Investing *Outside* Your Retirement Accounts

Katie: Welcome back to The Money with Katie Show, my Rich Family. I hope you're in the mood for a nerdy episode, because today we're going to explore how you can invest outside of your retirement accounts, aka money you can touch before you're 59 and a half. Think about this episode like a comprehensive overview of taxable investing. Because if you've ever sheepishly opened up a Robinhood account or curiously dabbled with a round-up app like Acorns, you're already doing some taxable investing. But most of the time I find that people don't have a systematized approach to their taxable accounts. Either that or you feel analysis paralysis about choosing a brokerage firm and just plowing ahead. Taxable brokerage accounts are an important piece of your financial ecosystem because of the flexibility they can provide for you. I think about ours, a joint account between my husband and me that we call KGTTMT World Domination, like our war chest. We've been shoveling cash into it since we got married in late 2021, which means we started investing at the tippy top, but then dollar cost averaged through the bear market of 2022. And we are currently up a whopping 18.27% in this account since its inception.

So before we get into the granular dirty details, let's talk about what a taxable brokerage account is, what it's good for, and why you need one. I find that taxable investing often gets the shaft so people will contribute the maximum to their retirement accounts. They'll still have money left over to save, but they won't know what to do with it or where to put it. But taxable investing, also colloquially known as your brokerage account or a non-qualified account, is great for a few things, specifically overflow money after you've contributed to qualified accounts like the 401(k) and IRA, or goals with flexible timelines or goals with timelines that are probably going to happen before you're 59 and a half, so think a home or another major purchase. And finally, bridge accounts for early retirement. This is especially helpful in years one through five of early retirement before your Roth conversions become available. And if you have no idea what I'm referring to, we will link our episode about this in the show notes. 

Like I said, I think about ours like a war chest. We're not saving for anything specific right now, so it's really just our flexible money for the future account. We have both opened different brokerage accounts over the years with different holdings, mostly to try out different platforms or to meet different needs. And the big reason that taxable investing rocks is because your capital gains are taxed favorably. Income you earn from your investments is probably going to be taxed at either 0%, 15%, or 20% depending on your income, rather than the marginal tax rates that dictate how your income from your labor is taxed, which can go upwards of 37%. Side note, this is part of the double-edged sword of a system that favors capital and ownership over labor, but in this case it benefits you. Yay. We'll return after a quick break. 

So who is the taxable brokerage account good for? Realistically, I think these types of accounts are the most important for high earners with solid save rates, because speaking from personal experience, I did not earn enough to contribute to my qualified accounts and also a taxable account until I was earning somewhere in the $90,000 range. And you don't wanna miss out on your tax breaks from our boys at the IRS. Now, that's not to say that you absolutely need to contribute the maximum to your 401(k) and Roth IRA and HSA and then screen print “I love tax breaks” on a T-shirt that you wear under all your clothes before you can contribute to a taxable account. But this probably isn't something you're gonna wanna pursue in earnest until you're making pretty consistent, solid use of all of your qualified options.

A taxable brokerage account also makes sense for someone who has a large medium-term goal they're saving for like a home or a wedding or something else that's roughly five or more years away, give or take, and or someone who definitely knows they wanna retire before age 59 and a half. So when should you use it? When you feel like you've already exhausted the other retirement account options you have access to, or you've got that mid-term goal for which saving in cash alone is insufficient. And thanks to the lack of rules and regs dictating how and when these types of accounts can be used, the “how” can be as simple as log in and press sell or withdraw when you're ready to use the money, but you'll probably wanna be a little bit more efficient than that from both a tax and investment perspective.

So let's dig a little bit deeper. We're gonna start with the longest-term goal first: the early retirement bridge account. So let's say you wanna retire at 50, so nine full years before you get access to your qualified accounts in the quote unquote “traditional” way. You will need some source of capital in that time, which is where this bridge account comes in. The most optimal way to use it is to begin performing your standard deduction sized Roth conversions from your 401(k) to Roth IRA in your first year of retirement, and then turn around, go to the taxable account and withdraw up to the 0% capital gains tax bracket from the brokerage account to live on. Whether you're single or married, this is between roughly $45,000 and $90,000 per year in tax-free income on top of your standard deduction. And again, for the full explanation of how this works, listen to the episode, “How to set yourself up to pay no taxes in early retirement,” which we will link in the show notes. 

Now that's great for the long-term goal, but what if you're using brokerage accounts for medium-term goals? I think about this like different brokerage buckets for different goals. So assuming you're trying to do big things with your money between now and when you see your AARP card in the mail, you may find it useful to have multiple brokerage accounts for different goals because that's gonna make it easier to achieve your target asset allocation specific to that goal’s timeline. For example, maybe you're interested in saving up for a kid that you plan to have someday. You don't necessarily wanna use this money on education, but rather for anything that parenthood might entail. Think family vacays, paying your insurance deductible for when you give birth and they promptly slap your slippery newborn with its own deductible (I love it here), five-figure daycare bills (I love it here), competitive cheerleading and gymnastics if you love your kids more than my parents loved me, because they said, yeah, no way we're paying for that.

All that to say, it's good to plan. So if you know you're probably gonna start a family in the next three to five years and you'll want this money over the following 10, your asset allocation in that particular taxable brokerage account should be far more conservative than what you have in that bridge account that you're gonna be using 25 years from now. You might have a 90% stocks, 10% bond split in the long-term account, but a 60/40 allocation in the 10- or 15-year account. And when it comes time to use it, you'll likely sell the underlying assets first in first out, which will sell off the oldest shares first. You likely won't need all of it at once. So in a way, you'll be smoothing out the ups and downs as you withdraw, and you might even be adding more little by little over time. This will also probably help ensure that you're being taxed on long-term capital gains as opposed to short-term ones, though we will revisit tax implications a little bit later. 

Another option to highlight is that taxable brokerage accounts are great for unexpected sums of money. So maybe you receive an inheritance or a large bonus or a big commission check. Whenever I receive larger than usual chunks of business revenue, I'll usually hold on to 10% of it or so in cash to treat myself with something fun. But then I'll turn around and invest the rest of it into that catchall taxable account. 

So those are a few examples of when and why you might use one, but what do you need to know as far as taxes are concerned? Let's start with a horror story, because I think that's fun. In 2021, novice retail investors who do not frequent moneywithkatie.com or read irs.gov for fun on Friday nights made big bets on GameStop and other meme stocks. Some of them really cleaned up, and they mistook a little light trader collusion in a stock market that only went up for 12 months straight for investing genius, but they realized their gains, meaning they sold their shares and took their earnings in 2021, thereby creating a…da da da…taxable event.

Say you made $40,000 on a $500 investment in GameStop. Well now you have $39,500 in short-term capital gains, and the IRS wants their cut. This wouldn't have been an issue had these traders just sat on that cash in a savings account so they could pay the estimated $10,000 tax bill that move generated, but most of them reinvested those earnings and other things in 2022 and well, we all know what happened to the market in 2022, but the IRS doesn't care. You realized a gain in 2021, you still owe taxes on that amount. Uncle Sam doesn't give a shit that you yoloed your earnings into Luna, Brendan, he wants his money. So many people found themselves with high tax bills in April 2022 that they did not actually have the underlying capital to pay. But I don't blame Brendan, because apps like Robinhood feel like a casino and there are surprisingly few warnings and barriers to let someone know, “Um, hey, you are gonna owe a bunch of money in federal taxes on this sell order. Make sure you have a plan, babes.” One more personal favorite horror story from this era of clown world, and then I promise we'll move on. 

Garrett: Yo, if you use Robinhood and you get margin called and delete your account, this is what happens. Okay, first little background. A couple years back there was a bug on Robinhood that allowed you to get infinite leverage. I ain't gonna explain exactly how it worked, but I used it to get $50,000 of margin off of a $1,000 deposit. And I'm guessing you know what happened next. I bought a bunch of zero date expire options and I lost it all, basically. So obviously the next logical step is to just delete the app, right? I did that. I thought I was good for like a month, right? Blocked Robinhood on my email, everything. Like two months go by and a dude shows up at my door with like papers. He said…like some collection company or some shit and it was like $75,000. Basically this guy said if I didn't pay up, he's gonna take me to court. I was like, go for it. I got nothing. I don't even got wages to garnish. In the end, I think Robinhood just like took the loss or whatever 'cause I haven't paid him a dime. 

Katie: No, Garrett, Robinhood did not take the loss. You're going to jail. Just kidding. I have no idea. But wow, have I said it enough? I love it here. All of this is meant to highlight one very simple lesson: You wanna learn the rules of the game, or at least attempt to do so. Fortunately, if you are a buy and hold investor and you're in it for the long haul, you probably won't have to worry about any of that happening to you. You just wanna remember that if you realize gains, which means if you sell a position that earned money, you will owe taxes on those gains, and if you have dividend income or interest inside your taxable account, it does not matter whether you take it as income or set it all to reinvest. You still owe taxes on those dividends every year. So plan accordingly. 

So what's gonna happen is you'll get a 1099-DIV form from your brokerage firm in late January or early February each year. It's gonna outline all of it for you. So it's not like you have to keep track of anything, just upload it to your tax software or throw it at your CPA and thank them for their service and you're good. Don't let this scare you, though. Unless you are investing hundreds of thousands of dollars, the chances that your dividend tax bill will be more than a few hundred dollars, maybe a thousand at the most, is slim. And if you're investing hundreds of thousands of dollars, well, you've got the dough to pay for it. We'll be right back after a quick break. 

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Katie: All right, next I wanna compare popular providers and help you potentially choose a brokerage firm if you're on the fence. 'Cause there's a very common question I receive in this realm that I wanna address transparently, which is, which brokerage firm should I choose? And I'm not the resident expert on all the ins and outs of brokerage firms, but generally speaking, I think it's safe to say the more boring, the better. So I'm gonna tell you who I personally invest with, why I like them, and why you might like them too. But I'll also share a few alternatives and competitors in the event you're turned off by something that I'm not aware of or not bothered by. So sound good? Okay, great. Let's do it.

So this is how I started my investing journey. I started with Betterment. So I began investing with Betterment in 2018. I had a Roth IRA and a taxable brokerage account on their platform. And I think Betterment is an excellent option for a few reasons and a few different types of people. Number one is, those who are not comfortable with defining their own asset allocation and would rather invest based on a timeline. For example, you'll tell Betterment when you need your money and then they will invest it in a diversified portfolio accordingly. It's also great for those who want tax loss harvesting performed for them and will hold multiple qualified and non-qualified accounts with the platform, 'cause the algorithm does a pretty excellent job of maintaining your overall asset allocation, but in a tax-efficient way. It's also good for those who just can't be bothered to pick their own holdings rebalance or tax loss harvest, even if they're comfortable with doing so.

But there's a 0.25% fee for their services, which I think is worthwhile if it's going to get you to start investing and feel confident about your portfolio. But once you've got millions in assets, some people choose to move to something that is lower cost because of fee drag. I stopped using Betterment for my taxable Investing in 2021 when Betterment became a sponsor of my social media posts, because there was an SEC regulation at the time against an advertiser having funds with the company because it was considered a conflict of interest. So I had to move my money somewhere else for the duration of the partnership. Similar companies and competitors include Wealthfront and Ellevest, as well as other robo-advisors that traditional brokerage houses have developed like the Vanguard Robo-Advisor and Fidelity Go.

And as an aside, some big wealth management companies actually white label these robo-advisors for their clients that have less than $250,000 in assets. So that's a fancy way of saying, even if you go to a fancy firm with your $100,000 of investments, there is a chance they're just gonna put it in a robo-advisor for you. So let's talk about other places that I have invested. I moved my holdings at the time, it was about a hundred thousand dollars, into a Vanguard individual investment account, which was a bit of a laborious process that involved taking paperwork to a bank (my millennial nightmare), getting a medallion signature to authorize the transfer, and then mailing everything off. Moving assets around in taxable brokerage accounts isn't hard, per se, but it can be a pain in the ass. So a relevant tip is, if you have to do this block a day to knock it out and just try to be as organized as possible. There's a chance you're gonna need a printer and to go to a bank, but Vanguard is a traditional asset management firm that you can invest with directly. So you can buy Vanguard ETFs at Betterment or you can buy them directly from Vanguard. Their user experience has improved. But if investing is brand, brand new to you, it still might be a bit of an overwhelming experience. 

If you invest with a company like Vanguard or one of its competitors like Charles Schwab or Fidelity, but you don't use their robo-advisor, you'll be picking your own funds and placing your own buy orders. And this isn't complicated, but it's a little tricky if you've never done it before. Now you can set up automations to automatically buy or sell things on certain days, but it does require a little more up-front planning on your end, though nothing that should scare you off. There is definitely an asymmetric reward for your time and effort to learn how to do this. That said, there are no management expenses unless you use the robo-advisor option to invest directly at Vanguard or Fidelity. You'll still have expense ratios in your funds, but nothing for the account overall. Each firm has its own versions of various indices and mutual funds. So you can compare expense ratios if you're worried about fees. Generally, the expense ratios for common index ETFs and funds are very, very low at both of these firms, in the ballpark of as low as 0% and sometimes up to around 0.08%. 

And finally, let's talk about where I currently invest, where I'm currently doing my taxable investing. So I learned about a company called M1 Finance on ChooseFi, and I looked into it a few years ago and now it's the firm where I am actively adding the most money to my brokerage account. And I like it for a few reasons. The first is that you can pick an expert-built portfolio pie based on your risk tolerance, even though this isn't as no-brainer as the Betterment onboarding flow, which will extrapolate your risk based on the timing you're telling it. The M1 finance expert pies have a handful of options based on how conservative or risky you wanna be. And every time you add more cash, it just distributes it amongst those holdings automatically. And I love how easy it is to use. It doesn't really take any effort. It also doesn't have any management fees, which is cool. I did get an email from someone who opened an account with them, funded it, and then realized they needed to move the money somewhere else, and they had to pay a $100 fee to move the money out. I believe they were hit with an account transfer fee, which is something that some brokerages have and others don't. I didn't realize M1 Finance had these 'cause I've never moved money out, but just a warning, they charge a hundred dollars to close a retirement account and a hundred dollars to perform an outgoing transfer. Now in the grand scheme of things, this is not a showstopper for me, but I wanted to include it nonetheless. To my knowledge, there aren't any direct competitors to M1 Finance that do the “shop for your ideal portfolio pie” model, but I admittedly have not looked very hard. So if you know of one, that's great. Email me. 

By now, you might be wondering, this all sounds relatively straightforward, but how safe is this money? Is it insured? So while cash in banks is covered by FDIC insurance from the Federal Deposit Insurance Corporation, assets in a brokerage account are protected by something else: SIPC insurance. You should never invest with a brokerage firm that doesn't have SIPC insurance. This coverage ensures people for up to $500,000 in cash and securities per account type. And this is what protects you if a broker/dealer fails, not from market volatility, because you're assuming that risk when you invest. So if you buy a stock and that stock goes to zero, that's on you. That's not on the Fed. But if your broker/dealer uses all your money to buy houses in the Bahamas, totally not inspired by real life events or anything, that's where the SIPC steps in to make investors whole. 

So I had to look into the details of how this insurance works for this episode. And it sounds like it's a little better than meets the eye, because to be clear, each account is covered separately. So for example, your total coverage per type of account is $500,000, but two accounts are not insured separately if they are the same type of account. So if you have a Roth IRA and a taxable brokerage account, they're considered different account types. They're both insured up to $500k. But if you have two brokerage accounts in your name with the same company, they're considered one ownership capacity. It doesn't matter that they're in technically separate buckets, they're treated as one thing 'cause they're the same type of account. 

All right, to close us out today, let's talk about the ongoing maintenance and effort required to invest. I was a guest on a non-finance podcast a couple weeks ago for an Investing 101 episode, and the host asked me, “I feel like my perception of investing is just that it takes a lot of ongoing work. Is that true?” And I would say, if you are an aspiring day trader with a masochistic desire for financial pain, sure, you might need to spend a lot of time closely watching your trades, but for those of us who are just trying to build wealth passively for the long term, the ongoing work required is pretty damn minimal. In fact, I would say starting is far and away the most time consuming part. Opening your accounts, determining your asset allocation, and deciding when you want to add new cash. Beyond that, it's a couple of minutes worth of work per month at the most. For example, I transfer new cash into our accounts on the last day of the month when I know how our overall income and spending nets out. Some months we have more excess cash than others. So I don't automate it because I like to get in there and see how much we can do. When my income was fixed, I automated contributions two days after payday into my brokerage account, the same amount each time, which was true dollar cost averaging. But roughly once a year you can double check your asset allocation, make sure nothing's gotten horrifically out of whack. But generally speaking, you shouldn't probably be checking this stuff frequently. I do like to record account balances month over month in my Wealth Planner to see how things are changing over time. But I'm not examining underlying holdings or making adjustments, I'm just making sure the balances are moving in the right direction. 

In conclusion, one of my biggest personal finance pet peeves is when people spend hours agonizing about which high-yield savings account is the best. Like “4.9% or 5.2%—is it worth the switch?” But they ignore the fabulous world of taxable investing altogether. And this pet peeve is, of course, inspired by my own mistakes. I was so preoccupied with where I was going to get safe yield that I missed out on the opportunity to sock away flexible, accessible money for the long term that was gonna make way more—remember, 18% so far in this account. Yay, we love it. 

I hope this breakdown was helpful, and as always, we'll link additional resources in the show notes. But if you loved this episode, we always appreciate when you share it with your friends. I believe that this type of information is life-changing, and sharing the show is how podcasts grow. So thank you in advance if you do. And if you hated it and you hate me, may I ask that you send me that feedback directly rather than publicly? I kid. 

Okay, that's all for this week. I'll see you next week, same time, same place on The Money with Katie Show. Our show is a production of Morning Brew and is produced by Henah Velez and me, Katie Gatti Tassin, with our audio engineering and sound design from Nick Torres. Devin Emery is our chief content officer. And additional fact checking comes from Kate Brandt.