10. Taxable Investing
Recommendation
Use low-cost index funds that track a market index, such as the S&P 500, and have low expense ratios. Ensure that dividends is reinvested.
Why Focus on Pre-Tax Investing Vehicles First?
- Tax Advantages: Pre-tax accounts like 401(k)s, HSAs, and IRAs offer tax-deferred or tax-free growth, reducing your current tax burden and maximizing long-term returns.
- Employer Match: Contributions to a 401(k) often come with an employer match, providing free money and an immediate return on investment.
- Higher Effective Returns: Tax-advantaged accounts allow your investments to compound without the drag of annual taxes on dividends or capital gains.
Why Use Low-Cost Index Funds for Taxable Investing?
Once you’ve maximized contributions to pre-tax accounts, low-cost index funds are ideal for taxable investing because:
- Tax Efficiency: Index funds typically have lower turnover, resulting in fewer taxable capital gains distributions.
- Low Fees: Lower expense ratios mean more of your money stays invested and compounds over time.
- Diversification: Index funds provide broad market exposure, reducing risk compared to individual stocks.
Example
Assume:
- You invest $10,000 in a low-cost S&P 500 index fund with a 0.04% expense ratio.
- The fund returns 7% annually.
After 30 years, your investment would grow to approximately $76,123, with minimal fees and tax drag compared to actively managed funds.