Smart Money Podcast: Diversify Your Portfolio: A Guide to Roth vs. Traditional Retirement Accounts


Welcome to NerdWallet’s Smart Money podcast, where we answer your real-world money questions. In this episode:

Learn to maximize retirement savings with tax diversification by balancing your Roth and traditional IRA contributions.

Nerdy Vocab: What are expense ratios? How do you decide between a Roth and traditional 401(k)? Hosts Sean Pyles and Sara Rathner discuss understanding investment terms and retirement account options and strategies to help you understand how to make more informed and beneficial financial decisions. They begin with a new segment called Nerdy Vocab, in which they explain tips and tricks on recognizing how expense ratios affect your investments. They offer clarity on how fees can eat into your returns, explain how to utilize tools like the FINRA Fund Analyzer, and explain considerations for selecting cost-effective funds.

Today’s Money Question: NerdWallet writer Alieza Durana joins Sean and Sara to help answer a listener’s question about how to decide between investing funds in a Roth versus a traditional 401(k). They discuss the tax implications of different retirement accounts, how to harmonize retirement savings with other financial priorities, and the importance of tax diversification in an investment strategy. Their discussion covers the tax benefits of traditional and Roth 401(k)s, IRAs, and HSAs, and the importance of balancing retirement contributions with immediate financial needs like debt and emergency funds.

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Episode transcript

This transcript was generated from podcast audio by an AI tool.

Hey, Sean, do you ever feel like the world of investing is full of overly complicated vocabulary?

Okay, so I’m not the only one. Well, this episode, we’re going to make some of that language a little easier to understand.

Welcome to NerdWallet’s Smart Money Podcast, where we help you make smarter financial decisions one money question at a time. I’m Sean Pyles.

And I’m Sara Rathner. This episode, Sean and I answer a listener’s question about how to choose between investing in a Roth versus a traditional 401(k) account, including when the Roth route might be better.

But first, we’re going to help you understand another part of the investing world by doing a little segment that we’re calling Nerdy Vocab. The idea is that we take a term that seems made up by an AI chatbot or a stodgy finance person and make it a little more accessible.

Honestly, it was probably made up by a stodgy finance person, but the hope is once you understand this word or phrase, you’ll be able to apply it to your own finances and make financial decisions that are more informed and, as a side benefit, you’ll just have a more expanded vocabulary.

The term this time around is, drum roll please, expense ratios. I’ve gotta say, Sara, this is really one of the more unappealing terms in the money space. Both words individually are a little off-putting. Combine them and many people’s eyes or, I guess, in the case of a podcast, ears may just glaze over. But understanding how to navigate expense ratios can save people thousands of dollars. So will you please explain what this is?

Yeah, if your ears have glazed over, you might want to unclog them a little bit because this is important.

You might want to go to the doctor, actually, if your ears are glazed.

Yeah, just hit one ear and let liquid come out the other side. You’re right that expense ratio sounds like boring business jargon because it is, but it’s really a fairly simple concept. Expense ratios are a fancy way to say fees. Yep, that’s it. Specifically the annual fees that an investment fund like a mutual fund or an exchange traded fund charges you to invest in it. A fund charges you these fees to cover things like marketing expenses and administrative costs, all that stuff.

And this is a ratio, so it’s telling us about the relationship between two things. In this case, it’s how the operating costs of a fund stack up to what’s known as its assets under management, which is yet another jargon-y word that essentially means all of the money that the fund is investing. Expense ratios around 1% are pretty common. You might see some around 2%, and a 1% or 2% expense ratio doesn’t sound like a lot, but an additional 1% can mean a lot of lost earnings over time. So I will give you an example and, listener, heads up, I’m going to mention some numbers here. So brace yourself, maybe grab a pen and paper. Maybe listen to it again if you want help digesting these numbers. But here we go.

So if you invest $10,000 into a fund with an expense ratio of 1% and hold it there for 10 years and get average returns of 8%, you will pay around $1,900 in expense ratio fees over the course of that investment. Now, say that you have a 2% expense ratio. The amount that you pay the fund in that expense ratio shoots up to nearly $3,700. So a difference of 1% translates to paying an additional $1,800 in this example.

Now, the good news is that expense ratios have actually been on the decline in recent years. It’s pretty common to find funds that have expense ratios below 1%, sometimes well below 1%. And generally the more passively managed a fund, is the lower its expense ratio, so something like an ETF should have a lower expense ratio than an actively managed mutual fund. And that’s because actively managed funds, where a real human being is regularly involved in decision-making about the fund’s investments instead of things being more or less automatic, require more money for the research and activity that goes into that person’s work or that group of people’s work, which they hope will result in better returns for investors. So in theory, you’re paying for performance. But Sean, what do you think about that?

Well, that’s the theory. The reality is a little bit different. The truth is that actively managed funds rarely outperform passively managed funds. So with an actively managed fund that has a higher expense ratio, you are effectively paying more for less reliable results. So, listener, what does this all mean for you? As ever, when you’re going to invest in anything, shop around. Know what you are signing up for. And while Sara and I are not investment advisors, we can say it’s probably not a wise idea to jump into a specific fund just because someone is telling you to do so or because honestly it might have the lowest expense ratio on the market. Take your time and research any fund that you’re considering so that you know how much you’d be paying for that investment. All right, Sara, anything else that we should mention about expense ratios?

Well, here’s a pretty interesting tool I found recently. It’s done by FINRA. That’s short for the Financial Industry Regulatory Authority. It’s a free comparison tool where you can actually see the costs of different funds side by side. You could find that at, you might want to grab a pen for this one, tools.finra.org/fund_analyzer.

Okay. I might need to listen to that again.

Maybe you could just Google “FINRA fund analyzer” and find it too. I can’t guarantee that.

Probably the easier way to go about that.

Okay, well, listener, I hope that that helps you make some smart investing decisions and maybe you can pull out your fancy new vocabulary term sometime this week. Now I want to revisit our Nerdy question of the month, which was what is your favorite financial mistake? Here’s a response that we got from Andy who left us a voicemail.

Hi. Andy from Miami calling. You asked for money mistakes for your new segment. Here’s one. The year 2021, we’re stuck at home due to a global pandemic searching through our phones, and I see something called nbatopshot.com, where people have the gall to pay $9 for digital trading cards of basketball players. I come to find out they’re called NFTs, non-fungible tokens, and if someone doesn’t know what that is, good for them, because it cost me a lot of money. I would never spend money on a digital product like that. I can just look at the images online, right? Well, less than six weeks later, I find myself spending $800 for a Luka Dončić card and $1,000 for LeBron, Durant. That’s my story. Hope you enjoyed it. Bye.

Hi, Andy from Miami. I’m actually originally from Miami and I always love a listener question or response from my hometown. So what’s interesting is, back in 2021, which is when Andy mentions making these purchases, Miami was really deep into this crypto and NFT trend. It was just all over the air in that city. It was crazy to watch from a distance. NFTs were all over Miami Art Week and Art Basel that year. Those are really big art shows and celebrity laden events. The largest Bitcoin conference in the world took place in the summer of 2021 in Miami. It’s really easy to see how you may have gotten swept up in the NFT madness. And Andy, I’m so sorry you lost money on this, but I’m sure that the lessons you learned were priceless. And the big lesson here is that investments can be boring. They don’t have to be sexy or exciting. They don’t have to be that buzz-y thing that everybody’s talking about and everybody’s excited about and there are all these big conferences about them. Remember, money talks, but wealth whispers.

I like that. Andy’s story is also a good reminder to try as best you can to not get swept up in the herd mentality that occasionally forms around trendy investments because sometimes a new company or a collection of digital images of monkeys will sweep the internet and people will want to jump on board so they don’t miss what seems like a really big opportunity, only for things to come crashing down when the trend peters out.

The thing about buying things like, I don’t know, funds, which are not exciting on the surface really, it’s not like a train where the doors open and if you don’t hop on you’re going to miss out and the train’s going to leave the station and it’s not going to come back for 30 minutes. You could buy shares during hours where the market’s open.

Right. And they are more reliable. There’s always the risk of loss, we always have to say that when we’re talking about investing, but we have so much more historical data about things like the performance of a mutual fund compared with a digital image of, again, a monkey.

I don’t know what you’re going to do with that digital image of a monkey besides look at it.

Cry a single tear as you look at it and think about the money lost.

Bored ape becomes sad ape.

Yeah. Well, listeners, we’ve really enjoyed hearing your favorite money mistakes. If you have more money lessons that you learned the hard way that you want to share with us and other listeners, leave us a voicemail or text the Nerd Hotline at 901-730-6373. That’s 901-730-NERD. Or you can email it to us at [email protected].

And while you’re at it, send us your money questions too. It’s our contractual obligation as Nerds to help you make smarter financial decisions, and plus, we just like to do it. So whatever money questions you are wondering about or topic you’d like to understand better, let us know.

And speaking of money questions, let’s get to this episode’s Money Question segment after a quick break.

We’re back and answering your real world questions to help you make smarter decisions about your money. And this episode’s question comes from a listener’s text message. Here it is. “Hey, money Nerds. I have a money question for you. My husband, who’s 36, had a choice to open a Roth or traditional 401(k) when he first started working at his company a few years ago. It made more sense for him to open a Roth with how much he was making, and we honestly knew nothing about all of this back then. Now he makes over $60,000 and I think it would make sense to also open a traditional 401(k) to lower the amount of money getting taxed at 22%. He does max out his HSA, so that helps.

“I’m 29 and I make the same amount, and I do have a traditional 401(k) that I contribute to. I contribute 8% and get a 4% match. Should he just see if he can open a traditional 401(k) as well? And what does he do with the Roth in this case? It’s currently at $70,000 in a low cost target date fund. Thanks for any input you have on this.”

This is a great question. And one note for our listeners, when you send us your money questions, I always love hearing your name, where you live, and any other details about your life that you want to include. We won’t necessarily include your personal information on the episode if you don’t want us to, but it helps us get to know you better and it can also help us answer your questions better too.

Plus, we’re just nosy people sitting on our front porches drinking lemonade, watching all of you come in and out of your houses. We want to know what you’re up to. So tell us as much as you’re comfortable and that can absolutely help us round out our answers. And speaking of rounding out our answers, today we have some help. For this listener’s question, we are joined by Alieza Durana. Welcome back to Smart Money, Alieza.

Hi, Sara and Sean. So glad to be back.

So Alieza, our listener, mentioned a few different kinds of investment vehicles in their question, Roth and traditional 401(k)s as well as HSAs. Also, when people think about Roths, Roth IRAs might come to mind too. So just to cover all of our bases, can you give us a brief overview of these types of accounts?

Of course. So we weren’t really sure at first if the listener was referring to a Roth 401(k) or a Roth IRA, so we’re going to go over all the options. To start, a 401(k) is a type of retirement account that your employer may provide. You typically invest pre-tax dollars in a 401(k), so it can lower your taxable income this year. And 401(k)s will sometimes come with a match, meaning your employer may top off the contribution if you contribute a certain percentage, like the listener mentioned in their text. A Roth 401(k) is a special type that allows you to make after-tax contributions and then withdraw that money tax-free in retirement. By comparison, an individual retirement account, or IRA, is a retirement account that you open through your own bank or brokerage account. The main difference between a traditional and Roth IRA, like the 401(k), is when you get the tax break.

So do you pay taxes on your income now or in retirement? And then, last but not least, an HSA, or health savings account, is a special type of investment account that you can access only with a high deductible health insurance plan. They are triple tax advantaged, but again, not everyone qualifies.

And we actually recently had you on to talk about HSAs. So if anybody listening missed that episode, I recommend you go back and give it a listen and learn a lot more about these types of accounts. So let’s go back to retirement accounts. Let’s talk a bit about why someone may invest in a Roth 401(k) versus a traditional 401(k). We’re talking about the employer sponsored accounts here. What are the advantages and disadvantages of each of these types of accounts?

The main differences to keep track of are the tax benefits, how much you can invest each year, and the investment choices each type of account offers. Let’s start first with taxes. A traditional 401(k) can help lower your taxable income now, but you’re taxed in retirement upon withdrawal. By comparison, if you contribute after tax dollars to a Roth 401(k), you can withdraw it later without paying taxes. In terms of contribution limits, 401(k)s have the highest contribution limits of any retirement account. The limit in 2024 is $23,000. So they can make a serious dent in lowering your taxable income. By comparison, the contribution limit for IRAs and Roth IRAs is $7,000 in 2024. And then, last but not least, the investment choices vary across the type of retirement account that you have. While a Roth IRA may offer many investment options, 401(k)s tend to be more limited in what investment choices they offer.

All right. So with our retirement accounts at NerdWallet, I can just select what percentage of my income I want to go to a traditional 401(k) and how much I want to go to a Roth 401(k), among other options. But it seems like our listener isn’t sure how their husband could establish a traditional 401(k) and begin to contribute to it. What would you suggest they do?

A great first step is just to talk with your retirement plan administrator, who is likely your company’s HR.

Our listener is also wondering what their husband should do with the existing Roth 401(k) they currently have if they start contributing to a traditional 401(k). And my first thought is they don’t have to do anything to it, just make sure the money in the account is invested in a fund or funds that meet their time horizon and risk tolerance, and hopefully watch it grow over time. But otherwise they’re really just making changes to their contributions going forward. Not going backwards. Do you have any thoughts on this?

You’re absolutely right, Sara. You don’t have to do anything with that Roth 401(k). Once you’ve opened the account, put money in it, invested it, it’s time to sit back. And you can have both a Roth 401(k) and regular 401(k) side by side because they compliment each other. People often wonder how often you should check in on your investments once they’re invested, and one option is to check in annually or during tax season in the spring just to ensure that your investments are still in alignment with your timeline and risk tolerance and preferences. It’s a process called rebalancing and, if your investments lean too heavily on any one asset like stocks, bonds or real estate, rebalancing involves diversifying your portfolio.

All right, that’s great advice. So this listener’s question got me thinking about how people prioritize which type of accounts to contribute to, Roth versus traditional IRA versus 401(k). Are there any general guidelines that people should keep in mind?

Absolutely. Each type of retirement account has its own contribution limits and tax benefits, like we mentioned earlier. So we recommend contributing to your 401(k) first to qualify for any retirement match that your company may offer. After that, if you are able to contribute to your Roth IRA or 401(k), even better. One benefit of investing across multiple types of accounts is having money in both pre-tax and after tax retirement accounts.

Yeah, and that is what we in the jargon-y world of personal finance call tax diversification. Like you mentioned earlier, Alieza, the hope is that when you are in retirement, you’ll be able to pull money from different types of accounts that have different tax treatments. And additionally, one benefit of investing for retirement through Roths earlier in your career is that you are likely earning less than you will earn later in your career. And thus the money that you contribute to that Roth will be taxed at a lower rate than you would be paying later on.

And I think, last but not least, we should say that investing retirement is likely not the only financial priority that people are working on. It’s important to find the balance between saving for long-term goals like retirement and more near-term goals like paying off high interest credit card debt, building an emergency fund, and having enough insurance for your needs.

One thing I’ll add onto this is people might be wondering if they have a Roth 401(k) and a traditional 401(k), how do they decide what amount goes into the Roth? What amount goes into the traditional? And I don’t have a clear cut answer for you. Again, I’m not a financial or investment advisor here, but the way I do it is semi based on vibes. I have most of my contribution going into a traditional 401(k) because I want that immediate tax cut now, but then I have a smaller percentage going into my Roth because I know later down the road I’ll be happy to have that amount of money to pull from tax-free. So it’s really up to your individual circumstances, what you want from your taxes now and later. Spend some time thinking through that and then make a decision based on that. And you can always retool it later on depending on how you feel.

Yeah, you can make changes to your 401(k) allocations and contributions all year. It’s not like open enrollment for health insurance where you make one decision once a year and you’re stuck with it for 12 months. You’re not, you can make changes to it over time and that provides an extra layer of flexibility to these types of accounts.

By comparison, my wife and I had a baby this year, and so I’m still getting my employer match, but I did reduce my retirement contributions because childcare costs are like another mortgage payment basically. So that’s where that is going right now.

Got to balance these short-term and long-term priorities here. Well, Alieza, do you have any final thoughts for those who are hoping to make the most of their retirement contributions?

It sounds like this listener is being really thoughtful about exploring their retirement options and initiating money conversations with their spouse. So congratulations. You’re doing great. I also just want to remind you that it’s an expensive time to be alive. Rent, food, medical, and caregiving costs can greatly impact your finances and life wherever you are. So if life happens and you can’t contribute as much as you like, that is okay. So don’t forget to congratulate yourself on whatever you’re able to do.

I love that advice. Thank you, Alieza, and thanks for coming on and talking with us.

And that is all we have for this episode. Remember, listener, that we are here for you and we want to hear your money questions because our job is to make you smarter about your financial decisions. So turn to the Nerds and call or text us your questions at 901-730-6373. That’s 901-730-NERD. You can also email us at [email protected]. Visit nerdwallet.com/podcast for more info on this episode. And remember to follow, rate, and review us wherever you’re getting this podcast. This episode was produced by Tess Vigeland, who also helped with editing. Sara Brink mixed our audio. And a big thank you to NerdWallet’s editors for all their help.

Here’s our brief disclaimer. We’re not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances.

And with that said, until next time, turn to the Nerds.



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