Before you open a taxable account
A regular brokerage account has no tax advantages and no restrictions, which makes it the right tool for goals that fall between the emergency fund and retirement. It comes last in the order of operations. Capture any employer match, clear debt charging more than about seven or eight percent, finish the emergency fund, and use an IRA first, because each of those beats the expected return of an unsheltered investment.
Match the investment to the deadline
The stock market has returned roughly ten percent a year before inflation over the long run, and it has also lost a third or more of its value within months, as it did in 2008 and briefly in 2020. It recovered each time, sometimes after years. The working rule is that money you will need within five years does not belong in stocks. Keep it in savings, certificates of deposit or Treasury bills. Money for ten years out or more can ride mostly in stocks, and for the years in between, a mix of stock and bond funds softens the swings.
Costs and taxes
Two drags are fully under your control. The first is fees: $10,000 growing at seven percent for thirty years becomes about $75,000 in a fund charging 0.05 percent and about $57,000 in one charging one percent. The second is taxes. In a taxable account, dividends and interest are taxed each year, and selling at a profit creates a capital gain. Hold an investment longer than one year and the gain is taxed at the lower long-term rates, while a quicker sale is taxed as ordinary income.
Habits that do the work
- Invest a fixed amount automatically every month, which buys more shares when prices are low and takes the decision out of your hands.
- Leave the account alone during downturns, because selling after a drop is how temporary losses become permanent ones.
- Limit individual stocks, cryptocurrency and other speculation to about five percent of your investments, an amount you could lose completely.
Warning signs
Be suspicious of guaranteed returns, urgency, strategies you cannot explain in two sentences, and anyone paid by commission on what they sell you. If you want advice, look for a fee-only fiduciary, who is legally bound to act in your interest and is paid by you alone.
Note Brokerage accounts are protected by SIPC up to $500,000 if the firm itself fails. That protection returns your securities to you, and it does not cover a fall in their value.
