Maximize Tax Savings and Choose the Perfect Investment Platform for Your Financial Goals

Liz Weston: Welcome to the NerdWallet Smart Money Podcast, where we answer your personal finance questions and help you feel a little smarter about what you do with your money. Im Liz Weston.

Sean Pyles: And Im Sean Pyles. You know the drill. Send us your money questions. Maybe you want to know if your credit is in a good place to buy a house, or maybe you just want to up your investment game. Whatever your money questions, we are here to answer them. You can call or text us on the Nerd hotline at 901-730-6373. Thats 901-730-NERD or email us at podcast@nerdwallet.com.

Liz: And hit that subscribe button if you want more Nerdy goodness delivered to your devices every Monday. If you like what you hear, leave us a review. And one more plug before we get into the episode: Were working on a special podcast where were going to share what youve learned this year about your finances because of the pandemic or otherwise. But to make this happen, we need to hear from you.

Sean: Right. We want your voice in this, so please email or send us a voice memo of your financial lessons from the wild year that is 2020. Send them to podcast@nerdwallet.com. For your voice memos, just open up that voice memo app on your phone, record your thoughts, and we will share them on a future episode.

Liz: We really cant wait to hear from you, so I hope youll do this. OK, lets get on to this episode. This week, we answer a listeners money question about which investing platforms are best. First though, in our This Week in Your Money segment, were talking about how you can reduce your tax bill next year.

Sean: Right. We are now in the final quarter of the year, somehow, meaning that if you want to reduce your tax obligation for the year, you only have a few months left to do so. Liz, lets talk through some of the go-to ways folks can do this. Where do you think people should start?

Liz: Well, the reality is that people dont have many ways to reduce their tax bill anymore. Most people dont itemize, and that was always the way that you got to gather up your deductions together and get that bill down. So the options that are still left to people are fewer, but they actually can be pretty effective in reducing your taxable income, and the most important one is saving for retirement — putting money into a 401(k) if you have one, IRA if you dont. That can bring your tax bill down, and its setting you up for the future. Thats obviously the go-to place. And if you do have a 401(k), youre probably getting a match for at least some of that money. Again, its not only a tax break, its free money on top of it. If you happen to be low- or moderate-income, there is a tax credit on top of the tax deduction. Again, its like supercharging your retirement savings — its a really good thing to do.

Sean: OK. One thing I wanted to mention is for folks who still have federal student loans that theyre paying off. Im in this camp. Obviously a lot of the payments have been on hold because of COVID relief bills, but if you still owe interest on these loans, it might not be a bad idea to keep paying them since people in general can write off around $2,500 in interest. I personally am, for better or worse, past that point in paying off my student loans, so Im not paying my loans right now. But if you owe interest, you might as well do that just so you can get that tax break come tax season next year.

Liz: Yeah. Its like $2,500. Its use it or lose it. You cant make it up in future years, so thats probably a good idea.

Sean: Right. And one thing I want to talk about as well is writing off donations. This is something that got more difficult for folks to do after the tax changes in 2017. But there is a slight change for the 2020 tax year where folks can write off up to $300 in cash donations without having to itemize it, which can make this process a lot easier. Weve all been donating more this year, at least I have been I know, so thats something that Im planning on taking advantage of as well.

Liz: Yeah. And that was the real worry for charities is that because so many people lost that deduction, they worried that people would give less. It seemed like that was happening before the pandemic, but now there does seem to be this real surge in generosity, which is great. And you should take advantage of that little tax break if you can get it.

Sean: Now, what if Ive spent $70,000 on hairstyling in the past year? Can I write that off?

Liz: No, theres all kinds of fun things you cant write off.

Sean: OK. Darn. It was a wasted $70K.

Liz: Yeah, oh well. Now, if we were talking about Shea Couleé again, if you are a drag artist and this is something that youre doing to raise money, thats totally different. But yeah, for most people …

Sean: … It would have to be a business expense.

Liz: Yes. And those can get tricky. If you do have a side business, you should also have a tax pro. Ask your tax pro about it.

Sean: I also want to hear from you, Liz, about flex spending accounts and health savings accounts, because these are two big options for people as well. Can you talk about that a little bit?

Liz: Yeah. And right now were in open enrollment season, so this is the perfect time to talk about it. So, flexible spending accounts and health savings accounts, theyre separate things, and FSAs are even broken down into two things. Theyre for medical expenses and for child care. Its no wonder people get super confused about this.

Sean: Right. Too many letters.

Liz: Yes, too many letters. But the fact is this is pretax, so again, youre shaving down your income, youre saving on taxes and youre putting aside money that you will probably spend anyway on these things. One easy way to do it is to look at your spending last year on, for example, medical spending — your out-of-pocket. And you should be putting at least that much into your FSA, the flexible spending account, if youve got that. And people get worried about FSAs because its use it or lose it. But typically you have a little bit of time after the end of the year to spend it, and you can spend it on a lot of different things, so its pretty flexible. Theres also FSAs for child care. And again, right now nobodys using child care, or very few people are able to use child care. Thats not going to continue forever. Its something to think about next year. At some point, you will be back, if you have kids, to needing care, so that might could be helpful.

Health savings accounts are really supercharged, super amazing things, but theyre not for everybody. And what HSAs do is theyre an account thats tied to high-deductible health insurance. You basically put money into the HSA, you get a tax break when you put it in, the money can be invested. Its not just sitting there, it can grow tax-deferred. And then if you take it out and use it for medical expenses, its tax-free. Its like this triple threat — theres three different tax advantages to it.

Sean: But its not for everyone.

Liz: Its not for everyone. And a lot of financial advisors tend to push these things because it really is, its the greatest thing since sliced bread. Some even like it better than 401(k)s, but not everybody should have a high-deductible account. If you have chronic health conditions, if you have kids, if you dont have savings to cover that deductible and you would put off health care, all those things mean the high-deductible plan probably isnt for you, which means the HSA isnt for you. But if youre in that category where it could be a help, definitely check it out.

Sean: I know you wrote an article about this, right?

Liz: Im sure I did.

Sean: All right. Well, we can dig it out of the archives and link to it on our show notes post.

Liz: I didnt write it, but we do have an article at NerdWallet about HSAs versus FSAs, how they differ, how theyre similar, and we can link to that in the show notes.

Sean: OK. One last thing that I know might be top of mind for a few people. Ive got this question from a couple of friends so far this year, and thats about whether they can write off the part of their apartment or house theyre using as a home office on their taxes next year. What about that?

Liz: Oh, yeah. Thats a great question. The home office tax deduction is a business deduction, which means you have to have business income, [Form] 1099, something like that. Its not really for employees. And there are rules to this, so you definitely, again, want to research it a bit and maybe talk to a tax pro, but thats a way to shave a little bit more potentially off a tax bill.

Sean: All right. Well, I think that about covers it for now. Folks still have a few months left to sort this all out, but I think now would be a good time to dig into it. Maybe over the holiday breaks that are coming up, spend some time and figure out how you can get the tax cuts that will help you when you need to file next year, because you wont be able to do it past the end of this year.

Liz: Yeah, so the clock is ticking.

Sean: All right. Lets get to this episodes money question, which comes from Marco in Brooklyn. They write, “Hey NerdWallet. I absolutely love your podcast and it has been a great resource during quarantine in getting some knowledge on investing. Im 27 years old living in Brooklyn, and my money has pretty much been sitting in a savings account for years. The reason I havent touched it and add little by little is because I always had the intention of buying property. But as Im getting old, Im realizing buying in New York City seems daunting and I dont think I want to put my money toward a 5-by-5 bedroom.” I can understand that, Marco.

All right. “With that said, I recently started researching how to invest. Ive learned a bit about stocks, index funds, mutual funds and so much more, but its very overwhelming, and Ive just been circling for weeks trying to decide where to open an account. I was hoping you could dive more into how to select the best platform to invest your money. What makes some better than others? I also currently have a 401(k) through my company. Is it smart to do my personal investing on the same platform to be consistent? Thanks for your info as always.”

Liz: Oh, I love these questions from “elderly” 27-year-olds.

Sean: I know. I was going to say, Marco, you are 27 and that is not old, but I do appreciate the detail of your question, so thank you for that. But again, 27 is not old, and in fact this age might be a huge asset for you. But to help answer Marcos question on this episode of the pod, were talking with Kevin Voigt, an investing super-Nerd.

Liz: Oh, Im looking so forward to this. Hey Kevin, welcome to the show.

Kevin Voigt: Hi guys. Thanks for having me.

Sean: Were really happy to have you. We got this question and we knew we had to have you on. Our dear and indecisive and elderly 27-year-old Marco wants to invest, but doesnt know how to start. What are your thoughts on this?

Kevin: First of all, like you guys said, oh my God, I wish I was Marco. I would love to go back to my 27-year-old self and [say], “Please invest more in your 401(k). Start investing in your 401(k), but actually, why dont you do something about that $10,000 credit card debt youre carrying on with?” It sounds like hes in a great position to invest. And its so surprising. Since the stock market started its tumult in the wake of the coronavirus, a lot of people are going in and, as they call it, buying the dip, which is when prices are going down, when the markets going down, get in there and buy. Marco mentioned that he has a savings account, which is great. Thats awesome. Definitely do that. But were in a low-interest environment right now — historically low, really. And in a savings account, you could expect to earn, right now, 1% interest a year or less.

Sean: Yeah, a lot less than a year ago.

Kevin: Meanwhile, if you invest in the S&P 500 or stocks related to the S&P 500, that has averaged 8% interest per year the last 50 years. The difference between 1% and 8% obviously is great, and Marco has the greatest advantage any investor has, which is time. Oh my gosh. I pulled out the trusty NerdWallet investment calculator just to be like, OK, if Marco put $100 [per month] in the savings account earning 1% versus invested that cash, earning on average 8%, what would the difference be over 10 years? And in 10 years, he would earn at 1% about $700 interest. At 8%, he would earn $7,000 interest over the same period of time. Its just the magic of compound interest.

Liz: But Kevin, we should raise the point that you dont get 8% guaranteed every single year, right?

Kevin: Oh, thats for sure. Thats the thing. Investing, its a long-haul strategy, because that 8% mathematically seems nice over time, but in the meantime, the S&P 500 dropped 34% between February and March. But theres always going to be this churning of the amount that you might receive from your investments, right? But time is on your side for investments to certainly pay off compared to what you purchased the original investment for.

Sean: Investing, especially when you dont need this money within the next five years, is a no-brainer. You will just make more, and thats been proven over time. But Marco was pretty unsure about how he wants to invest. He mentioned stocks, index funds, mutual funds. Can we talk through each of these options and maybe talk about some pros and cons of them?

Kevin: Sure. Stocks is probably the most common thing that people have heard of, which is youre buying shares in a publicly traded company — the Apples of the world, Microsoft — there are thousands of publicly traded companies. And you literally become an owner of that for whatever amount that you purchase in that. The downside with stocks is its hard to buy a lot of stocks in a lot of different companies. And you dont want to buy too many stocks in just one company because that company may be doing well now, but who knows five or 10 years from now? Enter mutual funds. And mutual funds — “We buy the stock so you dont have to.” They are companies that go out, and they buy, and they invest in all these different companies, and then instead, you purchase shares of that fund.

The other thing he mentioned was index funds, and index funds are like mutual funds in that they go out and they purchase all the stocks so you dont have to. But where theyre different is — youve heard of this thing, the S&P 500 — thats a stock market index of the largest, by market share, 500 companies in the U.S. Index funds have the idea that, “Hey, you know what? We dont necessarily want to beat the market, we want to be the market.” As we noted, the S&P 500 has increased 8% on average. Its a jagged line, but on average per year. And index fund investors are saying, “You know what? Thats fine. Ill take that.” Whereas many mutual funds or actively managed mutual funds, theyre trying to beat the market. If the S&P 500 is averaging 8%, they want to bring in 10% or 12%. News flash: They rarely do that. Its very hard to beat the market. Thats the description of those three assets — stocks, mutual funds and index funds.

Liz: And I know at NerdWallet, we really like the index fund approach because its passive, its cheap. Warren Buffett likes it too, right?

Kevin: Yeah. Warren Buffett is famous for saying, and this is probably good advice for Marco to hear, is theres a beguiling number of things you could do. Theres stocks, theres options trading, theres futures trading. What about forex [foreign exchange]? You can buy one or two well-diversified funds, regularly put more money into them, call it a day, and open up that piggy bank after retirement and enjoy your life.

Liz: And youll probably do a lot better.

Kevin: Yes. For sure.

Liz: OK, Kevin. Weve gone over the basics of what you invest in. Now, how do you invest? How do you go about it?

Kevin: Right. And thats where it seems like Marco is frozen. “What do I do? There are so many” — and there are. We review dozens of different brokerages, and thats what you need to do is open a brokerage account. With stocks, you cant go to a department store and say, “I would like to buy some Apple stock please.” You have to go through a licensed brokerage, and thats opening a brokerage account. So, thats for starters. You have to open up a brokerage account to begin trading. Then the next decision — and if Marco was in the room, I might ask him a little more questions regarding this because he mentioned stocks, index funds, mutual funds — which should I go? The next decision you need to make is, “OK, do I want to do all of this by myself?” Which is to say, “Im going to choose what stock, Im going to choose what index fund. …” We didnt mention bonds or exchange-traded funds or all these different asset classes. “… Do I want one to do that myself?”

And if you do, then you want to open a self-directed brokerage account, where basically you go through, answer some questions, you fund the account. And once you fund the account, you still have time to decide what to buy. So you can actually fund your account before having to make the decisions about what to buy, or do more research, but youve got to have that to get going. And theres a lot of them out there. For example, Ally Invest, Fidelity, Merrill Lynch, Schwab, Robinhood, SoFi Invest, TradeStation, Vanguard, and some of those names you know, some of them have only been around for a few years. Its really been the advent and explosion of technology and online trading that has really expanded the number of options that consumers have in this regard.

If instead you want someone to “please make these decisions for me, Ill give you the money and you tell me where to go,” the next choice for you would be a robo-advisor. These are companies that you go online, you fill out a questionnaire that details your risk profile, and most of these robo-advisors have different portfolios you can choose from based on risk profile. And you do that, you sign up, and often they strongly encourage and would lower limits for starting an account if you sign up for regular contributions. In that world, theres a whole host of other names to choose from. Theres Betterment, theres Wealthfront, theres E*TRADE, Schwab also has it, Ally Invest, many others that offer this form of automated investing. Its a real game-changer for investors.

Sean: And Ive been thinking that this would probably be the easiest route for Marco because theres a lot less decision-making involved. And if youre circling, trying to figure out which one to do, itd be easier to just find one that does a lot of the heavy lifting and complicated math and all that for you. When I was just getting started in investing, I was pretty much in Marcos same exact situation. I wanted to, but it took me a long time to figure out how to do it. And when I just jumped in and signed up for a robo-advisor, I was, one, shocked by how fast it was to sign up. It took 15 minutes versus the 15 hours Id spent just contemplating all these different options. But now that Im doing it and I have monthly contributions, its such a relief to know that Im doing something. And again, I barely think about it because its just going and I have my contributions. But when I do think about it, Im like, all right, pat myself on the back for actually investing. I think that would be a good option.

Kevin: Yeah. And its advantageous because its kind of like Netflix. You just sign up for it and every month, a direct deposit. Theres a real ease to it. But a lot of people do like active investing. The longer Im here at NerdWallet, the more I personally dislike active investing for myself because its really scary. But a lot of people, certainly in these times were seeing it, a lot of people are very excited about trying more advanced investing options for themselves. And we spend a lot of time also looking, for those consumers, what are the best platforms for options trading? What are the best platforms for forex? And so forth. But me personally, “Yeah, do it for me please.”

Sean: Yeah. Well, that brings me to my next question which is, what would make one of these better than another? Because that was a key part of Marcos question too.

Kevin: Yeah, and its a tough one to answer without Marco in the room. And this might be a good time to pause and say, for any investor like Marco, it wouldnt be bad to spend some of that savings to go to see a fee-only financial advisor for a visit or two, just to help you out with some of these thoughts. And its always good to get an outside opinion on your financial state. But that said, there are so many of these brokerages out there now, and they all have really different attributes. It really depends on what youre looking for. If youre new to investing and you want to learn more about investing itself, theres many firms that specialize in having strong educational resources, having live seminars and, of course, having a deep bench of online educational materials. That might be one new way to go.

If you are a fund investor, there are some brokerages that will not deal in mutual funds or index funds. So be careful about that, if you sign up for one service and find out, oh, wait a minute, I cant actually buy an index fund or a mutual fund through this provider. If you have a limited budget, then obviously you want to shop around for someone whose cost to open an account is low or perhaps has options like fractional shares. Buying Apples stock is really expensive, so fractional shares are like, well, just buy an affordable bit of it. That would be one thing to look at. And if you are going to go the day trading route — I dont have the stomach for it, but if you do — then there are definitely providers out there that have very heavyweight analytical tools, a very deep bench of resources that you can pay for, potentially additionally to your standard brokerage costs. But theyre out there and theyre waiting for you. It really depends on what you want to get out of it, I believe.

Liz: So Kevin, Marco asked if he should use the same platform for his individual account as he does for his 401(k). What are the pros and cons of doing that?

Kevin: Its a perfectly good choice if that firm has all the bells and whistles that you want. For example, a 401(k) provider may or may not have fractional shares on offer. They may or may not have day trading platforms on offer. I would look to that. There may be incentives, too, that companies may offer to encourage you to also open a second account with them, like in this situation. But as long as that firm does the things you want to do with your investing life, thats totally fine. Why not have it in one place?

Sean: Should Marco be worried at all about putting all of his investment eggs in one investment basket?

Kevin: No, because hes not putting all his money in one specific investment. Its just going through that brokerage account. He may have limited choices in terms of certain types of investments, but no, theres no worry about putting all your money through that one account.

Liz: Well, one of the things that we should mention really briefly, though, is SIPC [Securities Investor Protection Corporation] insurance.

Kevin: Yes. SIPC insures brokerage accounts up to $500,000 and of that, $250,000 in cash it provides if the brokerage fails. But other than that, investing is buyer beware, so there is no insurance for bad investing decisions.

Sean: Well, Kevin, do you have any final words of wisdom for our dear 27-year-old, elderly Marco?

Kevin: Yes. Just some rules of thumb to always keep in mind when it comes to investing is No. 1, as you mentioned earlier, I believe, Sean, never invest cash that youll need back in the next five years. You want the amount to be able to weather the natural ups and downs in value thats going to happen over the course of a few years. Another rule of thumb is to keep no more than 10% of your portfolio in individual stocks, just to keep diversified. And another caution: If you are going to buy some individual stocks, never invest more than you can afford to lose.

Sean: Well, thank you so much for talking with us, Kevin. Appreciate it.

Kevin: Thank you both. Enjoyed it.

Sean: Now lets get into our takeaway tips. Liz, do you want to kick us off?

Liz: I will. OK, first, dive in. You can learn as you go.

Sean: Next up, the “best way” to invest depends on your comfort level, time horizon and risk tolerance.

Liz: And finally, robo-advisors can be a good solution if you want someone or something else to do the heavy lifting for you.

Sean: And that is all we have for this episode. Do you have a money question of your own? Turn to the Nerds and call or text us on the Nerd hotline at 901-730-6373. Thats 901-730-NERD. You can also email us at podcast@nerdwallet.com.

Liz: And heres our brief disclaimer, thoughtfully crafted by NerdWallets legal team. Your questions are answered by knowledgeable and talented finance writers, but we are not financial or investment advisors. This Nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances.

Sean: And with that said, until next time, turn to the Nerds.