If you have a Facebook account, you’ve likely seen the posts with algebraic equations…
The picture is nothing more than an equation like this one…
And at the bottom, the post asks users to share their answers in the comments.
Now, I learned in math class that there’s usually only one right answer to an algebraic equation. But that doesn’t stop the comments section from turning into one big argument.
I don’t want to spoil the fun. But for this example, most folks come up with “9” or “1.”
The answer boils down to a grade-school math classic – the order of operations.
And as you can see, that order matters a lot… One and nine are very different numbers. But there’s only one order of operations. And you need the correct order to get it right.
That holds true in investing, too. Get the investing order of operations wrong… and you’ll likely fail to maximize your investments.
You’ll also give the taxman free money. Nobody wants to do that.
So today, let’s go over the investing order of operations. And we’ll make sure you’re not making this grade-school math error with your life savings…
Step 1: Maximize “free money.”
“Free money” refers to the company matches on 401(k) or employee stock option plans.
A company match is an addition to your savings plans provided by your employer. For example, you contribute 6% to a savings account… and the company matches up to 3%.
That’s free money.
So start by making sure you’ve hit the upper limit on any available company matches.
A word of warning, though… Double-check how long that money takes to vest. Make sure you plan on staying with the company that long.
Employee stock option plans are another form of free money. Remember, discounted stock is nearly free money, too. The discount you’re receiving is your automatic return on the stock.
Again, I caution you to double-check the vesting rules. Secondly, make sure you’re not too overexposed to your company’s stock. You need to be able to liquidate the shares in a way that makes sense for you.
But most importantly… don’t leave free money on the table.
Step 2: Don’t pay the taxman a nickel more than needed.
This idea seems obvious… But a lot of folks “invest” in non-tax-advantaged accounts before maxing out their retirement accounts – like 401(k)s and IRAs.
These accounts are primarily for retirement… But that’s investing, too. And in an IRA especially, you have the option to make more active investing decisions.
Simply put, if you’re investing in non-tax-advantaged accounts… and you haven’t maxed out your tax-advantaged accounts… you’re paying Uncle Sam extra for the privilege of investing.
In a standard investment account, you owe money every time you profit and sell a stock…
If you’ve held the stock for longer than a year, it’s taxed as long-term capital gains up to a maximum of 20% (depending on your tax bracket). If you’ve held it for less than a year, it’s taxed as short-term capital gains, which tops out at 37% (again depending on tax bracket).
Either way, that’s an extremely hefty tax cost. And you owe that on every profitable trade.
So I highly recommend maximizing investments in your tax-advantaged accounts before investing in taxable accounts. Don’t be a sucker and overpay the taxman.
Folks, this is investing 101. Before you put your money to work in the market, make sure you’ve respected the investing order of operations.
First, maximize free money. And after that, maximize your tax advantage.
If you can do those two things, you’ll be much better off in the long run.
Good investing,
Karina Kovalcik
P.S. If you’ve made it this far, I’m in the “9” camp for the Facebook question.
