Fund (FSKAX) and $3k of Fidelity Intermediate Treasury Bond Index Fund (FUAMX).

Here’s a slightly fancier asset allocation, recommended by David Swensen, who’s the legendary manager of Yale’s endowment fund. He helped Yale grow its endowment fund from $2b to $27b over the last 34 years, so to me – whatever he recommends is gold. He recommends the following asset allocation:

David Swensen recommendation:

• 30% in Domestic Equity
• 15% in International Equity
• 10% in Emerging Markets
• 15% in U.S. Treasuries
• 15% in inflation-protected U.S. Treasuries
• and 15% in real estate

So if you have $10k to invest and you’re using Fidelity index funds, your portfolio would have 6 different funds in it and look something like this:

Again, you can refer to my free PDF download, which I’ve linked in HERE. It has all this info in there, with pie charts that explain these recommended asset allocations as well as a list of the Fidelity index funds you can use.

FINAL THOUGHTS

So there you have it! Now you know:

• What criteria to look for when investing in Fidelity index funds
• You have a list of the best Fidelity index funds that meet these criteria
• And you also know how to buy them and how much to buy of each

Investing doesn’t have to be hard or complicated. Index funds are the best way for a beginner to start. Investing with low-cost index funds using a proven asset allocation (like the ones I showed you by Jack Bogle and David Swensen) is a no-brainer way to create lots of wealth over the long run. If you’re sitting on some cash and you want to start putting your money to work, I highly recommend choosing one of those asset allocations and getting started asap with Fidelity index funds. The key here is to start now, perfect later! Because every day you wait is another day when your hard-earned money isn’t working for you.

The post Fidelity Index Funds For Beginners (DETAILED TUTORIAL) appeared first on Rose Han.

Which investing platform should you use, Betterment or Robinhood?

I’ve used Betterment for about 2 years now, and Robinhood for just a couple of months. In this blog, I’m going to compare each app side by side, take you on a tour of my accounts, and finally, provide some guidance on which one to go with.

Side-by-side comparison

Now, I started investing with Betterment about 2 years ago, and I absolutely love it. Then when Robinhood came on the scene, I got really curious because the platform was offering stock trading for zero commissions. I’d never seen that before, so I decided to try it out. While both apps are for investing, I’ve found that they actually serve totally different purposes.

Roboadvisor VS Trading Platform

Betterment is a roboadvisor, while Robinhood is a trading platform. What does this mean?

A roboadvisor is x. So Betterment does x.

On the other hand, a trading platform is nothing more than x.

On a trading platform, you need to know exactly what you want to buy or sell and initiate the orders yourself, whereas a roboadvisor executes them for you based on their algorithms.

So if you want to do your investing in Robinhood vs with a roboadvisor like Betterment, then you better know what you want to buy and why it’s a good investment.

ACCOUNT TYPES OFFERED

• Betterment: IRAs, Smart Saver, etc.
• Robinhood: cash and margin, no interest on your cash

I get worried when someone tells me that they don’t have an IRA, they’re not maxing out 401k, but they’re “doing Robinhood”. This tells me they’re leaving a lot of money on the table by not investing in tax-advantaged retirement accounts. Ideally, you have a 401k that you’re maxing out your employer match, an IRA at Betterment, and then a trading account at Robinhood for buying stocks.

INVESTMENTS OFFERED

• Betterment: portfolios (SHOW THE LIST OF ETFs)
• Robinhood: individual stocks and ETFs and cryptocurrency and options

… no AUTOMATIC investing or dividend reinvestment

… check out my stock investing checklist

TOUR OF MY ACCOUNTS

Betterment

• Goals
• Portfolio and the projection graph/calculator
• Auto and recurring deposits

Robinhood

• Charts and news feed (very day-trader ish), show my HSBC desk!
• Buy and sell orders

The post Betterment vs Robinhood (SIDE-BY-SIDE DETAILED REVIEW) appeared first on Rose Han.

In this blog, I’m going to compare Ellevest vs Betterment, which is two investing apps – or roboadvisors – that take a goals-based approach to invest.

So let’s get right into it! I’m going to compare Ellevest vs. Betterment in terms of:

• Mission
• Investment portfolios offered
• Investment strategy
• Account types offered
• Fees

Finally, I’ll end with some closing remarks and a recommendation on which one you should go with.

MISSION

• Let’s talk about the mission. As a potential customer of any company, I always want to know what that company is all about. What’s their mission, and has difference are they trying to make in the world?
• What intrigued me about Ellevest is that the company is 100% women-run and women-owned. The company’s tagline is “Invest Like A Woman”, and they’re on a mission to close the gender investing gap,  with an investing approach designed by and for women.
• On the other hand, Betterment doesn’t have as clear of a mission, although they do feature a picture of a WOMAN on their home page, which is kind of nice since marketing investment products is typically directed at men, or at least that’s how it’s been in the past.
• However, between the two, Ellevest is definitely more targeted towards women, whereas Betterment is designed for pretty much anyone who wants to invest, man or women.
• Something else that’s really cool about Ellevest is that you get the opportunity to invest in companies that value gender diversity and women’s leadership, which brings me to my second point of comparison: investments offered

INVESTMENT PORTFOLIOS OFFERED

• Both Ellevest and Betterment offer a couple of different portfolio options.
• At Ellevest, you get the option to choose between TWO portfolios, and at Betterment, you get the option to choose between FOUR portfolios.
• Let’s first talk about Ellevest. The two portfolios they offer are the Core and the Impact portfolio. The Core portfolio includes up to 26 different exchange-traded funds, or ETFs, that give you exposure to a wide range of asset classes. The Impact portfolio is very similar, except that they’ve switched out some of the funds in the Core portfolio for funds that focus on socially responsible investing. For example, the Impact portfolio incorporates the Pax Ellevate Global Women’s Leadership Fund, as well as the iShares MSCI EAFE Fund. These are both ETFs that contain companies that advance gender equality and also have a positive impact on the environment. So it’s pretty simple – at Ellevest, you have 2 portfolios to choose from, the Core or the Impact portfolio.
• On the other hand, Betterment offers 4 portfolios. Their default option is the Betterment Portfolio (which is comparable to the Ellevest Core Portfolio). They also offer the Betterment Socially Responsible Investing portfolio (which is comparable to the Ellevest Impact Portfolio). Betterment also offers the Goldman Sachs Smart Beta portfolio (which is a riskier but potentially more profitable portfolio), and the BlackRock Target Income portfolio (which is specifically for people who want to generate income off of their nest egg). As you can see Betterment does have a few more options.
• If you’re about to retire and you’re looking to generate income, then Betterment’s BlackRock Target Income portfolio is probably the best fit for you. Because as of now, Ellevest doesn’t offer a specific portfolio for income generation. Their portfolios are mainly designed for growth.
• If you’re passionate about socially responsible investing, then both platforms have portfolios for you. I will say though, that the Ellevest Impact portfolio has a LARGER percentage in socially responsible investments than Betterment’s version. For my Retirement goal, Ellevest has 51% in socially responsible funds, versus Betterment’s 39%. Also, Betterment doesn’t target social impact specific to women, whereas Ellevest chooses funds that specifically help advance women’s leadership and economic opportunities for women.

ACCOUNT TYPES OFFERED

• Now let’s talk about the different account types offered on each platform.
• Both Betterment and Ellevest offer Traditional IRAs, Roth IRAs, SEP IRAs, non-retirement Individual accounts, and 401k or 403b Rollovers.
• Betterment goes even further and also offers Joint accounts, which are accounts with two owners such as you and your spouse, and they also offer Trust accounts, which are accounts that you manage but belong to someone else, such as your children.
• Another thing to consider when choosing an investing platform is what kind of banking features they provide. Savings & checking accounts are nice amenities that make it easier to manage your money & investments all in one place.
• As of now, Betterment offers a savings account called the Everyday Savings account. It pays a generous interest rate of 2.44%, and any withdrawals take about 1-2 business days to process. They’re also rolling out a Checking account soon, but as of today, it’s not ready yet.
• Ellevest is a little bit behind the ball in this regard. I haven’t heard of any plans to roll out a checking account program as of yet. And their savings account, called the Ellevest Emergency Fund, pays a meager 0.01% interest, which is a lot less than Betterment’s 2.44%. But Ellevest hasn’t been around as long as Betterment, and they’re continually adding new features so my guess is that they are going to offer good savings account alternative at some point.

INVESTMENT STRATEGY

• Moving right along to Investment Strategy. Ellevest and Betterment are very similar in the sense that their investment strategies are based on maximizing your chances of achieving your goals. Most other roboadvisors out there have investment strategies that are based on your risk-tolerance, and they don’t ask you much about your goals. I think this is a big mistake because that usually doesn’t help people actually achieve their investing goals. Smart investing should aim to maximize your chances of having the amount of money you need, when you need it, regardless of your risk tolerance.
• At Ellevest or Betterment, the first thing they’ll always ask you is what goal you’re investing towards. Then depending on your goal AND your timeline for achieving that goal, they’ll design an investment portfolio that gives you the highest probability of accomplishing it.
• For an in-depth explanation of goals-based investing, make sure to check out this blog. I’ll explain to you how Ellevest invests your money based on the goals that you have. I don’t want to repeat myself in this article, so definitely make sure to find time to read and learn more.
• So how are Betterment and Ellevest different?
• Again, Ellevest’s investment style is geared more towards women. First of all, the typical financial situation for women does NOT look like the typical financial situation for men. Women live longer, and due to things like taking time off work to raise children, their career trajectory and salaries look different from men’s. So all their forecasting and advice take this into account.
• For example, since women tend to have longer lifespans than men when you have a retirement investing goal at Ellevest, they’re going to recommend that you aim for a larger nest egg than other platforms would recommend. I think this is smart, especially given that statistically, women are 80% more likely than men to be living in poverty at age 65 and older. Not fun to think about, but hey, it’s a reality so women need to invest accordingly!

FEES

• Last but not least, I want to quickly touch on fees.
• Betterment and Ellevest both charge an annual fee of 0.25%. That means that if you have $1k invested with them, you’ll pay $2.50 per year in fees. Most roboadvisors charge 0.25%, so fees aren’t really a distinguishing factor when choosing a platform.

MY FINAL THOUGHTS

Clearly, the distinguishing factor between Ellevest vs Betterment is that everything about Ellevest is women-centric, whereas Betterment is built for the general investing public.

• MISSON: Everything from the Ellevest mission to close the gender investing gap, to the way they design their investment portfolios, is created to help women invest the way they want to invest.

• PORTFOLIOS: Compared to Betterment, Ellevest offers superior options for socially responsible investing, because their Impact portfolio allocates a much higher percentage of 51% to socially responsible funds, vs Betterment’s 39%. However, Betterment does offer a wider range of portfolios for the more advanced investor, such as their Goldman Sachs Smart Beta portfolio and their BlackRock Target Income portfolio. Only you understand your financial needs well enough to know which platform has the right portfolio for YOU.

• ACCOUNT TYPES: As a newer platform, Ellevest doesn’t offer as many account types as Betterment. The biggest one being their lack of a good savings account. Betterment’s savings account is currently one of the highest I’ve ever seen, at 2.44%, vs Ellevest’s rate of 0.01%. Hopefully, Ellevest comes out with a better option soon.
• INVESTMENT STRATEGY: Finally, the investment strategy of each platform is slightly different. The advice you get at Ellevest is going to be more tailored to the typical financial profile of women, which is that they live longer and earn less than men over their lifetime.

Personally, I keep my emergency savings at Betterment so that I can collect the 2.44% interest, but I have investments at Ellevest because I want to support their mission and as their tagline says, I want to “invest like a woman”. I hope this article has been helpful for you in deciding between the two platforms.

As you can see, there are nuances and differences in features, but at the end of the day, all of these apps are investing in the same stock and bond markets, so it’s not going to make a huge difference in how much money you can make. The point is to just get invested!

The post Ellevest vs Betterment (WHICH PLATFORM IS THE BEST?) appeared first on Rose Han.

I’m telling you – 1 year of serious focus & alignment can put you 10 years ahead in life! If you could use a motivational kick in the ass, plus some tips on how to set good financial goals (and actually achieve them)…. then KEEP READING

Let’s talk about setting financial goals. The new year is just around the corner, and we all know how important it is to have goals – goals that get you closer to the life that you truly want.

FOUR SMALL STEPS TO SET FINANCIAL GOALS

In this blog post, I will share with you 4 simple steps to set financial goals and actually achieve them. I know it’ll be encouraging for many of you to hear about my own personal journey as well. But don’t take my word for it – all the tips and strategies I’m going to share with you are backed by research and data as well!

#1 THINK BIG BUT START SMALL

A lot of us have big goals for ourselves, but sometimes that gap between where you are now and where you want to be can be so big that it paralyzes you from taking action.

Back when I started my personal finance journey, I had $100k of student loans, but I always knew I wanted to be a millionaire. But whenever I thought about wanting to be a millionaire, instead of motivating me to take action, I just felt super deflated and helpless. Like, here I am with a net worth of NEGATIVE $100k, so I didn’t see a path to one day having a POSITIVE net worth of $1M.

Humans are motivated by the belief that they can make progress. If something seems impossible, you’re not even going to try. In a study done by Stanford researcher Szu-chi Huang, they found that “When you are just starting a pursuit, feeling reassured that it’s actually doable is important, and achieving sub-goal increases that sense of attainability.”

One day, I realized that it would feel amazing just to be at ZERO. Forget $1M – just having a net worth that’s no longer negative would be amazing! So rather than thinking about this huge financial goal in the distant future, I decided to focus on a sub-goal of getting to zero. It seemed so much more achievable for me, and I’m telling you… EVERYTHING changed from that moment on.

I started chipping away at my debt, $1k at a time. Every time that thousand-dollar decimal place went down, I focused on the progress I was making. These moments of mini-progress created a snowball effect, it motivated me SO much to keep going. It’s almost like I got addicted to that feeling, so I started paying off my debt with whatever extra money I could come up with. It literally became a hobby of mine, and 3 years later, my net worth finally crossed the zero mark.

So think BIG, but start small. It’s super cliche, but a journey of a thousand miles really does begin with a single step. And just because you start small doesn’t mean you think small. Now that I hit the zero mark, now I’m focused on the $100k mark. Then, when I reach that sub-goal, I’ll start focusing on the half-million mark. Then, when I reach that sub-goal, I’ll focus on the $1M mark. See how it works?

So for step 1, I want you to think about what starting small looks like for you right now. Just close your eyes and think about it for a second. If it gets you a little bit closer to your ultimate goal, and it makes you feel motivated vs deflated, then you know you’re on the right track.

#2 Activate your RAS

Your RAS (Reticular Activating System) is the part of your brain that tells you what to notice. Selectively filters out information. At any given moment, there are billions of bits of data coming at you. So the RAS is a survival mechanism that saves your brain from having to process all that information all the time. Without the RAS, your brain would short-circuit, like a 120V blowdryer that you plug into a 240V outlet.

Even without being consciously aware of it, your RAS selectively notices only what it thinks is important. That’s why you can often tune out the noise as you’re walking down a busy street, but when someone calls out your name, you instantly snap to it.

So when you tell your RAS what’s important, it will start noticing things around you related to that. The more specific, the better. Recently, I set a goal to get a puppy in the next year. I got really specific, and I know I want a grey-colored French bulldog. As soon as I did that, I started noticing French bulldogs everywhere – on the street, in my building, on my Instagram feed – and pretty soon, my neighbor who has a French bulldog asked me to petsit while she was away.

That’s how the RAS works – when you tell your brain what you want, it starts looking for ways to make that a part of your reality, and it also filters out everything that isn’t in line with what you want. The RAS is literally the scientific proof behind the Law of Attraction!

So here’s what I want you to do: I want you to get super clear on your financial goal, and write it down. Be specific! Instead of “I want to get out of debt”, make it “I want to pay off my Discover credit card by February.” Instead of “I want financial security”, make it “I want to build a $5k emergency fund in 3 months”. Instead of “I want to start investing for my future,” make it “I want to have $10k in my Roth IRA by my 30th bday”. Put it on a sticky note on your mirror, or somewhere where you can see it DAILY.

And even if you have no idea how you’re gonna come up with that money, don’t worry the HOW, just worry about the WHAT! Your RAS is going to figure out how. It works 24/7 to scan your environment for all the messages, people, and opportunities related to your financial goal.

When I was working to get out of negative net worth, I had a piece of paper on my wall where I had my goal net worth clearly stated. Now, it’s a spreadsheet that I look at every day.

#3 Plan for obstacles in advance

Plan ahead for anything that might derail you for obstacles in advance. Think about all the things that might derail you and deal with them now – before it happens. Do you have a friend with expensive taste, and she always wants you to go to fancy restaurants with her, go on trips with her, etc? Tell her in advance that you can’t spend that much on going out anymore, because you have financial goals. If she’s a REAL friend, she’ll support your decision and find other ways to hang out with you. If not – then you need to defriend her ASAP.

Other things that might derail you – if you shop online a little too much, then delete the Amazon Prime app from your phone, and delete all the auto-saved credit card information.

For me, it was spending too much on Seamless. When I’m hungry and don’t have any food in the fridge, I’ll just go crazy on food delivery. So planning ahead to always have groceries in the fridge was one of the things I did.

Basically, it takes a LOT to reach your financial goals, don’t expose yourself to anything that might make it harder. When your best friend calls you on a Friday night expecting to go out for yet another $70 dinner, it can be hard to say no. Ask her in advance not to do that. Do whatever you need to do to set up your environment to naturally breed financial success.

#4 Eliminate the need to exercise will power

The fourth step is to eliminate the need to exercise will power, by putting your financial goals on AUTOPILOT. When I was climbing my way out of debt, I had automatic monthly payments on ACH from my checking account to my student loans. The recurring amount was a little more than I was comfortable with, but once I set it on autopilot, it was no longer a question of IF I’m going to pay off debt, or whether I should pay off this much or that much. It just became a fact.

And now, my financial goals have expanded to things like investing goals, and I put all of that on autopilot as well. Here’s a screenshot of a recurring automatic monthly investment that I set up in my Fidelity account: on the 1st of every month, $200 goes from my checking account to my HSA, and it automatically buys more of the index funds that I already own.

If I left it up to chance, I’d probably never remember to log in and buy more investments, I’d probably come up with all kinds of excuses to not save that $200 and to spend it on something else instead. But because it’s all automated, I get closer to my financial goals whether I feel like it or not. Wherever possible, put your goals on autopilot.

Ok, if you’re feeling inspired and full of ideas by now, GOOD. Don’t let this be some Youtube video that you consume but don’t take any action on. To kickstart your financial goal-setting, I want you to take ONE tiny baby step action RIGHT NOW.

When I started my $100k debt payoff goal, that baby step for me was to just add up all my debts on a spreadsheet. Easy, fast, something you can do right now.

Here are some other ideas for you:

• If your goal is saving money: go through your credit card statement and cancel ONE monthly subscription that you don’t really need, and reroute that to savings instead
• If your goal is investing: call your HR department and make sure you’re maxing out your 401k employer match

It’s too easy to think about your financial goals and go “I’ll start tomorrow”. No, start today! Think of one small thing you can do and tell me what it is in the comments below!

Like RIGHT NOW. I’ll wait.

Thanks so much for taking your time reading this article until the end! I really hope this blog has helped you learn how to set good financial goals (and ACTUALLY achieve them). It’s kinda my first time sharing so openly – but hey – it felt pretty good and I’m sure a lot of you can relate to my stories.

The post Financial Goal Setting (HOW TO ACHIEVE BIG MONEY GOALS) appeared first on Rose Han.

I’m going to share all the tips and tricks that helped me pay off $80,000 of student loans debt in less than six years.

Now, if you have a lot of student loans to pay off, welcome to the club. The national student loan debt is over one and a half-trillion dollars and the average borrower graduates with about $30,000 in student loans. I went to an expensive private school in New York City, so I graduated with actually a lot more than that at $100,000. Most people don’t have parents who can just pay for college and cash and tuition costs have all risen exponentially faster than wages, so it is pretty normal to have to borrow money to pay for college.

That being said, student loans are a huge obstacle to financial independence and the sooner you pay it off, the sooner you’ll have more freedom in your life. So let’s not settle for less around here. Let’s get that shit paid off.

In this article, I’m going to share all the tips and tricks that helped me pay off $80,000 of student loan debt in less than six years. I’ll talk about the mindset shifts you need to make, as well as some creative ways to come up with extra cash to help you pay off your student loans even faster. So if you’re ready to wipe out your student loans once and for all, then keep reading.

Tip # 1

My first tip is to start tracking your progress and that all starts with figuring out how much debt you have today. So for me, it started with a simple piece of paper on the wall where I wrote my total student loan balance and then I updated it every time I made a payment towards paying it off. Before that, I wasn’t even sure how much total I owed. So you know, I just didn’t want to know, so I had this head in the sand approach, but when I finally faced the truth head-on and then started tracking my progress monthly, that’s when my student loan balances started to go down quickly.

Sometimes it feels like you have this mountain of debt that’s just never going to go away, but when you start seeing that number go down, it creates this incredibly motivating feeling of progress and there’s really nothing more motivating than progress. Even just making a little dent will motivate you to get out of debt even faster and then that increases your motivation even more and then creates this unstoppable snowball effect. So all you really need is a post-it note on your bathroom mirror or somewhere you can see it every day and that’s what I had.

If you want something a little fancier, I found this awesome website called the debtfreecharts.com and you can download these super cute coloring charts to track your progress and these coloring charts, because you can really see how much left you have to go, it really motivates you to want to keep coloring in that space even faster and you know how it feels like really awesome to just check things off a to-do list? So that’s because whenever you finish a task or a project and you get to cross it off, your brain releases a hit of dopamine and it makes you feel accomplished and happy. So why not hack your brain to just help you pay off your student loans faster? Again, the website is called debtfreecharts.com.

Tip #2

My next tip for you is to put $100 extra towards your student loans every month. Why a hundred dollars? Because everyone can manage $100. You can either reduce your expenses by a hundred or find a way to earn an extra 100. Only $100, so no excuses. Examples of expenses you can cut out are, for example, you can pack lunch two times a week. That’ll save $12.50 for a total savings of 100 a month. You can cancel your gym membership, which is, $100 usually, and you can work out in your living room instead. There are tons of free workout videos on YouTube and a lot of you probably have a free gym in your building that you can use otherwise. Some other ideas, you can start doing manicures and pedicures at home instead of getting your nails done at a salon that saves $100 a month or challenge yourself to take only public transportation for a month and save on Uber’s. There are so many ways to come up with an extra $100 to throw towards your debt every month. It’s all about being committed and if there’s a will, there’s a way.

Now if your budget is already super lean and there’s absolutely nothing to cut out, then you can also start a side hustle to earn an extra $100. Again, it’s just 100, so it’s doable for everyone, so don’t say that you don’t have any skills that you can turn into a side hustle cause that is BS. So when I started getting serious about paying off my student loans, I started in Airbnb side hustle out of my apartment and that made about $500 a month. Thanks to the internet, it’s amazing how many other ways there are to make extra money. So if you don’t want to do an Airbnb, you could go, for example, go to Fiverr, which is an online marketplace for freelancers and it’s really crazy what kind of tasks you can find on there.

For example, I’ve used Fiverr to hire freelancers to do things like really random things like remove background noise from my audio or to outsource things like admin and just graphic design for my thumbnails. Literally anything you can think of, you can probably sell that skill on Fiverr. So you know, I’ve seen jobs where you get paid to like and comment on Instagram posts and you know most of us do that anyway so why not get paid for it.

Some other ideas, you probably have some old stuff in your house that you could get rid of. So for clothes and shoes that are in good condition, you can try selling it on Poshmark, which is an app where you can sell used fashion items and get pretty good prices for it. So I’ve sold a couple of things that I don’t use anymore on Poshmark and I think it’s just a really great app to repurpose your things.

I actually have a friend who makes a living doing this. She finds brand name clothing at places like Goodwill and thrift shops for nothing and then she flips it on Poshmark for a nice profit. For other items like books, electronics, and furniture, try apps like Mercari or Facebook Marketplace. Other side gigs to come up with an extra $100 you can do deliveries on apps like Postmates, DoorDash or Instacart. You can become a dog walker on Rover or you can do handyman tasks like assembling Ikea furniture on apps like Handyman and TaskRabbit.

So please don’t say I don’t have any skills because everyone has skills and interests that they can turn into a side gig to bring in extra income. Getting out of debt isn’t just going to happen by itself. You know, nothing changes if nothing changes. You’re going to have to do things you’ve never done before and get out of your comfort zone a little and I know you can do it.

Now, $100 a month may not seem like a lot but for a $30,000 loan, paying an extra $100 towards your student loans shaves off almost 10 years off your loan term and the reason why paying even just a hundred dollars extra towards principal makes such a big difference, meaning shortening your debt pay off period by 10 years, is because of the way student loan amortization schedules work.

In the beginning, almost all of your monthly payment goes towards interest rather than paying down the principal. So your monthly payment is going to be fixed but the portion of that payment that goes towards interest versus principal changes over time. So when you first start paying back your loans, almost your entire monthly payment is going into your lender’s pocket as interest and hardly any of it is going towards principal, which means at the beginning, your student loan balance goes down very, very slowly because it’s all going towards interest. But towards the end, it goes down a lot faster.

This is exactly how mortgages work as well and because of the way these loans amortize over time, it pays off huge and I mean huge to start making extra payments sooner rather than later because anything extra that you pay goes directly towards your principal, which has the double whammy effect of reducing your balance owed and

So again, just the hundred dollars extra a month to pay off your student loans 10 years faster. That’s pretty freaking great and I’m not telling you to live on just Ramen noodles and be broke all the time. I just want you to come up with an extra $100 because everyone can manage $100.

Tip #3

Tip number three. Once you come up with that extra cash to throw towards your student loans every month, it’s time to decide where and how to apply for that extra principal payment. You have a choice between two debt payoff methods, the debt snowball or the debt avalanche.

The Debt Snowball method is where you pay off your debts in order from the smallest balance to the highest, regardless of the interest rate. For example, let’s say you have three different student loans; a $10,000 loan at 10% interest, a $2,000 loan at 5% interest, and an $18,000 loan at 6% interest.

With the debt snowball method, you would direct your $100 of extra money towards the $2,000 loan first, while making only the required minimum monthly payments on the other two loans. Then when that $2,000 loan is paid off in full, you would direct the extra $100, as well as whatever monthly payment you were making towards that first loan, towards your next biggest loan, and then you just rinse and repeat until all of your debt is paid off. Most people get out of debt this way within five to seven years, if not sooner.

The Debt Avalanche method, also known as debt stacking is where you pay off your debts in order from the highest interest rate to the lowest. So going back to my previous numbers, you’d start paying off the $10,000 loan first because it has the highest interest rate and then once that’s paid off, you’d work on the next highest interest rate loan next, the $18,000 loan. Then very last, you would pay off the $2,000 loan.

But Rose, isn’t the debt avalanche method obviously the better choice? Anyone with basic math skills knows that alone with 10% interest is too high and that’s the one you should pay off first. My answer to this is yes, mathematically the debt avalanche method makes more sense because obviously you’d want to pay off the highest interest rate loan first. However, it’s not just about math and logic. It takes a lot longer to see progress with the debt avalanche method than it does with the debt snowball method. The motivation piece is huge. So much of finance and getting out of debt is behavioral, so the reason why the debt snowball is so effective is that you start seeing progress much faster. Most people who have a lot of debt, they feel very hopeless, so it’s very important to get that motivational push early on, which is exactly what the debt snowball is designed to do.

Once you wipe out that $2,000 loan, you’re going to feel really good about yourself and you’re going to want to keep going. It feels way more rewarding to completely knock out one small loan than to make tiny, barely visible progress on multiple loans. Again, it’s all about getting that dopamine hit. There’s also plenty of studies shows that the debt snowball method is more effective than the avalanche method, precisely because it’s so much better for your psychology.

I started with the debt snowball method and I have to say I’m really glad I did because in the beginning I really just didn’t see the light at the end of the tunnel, so the debt snowball helped me start paying off entire loan balances, which fired up my motivation like crazy and that’s why I was able to make so much progress in just a few years.

Now that I’m super committed to being debt-free, I switched over to the debt avalanche method because I no longer need that motivational boost and I’m pretty disciplined with my pay off plan. So for you, if you’re just starting out and you feel super overwhelmed by your debt, I recommend starting with the debt snowball method until you get some quick wins under your belt and you get that early boost of motivation and then you can consider switching to the avalanche method later once you feel like you’ve got the motivational juice to keep going.

Tip #4

My next tip is to consider refinancing any student loans with interest rates higher than 6%. If you have a good credit score, you’ll probably qualify for something much lower than 6%, like 4% or even less and if you have someone who will co-sign your loans for you, you might be able to get something even lower.

Now there are fees associated with refinancing, so it’s not always worth it, but if you can lower your rate after accounting for the fees, then you’ll be able to pay off your loans much faster, so consider looking into it. Start shopping around online. For example, SoFi has a free online application where you just basically put in some financial information about your job experience, your loan balance, and then they’ll show you what kind of offers an interest rate you qualify for. It only takes a few minutes and it’s not a hard credit inquiry, so it’s not going to affect your credit. It doesn’t hurt to look.

Final Tip- Tip # 5

My final tip is my favorite and it is to want more for yourself. We live in a society where debt is totally normalized. We’ve basically just become numb to living with debt and almost everybody in America finances their college degree, house, car, vacations and the average American has $6,000 of credit card debt, $30,000 of student loan debt and most likely also has a car loan and a mortgage but just because everyone around you has debt doesn’t mean you need to be in debt either.

In my family, I grew up thinking debt was normal because whenever we didn’t have enough money for something, it always seemed like just getting into debt was the answer, whether it was for college or a house or whatever. But consider that there are countries where people pay cash for everything and if they don’t have the cash, they just don’t buy it. We have to stop resorting to debt to pay for things and learn how to delay gratification and just save cash for things and to not just accept the status quo of being in debt.

This is the stuff that society isn’t going to teach you because if everyone stopped financing their purchases and started paying in cash for everything, then companies wouldn’t be able to sell as much and the economy would probably slow down a lot. Debt is literally what keeps us trapped in the hamster wheel of consumerism and materialism. Just imagine what it would feel like to not owe a monthly payment to anyone anymore and all the money you make would just go straight into your pocket instead of to other people. You could start investing so you can start making money on your money. You could work smarter and not harder and that’s why becoming debt-free is the first step to financial independence.

You can totally get there if you’re all about wanting more for yourself, breaking the status quo and becoming debt-free. When do you want to finish paying off your student loans? I’ve got $20,000 more to go and my goal is to pay it all off by the end of 2020.

The post How To Pay Off Student Loans…5 TIPS THAT ACTUALLY WORK!) appeared first on Rose Han.

But are they really free, or is there a catch? That’s exactly what we’re gonna talk about in this blog.

Not too long ago, I posted an article about Fidelity index funds. In that article, I talked about what criteria you need to look for when picking index funds, I talked about the 6 specific Fidelity index funds that I used to build my portfolio, and I also showed you how to buy them and in what amounts.

Then, literally right after I published that article, I found out that Fidelity announced a brand new set of index funds called Fidelity ZERO funds. Each of these charges a 0% annual fee when you invest in the fund.

So in today’s topic:

• I’m going to show you how to build an investment portfolio using Fidelity ZERO funds,
• And I’ll also talk about the pros and cons of using Fidelity ZERO funds vs their other funds. There’s a lot of skeptics out there saying that the ZERO funds are just a marketing gimmick and not a good investment, so I decided to do some digging and found some pretty interesting stuff.

So if you’re interested in learning how to build your own diversified investment portfolio of low-cost (or better yet… free) index funds with Fidelity, then keep reading.

How to build your portfolio with Fidelity ZERO funds

In my original blog about Fidelity index funds, I talked about asset allocation – in other words – what % of stocks vs bonds you want in your portfolio. For example, if you have $10k of investments and $5k of that is in stock funds, and $5k is in bond funds, then your asset allocation is 50% stocks / 50% bonds.

Asset allocation is THE number one decision you need to make before you buy ANY index fund. For example, do you want to have 100% stock allocation, or do you want to have 70% in stocks and the rest in bonds?

Generally, the longer your time horizon, the more you want to have in stocks because you have more time to let the stock market’s long-term historical average return of 9% to play out. You also have plenty of time for your money to recover from any market downturns, as long as you’re not retiring or need the money anytime soon.

Now, asset allocation is an important topic that warrants a much deeper dive. However, I don’t want to repeat myself too much in this article, so you can either check out the other blog that I mentioned or download this free PDF cheatsheet. It has some quick tips and pie charts of recommended asset allocations, as well as a list of the Fidelity index funds you can use to build those allocations.

So how do you create a portfolio using Fidelity’s ZERO funds? Let’s say you want a basic split between stocks and bonds, say 70% stocks and 30%. Fidelity has 4 ZERO funds:

• Fidelity® ZERO Large Cap Index Fund (FNILX): This means you’re investing in the 500 largest companies in the U.S. This is essentially an S&P 500 fund, but Fidelity doesn’t call it that because they’d have to pay expensive licensing funds to use the S&P 500 name.
• Fidelity® ZERO Extended Market Index Fund (FZIPX): This means you’re investing in the 2500 largest companies in the U.S., minus the 500 that were in the previous fund. So it’s the next 2000 by size and contains mid- to small-cap stocks.
• Fidelity® ZERO Total Market Index Fund (FZROX): is basically the first two funds combined: it has 2500 stocks ranging from the small-cap, mid-cap, to large-cap.
• Fidelity® ZERO International Index Fund (FZILX): which means you’re investing in stocks all over the world minus the U.S., from 47 different countries ranging from developed countries like Japan, France, and Australia, to emerging market countries like Brazil, China, and India.

So as you can see, knowing that you want 70% in stocks, 30% in bonds is a great start, but you need to get more specific: What kind of stocks? Domestic stocks? International stocks? Small-cap stocks, large-cap stocks, or both?

As you can see, you can really go down a rabbit hole with this. Here’s my take on this. If you’re looking at index funds, you’re going for diversification. Rather than trying to be the next Warren Buffett and pick the best stocks, you’re just looking for safety in numbers. So I say if you’re going the diversification route, go all the way.

That’s why if I were you, I’d do a combination of the Fidelity ZERO Total Market Index Fund and the International Index Fund for your 70% allocation to stocks. That way, you’re invested in stocks of all sizes, from all countries.

Ok… not ALL countries. Like not… Botswana.

For example, if you invested in just the Fidelity ZERO Large Cap Index Fund, then you’re cutting off the whole universe of U.S. stocks that aren’t considered “large-cap”. If you compare the performance of small caps stocks to large-cap stocks over the last 20 years, you’ll see that small caps have majorly outperformed large caps. Small caps gained a total of 261%, while large caps gained a total of 182%. Big difference.

However, if you compare the performance of small caps stocks to large-cap stocks over the last year, small caps gained almost nothing, while large caps gained over 9%.

So it’s a mixed bag, although small caps grow faster than large caps over the long-term, you get a lot of noise in the short-term. It’s the same with domestic vs international stocks. Over the last 10 years, the U.S. stock market has been on a major winning streak compared to international stocks. But that trend isn’t going to continue forever, and there’s plenty of times in history when it was the other way around.

That’s why it’s generally not a good idea to invest in only select segments of the stock market – for example only in U.S.stocks, or only in small caps. Unless you have a specific view on the economy and you have a well-informed opinion on something, it’s best to just diversify as much as possible.

So if I were you, I’d lean towards investing in the Fidelity ZERO Total Market Index Fund, or FZROX and the Fidelity ZERO International Index Fund. That way, you don’t have to worry about timing the market correctly

Pros and cons of Fidelity ZERO funds

Now let’s talk about the pros and cons of Fidelity ZERO funds compared to Fidelity’s non-zero funds.

Pro– It goes without saying that one of the biggest pros is that they’re FREE! I’m 99% sure that the ZERO funds are a loss-leader for Fidelity, but they do it in the hopes that it’ll attract more business to their other products, and therefore generate more profits for them down the line.

The second pro is that if you currently have a portfolio of paid index funds, you can literally replicate an almost identical portfolio with Fidelity’s free index funds. For example, investing in FZROX would be equivalent to investing in FSKAX, which charges 0.015%.

0.015% is already dirt cheap, so the cost savings with Fidelity ZERO funds aren’t THAT huge.  But still, it is free.

Cons– here’s where it gets interesting.

When choosing your index funds, the expense ratio is definitely one of the MOST important factors to consider. But something else that’s often overlooked is the tracking error. Tracking error is the difference between the index fund’s returns and the benchmark index it was designed to copy.

All index funds have tracking error, but the legit ones have long histories of minimal tracking error. But because Fidelity ZERO funds are so new, it still remains to be seen whether they’ll be able to track the index as closely as they should. Since inception, FZROX had a tracking error of 0.03% – so minuscule. But FNILX has a tracking error of 0.09% – so a little bigger. Fortunately, the tracking error was on the positive side, meaning that the fund’s return was slightly higher than the return of the index. If for whatever reason, next year the ZERO fund underperforms the index, then even though the fund is “free”, you’d lose out due to the tracking error.

The other con is that all the Fidelity ZERO funds are stock funds. So if you wanted to balance out your portfolio with bonds, there isn’t a ZERO fund for that – you’d have to buy one of their paid funds.

The post Fidelity ZERO Index Funds (HOW TO INVEST WITHOUT PAYING ANY FEES!) appeared first on Rose Han.

For those of you that don’t know, Michael Burry is the hedge fund manager featured in the movie, The Big Short. He became famous for seeing the real estate bubble that was forming in the years leading up to the 2008 financial crisis. His fund made $700 million betting against subprime mortgages. He’s also made a killing shorting overpriced tech stocks during the 2000 dot com bubble, and he’s made a ton of money for his investors over the years.

Basically, when Michael Burry talks, people listen. So, now he’s saying that index funds might crush one day, and that like most bubbles the longer it goes, the worst the crash will be.

If you’re thinking of investing in index funds or if you’re already invested in index funds, you might be wondering what to make of his prediction.

In this article, I’ll explain Michael Burry’s index fund bubble prediction in layman’s terms, so that anyone can understand. I’ll also examine each of his points one by one and present both sides of the argument. And finally, I’ll end with my own personal thoughts on whether or not you should be worried about the index fund bubble.

Let’s start with a quick explanation of Michael Burry’s index fund bubble prediction. In his exact words, “The dirty secret of passive index funds is the distribution of daily dollar value traded among the securities within the indexes they mimic. In the Russell 2000 index, for instance, the vast majority of stocks are lower volume, lower value traded stocks, yet through indexation and passive investing, hundreds of billions of dollars are linked to stocks like this. The S&P 500 is no different. The theater keeps getting more crowded, but the exit door is the same as it always was.”

So, here’s what this means in plain English. An index is a basket of hundreds and sometimes thousands of different stocks. And an index fund is a fund that mirrors the returns of a particular index by holding the same stocks as that index. Take the S&P 500 for example, an S&P 500 index fund has to buy all the stocks in the S&P 500 index. If Apple is in the S&P 500 index, which it is, then all S&P 500 index funds have to own Apple stock also.

There are a lot of S&P 500 index funds out there, both mutual funds and ETFs, so that’s a lot of money invested in Apple stock. So, what Michael Burry is saying, is that in order to keep up with the demand from passive investors, these index funds are all piling into a limited supply of stocks, which would be the equivalent of a movie theater becoming more and more crowded while the exit door remains the same size.

So, Apple stock is very liquid and easy to buy and sell in large volumes. But stocks of smaller companies in indexes like the Russell 2000, these stocks are not as liquid and readily available to trade. And so, what Michael Burry is saying, if all the Russell 2000 index funds own these thinly traded stocks, then what’s going to happen if everyone runs for the exit door at the same time? With all these huge index funds piling into a finite number of stocks, we’re getting a crowded movie theater with the same size exit door.

The second part of his index fund bubble prediction is that passive index investing is distorting stock prices, which he says is making stocks more vulnerable to a nasty correction. In his words, “Passive investing has removed price discovery from the equity markets. This is very much like the bubble in synthetic asset-backed CDOs before the financial crisis, in that price-setting in that market was not done by fundamental security analysis, but by massive capital flows based on Nobel approved models of risk that proved to be untrue.”

Okay. That’s a lot of financial jibberish. Let’s unpack this. In a healthy market, people buy stocks because of their underlying intrinsic value. People will do a detailed analysis of companies. They’ll look at the company’s cash flows and profits, and they’ll come up with a reasonable buying price for that stock, based on what they find in their research. This is what Burry is referring to as price discovery. For example, let’s say Apple stock is trading at $300.

However, based on the company’s future prospects, is $300 too low, or is it too high, or is it just right? So, that’s what price discovery is all about. It’s about doing the research to find out what is a good price to pay for a stock. Index funds don’t do any of this, because their mandate is simply to just buy whatever stocks are in the index regardless of price. If it’s in the index, they buy it.

Compare this to active investors like Warren Buffet. He’s super selective about the stocks that he buys, and he’ll only buy the stocks at a price that he thinks is fair given the longterm prospects of the company. So, investors like Warren Buffet and this whole process of price discovery, is what keeps stock prices in line with reality. Without price discovery, then all stocks would maybe just go to the moon because nobody’s really looking at whether this company warrants that high of a price.

So, according to Michael Burry, if most of the money going into the stock market is by index fund investors, then no one is doing price discovery, and stock prices are getting totally distorted. And the market has a way of eventually correcting distortions like that. He’s comparing price distortions caused by index funds to what happened in 2008 with CDOs.

CDOs are fancy financial products, short for Collateralized Debt obligations, and these are fancy financial products that give investors exposure to subprime mortgages. And the problem there was that no one was taking the time to do price discovery on these CDOs. If they had, they would have realized that CDO prices were totally out of whack and that the subprime mortgages underlying those CDOs, were very close to default and on very shaky ground. But because no one was doing this price discovery, CDO prices got totally out of whack. Everyone bought them when they really shouldn’t be. And eventually, when the subprime borrowers started defaulting on the mortgages, the CDO prices came crashing back down to reality. And this is what triggered the domino effect that turned into the 2008 financial crisis. So now, Michael Burry is comparing the CDO bubble in 2008 to the index fund bubble.

That’s a pretty dramatic statement. So, we’ll dive deeper into whether or not this is true later in this article. He also says that the index fund bubble could be even worse because of derivatives.

Derivatives are fancy financial instruments that give investors exposure to stocks without actually buying the stocks. Derivatives create leverage, because they essentially 10X your profit or loss, whereas you’d only make 1X profit or loss if you own the stock direct. So, derivatives allow you to make leveraged bets on stocks. Essentially, magnifying profits and also magnifying losses. “Potentially making it worse will be the impossibility of unwinding the derivatives and naked buy/sell strategies used to help so many of these funds, pseudo-match flows and prices each and every day. This fundamental concept is the same one that resulted in the market meltdowns in 2008.” Again, what does this mean in plain English?

What Michael Burry is referring to, is how index funds use derivatives to help them match their benchmark index. For example, for Vanguard’s most popular index fund, VTSAX, they track a total stock market index, and this fund that specifically states on their website, “…to help stay fully invested and to reduce transaction costs, the fund may invest to a limited extent in derivatives.” Most index funds use some derivatives to stay on track with their index. So, Michael Burry is saying that any big market moves could be like 10 times worse, due to the leverage created by derivatives. So, to summarize the key points of Michael Burry’s index fund bubble theory, one, due to the growing amounts of index fund dollars going into a limited supply of stocks, a crash in the index fund bubble would be like everyone in a crowded movie theater running forward the same exit door.

Two, since index funds don’t do any price discovery on the stocks that they’re buying, this is distorting stock prices, and this is going to make them very vulnerable to a nasty correction. Three, the index funds losses could be magnified due to their use of derivatives. Everything Michael Burry says in his argument, it sounds extremely well thought out and valid. But before we take his theory at face value, let’s go through each of these points one by one. His first point about the crowded movie theater and the same size exit door, this is absolutely true. The thing is, this is true of any investment, not just index funds. For example, Tesla stock, stocks all have a pretty fixed daily trading volume and there is a limited number of Tesla stock. So, if everyone who owns Tesla stock tried to sell it at once, that would cause the stock price to crash. So, yes, all the index funds are piled into the same supply of stocks, and so his point is absolutely valid.

He’s not really saying anything new. If everyone who owns something sells it all at the same time, it’s going to crash. But here’s the thing, this crowded movie theater and same size exit door situation is only an issue, if, everyone runs for the exit door at once. Though Michael Burry is making a huge assumption that everyone would run for the exit door at once. But why would people do that? Most index fund investors buy and hold investors. The vast majority would only sell either to cash out for retirement or when they’re re-balancing their portfolios. Sure, there’s always going to be panic selling, as well as some day traders selling to do short term stuff. But it’s hard to imagine everyone in the movie theater running for the exit door at once. There might be a lot of people running for the exit door, but not everyone.

Plus any price drops caused by panic selling would be temporary, because a lot of the people who run for the exit door, will eventually want to get back into the theater. Now let’s talk about the second part of his argument where he’s saying that there is no longer any price discovery and that is distorting the stock prices. So, Michael Burry is absolutely right about index funds eliminating price discovery. Index funds don’t do price discovery, and they just buy whatever stocks are in the index regardless of whether the price makes sense or not. So, the rise of passive investing via index funds, means that fewer and fewer investors in the market are doing price discovery. However, I disagree that index funds are totally distorting everything. While it’s true that fewer investors are doing price discovery due to the rise of passive investing, there’s always going to be stock pickers like Warren Buffet looking for deals.

If prices get really distorted, some smart active investor like Warren Buffet is going to notice, and they’re going to make a profit on that distortion until eventually, the price goes back to a more reasonable level. As a very exaggerated example, imagine if Apple was so distorted due to index funds buying up the stock, and Apple stock went to like $5,000 a share. Again, just an exaggerated example, now if Apple stocks stayed at $5,000 a share, that’s definitely a bubble and we would all be worried. However, I guarantee you, people would notice and they would short the stock, in other words, sell it until the price came back down to earth. So, my take on Michael Burry’s argument is that, yes, index funds are causing distortions in stock prices. However, those distortions are always temporary, because there will always be smart active investors exploiting any obvious dislocations in price.

Now let’s talk about the last point of Michael Burry’s index fund bubble theory, derivatives. Now, derivatives are a double-edged sword, because they can magnify profits but they can also magnify losses. And as we all know, derivatives were the cause of a lot of the notorious market crashes in history, like the 2008 financial crisis. And you might remember the implosion of Long-Term Capital Management, which was a hedge fund that blew up in 1998, and they had to be bailed out in order to prevent a catastrophe. Basically, in the financial world, derivatives are like weapons of mass destruction. So, when I heard Michael Burry mention derivatives and index funds, I got a little worried and decided to do some research. Because if index funds are using derivatives the way those huge wall street banks and hedge funds were doing, then we should all be very, very, very worried.

I did a deep dive into the prospectus of one of the index funds that I own, FSKAX, which is the Fidelity Total Market Index Fund. In the schedule of investments, as of February 28, 2019, you can see the entire list of stocks that the fund holds, as well as the dollar amounts and actual stock holdings. So, you can see here that their actual stock holdings totaled $59.5 billion. You can also see that FSKAX is holding $1.7 billion in money market funds. So, that brings FSKAX’s total investments to 61.2 billion. Then, right below that, you can also see the funds derivative positions. As you can see, they hold some futures contracts, which are one type of derivative. And the total notional amount of these futures contracts is roughly $141 million. That’s just a fraction of the funds’ total assets. They even state it right here.

The notional amount of futures purchased as a percentage of net assets is 0.2%. 0.2% is peanuts. That’s how much some mutual funds charge in annual management fees alone. So, my conclusion is that derivatives are a very small portion of an index fund’s overall assets, so they’re really not something to worry about. Derivatives are actually more of a problem for leveraged index funds and synthetic index funds, which are specific types of funds that use derivatives to get exposure to stocks without actually owning those stocks. For example, the UltraPro S&P 500 or UPRO, is an ETF that uses derivatives to give you three times the returns of the S&P 500. The prospectus specifically states. “The fund invests in derivatives as a substitute for investing directly in stocks. And that investing in derivatives may be considered aggressive and may expose the Fund to greater risks, and may result in larger losses or smaller gains, than investing directly in the reference assets underlying those services.”

Bottom line, unless you’re an experienced trader, stay away from these leveraged funds that use a lot of derivatives and you will be just fine. The reality is, the future is uncertain and Michael Burry could very well be right. But there’s plenty of experts and arguments that support the other side as well. Warren Buffet is a master investor who’s been around much longer than Michael Burry has. And he is a believer in index funds. To quote Warren Buffet, “A low-cost index fund is the most sensible equity investment for the great majority of investors.” He also is putting his money where his mouth is. Because in his 2013 letter to shareholders, he shared that he has instructions in his own will to invest 90% of his wife’s money into a very low-cost S&P 500 index fund. So, apparently Warren Buffet isn’t worried about an index fund bubble, and if he’s not worried then I don’t think you should be either.

Now, even if you are worried about an index fund bubble, Warren Buffet has some advice for you. So, in his letter to shareholders, he says, “The main danger is that the timid or beginning investor will enter the market at a time of extreme exuberance. The antidote to that kind of mistiming is for an investor to accumulate shares over a long period and never to sell when the news is bad and stocks are well off their highs.” So, accumulating shares over a long period of time is a strategy known as, dollar-cost averaging, and it’s the safest way to invest in index funds.

In this article, I go into detail about how to do dollar-cost averaging. So, you should definitely check it out. Here’s something else I want you to keep in mind, Michael Burry has been right many times in the past, but that doesn’t guarantee that he’ll be right about everything going forwards.

No one has a crystal ball and no one really knows what the future holds. So, I think you need to be careful about making sweeping decisions, such as refusing to invest at all in index funds, just because of what one expert is saying. History has shown that investing in the stock market via low-cost index funds has been a very successful profitable strategy. Lots of millionaires have happened because of low-cost index fund investing, and Michael Burry is basically saying that everything as we know it, the stock market as we know it, is going to change drastically. So, that’s a very dramatic prediction to make. So, I’m going to really question it before I just believe it. If you don’t have any factual basis of your own, it’s pretty easy to get spooked by headlines like this. It also doesn’t help that the news loves to sensationalize stories like this, because stories about pending market crushes and bubble predictions and disaster and financial catastrophe, these kinds of stories always get tons of clicks. And the news is out there to get clicks, to get eyeballs on their stories.

So, bottom line, there will always be something scary in the news, and it could make you second guess your entire investing strategy if you let it. But the more educated you are, the more you can filter all the news and the noise out and just stick with your investing plan. It’s important to educate yourself so that you can base your financial decisions on facts, not emotions.

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So let’s get right into it. All 3 of these accounts are designed to help you save for retirement. That means they come with restrictions on when you can withdraw the money (so typically you have to wait ’til you’re 59.5 to start spending it), but they also come with AMAZING tax benefits. If you don’t take advantage of the huge tax breaks you get from having these accounts, you’re leaving tens of thousands of dollars on the table!

What is the IRA?

IRA-  stands for Individual Retirement Account. Back in the day, the Traditional IRA was the only type of IRA – hence the name Traditional. The Roth IRA is a much newer option that came around several decades later in 19XX, thanks to a senator named X Roth – hence the name Roth IRA!

Since the Traditional IRA came first, I’ll start by explaining that one. Traditional IRAs are investment accounts that give you special tax benefits that you don’t get with non-retirement investment accounts. When you contribute to a Traditional IRA, it immediately reduces your taxable income. So if you contribute $6k to your Traditional IRA (which is the maximum allowed contribution in 2019), then you reduce your taxable income by $6k. That’s huge! That’s 30-40% on $6k that you DON’T have to pay in taxes. Do you know how you get a tax break when you donate to charity? It’s just like that, except that the money is going to yourself, rather than to charity! So if you put away $6k into a Traditional IRA every year, the tax savings are really gonna add up.

So you get to put in tax-free money upfront, BOOM. OK, that’s one benefit, but it doesn’t end there. The investments in your Traditional IRA also get to grow tax-free. This is huge because outside of a retirement account, you typically have to pay capital gains taxes when your stock investments increase in value. Given that 94% of your retirement nest egg will come from stock market growth – investing inside a Traditional IRA is gonna save you SO much money in taxes.

If you want to find out about some other ways to reduce your taxes, then keep reading!

Alright and then what happens with the Traditional IRA when you retire? When you turn 59.5, you can start withdrawing money from it, but now those withdrawals will be taxable. So a Traditional IRA lets you make tax-free contributions on the front end, but you don’t get to take tax-free withdrawals on the back end.

The tax benefits of 401ks, which I’m going to explain in just a minute, are a lot like Traditional IRAs. The main difference is that 401ks are sponsored by your employer, while IRAs are not. There are also a few other important distinctions, so I’ll explain that a little bit later in this article.

How about the Roth IRA?

Let’s talk about Roth IRAs. The only difference between a Roth IRA and a Traditional IRA is in the timing.

Remember how with Traditional IRAs, your contributions result in an immediate tax break that year? Well with a Roth IRA, you don’t get that. So even if you contribute to a Roth this year, your tax bill isn’t going to change. That’s because contributions to a Roth are after-tax. So you get your paycheck, taxes get taken out, and then, you can put away some of what’s left into your Roth. With the Traditional IRA, you get your paycheck, put away what you can into your Traditional, and you pay taxes on what’s left.

But here’s the good part. With a Roth IRA, when you turn 59.5, you can start withdrawing money from it 100% tax-free. Yes, tax-free retirement income for the rest of your life. Hell yes!

To recap:

• Traditional IRAs give you a tax break upfront and no tax break in retirement
• Roth IRAs DON’T give you a tax break upfront but you do get a permanent tax break in retirement

So you can get a tax break now OR in the future… but not both. An easy way to think about it is that Traditional IRAs give you immediate gratification in the form of tax benefits today, while contributions to a Roth is delayed gratification because you have to wait until retirement to enjoy the tax benefits.

Reasons to open one or the other

So now that you know the difference, how do you decide which? Let’s go over some of the pros & cons:

First of all, if you’re single and you make over $122k, a Roth is not even an option for you. This also applies if you’re married and you make over $193k. Unlike Traditional, Roth IRAs have income qualification limits. That’s because they’re so awesome. So obviously if you’re over the income limit, this is an easy decision because you’ll just have to go with the Traditional IRA!

Both types of IRAs let your investments grow tax-free, and they both allow you to contribute up to $6k every year. You can even have both, as long as you keep your total contributions to no more than $6k.

Personally, I prefer Roth IRAs by a long shot. I don’t know anyone who enjoys paying taxes (if you do, then you’re weird) – and I love that with a Roth I can just pay taxes once and never pay taxes on it again.

The judgment call you have to make is whether you think your tax rate will be lower or higher in the future. If it’s going to be higher, then it’s better to pay the taxes now with a Roth. If your tax rate is going to be lower when you retire, then it’s better to pay the taxes later with a Traditional. And if your tax rate stays the same, then it doesn’t make a difference whether you go with the Traditional or the Roth.

But think about it – it’s much more likely that tax rates will be higher in the future, not lower. Regardless of your tax bracket. The U.S. government is currently $22 TRILLION in debt, and that number is growing every day. And politicians keep introducing tax cuts in order to get elected, so they’re just kicking the can down the road and one day we’re all going to have to pay for it.

So if you’re on the fence, I say go with the Roth IRA, because even if taxes go up to 50, 60, 70% – no matter what, you’ll have the security of a tax-free retirement.

What is the 401k?

Now let’s talk about 401ks. The name comes from its place in section 401(k) of the Internal Revenue Code – so even though it sounds like something fancy, it’s really not.

A 401k is just a retirement plan that behaves just like the Traditional IRA, EXCEPT that it’s sponsored by your employer. IRAs, on the other hand, have nothing to do with your employer. Anyone can open an IRA, whether you have a job or not.

401ks let you put away a portion of your paycheck pre-tax to save for retirement, the same as a Traditional IRA. The age you can start taking withdrawals is also 59.5.

The best part about 401ks is the employer match. Most companies offer to match your 401k contributions dollar-for-dollar. It might also just be 50 cents for every dollar you put in, or better. At my first job, the employer match was 3-for-1, so they gave $3 for every $1 that I contributed. I know – it was pretty amazing, and it’s literally the main reason why I have a good-sized investment portfolio for someone my age. Employer 401k match is FREE money, so if your job offers it, you should ALWAYS max that out. Period. Life lesson: Never say no to free money.

401k contribution limits are much higher than IRAs. As of 2019, you can contribute up to $19k per year, and if combined with an employer match, you can contribute up to a total of $56k per year. This means you can put a shitload of pre-tax money away for retirement. So yes, 401ks are great.

Now, what about if you’re self-employed? Don’t worry, I’ve got you covered.  If you don’t have a 401k, there are other types of retirement accounts for you, and some of them are even better than what we’ve talked about here. So check out my other blog articles, if you want to learn more about that.

Summary

In general, the ideal combination is to have a 401k plus a Roth IRA. Yes, you can – and SHOULD – have both. You can have a 401k and a Traditional, you can have a 401k and a Roth, and you can even have all 3 – as long as you stay within the contribution limits.

It’s great to understand what all these accounts are and how they work, but just because you have an IRA or a 401k doesn’t mean you have investments.

I want to mention this because I have a friend who once thought that just because she had a Roth IRA, she was investing. But as it turns out, if you don’t actually buy stocks and do stuff, whatever you’ve put into your IRA is just going to sit there in cash, doing nothing and not growing.

So opening a retirement account and putting money into it is one thing, but making investments is a totally different story. Think of 401ks and IRAs as shopping baskets, and the investments as the groceries. You can put stocks in a Roth IRA shopping basket, you can put stocks in a Traditional IRA shopping basket, and or you can put stocks in a 401k shopping basket. But you’re the one who has to pick the stocks, it doesn’t automatically happen for you. Actually I think with 401ks, they generally put you in some index funds by default, but with IRAs, you’re definitely the one who has to take the initiative.

401k plans are generally pretty limited in their investment options, whereas IRAs give you a lot more flexibility. You can’t pick your own stocks in a 401k, and you’ll probably only have a handful of index funds to choose from. But with an IRA, you can invest in whatever stocks and bonds you want, you can buy and sell options, and you can even invest in real estate. Really anything is game.

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Which is better for you and which account should you use to invest with? I personally have a lot of experience with both of these accounts, so I have a lot of valuable insights to share with you.

What you learn in today’s blog is going to save you tens of thousands if not hundreds of thousands of dollars.

Now, this isn’t an exaggeration, because taxes are going to be your single biggest expense in your lifetime. According to Forbes, someone who makes $100k a year can expect to pay over $760k in taxes over their lifetime, which is over $1.4M when adjusted for inflation.

So it makes sense to try to reduce your taxes as much as possible because the less you pay in taxes, the more money you have to save and invest. Roth IRAs and 401ks are powerful ways to build a sizeable nest egg …fast.

In this blog, I’m going to explain:

• Some background info on the Roth IRA and the 401k
• The pros and cons of each account
• And finally, some clear recommendations on which one you should prioritize

So if that sounds good to you, let’s get right into it!

Background information

Let’s start off with some basic background info.

The Roth IRA is named after Senator William Roth, who sponsored the part of the tax code that brought this account into existence. The Roth IRA is a type of retirement account that offers HUGE tax benefits. Although your contributions to a Roth IRA are not tax-deductible, all your profits and earnings in your Roth IRA are tax-free, forever. No matter how much your investments have gone up in value. To put this into perspective, quick illustration on AAPL stock or S&P 500 index fund. 

However, there’s no such thing as a free lunch – especially when it comes to the IRS! So the Roth IRA also comes with restrictions – you’re not supposed to make withdrawals of profits from your Roth IRA until you turn 59.5. If you do, you’ll incur a lot of taxes and penalties, so basically it’s not really an option.

The 401k is also a type of retirement account, and it’s named after Section 401k of the IRS tax code. I know… so creative right? 401k plans are sponsored by your employer, and unlike Roth IRAs, your contributions to a 401k ARE tax-deductible. However, all your withdrawals later on when you retire are going to be fully taxable at regular income tax rates.

So the main difference between the two is in the TIMING of the tax benefit. With Roth IRA contributions you get no tax benefit upfront, but you get unlimited tax benefits in retirement. With 401k contributions, you get the tax deduction today, but you eventually pay all the taxes later on in retirement.

Pros and cons

So now that we’ve covered the basics of the Roth IRA and the 401k, let’s take a look at the pros and cons.

Roth IRA:

One of the biggest pros of the Roth IRA is that you’re guaranteed a tax-free retirement, no matter what. You make your contributions with after-tax money, so you take the hit now, but in the future, even if you become a billionaire in the highest tax bracket, you will never NEVER have to pay any taxes on your Roth IRA.

Not only this, but U.S. marginal tax rates have been as high as 94% in the past – during WW2 in the 1940s. And now they’re back to a more reasonable 30-40% range, but if taxes have been that high in the past, it means they can be that high again in the future.

Do you really want to expose YOUR retirement to this kind of political uncertainty?

Other PROS of the Roth IRA:

• You can take out contributions penalty-free. Because your contributions were after-tax, no required distributions, can be used to buy the first house with some restrictions? Unlimited investment options (btw Roth IRAs aren’t investments.

And now for some of the cons:

The Roth IRA has a $6k annual contribution limit. If it were allowed, I’d stash away AS MUCH AS HUMANLY possible in my Roth, but the IRS only allows up to $6k per year.

Another con is that the Roth IRA doesn’t give you any tax deduction today. I know many of you want to maximize your deductions and pay as little taxes as possible this year, but because you get all the tax benefits later in life, the Roth IRA doesn’t do anything to reduce your tax bill today.

Finally, there are income limits to qualify for a Roth IRA. So if you make too much money, you can’t contribute to a Roth IRA. However – there is a really cool way to get around it (and it’s 100% legal), and I show you exactly how to do it in this video. Roth IRA income limits are $124k in 2020 if you’re single, and $196k in 2020, so if you don’t qualify but you want to learn a workaround.

401k:

Moving right along to the 401k! BY FAR, the biggest pro is that 401ks often offer you an employer match. That means that for every dollar you contribute to your 401k, your employer will throw in some money for you as well. It could be dollar for dollar, it could be 50 cents per dollar, it’s whatever your employer offers. At my first job, the employer match was $3 for every dollar I contributed! This is free money.

Another pro is that the annual contribution limit for the 401k is higher. For 2019, it’s $19k vs $6k for the Roth IRA. And that’s not counting employer match. With an employer match, your total allowed contribution is $56k. So if you have a shit ton of money to put away and you need to shield it from taxes, you’ll be thrilled to have a 401k.

Another pro is that you can set up your paycheck so that a % gets routed to your 401k automatically. That way, what actually lands in your bank account on payday is what’s left after you’ve paid into your 401k. Since you don’t even see the money, you’ll hardly feel the pain, and it’s a great way to “trick” yourself into saving.

Finally, two cons: We’ve already talked about the first one – you’ll owe full taxes on your 401k withdrawals in retirement. Most of us have no idea what our tax rates will be at age 65, so there’s lots of uncertainty there. Although the 401k gives you a big fat tax deduction today, you’re just kicking the can down the road because you’ll have to pay the taxes in the future.

Another con is that most 401k plans give you very limited investment options. Most employers only give you a handful of mutual funds to choose from, and you can’t pick and choose your own stocks and ETFs in a 401k. I don’t know about you, but I don’t like being limited to a few mutual funds, I’d rather have full control and freedom over what my money gets invested in.

Recommendations

So we’ve covered a lot here. Let’s wrap it up with some final recommendations:

• If you have a 401k with employer match, max it out – no ifs and or buts! Then max out your Roth IRA. A very wise person once told me, the only thing better than tax-free money, is free money. Just kidding, no one ever told me that, but still… you get my point.
• Now if you have a 401k WITHOUT employer match, then you need to prioritize your Roth IRA. Obviously, this is just MY opinion, and your tax situation could be very different, but for most people, the Roth IRA will be the best thing that ever happened to them.

If you have limited cash flow, and you’re not sure how to prioritize, then here’s a simple way to think about it:

• first, get all the free money
• then, if you have anything left to save, get all the Roth IRA tax-free money
• then, if you still have even more left to save, get all the rest of the tax-free money, by either maxing out the rest of your 401k or using other tax-advantaged vehicles

I know it’s a lot to think about, but it’s worth it. With income taxes in the U.S. around 30%, just investing within either of these retirement accounts gives your investments a 30% head start.

So making the most of 401ks and Roth IRAs is the #1 way to set yourself up for success.

Something I haven’t talked about yet is the Roth 401k. The Roth 401k is like the Roth IRA on STEROIDS. It has the same high $19k contribution limits as the 401k, AND it offers Roth-style tax treatment. It combines the best of both worlds. It’s a fairly new retirement vehicle, but it’s one that I recently opened for myself as a self-employed individual. Your employer might also offer Roth 401ks.

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