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Understand and Use the Priority of Money

Before you can build a successful investment portfolio, you must understand the difference between financial assets (or investment assets) and investment vehicles. Financial assets are specific classes of securities in which you may invest, including stocks, bonds, mutual funds, real estate, money-market mutual funds, CDs, and so on. As you will learn in later lessons, these financial assets are grouped into asset classes and are associated with different levels of risk.

Investment vehicles are special types of investment accounts that provide a tax-advantaged framework that allows you to invest in various financial assets. Tax advantages include the deferral of current taxes (i.e., traditional IRA or 401(k)) or the elimination of future taxes on earnings (i.e., Roth or Education IRA). These accounts are useful because they provide specific tax advantages that are not available when financial assets are purchased individually.

There are many types of investment vehicles. Many investment vehicles are geared towards helping you build a retirement account. Most are named after a specific line in the Internal Revenue Code. For example, a 401(k) plan is a retirement plan offered to employees of private companies, a 403(b) plan is a retirement plan offered to employees of public companies, a Simplified Employee Plan (SEP-IRA) is a retirement plan designed for employees of small businesses, and an Individual Retirement Account (IRA) is a retirement plan designed for individuals. Table 1 shows characteristics of select investment vehicles for 2008.


Table 1 Select Investment Vehicles for 2007

Investment Vehicle: Tax-deferred Tax-eliminated Maximum Amount Retirement Plan For Employees of:
401-k Y   $15,500 Businesses w/plans
Roth 401-k   Y 15,500 Businesses w/plans
403-b Y   15,500 Non-profit, tax-exempt
Roth 403-b   Y 15,500 Non-profit, tax-exempt
457 Y   15,500 State/municipalities
SEP IRA Y   46,000 Small businesses
SIMPLE IRA Y   10,500 Small businesses
IRA Y   5,000 Individuals
Roth IRA   Y 5,000 Individuals
Education IRA   Y 2,000 Individual Education
529 Plan   Y >300,000 p.c. Individual Education


Understanding the priority of money can help you identify the tax benefits and other benefits that different investment vehicles offer. Understanding these priorities can help you to determine which investment vehicles will help you achieve your financial goals the quickest. The priority of money is divided into three sections: free money; tax-advantaged money; and tax-efficient, wise investments. Understanding the priority of money can help you determine which investment vehicles you should use first in working toward your financial goals.


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