Align Your Investments With Your Goals

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. In our special series, 21 Days to Improve Your Financial Life, we're going to help you improve your financial well-being, one day and one job at a time.

Week 2 is all about making sure that your investments align with your goals. One aspect of investment planning that doesn't get much attention is tax management, but proper attention to tax matters can really improve your bottom line.

Almost every investor knows to take advantage of tax-sheltered vehicles, but it can be tricky to prioritize them. If you can contribute to both a 401(k) and an IRA, for example, how should you choose? One rule of thumb is to start by contributing enough to the 401(k) to earn matching contributions, then turn to an IRA for additional money you have to invest. The virtue of an IRA is that you won't have significant administrative fees to maintain the account, in contrast with a lot of 401(k)s. If you have additional assets to invest, you can go back to the 401(k) and fill it up to the maximum allowable amount.

If you still have assets to invest, you can turn to a taxable brokerage account. Just watch what you hold inside of it--you definitely want to avoid anything that kicks off a lot of ordinary income, such as junk bonds or REITs. Focus on tax-friendly investments like low-turnover equity index funds and exchange-traded funds instead. If you have a shorter time horizon and need to keep your money pretty safe, stick with plain old cash instruments and municipal bonds. Muni bonds' income is free of federal, and in some cases, state and local taxes, too.

Thanks for watching. I’m Christine Benz for Morningstar.com.