Make your money work for you. If you have $20K to invest, here’s how to invest your hard-earned cash wisely.
Perhaps you have an excessive amount of money in your emergency savings, inherited some money, or had an unexpected windfall.
While $20K is undoubtedly not a tiny sum, don’t quit your day job yet. But with the right strategy, you can set yourself up for long-term financial success.
1. Max-Out Your Traditional Retirement Accounts
If you are unsure how to invest $20K, the wisest approach is to max out your traditional retirement accounts. The most common retirement accounts are 403B and 401K plans.
These plans are funded with pre-tax dollars via payroll deductions. If you have $20K in your bank, one of the wisest ways to invest $20K is by increasing your retirement contribution percentage at your employer. You effectively do a 401k swap by using the cash on hand to supplement your decreased paycheck.
However, it’s important to note the contribution caps for those under 50:
401(k): Most for-profit companies sponsor this type of plan. It allows you to contribute pre-tax dollars to your account. The maximum contribution amount for 2023 is $22,500.
403(b): Also called a tax-sheltered annuity or TSA plan. If you’re a teacher or work at a non-profit 501 (c) (3), you most likely are offered this type of retirement plan. The maximum contribution amount for 2022 is $20,500.
Most employers make it reasonably easy to increase your contribution amount. Contribution adjustments can generally be made through your company portal or a form provided by your retirement servicer.
Once you have invested your desired amount, decrease the contribution amount to avoid exceeding the contribution cap.
This brings me to my next point…
2. Open A Backdoor Roth IRA
Backdoor Roth IRAs allow you to invest up to $6,000 in after-tax money. The withdrawals are tax-free once you reach age 59 1/2 and the account has been open for at least five years.
You could use your $20K to fund three years of Backdoor Roth IRA contributions!
One exciting benefit of Back Door Roth IRAs is that you can withdraw up to $10,000 in earnings if you make your 1st home purchase (you need to have your account for at least 5 years).
Back Door Roth IRAs had generally flown under the radar until Pro Publica recently published an article documenting how investor Peter Thiel has a Roth IRA worth $5 Billion! Thiel’s case is extreme and highly unusual compared to your average investor.
3. Open A Traditional Brokerage Account
When you open a taxable brokerage account, you fund the account with after-tax dollars. You will pay capital gains taxes on any realized earnings, e.g., when you sell a stock or mutual fund and make a profit. Traditional brokerages offer stock, bonds, mutual funds, ETFs, REITs, options trading, and margin accounts.
Taxable brokerages allow for the most flexibility when it comes to investing but also are the least tax advantageous.
There are quite a few brokerage accounts for stock market investing options, and most of them offer similar services. Hence, it’s usually a matter of preference for which company is considered the “best.”
A few big-name brokerages are:
- TD Ameritrade
- Charles Schwab
- E-Trade
- Vanguard
To name a few. In addition, some fintech firms, such as M1 Finance, offer bonuses for opening accounts with them if that appeals to you.
Alternatively, if you are ready to invest $20k but don’t know where to start, an ETF like VOO or SPY is a great option. These ETFs track the performance of the S&P 500. By investing in this type of ETF, you already have considerable diversification – buying into an index of the 500 largest companies.
Furthermore, they have the lowest expense ratio of any other actively traded ETF.
4. Fund A 529 Savings Plan For Future Education Costs
The cost of college tuition has risen by more than 25% in the last 10 years, so it’s never a bad idea to invest 20K for future education expenses.
After-tax dollars are used to fund a 529 plan. Withdraws are tax-free when they are used for qualified education expenses. Qualified expenses are amounts paid for tuition, fees, and other related expenses required for enrollment or attendance at an eligible educational institution.
Benefits of Funding A 529 Savings Plan
- You can open a 529 before you have children and start investing for them now.
- No limits on the number of 529 accounts you can fund
- Possible tax deduction if you open a 529 account through your state
In addition, investing in a 529 plan is also a great way to create generational wealth because there are no limits on the number of 529 accounts you can fund.
Time is our best friend in the investing world!
Many states also offer their own 529 plans, but it’s not always required to open through your home state. However, tax deductions or credits may open through your home state.
Alternatively, most major retail brokerages also offer 529 savings plans, such as the companies listed above in point 3.
5. Consider Investing With A Robo Advisor
Not everyone has the investment acumen to jump into the deep end.
Perhaps you are interested in investing but don’t know how or where to start.
A Robo-advisor makes automated investment choices on your behalf that involve limited human intervention. The decisions are made on your behalf through information collected in a survey you fill out. A robo-advisor is a good choice if you are unsure where to start, but are turned off by the high fees of financial advisors.
When using a robo-advisor, they will survey you to understand your financial goals and your current financial situation.
Some Robo Advisors charge a management fee of around 0.25% – 0.50% of assets invested, and some are free.
A few popular Robo Advisors include:
- M1 Finance
- Acorns
- SoFi
- Vanguard
Note: The critical thing to consider is that you are getting investment advice based on your situation and eliminating the decision-making process from your end. In exchange, you may be required to pay a management fee. If that trade-off is worth it based on your unique circumstances, then perhaps Robo-advising is wise.
6. Invest in Real Estate
Real estate is another great way to invest $20K for passive income.
Until a few years ago, buying physical property yourself was the only way to invest in real estate. Luckily, things have changed since then. Quite a few companies offer the opportunity to invest in real estate without buying property.
Private real estate, in general, tends to be a more stable, income-generating type of investment with a low correlation to the stock market. There are publicly-traded REITs, but they tend to have a much lower dividend payment than private real estate and fluctuate more in line with the overall stock market.
Over the past 20 years, NPI (the index that tracks private real estate performance), has averaged a higher rate than the yields of other major asset classes, such as publicly-traded REITs, Bonds, and Stocks.
And to that end, my favorite real estate investing platform is a company called Groundfloor. They specialize in short-term loans to flippers, with a time horizon of 6 – 12 months, while earning an average interest rate of around 10%.
Other real estate platforms require you to lock up your money for at least 3 years – 5 years or pay a fee to withdraw early. So in the context of real estate investing, it’s a relatively short investing horizon.
Plus…
Groundfloor has been around since 2013, repaid over 1,100 investments, and distributed nearly $12.7 million in interest payments.
7. Pay-Off High-Interest Debt
This isn’t investing in the traditional sense. But if you’re an investing and finance nerd like me, the concept of a risk-free return comes into play.
In general, the risk-free rate is the theoretical lowest interest rate you would pay, assuming no default risk. In 2022, the 10-year treasury hovers in the 3% range, so if you can borrow money at 3%, you are, in theory, borrowing at the cheapest interest rate possible.
In the world of finance, this benchmark is the 10-year Treasury Note, the rate the U.S Government pays to service its debt maturing in 10 years.
Over the past 50 years, the S&P 500 returned 10% on average, so it may make sense to pay off your debt before investing, depending on your interest rate.
Debt with an interest rate below 4% is generally considered a good rate. Comparatively, credit cards have rates as high as 30%, so there’s a big range.
The below chart shows the interest rate, whether you should pay off your debt or debt, and the types of debt at that interest rate.
| Interest Rate | Pay-Off or Invest? | Types of Debt |
|---|---|---|
| <3% | Invest, money is basically free | Mortgage/Student loans |
| 3 – 4 % | Probably Invest (Subject to Debate) | Student Loans, Car loans |
| 4 – 5% | Pay Off (Subject to Debate) | Student loans, Car loans |
| 5 – 10% | Pay Off, for sure | Personal loans (Unsecured), Student loans |
| >10% | Pay Off, are you crazy? | Credit Card debt, Payday loans |
The Bottom Line
Taking the initiative to invest $20K is a wise decision. There is no right or wrong answer on how to invest $20k. The most crucial point to consider is to decide what makes sense for your unique circumstances.
Everyone’s financial situation is different, but it’s essential to consider your current situation, goals, risk tolerance and needs before investing.
How to invest $20K wisely:
- Max out your traditional retirement accounts
- Open a backdoor IRA
- Open an online brokerage account
- Fund a 529 savings account
- Consider investing with a Robo advisor
- Invest in real estate
- Pay-off high-interest debt
Weigh the pros and cons of the above options against your objectives to help make the most educated decision possible.
Frequently Asked Questions
Below are some common questions when it comes to investing $20k.
What’s the best way to invest $20K short term?
If you don’t want to risk losing your capital, one of the best ways to invest $20K short term is a high-yield savings account or short-term certificate of deposit (CD).
