By: TK Irons
Okay, for some reason, certain people grasp this concept right away, and others need to hear it a few times to keep it all straight. I hear people getting mixed up* when speaking about various investment accounts. You’ll pretty much always have three main components to think about – the company, the account type, and the fund.
To me, some of these words, (401k, 403b, 457b, SEP IRA) would sound more at home if I were over-hearing an air traffic controller speak over his radio. This is a little mental trick to keep things sounding simple.
Consider this simple paradigm to keep it all straight – let’s call it the Cup Method. To illustrate, let’s compare a few common accounts to the humble drinking cup. This works for any investment account.
First, what brand is the cup? For example, you could have a cup made by Hydroflask, Starbucks, or Solo. Similarly, you can have an investment account by Vanguard, Fidelity, or TD Ameritrade. These companies may specialize in a particular account type and range in quality. However, the company is really just the brand of cup. You could potentially have two identical cups that are different brand and they’ll do the same thing. It is the same with your investment accounts.
Next, what is the style (or function) of the cup? It could be a stainless steel thermos, a plastic tumbler, or a beer stein. Now here, we’re focused on the design of the cup (e.g. it may keep cold drinks cold or hot drinks hot). It is the same with your investment accounts. 401ks are great for retirement saving, HSAs are excellent for healthcare savings, and taxable accounts might be for long-term money that’s not necessarily earmarked yet. The rules of these accounts help them specialize in particular types of saving, similar to how the design of the cup helps them perform a specialized function for your drink.
Lastly, what is in the cup? You can think of the beverage as the fund. Cups can hold coffee, water, tea, beer, etc. Similarly, your investment account can hold: large cap mutual funds, target date retirement funds, commodities, bonds, real estate investment trusts, etc.
So, the funds are merely the contents held within the confines of the account type which is then held at a particular company.
It’s very important to understand the semantics here because any education or advice you come across will require understanding each, and how they work together. If your understanding of your investment account has ever felt fuzzy to you, hopefully this trick will help. Take a moment to run through your accounts (or the ones you plan to open), and make sure you understand them thoroughly.
*Here’s how the confusion I’m talking about sounds: “I’m already putting money in the IRA I have at work.” “My money is invested in Fidelity.” The first quote probably means he or she has a 401k or 403b at work. An IRA is an ‘Individual’ Retirement Account – So, it is not offered by an employer, but instead, opened by an individual, independent of any job currently held. The second quote makes it sound like this individual holds Fidelity stock. They probably mean they hold mutual funds in their account at Fidelity, the financial services firm.
Author Bio: TK is a past 3rd Decade graduate who lives and breathes the philosophy taught in class. He avidly researches personal finance and investing topics, and occasionally contributes thoughts here on the blog. He graduated cum laude from the University of Arizona with his BSBA. As a longtime saver and investor, his net worth today is higher than the total number of dollars earned in his lifetime. He keeps his annual living expenses super low, owns his house free and clear, and has zero personal debt. TK currently resides in Tucson, AZ with his wife, and works full-time as a firefighter. Feel free to send him a message at [email protected]