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Robo-advisors make investing incredibly easy and even enjoyable. But just because you're using an app to manage your investments doesn’t mean you're making the right choices for your financial future.
A friend recently shared that she was using an app to invest. I asked her, “Are you using a robo-advisor for retirement savings?” She hesitated, unsure if she even had a retirement account. It turned out, she didn’t—she was simply using the app to open a regular, taxable investment account.
The primary goal of investing is to build wealth for the future, especially for retirement. There are specific retirement accounts, such as a 401(k) or an Individual Retirement Account (IRA), that offer significant tax benefits, making them ideal for long-term investment.
For instance, most 401(k)s and Traditional IRAs allow you to deduct your contributions from your taxable income, reducing your tax burden for the year. On the other hand, a Roth IRA lets your earnings grow tax-free, meaning you won't have to pay taxes on that growth.
These tax benefits are significant, which is why experts recommend focusing on retirement savings first instead of regular taxable investment accounts, which don’t offer much of a tax advantage. Ramit Sethi refers to this approach as 'the Ladder Method.' Here’s how it works:
Step 1: Fully take advantage of your employer’s 401(k) match, if available. It's essentially free money.
Step 2: Pay off your credit card and other high-interest debts. Your interest rates are likely high, and paying off this debt provides a 'substantial instant return,' according to Sethi.
Step 3: Open a Roth IRA and contribute as much as possible. Check out our beginner’s guide to IRAs for more details on Roth IRAs.
Step 4: Once you’ve maxed out your Roth IRA, invest more in your 401(k).
Step 5: If you still have funds to invest after fully funding your 401(k), consider opening a regular taxable account for further investments.
You should only open a taxable investment account after you’ve reached Step 5. However, many people are unaware of this. They often view robo-advisors as a one-size-fits-all solution and think:
“Great! I’m investing now. I’m a responsible adult!”
What many people don’t realize is that, while they are technically investing, they aren’t prioritizing their savings the way they should be.
This isn’t meant to criticize apps like Acorns, which help you invest your spare change or begin investing with minimal funds. The important thing is, if you choose a robo-advisor, ensure you understand the type of investment account you're dealing with.
Apps like Acorns make investing accessible and enjoyable, but they’re not intended to replace retirement savings. However, some robo-advisors do specialize in retirement planning, and you can use a tool like NerdWallet to compare and research your options. Even better, if you're ready to start saving for retirement, check out our comprehensive guide to ensure you're fully informed.
