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Investing

What is a 401(k)?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

You already know that saving for retirement is one of the most important financial decisions you can make. But how, exactly, should you go about it?

The best way to save for retirement is to invest your money so it can go to work for you. The magic of compound interest can turn today’s spare change into tomorrow’s nest egg.

If you’re a full-time employee, chances are the most readily-accessible investment plan available to you is a company-sponsored 401(k). But what, exactly, is that alphabet-soup-sounding retirement account? And how does it work?

What is a 401(k)?

A 401(k) is an employer-sponsored investment account. It helps you save for retirement by combining the powers of time, consistency, compound interest and hefty tax benefits to help set you up for your golden years.

Like other retirement accounts, 401(k)s are available in both traditional and Roth varieties.

In a traditional 401(k), your contributions are tax-deductible (and thus reducing your total taxable income for the year), and grow tax-free until you withdraw them — at which point they are subject to regular income tax.

With a Roth 401(k), your contributions will count toward your taxable income for the year, but they are not taxed upon withdrawal.

Your employer has control over whether or not to offer a 401(k), employee participation eligibility, and at what point the funds you contribute will be fully under your ownership — a process called “vesting,” which we’ll get to later in this post.

(Psst: if your employer doesn’t offer a 401(k) plan, you still have some valuable savings options.)

How does a 401(k) work?

A 401(k) is funded primarily by elective contributions — the portion of your wages that is automatically deducted from your paycheck each period. You have control over how much you contribute to your 401(k), although there are limits imposed by the IRS. For 2019, you can contribute up to $19,000 of your personal income.

Once the funds are deducted from your paycheck, they’re invested in a portfolio of your choosing. You’ll have the opportunity to choose from a variety of available options — an average of eight to 12 alternatives, according to FINRA. These may include individual stocks and bonds, but mutual funds are the most common option.

Depending on where you work, you may also have access to an employer match program — and if you do, it’s a very good idea to take advantage of it to maximize your 401(k) returns. An employer match means just that: your employer will match your 401(k) contributions — dollar for dollar— up to a certain percentage, which basically means free money to put toward your retirement.

Of course, employer matches aren’t limitless. The average match hovers between 3% and 6%, according to Malik S. Lee, a Certified Financial Planner at Atlanta-based financial advisory firm Felton & Peel. Some generous employers will match paycheck contributions up to 8%, or even higher — Lee said he’s seen some Georgia universities matching as high as 10%.

No matter how much — or how little — your employer contributes, it’s well worth it to take advantage of your employer match.

Say you’re making $30,000 and putting 4% of that toward your 401(k), for a total annual contribution of $1,200. An employer match of just 1% puts an additional $300 into your 401(k), which increases your total annual contribution to $1,500.

That might not seem like much. But thanks to the exponential nature of compound interest, that extra $300 could make a big difference down the road. After 10 years of contributions and investments growing at a relatively modest 6% annual interest rate, you’d have $15,816.95 without the employer match, but $19,771.19 with it. That’s a difference of nearly $4,000!

More on employer match programs: Getting vested

Not every employer allows new hires to start contributing to their 401(k) plan as soon as they start — and those who do may not grant ownership of employer contributions immediately. Vesting, the process of earning total control of your retirement account, means your employer’s 401(k) contributions will not be taken back or forfeited upon your resignation or dismissal. Remember, vesting applies only to employer contributions. You’ll always own 100% of the funds you put into your account.

Many employers will gradually vest their employers based on the time they’ve worked for the company. For instance, you may start at 0% and achieve 20% vesting after the first six months of employment, then 40% by the end of the year, and so on.

Other employers utilize a “cliff” method of vesting, wherein employees are 0% vested for a longer period of time (such as the first two years of employment). They achieve 100% vestment after a certain threshold (say, three years).

According to the IRS, “All employees must be 100% vested by the time they attain normal retirement age under the plan or when the plan is terminated” — that is, if the employer decides to end their 401(k) program entirely.

How much can you contribute to a 401(k)?

As mentioned above, there are limits to how much you can put into your 401(k) while still enjoying the tax benefits the account offers. The IRS sets these limits annually and they change from time to time.

For example, in 2018, employees could contribute up to $18,500 of their personal income to their 401(k) plans, but that figure has been raised to $19,000 for 2019. For more information on 401(k) contribution limits, see this MagnifyMoney article.

How much should you contribute?

The answer to this question seems obvious: as much as possible. But as in all parts of our financial lives, your mileage may vary depending on your circumstances. For example, you may still be paying down high-interest debt or trying to bolster your emergency fund, either of which makes hefty retirement contributions more difficult. Getting started is the key, because the earlier you start, the more time you’ll have on your side to take advantage of compound interest.

“You always want to put something away inside your 401(k),” Lee said. “Even if you’re trying to pay down debt or build your emergency reserve.” Ideally, you’ll want to meet your employer match if it’s available — but even if not, you should still contribute what you can.

Accessing your savings: How 401(k) withdrawals work

Generally, you can’t withdraw from your 401(k) savings before the age of 59 and a half without paying an additional 10% tax penalty. The withdrawal will also be taxed as regular income at the time it is taken out of the account.

However, you’ll be required to take minimum distributions once you hit age 70 and a half, unless you own more than 5% of the company or have not yet retired.

There are several exceptions in both cases. For instance, you may be eligible for penalty-free distributions before the age of 59 and a half if you can demonstrate financial hardship or you have a qualifying disability. (See the IRS guidelines for a full details)

You will also incur the 10% penalty if you take money out to perform an indirect rollover, which we’ll go over next.

Got a new gig? 401(k)s are portable

These days most of us hold more than one job over the course of our lifetimes. Fortunately, when you get a shiny new job, your old 401(k) can come with you!

The easiest way to bring your 401(k) funds along on your career move is to ask your account custodian to initiate a direct rollover. Your funds will either be transferred directly to your new account, or the custodian will write a check made out to the new account in your benefit. In either scenario, you’ll never have direct access to the money, which means you won’t incur any penalties or taxes during the process.

You can also opt for an indirect rollover, allowing you to cash in the account and then reinvest it manually; however, this route does come with some tax-related rules and limitations. The IRS requires the administrator to withhold 20%, which means you’ll receive only 80% of the amount you see reflected in your 401(k) account balance. In order to avoid the tax penalty and make up the difference in the form of a tax credit, you’ll need to reinvest the total amount within 60 days of initiating the rollover, which means pulling a potentially significant chunk from your own pocket. Since 401(k)s are eligible to be rolled over into just about every type of retirement account available, a direct transfer is a much more sensible option.

The 401(k) is the workhorse of retirement accounts — one of the most readily-accessible and powerful financial tools in the American earner’s arsenal. If you have access to one through your employer, start taking advantage of it today. You’ll thank yourself tomorrow.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Jamie Cattanach
Jamie Cattanach |

Jamie Cattanach is a writer at MagnifyMoney. You can email Jamie here

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Investing

E*Trade vs. TD Ameritrade

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

E-Trade and TD Ameritrade are two of our picks for the best online brokers available in the market today. While these firms share broad similarities in the services they offer, there are some important differences that can hopefully help you make an informed choice between these two key industry players.

Based on our comparison, E-Trade is less expensive for high volume traders who do more than 30 trades per quarter. TD Ameritrade seems to offer a wider range of trading options, including foreign exchange and cryptocurrency, plus more portfolio management options for larger balance accounts.

E-Trade vs. TD Ameritrade: Feature comparison

E-TradeTD Ameritrade
Current promotions

For customers who deposit at least $10,000, E-Trade offers up to 500 commission-free trades for each stock or options trade executed within 60 days of funds becoming available.
For new accounts with a deposit of at least $25,000, you'll also receive a cash bonus, which can range from $200 to $2,500 depending on the amount deposited.

Deposit $3,000 or more and get 60 days of commission-free online equity, ETF and option trades.
Stock trading fees
  • $6.95 per trade (less than 30 trades per quarter)
  • $4.95 per trade (more than 30 trades per quarter)
  • $6.95per trade
Amount minimum to open account
  • $500
  • $0
Tradable securities
  • Stocks
  • ETFs
  • Mutual funds
  • Bonds
  • Options
  • Futures/Commodities
  • Stocks
  • ETFs
  • Mutual funds
  • Bonds
  • Options
  • Futures/Commodities
  • Forex
Account fees (annual, transfer, inactivity)
  • $0 annual fee
  • $75 full account transfer fee
  • $25 partial account transfer fee
  • $0 yearly inactivity fee
  • $0 annual fee
  • $75 full account transfer fee
  • $0 partial account transfer fee
  • $0 inactivity fee
Commission-free ETFs offered
Mutual funds (no transaction fee) offered
Offers automated portfolio/robo-advisor
Account types
  • Individual taxable
  • Traditional IRA
  • Roth IRA
  • Joint taxable
  • Rollover IRA
  • Rollover Roth IRA
  • Coverdell Education Savings Account(ESA)
  • Custodial Uniform Gifts to Minors Act (UGMA)/Uniform Transfers to Minors Act (UTMA)
  • Custodial IRA
  • SEP IRA
  • Solo 401(k) (for small businesses)
  • SIMPLE IRA (Savings Incentive Match Plan for Employees)
  • Trust
  • Guardianship or Conservatorship
  • Individual taxable
  • Traditional IRA
  • Roth IRA
  • 529 Plan
  • Joint taxable
  • Rollover IRA
  • Rollover Roth IRA
  • Coverdell Education Savings Account(ESA)
  • Custodial Uniform Gifts to Minors Act (UGMA)/Uniform Transfers to Minors Act (UTMA)
  • Custodial IRA
  • SEP IRA
  • Solo 401(k) (for small businesses)
  • SIMPLE IRA (Savings Incentive Match Plan for Employees)
  • Trust
  • Guardianship or Conservatorship
Ease of use
 
 
Mobile appiOS, AndroidiOS, Android, Windows phone
Customer supportPhone, 24/7 live support, Chat, Email, 30 branch locationsPhone, 24/7 live support, Chat, Email, 364 branch locations
Research resources
  • SEC filings
  • Mutual fund reports
  • Earnings press releases
  • SEC filings
  • Mutual fund reports
  • Earnings press releases
  • Earnings call transcripts
  • Earnings call recordings

E-Trade vs. TD Ameritrade: Fees & account minimums

Some brokers charge an annual or monthly fee to maintain your account. Neither E-Trade nor TD Ameritrade impose such a fee, nor do they charge a fee if your account is inactive during the year. However, E-Trade does impose a $500 minimum to open an account at the firm. TD Ameritrade requires no minimum account balance.

E-Trade and TD Ameritrade charge investors a flat fee for each stock trade. At E-Trade, the charge is $6.95 a trade for the first 30 transactions in a quarter. When you make more than 30 transactions per quarter, E-Trade drops its commission to $4.95 per trade. TD Ameritrade charges a flat $6.95 commission per trade. This makes E-Trade less expensive for high volume traders. Both firms offer a range of commission-free exchange traded funds (ETFs) and the ability to purchase mutual funds without a transaction fee.

Both brokers charge fees for professional account management services. At E-Trade, fees range from 0.30% to 0.90% of assets under management, depending on the services chosen by the investor. At TD Ameritrade fees are similar, ranging from 0.30% to 0.90% of assets the firm manages.

E-Trade charges a $75 fee for a full account transfer and a $25 fee for a partial transfer. TD Ameritrade charges the same $75 fee for a full account transfer. However, at TD Ameritrade, partial account transfers are free, offering investors additional flexibility.

Many online brokers offer special incentives to attract investors. E-Trade and TD Ameritrade both currently offer commission-free stock and options trading. At E-Trade you get $600 (and up to 500 free trades) for a $10,000 deposit. At TD Ameritrade you must deposit at least $3,000 to get 60 days of free trades. In addition, you get $100 if you deposit $25,000, $300 if you deposit $100,000 and $600 if you deposit $250,000. Offers vary over time.

E-Trade vs. TD Ameritrade: Tradable securities

In addition to trading stocks and bonds, E-Trade and TD Ameritrade offer their customers a wide range of investable asset classes to choose from:

  • Mutual funds: For investors interested in the professional management that mutual funds offer, at E-Trade you can invest in more than 4,400 mutual funds with no transaction fee. Meanwhile, TD Ameritrade offers more than 13,000 mutual funds.
  • Options: An option allows an investor to sell a security at a predetermined price for a certain period of time. At E-Trade investors can trade options at regular commission rates plus an additional fee of $0.75, which drops to $0.50 with 30 or more trades per quarter. TD Ameritrade permits investors to trade options for $6.95 plus $0.75 per contract.
  • ETFs: Including ETFs in your portfolio is a great way to add an element of diversity. E-Trade gives investors access to more than 250 ETFs free of commission. At TD Ameritrade, investors have access to more than 550 ETFs that are commission-free.
  • Foreign exchange trading. At TD Ameritrade, investors can access the currencies of more than 20 countries. E-Trade does not offer foreign exchange trading.
  • Futures. If you decide to trade in futures you are essentially agreeing to sell a security or other asset at a set price at a predetermined time in the future. E-Trade offers futures trading for $1.50 per transaction. TD Ameritrade gives investors access to more than 70 futures products.
  • Cryptocurrency. TD Ameritrade recently began offering cryptocurrency investing through ErisX, a regulated exchange for cryptocurrency trades. E-Trade does not offer the ability to invest in cryptocurrency.

E-Trade vs. TD Ameritrade: Special features

E-Trade offers two levels of managed account services. Core Portfolios is the company’s robo-advisor product, which offers you an automated portfolio of ETFs customized to your investment goals. Just complete a five-minute online questionnaire to get started, which includes information about your goals, timelines and attitudes about risk. The minimum investment is just $500 and the annual fee is 0.30% with no commissions.

Blended Portfolios is E-Trade’s second level of managed accounts. Investors work with a financial consultant to tailor a portfolio that meets their needs, however you need a $25,000 minimum balance to gain access to Blended Portfolios. Annual management fees range between 0.65% and 0.90%, depending on the total amount of money invested under the service.

TD Ameritrade offers investors three levels of managed portfolios. Essential Portfolios is the firm’s robo-advisor option, offering five goal-oriented ETF portfolios. The minimum investment is $5,000 and the annual management fee is 0.30%.

Selective Portfolios offers more personalized service, and invests in both ETFs and mutual funds. A financial consultant helps you set investing goals, and a support team that regularly updates you on how the account is tracking towards those goals. The minimum investment is $25,000, while annual fees range from 0.55% to 0.90% depending on account balance.

Personalized Portfolios provides TD Ameritrade’s highest level of service, with tailored advice and portfolio construction. It gives you a one-on-one relationship with a financial consultant, plus extra guidance and support from a team of investment professionals. The minimum investment is $250,000, and annual fees range from 0.60% to 0.90%, depending on portfolio type and the total amount invested.

E-Trade advantages

  • If you are a high-volume stock trader, after you do 30 trades in a quarter, the cost per trade drops to $4.95 from $6.95. TD Ameritrade offers only a flat fee of $6.95 per trade.
  • E-Trade offers its clients access to solid research tools including market news, recordings and transcripts of earnings calls as well as the ability to analyze companies with fundamental stock research, technical research and bond, mutual fund and ETF research tools.
  • E-Trade has a “better” bonus for new clients. For a deposit of only $10,000 you get $600 and up to 500 free trades. While TD Ameritrade offers 60 days of free trades for only a $3,000 deposit, you need to deposit $250,000 to get a $600 cash bonus.

TD Ameritrade advantages

  • TD Ameritrade does not impose a minimum balance to open an account. At E-Trade, the minimum initial investment to open an account is $500.
  • Some transfer fees at TD Ameritrade are lower. For example, there is no charge for a partial account transfer while E-Trade imposes a $25 fee.
  • TD Ameritrade has 364 branches located around the country to provide customer support. E-Trade has only 30 branches.
  • TD Ameritrade offers investors access to more mutual funds and ETFs that are free of transaction fees. For example, TD Ameritrade offers more than 13,000 mutual funds, nearly three times the number of mutual funds at E-Trade(4,400).

E-Trade vs. TD Ameritrade: Which is best for you?

When the time comes to choose between E-Trade and TD Ameritrade, E-Trade is likely to appeal to high volume traders, since the cost per trade drops to $4.95 after 30 trades in a quarter. Similar price cuts are available for options as well. TD Ameritrade will appeal to investors who are looking to trade foreign exchange and cryptocurrency. And for investors who are looking for stronger portfolio consulting options, TD Ameritrade offers a wider choice of customized investing advice for larger account balances.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Peter Fleming
Peter Fleming |

Peter Fleming is a writer at MagnifyMoney. You can email Peter here

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Investing

Where Investing in Housing Outperforms the Stock Market

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

The housing market has come a long way since the Great Recession. The demand for homes has reached such a fever pitch that in certain U.S. metro areas, the equity you have in a home outperforms investments in index funds tracking the S&P 500 — long considered one of the most reliable vehicles for investors and a strong indicator of how the stock market is performing as a whole.

Key takeaways

  • We examined the performance of home prices in 20 U.S. metro areas from 2012 to 2018. Of these 20 areas, housing appreciation in the Los Angeles, San Francisco, San Diego, Miami and Seattle markets outpaced the S&P 500 over this period.
  • San Francisco outperformed the S&P 500 by the greatest margin, growing approximately 127 percentage points from 2012 to 2018, compared with the S&P 500’s gain of nearly 98 percentage points.
  • Among the five metro areas that outperformed the S&P 500, only Los Angeles has a majority of homes occupied by renters rather than by owners. Renters obviously don’t reap any benefits from the explosive growth in home values — in fact, they often see their rents rise as landlords see the growing value of their real estate.
  • From 2012 to 2018, the housing markets in all 20 cities we looked at increased in value. The slowest-growing market, Cleveland, still rose by almost 22 percentage points.

How we know housing markets have outperformed the stock market

Among the most reliable and most widely cited indices used to measure housing markets are the Case-Shiller indices, calculated each month by Standard & Poor’s and CoreLogic. There are several Case-Shiller indices, but we chose the Composite 20 index, which tracks housing values in the following 20 metropolitan areas:

  • Atlanta
  • Boston
  • Charlotte
  • Chicago
  • Cleveland
  • Dallas
  • Denver
  • Detroit
  • San Francisco
  • Seattle
  • Las Vegas
  • Los Angeles
  • Miami
  • Minneapolis
  • New York
  • Phoenix
  • Portland (OR)
  • San Diego
  • Tampa
  • Washington D.C.

The index examines the change in home prices for each of these cities by looking at residential home sales and running that data through an algorithm. To learn more about the Case-Shiller index, there’s plenty of information from Standard & Poor’s here.

In the 2012-2018 time period of our study, the Case-Shiller Composite 20 index showed a growth in average home values in all 20 metropolitan areas. You can then compare the Case-Shiller index to the growth in the S&P 500, an index of roughly 500 stocks that often serves as a bellwether for the U.S. stock market as a whole.

The chart above indicates that according to the Case-Shiller Composite 20 index, the housing markets of five metro areas grew quicker than the S&P 500 in the 2012-2018 period, which saw a rise of 97.97 percentage points:

  • San Francisco (+127.26 percentage points)
  • Los Angeles (+111.57 percentage points)
  • Seattle (+110.95 percentage points)
  • Miami (+109.10 percentage points)
  • San Diego (+98.67 percentage points)

That means in theory, the equity you have in a home in one of these markets may have appreciated by a greater amount than if you had invested it in an index fund that tracks the S&P 500 — a common stand-in for the entire stock market.

Good news for homeowners, bad news for renters

While homeowners may be celebrating, our study gives the renters living in these five metro areas little reason for joy. As the value of a home goes up, landlords increase rents to reflect the broader housing market (as much as they are able under the constraint of local housing laws and regulations). The chart below estimates the performance of rents in the five metro areas that outperformed the stock market from 2012 to 2018:

In San Francisco, for example, the average rent rose nearly 46% during the time period in question from $2,359 to $3,433 a month. While the City by the Bay offers the most dramatic example of rent increases, tenants in the other four metro areas also had to pay more for the privilege of renting in a hot housing market.

Another concerning consequence of rising home values in these cities is that homeowners in these markets tend to already be wealthier than their non-owning neighbors, which means real estate appreciation widens the wealth gap. For example in Los Angeles, only approximately 31% of renters have an income of $75,000 or more a year, compared with 63% of homeowners. Homeownership also has a racial disparity in these metro areas: Almost 71% of African American households in Seattle rent, compared with just 36% of white households.

Why stocks are still a better bet than housing

Despite the value of housing outpacing the growth of the stock market in certain metro areas, homeowners should think twice before funneling funds earmarked for their investment accounts into hearth and home.

The most obvious difference is the relative liquidity of investment securities and a house (especially one that’s your primary residence). Selling a house comes with a litany of costs that eat up both your time and your money, while cashing out on your investments can usually happen in a matter of days (not that selling an investment in an index fund or stock is without potential tax costs and other potential losses).

There’s also the matter of putting all of your eggs in one basket. The ability to diversify your investments is one of the greatest advantages of investing in markets. By placing your money in a diverse array of securities, from stocks, to bonds, to money market accounts, it can help shield you from volatility in any one particular market. But if you put all of your money in your home as an investment and the housing market crashes (like it did most recently in 2008), then your nest egg is scrambled.

Finally, owning a home comes with property taxes you need to pay every year. In the city and county of San Francisco, the property tax rate for the financial year of 2018-2019 was 1.1630%. With investments, you typically only pay a capital gains tax one time: when you sell it.

Methodology

Data on change in S&P 500 value over time comes from the Stern School of Business at New York University. Data on home value for each of the metro changes comes from the Case-Shiller Index of home values and is pulled from the Federal Reserve Economic Data. Data was analyzed over the 2012-2018 time period.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

James Ellis
James Ellis |

James Ellis is a writer at MagnifyMoney. You can email James here