Common financial tools for saving, investing and building wealth:
Tools for saving
- Savings AccountHow it works: Offered through a bank, a savings account is a safe place to keep your money and may pay a small amount of interest. It’s a good place to put money that you could need to access quickly.What it’s for: Growing short- to mid-term savings, building an emergency fund
- High-Yield Savings AccountHow it works: Typically offered through an online bank, these savings accounts work exactly like the one above except that they pay a higher rate of interest on your money. The only drawback is that these banks may not have a physical location that you can easily get to.What it’s for: Growing short- to mid-term savings, building an emergency fund
- Money Market Bank AccountHow it works: These work like a checking account but often also pay a small amount of interest. This is a good place to put money that you can’t afford to lose and may need to access quickly.What it’s for: Everyday expenses, growing short- to mid-term savings, building an emergency fund
- Certificate of Deposit (CD)How it works: A bank or credit union pays a pre-determined amount of interest over a set time span, such as six months or a year. There is usually a penalty for early withdrawal. CDsare a safe place to keep money that you can’t lose but that you won’t need immediately.What it’s for: Growing short- to mid-term savings
Tools for long-term investing
- 401(k)How it works: This is a type of tax-advantaged retirement account that’s offered through employers. You can use a 401(k) to invest in a range of financial products like stocks, bonds or funds. Money goes in without being taxed and grows tax-deferred, but you will owe taxes when you withdraw funds in retirement. A 403(b) or 457 account operates in a similar way. While there are some options to access funds in these accounts, in general, if you take money out prior to age 59½, you will owe a penalty on top of taxes.What it’s for: Saving for retirement
- Roth 401(k)How it works: A Roth 401(k) is the same as a 401(k) except that the taxes work a little differently. With a Roth 401(k), contributions are taxed. But then the money is usually never taxed again.What it’s for: Saving for retirement
- Individual Retirement Account (IRA)How it works: An IRA works in a similar manner to a 401(k) in that contributions are tax deductible and funds grow without being taxed, but you will owe tax when you withdraw funds in retirement. Unlike a 401(k), which is offered through an employer, anyone can open an IRA. As with a 401(k), there may be a penalty if you withdraw funds prior to age 59½.What it’s for: Saving for retirement
- Roth IRAHow it works: A Roth IRA is the same as an IRA except that the money you contribute is taxed. It’s then usually never taxed again. With a Roth IRA, you’ll be able to access contributions should you need them prior to age 59½. (You would owe taxes and a penalty if you withdraw earnings.)What it’s for: Saving for retirement
- 529 PlanHow it works: A 529 plan is a tax-advantaged way to save for education expenses. You may get a tax break when you contribute money, and you’ll usually never owe tax on money taken out of a 529 plan as long as it’s used for qualified education expenses.What it’s for: Saving for education
- StockHow it works: Investing in stock is common. Stock is a partial ownership stake in a company. When you own stock, you may share in the company’s profits, and the price of the stock may go up if the value of the company increases over time. Conversely, if the value of the company falls, your stock may lose value. The values of stocks that trade on the open market tend to fluctuate frequently.What it’s for: Long-term goals
- BondHow it works: A bond is a loan that you make to a government or company. In exchange for the loan, you get interest payments (known as coupons) for a set period. When that time is over, you receive the amount invested back in full. Bonds can be a less risky way to grow money over the long term. However, they may not grow as much as stocks. Bonds are also not without risk entirely. It’s possible that a company or government could default, failing to make payments.What it’s for: Mid- to long-term goals
- Mutual FundHow it works: When you buy into a mutual fund, your money is allocated to a basket of investments. Mutual funds can be set up in different ways with different investment objectives. Some may attempt to follow market indexes, while others may invest for growth. You can put money into mutual funds that invest in international or domestic companies. Mutual funds allow you to diversify your investments with a single purchase.What it’s for: Mid- to long-term goals, saving for retirement, saving for college
- Index FundHow it works: An index fund is also a basket of investments; however, these are designed to mirror a specific index, such as the S&P 500. What it’s for: Long-term goals, saving for retirement, saving for college
- Exchange-traded Fund (ETF)How it works: An ETF is like a mutual fund or an index fund but with one key difference. With a mutual or index fund, you can only buy and sell once per day at the fund’s closing price for the day. With an ETF, the price moves during the day, and you can buy and sell throughout the day like you can with stocks or bonds.What it’s for: Long-term goals, saving for retirement, saving for college
- AnnuityHow it works: An income annuity allows you to create steady, guaranteed income in retirement.1 While some people use a portion of their savings to purchase an income annuity when they retire, others purchase annuities many years before they retire.What it’s for: Retirement
The list above is certainly not exhaustive. As you can see, though, different types of accounts work better for different goals. And they can complement each other. For instance, when you get to retirement, it can be beneficial to have a mix of Roth and traditional accounts. This can allow you to strategically withdraw money in a way that minimizes taxes.
Source: https://www.northwesternmutual.com/life-and-money/4-steps-to-building-a-solid-financial-foundation/