How to Invest Your 401k

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How to Invest Your 401k: How It Works

When you put your money in a 401k or other tax deferred plan you are dealing with marginal tax rates. This has to do with the amount of tax paid on an additional dollar of income. The marginal tax rate for an individual will increase as income rises. When you put money in your 401k you are taking money that you would invest or save anyway. And you are not taxed for this last bit of income so long as it goes into your 401k. That can be a savings of around 25%. Then the appreciation of your investment in the 401k is allowed to increase without yearly taxes. For example, if you have a dividend stock in your 401k portfolio you will not be taxed on the dividends over the years. Likewise, if you buy a growth stock and then sell it after a big run up you will not pay capital gains on the stock while it is in your 401k. When you do pay taxes, it will be when you are retired and typically in a lower tax bracket. The exponential growth of your investments is substantially better when not taxed until it is taxed just one time on withdrawal. This is why a 401k is a preferred way to save.

How to Invest Your 401k: Best Vehicles

Always remember that how you invest your 401k versus investments with other vehicles has to do with the tax advantages of deferring taxes until after an investment has exponentially appreciated in value for many years. As an example you would not want to put municipal bonds in a 401k because they are already tax advantaged. In our most recent articles, Invest Your Money, we note that you should pay off credit card debts, purchase a home and have a rainy day stash the bank before thinking about investing. To a degree this also applies to the first years of how invest your 401k. Thereafter think of long term growth stocks, hot stocks that you can buy cheap and sell when then they run up and avoid the immediate tax consequences and stocks with a substantial margin of safety. This is because the worst thing that can happen is that you play with your 401k and lose everything. The way to save money on paying taxes on investment income is decidedly not to have any 401k withdrawals on which to pay taxes.

How to Invest Your 401k
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