Archive for November, 2005

Most financial advisers will tell you that every year around April 15 they hear from more than a few clients who have just “bought” an individual retirement account from the bank. This is a common misconception about accounts and the investments within accounts. As the tax deadline approaches, the rush to make an IRA contribution begins. These folks, however, have likely purchased a CD within an IRA account from their favorite financial institution rather than “buying” an IRA. Here is how it works.

First, you must decide which financial institution you prefer. The choices can range from a mainstream brokerage house, to a bank or even an online trading account.

In my opinion, your choice should be about whom you trust and not about how much it costs. Please know I am not suggesting you should not be educated about the fees associated with your investments. Investing is complicated, though, and you should work with someone with whom you are comfortable asking “silly” questions, such as how much you are paying him to handle your investments on an annual basis.

Once you have chosen a financial institution and a trusted adviser, you will have to determine if you are investing in a taxable (also referred to as retail) account or a tax-favorable account. These account types are not mutually exclusive. In many cases, investors will need both types of accounts.

In a taxable account, the investments are – you guessed it – taxable. This means that any dividends, interest or capital gains generated by the underlying investments will be taxable to the owners of the account. In the tax-favorable accounts, the dividends, interest or capital gains are either tax deferred or tax free (depending on the account). A checking account is an example of a taxable account. A retirement account (such as an IRA) is an example of a tax-favorable account.

Simple, right? Here is a very short list of just a few of the available choices: IRAs, Roth IRAs, Education IRAs, 529s, 401(k)s, 403(b)s, JTWROS and JTTEN. The list of choices is ridiculously long. Hopefully, your adviser will help you make the right choice.

If that isn’t confusing enough, you can really muddy the waters with the available investment choices. However, there is one main point about investments that hopefully will clarify the difference between an account and an investment. Any investment that can be purchased in a taxable account can likely be purchased in a tax-favorable account as well. For example, you can buy a CD, a mutual fund, a stock or bond (as well as many other choices) in either your taxable or your tax-favorable account.

Investing your money can be confusing. I hope this information has been at least somewhat clarified the difference between accounts and investments. But more importantly, I hope I have made the point that it is imperative you choose an adviser that you trust who can help you make the right choice for your individual situation.