Explain the difference between tax-deferred and taxable investments.

Tax-deferred investments are designed to allow individuals to postpone paying taxes on earnings until a later date, typically when the investment is withdrawn. This means that the growth on investments, such as retirement accounts like 401(k)s or IRAs, is not taxed annually. Instead, taxes are due only when funds are taken out of the account, often during retirement when the individual's tax bracket may be lower. This feature enables investors to utilize the full compounding effect on their investment without the immediate reduction of their returns by taxes.

On the other hand, taxable investments, such as stocks and bonds held in a standard brokerage account, require investors to pay taxes on any earnings, such as dividends or capital gains, in the year these earnings are realized. This can lead to a higher tax burden in active investment years, as investors need to account for taxes annually which can hinder their overall investment growth.

This fundamental distinction enhances the attractiveness of tax-deferred investments, particularly for long-term financial planning, allowing for potentially larger accumulations over time due to tax costs being deferred rather than incurred immediately.