The Ideal Investing Order of Operations
A simple order to help you get started.
With so many possible accounts to invest with, it can be confusing knowing where to start. It’s impossible to create an order of operations that accounts for every unique situation, so take this post as a rule of thumb. Some steps might not apply to you. If so, just move on to the next.
Here’s a brief investing order of operations:
Get your full employer match
Max out your Roth IRA
Max out your HSA
Max out your workplace plan
Invest in a taxable account
1. Get Your Employer Match
If your job offers a 401(k), a 403(b), a SIMPLE IRA or other type of employer-sponsored account, find out if your employer will match any of your contributions. Maybe your employer matches 3% of your salary, so if you contribute 3% to your workplace plan, your employer also contributes 3%. Consult HR at your company to find out what you need to do to get those matching contributions.
If you have a 401(k) and you aren’t getting your full match, you’re basically telling your employer to pay you less. Don’t leave this money on the table. Get your full match.
2. Max Out Your Roth IRA
After you get your match, now’s the time to max out your Roth IRA. You have more investment options with a Roth IRA compared with your employer-sponsored retirement plan. That means you can open an account at a low-cost brokerage provider like Vanguard, Fidelity or Charles Schwab and invest in low-cost index funds. You can put $6,000 a year into a Roth IRA, or $7,000 if you’re over 50.
Alternatively, you could max out a traditional IRA, but there are certain caps on the amount you can deduct if you have both a traditional IRA and a traditional workplace plan, and most investors are better off investing in a Roth IRA anyway because of their tax bracket.
3. Max Out Your HSA
If you have a high-deductible healthcare plan, you’re eligible to contribute to a health savings account (HSA). Your employer might offer one, in which case you can have your contributions deducted from your paycheck pre-tax and deposited directly into the account. Or you can open one on your own and make contributions after-tax and claim the deduction when you file your taxes. Contributions limits are $3,600 for individual health plans and $7,200 for family health plans with a $1,000 catch-up contribution if you’re 55 or older.
Fidelity arguably offers the best overall HSA account. They have no investment minimums and no fees beyond the funds you invest in. If you’re already using Fidelity for your other investments, this makes things incredibly simple, as you can keep all your accounts in one place.
Note: If you live in California or New Jersey, you won’t get any state tax advantages for HSA contributions or investment growth. This puts you at a disadvantage and limits the “triple tax advantage” appeal of using them in the first place. It might still make sense to use HSAs in these states, but it’s something to keep in mind.
4. Max Out Your Workplace Plan
After maxing out your Roth IRA and HSA, go back to your workplace plan and max that out. 401(k) and 403(b) contribution limits are $19,500 a year, or $26,000 if you’re over 50. One reason to save this step for now is your workplace plan may have limited investment options and higher fees, so this is often the last tax-advantaged bucket you want to fill up.
5. Invest in a Taxable Account
If you’ve managed to max out all possible tax-advantaged accounts, you can start investing in a taxable account. Because all the other accounts are either tax-deferred or tax-free, you don’t have to worry about the tax efficiency of your investments. With a taxable account, you should be a little smarter about what you invest in. Stick with tax-efficient index funds like the Vanguard Total Stock Market ETF or the Vanguard S&P 500 ETF. One big benefit of the taxable account: There are no contribution or income limits.
Generally, you should avoid bonds, as almost all bond interest is taxable. Municipal bonds are the exception, which aren’t taxed at the federal level and may not be taxed at the state level either. International funds may be appropriate in a taxable account, as you can often claim the Foreign Tax Credit to compensate for taxes international companies pay outside the U.S.
Deviating from the Order of Operations
You may have occasion to deviate from this order of operations. Suppose you have a long-term goal, but not quite as long-term as retirement. In that case you may want to put more money in a taxable account sooner, before maxing out other accounts.
You could choose to max out an HSA before a Roth IRA. Some people really like the triple tax advantage of the HSA and choose to prioritize that. The HSA is a hybrid account. You can use it for medical expenses now and then as a traditional retirement account when you reach 65.
And if you happen to have a really solid workplace plan with low-cost index funds and limited fees, it could make sense to invest more money there before maxing out your Roth IRA or HSA.
If you’re just getting started, this order can be a great way to make sure you’re prioritizing the right investment vehicles and taking advantage of all the tax breaks you can.