On this episode of Financially Well, the finance podcast for Millennials, I want to help other Millennials start to feel more empowered financially. Specifically, I want to focus on investments. I’ve put together a free investment quiz with 11 questions that cover key investment terms and concepts.
This quiz won’t address all of your investment questions. And the quiz certainly can’t capture how you individually may want to invest to build the life you seek for yourself.
But the terms and concepts in the investment quiz reflect many of the questions that I hear from my Millennial clients. Along the way, I’ll highlight different authors, books, and websites that I’ve found valuable for Millennials who want to improve their financial wellness.
Let’s get started with the investment quiz!
In the stellar personal finance book, The Index Card: Why Personal Finance Doesn’t Have to Be Complicated, Harold Pollock and Helaine Olen write, “We diversify to spread risk. The idea is that not everything in your investment portfolio rises and falls by the same amount at the same time. By not putting all your eggs in one basket, you protect yourself against any one investment’s misfortune. You also, to the extent possible, protect yourself against larger, systemic risks that may affect various sectors of the economy.”
A person who has savings to invest always faces the allure of trying to become wealthy overnight. If only you had invested in Amazon in 1997, right? That temptation has become even stronger for many Millennials. We see headlines about rapidly-growing meme stocks (until they crash). And we have gamified investment apps, such as Robinhood, in which we can quickly invest with just a few taps on our phone. But research has consistently demonstrated that most people who play this game are most likely to underperform simple, “boring,” well-diversified index funds. And you don’t want your life-defining, long-term investment goals to depend on a single company or industry.
The correct investment quiz answer is C: you can protect yourself from unnecessary risk.
Vanguard’s investor education page notes, “An expense ratio reflects how much a mutual fund or an ETF pays for portfolio management, administration, marketing, and distribution, among other expenses.” They add, “The cost of investing is usually associated with trading commissions and account service fees—items you see as “debits” from your accounts. But expense ratios are less obvious because they’re not itemized on your account statements or confirmations. Instead, each fund’s expenses are deducted from its total value on a regular basis. And those expenses cut directly into your investment returns.”
When Millennials invest on their own, in an account such as an Individual Retirement Account (IRA), they get to pick their investment funds. You can maximize your diversification. And you can minimize your investment costs. With the Vanguard Total Stock Market Index Fund, for example, your expense ratio is only 0.04%. In other words, for a $10,000 investment, over 10 years, you would only pay $95 in fund costs. This represents one of the best expense ratios available to Millennial investors.
Compare this situation to what many Millennial employees encounter at work. With a 401(k) plan, you can only select from the investment options made available to you. This task can feel daunting. Many 401(k) plans offer numerous options without much information about what those options mean. And one detail that’s often hidden from employees is the investment’s expense ratio. It’s not uncommon for me to discover that one of my client’s 401(k) investment selections has an expense ratio of 0.65% or higher. This percentage still may appear small to you. But over multiple decades, with thousands of dollars invested, you will lose a meaningful amount of money – completely unnecessarily – to investment costs.
The correct investment quiz answer is B: expense ratio.
Ramit Sethi’s excellent personal finance book, I Will Teach You To Be Rich, says, “Target date funds are simple funds that automatically diversify your investments for you based on when you plan to retire. Instead of you having to rebalance stocks and bonds, target date funds do it for you…. Target date funds automatically pick a blend of investments for you based on your approximate age. They start you off with aggressive investments in your twenties and then shift investments to become more conservative as you get older. You do no work except continuing to send money into your target date fund.”
As a one-size-fits-all option, target-date funds aren’t perfect. But they’re good enough for young, Millennial investors. This becomes especially true if the alternative for you involves taking no action at all. Let’s say, for example, you feel overwhelmed by the investment options in your 401(k). You can feel good about yourself for picking a target-date fund, at least as your initial selection. Long-term investment success often hinges on diversification, low costs, and total time in the stock market. Target-date funds can help you to check all three boxes quite quickly.
The correct investment quiz answer is A: they automatically diversify your investments based on when you plan to retire.
My friend and fellow Certified Financial PlannerTM, Meg Bartelt, writes that a brokerage account “works pretty much like a retirement account does but you don’t get any tax savings with your contributions. On the other hand, there’s no limit to how much you can save or contribute to a taxable investment account.”
I often describe a brokerage account to my Millennial clients as a non-retirement-specific, non-education-specific, taxable investment account. In other words, you can use your brokerage account investments for any purpose. Multiple purposes, in fact! You benefit from stock market growth in the same way you do within an employer-sponsored retirement plan, such as a 401(k). But you’re not limited – in terms of IRS penalties – in when and how you withdraw the money. This dynamic makes a brokerage account highly valuable to Millennials with multiple goals. Or even uncertainty about how they might want to spend the money in the future.
The correct investment quiz answer is C: a general-purpose investment account used to buy and sell securities, such as ETFs.
Peter Lazaroff, the chief investment officer at Plancorp, notes that, “HSAs are special accounts used to pay for medical expenses and other qualifying health-related costs. Your HSA contributions are tax-deductible, and they grow tax-free when you invest them, just like the money in your 401(k) and IRA. As long as you use the funds for qualifying medical and health-related costs, you won’t pay taxes on the HSA money you use.”
Health savings accounts may be the most underutilized investment option among Millennials. We often confuse them with flexible spending accounts (FSA), which don’t offer the same investment option as HSAs. And many Millennials who do use HSAs spend the money in the current calendar year. As a result, their contributions never have an opportunity to grow over time in the stock market. As confusing as 401(k)s and IRAs can feel, many people still understand the potential that they offer. With HSAs, many Millennials are still learning that their tax benefits and investment potential outweigh even the most well-known retirement accounts.
The correct investment quiz answer is D: an HSA offers an upfront deduction, tax-free growth, & (qualified) tax-free withdrawals.
Mike Piper, known on his personal finance blog as the “Oblivious Investor,” writes that, “Reducing your investment costs is one of the most reliable ways to improve your investment returns…. Many 401(k) plans, however, do not provide their participants with low-cost options. If that’s the case with your employer’s plan, that’s a strong point in favor of rolling the money into an IRA, where you’ll have access to a wide array of low-cost investment options in every asset class.”
If your former company’s 401(k) has strong investment options, you’re not hurting yourself much if you keep the funds in that old account for some period of time. At some point, you’ll save yourself a small administrative fee by rolling over the funds to your new 401(k). You also will be able to keep better track of your investments. But if you previously dealt with a high-cost or limited 401(k) plan, you’re likely better off rolling over those funds to your new 401(k) or an IRA. And in doing so, Millennials can upgrade their investments for the long term through lower costs and more diversification.
The correct investment quiz answer is B: rolling over a 401(k) can reduce your investment costs and improve your diversification.
Financial planning industry guru Michael Kitces points out, “Mathematically, the Roth-versus-traditional IRA decision will actually be the same, regardless of growth rates and time horizon, as long as both accounts remain intact and tax rates don’t change…. To cope with this uncertainty, one popular approach is to ‘tax-diversify’ between the two types of accounts, splitting contributions between traditional and Roth IRAs so that there is at least ‘some’ benefit regardless of which direction tax rates go.”
He continues, “However, the reality is that splitting dollars between traditional and Roth retirement accounts isn’t just a form of diversification; because the outcomes are correlated to each other…the net result is that tax diversification doesn’t actually diversify the risk, it simply neutralizes the opportunity altogether.”
Many Millennials spend a relatively large amount of time fretting over whether a traditional IRA or Roth IRA is better for them. Ultimately, it’s important to keep in mind that just the act of making this investment is a huge accomplishment. If you have a particularly high-earning year, then, sure, pick the traditional IRA. Or, if you can foresee a lower-than-usual earning year, pick the Roth IRA. But most importantly, just make sure you’re investing for the long term.
The correct investment quiz answer is D: the tax benefits depend on your taxable income during the year in which you invest.
Morningstar’s director of personal finance, Christine Benz, argues, “Finding the right asset allocation – or mix of investments – for college can be a tricky business. If you’re a minimalist, it may be tempting to buy a good-quality balanced fund and call it a day. Especially if you’re just starting out and the assets in the college savings plan are still small, it may seem like overkill to manage a college portfolio with lots of moving parts…. [But the differences between college and retirement] argue for taking a more hands-on approach to asset allocation than a balanced fund would allow. Nor do target-retirement vehicles fit as one-stop options for college savers.”
The short timeline and significant uncertainty that surround saving for college demands strong, comprehensive knowledge about your personal finances. At some point in a child’s life, Millennial parents must reevaluate their college investment decisions based on the overall resources available to them. Good information also plays a key role. When you have a sense for the type of college that your child is most likely to attend, you can adjust your investment decisions accordingly.
The correct investment quiz answer is D: all of the above.
In The Price You Pay for College, New York Times personal finance columnist Ron Lieber notes, “If your child gets a big scholarship or you save private school dollars for a child who goes to a cheaper state school, you could simply keep the money in the account for graduate school. You could also change the name of the beneficiary and use the money for a younger sibling or a niece or nephew. You could even use it for yourself to take classes for credit, even in retirement.
One particularly generous option: just let the money ride for a few decades more in the hope that grandchildren will appear on the scene. It would take a lot of pressure off your adult child or children, and the magic of compound interest would have that much longer left to work. Also keep in mind that the 529 plan rules changed in 2017 to allow people to use some money from the accounts each year for K-12 tuition in most states.”
Let’s say you don’t feel passionately about covering the entire cost of your child’s education. You may not want to put every last dollar into a 529 plan. A general-purpose brokerage account, by comparison, may be a better fit at some point. But if you do have strong feelings about your child and their college education, 529 plans include a pretty flexible definition of “qualified expenses.” As a result, you can save and invest with confidence, knowing that you have multiple options for using the money.
The correct investment quiz answer is A: the definition of “qualified higher education expenses” includes many uses for the money.
Ben Carlson writes about personal finance in a clear, relatable way on his blog, “A Wealth of Common Sense.” Earlier this year, he shared his latest thoughts about housing as an investment: “The combination of rising housing prices and fewer houses being built has created a situation where a home is probably a better investment option than it was in the past.”
He continues, “I’m not suggesting buying a home is a slam dunk investment. Nothing is. There are still issues with housing as a financial asset. Most people underestimate all of the ancillary costs involved — property taxes, insurance, maintenance, upkeep, renovations and borrowing costs…. So maybe where I fall on this is that housing is a cyclical investment opportunity. At times it can be a wonderful investment. Other times it’s just a place you get to live while you don’t necessarily get rich.”
Most Millennials are eager to grow their wealth. This is especially true for those who have spent years paying down student loans. As a result, many think about home ownership as much for the investment potential as for its utility. No matter what housing prices look like today, it’s important to remember that buying a house should first be viewed as a form of consumption. In other words, you’re buying a house primarily to live in it. It’s also worth keeping in mind that, historically, the stock market has grown at a faster rate than home prices. Of course, it will be wonderful if you eventually sell your house for a profit. But from a financial perspective, you’re usually better off focusing on whether the house itself is the best fit for you and your family.
The correct investment quiz answer is C: maybe.
In The Psychology of Money, Morgan Housel summarizes how we all ultimately should approach our personal finance decisions. He writes, “You’re not a spreadsheet. You’re a person. A screwed up, emotional person. It took me a while to figure this out, but once it clicked, I realized it’s one of the most important parts of finance. With it comes something that often goes overlooked. Do not aim to be coldly rational when making financial decisions. Aim to just be pretty reasonable. Reasonable is more realistic and you have a better chance of sticking with it for the long run, which is what matters most when managing money.” Housel later added, “My own theory is that, in the real world, people do not want the mathematically optimal strategy. They want the strategy that maximizes for how well they sleep at night.”
The correct investment quiz answer is D: all of the above.
So, how did you fare with the investment quiz? I would love to hear your reaction to these questions, and any follow-up questions that you have of your own. You can always reach me at email@example.com. You also can subscribe to this finance podcast for Millennials to hear more details and discussion about the investment topics mentioned today.
[Editor’s note: this article reflects the transcript (which I’ve edited for clarity) of a recent Financially Well podcast episode.]
Kevin Mahoney, CFP® is the founder & CEO of Illumint, an independent firm in Washington, DC that offers financial planning for Millennial parents. He specializes in navigating the new financial decisions that arise during our 30s and early 40s, such as repaying student loans, buying a house, saving for college, & investing for the future. In addition, Kevin also leads a financial wellness benefits program for Millennial employees around the country, including group speaking engagements.