Investing isn’t just for stock market gurus and the rich. This is an important part of your financial journey and is vital to building long-term wealth.
Fortunately, you don’t need a lot of money to start investing. But you need to know the basics of making a plan and sticking to it over time.
The best way to invest your money
Every financial situation is different. How you invest depends on your unique situation and the financial goals you want to achieve. Before you dive in, make sure you have a good understanding of your financial life and understand your income level, what you have and owe, and how much you spend.
Once you’ve mastered these basics, you can begin the investing process. Here are some tips on how to invest now.
1. Determine your goals
Before you start investing, you should take some time to consider your short- and long-term investment goals. A timeline of your goals will help determine which investments are best for you.
- Short-term goals: buy a car, buy a house, plan children, go on vacation, save money
- Long-term goals: Retire, fund your child’s education, buy a vacation home
Goals may vary from person to person. For some it is a short-term goal, for others it may be a long-term goal. Generally speaking, short-term goals apply to what you expect to achieve in the next three years or less, while long-term goals may apply to at least three years or more.
You should be more conservative when investing in short-term goals rather than long-term goals because you don’t have that much time until you need the money. On the other hand, long-term goals allow for greater risk-taking because you have more time to cover losses.
2. Choose your investment strategy
There are several different levels to choosing your investment approach, both of which revolve around how you want to be involved in managing your investments. First, you need to decide whether to go with a financial advisor (traditional or robotic) or handle things yourself. If you decide to manage your own portfolio, you must also decide whether to choose individual investments (active) or broad funds that track an index (passive).
Let’s take a closer look at these options:
Traditional Financial Advisor: A traditional advisor will guide you through the investing process, helping you set goals, determine risk tolerance, and develop an investment plan. You probably check a few times a year to make sure you’re on the right track, but other than that, don’t worry too much. On the downside, traditional advisor fees can be around 1% of your total assets, which will affect your returns over time.
Robo-advisors: Robo-advisors offer different solutions and, by automating most of the process, often keep the fees much lower than traditional advisors. You answer a series of questions to determine goals and risk tolerance, and your portfolio is then constructed using the robo-advisor’s algorithms. You may also get features like automatic rebalancing and tax loss collection.
Proactive: If you decide to go your own way, you need to decide whether you want to try to identify individual investments that are outperforming the rest of the market, or take a reactive approach and target the market’s overall return. While an active approach is tempting, it is very It is difficult to outperform the market for a period of time. You need to spend a lot of time tracking stocks and other types of investments and be well educated in the market.
Passive: A passive approach makes sense for most people and involves investing in funds that track broad market indices such as the S&P 500. This approach helps keep fees to a minimum and ensures that more of the market returns go to you, rather than the fund manager. You also don’t have to worry about tracking the daily movements of your portfolio. Index funds are as close to a “set it and forget it” approach as investing.
3. Decide where to invest
In order to invest, you need some kind of investment account to trade. There are different types of investment accounts, but only a few can cover most people. Some have tax benefits that come with certain rules, while taxable accounts are simpler. Most of these accounts can be opened with online brokers such as Schwab, Fidelity or E-Trade.
Below are some of the most common investment accounts.
401(k): Many people have a 401(k) retirement account through work. These accounts allow you to contribute directly from your salary, and the funds are regularly invested in various funds. Your employer may even offer matching contributions that you should maximize before investing in other accounts.
Traditional IRA: An IRA is a different type of retirement account, but it offers more investment options than a 401(k) plan. With a traditional IRA, contributions are tax-deductible, but you pay taxes on your retirement distributions. If you withdraw your funds before retirement age, you will pay a penalty.
Roth IRA: A Roth IRA is similar to a traditional IRA, but contributions are made in after-tax dollars, which means you won’t get a tax deduction right now, but you won’t have to pay tax on your retirement distributions. Financial experts say a Roth IRA is one of the best investment accounts because it creates a tax-free pool of money that can be used in retirement.
Broker Accounts (Taxable): These accounts have no contribution or withholding tax rules. You can donate as much as you want and withdraw at any time. However, keep in mind that you will be taxed on any capital gains you make. A brokerage account is good for achieving long-term goals that may not be as distant as retirement.
Education Savings Accounts: These accounts are designed to help you save on education. A 529 plan is a popular account for saving for college that allows your money to grow tax-free and tax-deferred as long as it is spent on eligible expenses. Coverdell ESAs also provide tax benefits that can be used to pay for college, primary or secondary education.
4. Choose investments that match your goals and risk tolerance
Once you’ve opened an account with an online broker or robo-advisor, it’s time to start investing. You should choose investments that are consistent with your chosen investment objectives and make sure you understand the risk profile of each investment.
Here are some of the most popular investments to choose from:
- Stocks: Stocks represent an ownership interest in a public company and you can earn money over time based on the success of that company. Stock prices can be very volatile, so they are best suited for long-term goals like retirement. They have huge growth potential but are very risky in the short term.
- Mutual funds and ETFs: These funds allow you to invest in a basket of securities, such as stocks or bonds, spreading risk across a large number of investments, reducing portfolio risk and allowing you to diversify by purchasing a single fund. Mutual funds and ETFs have a lot in common, but ETFs trade like stocks throughout the day, while mutual funds only trade based on net asset value, or NAV, at the end of the day.
- Bonds: Bonds are debt instruments that allow governments and companies to borrow money to finance their operations or specific projects. Investors receive the interest on the bond and receive the principal on the bond’s maturity date. Bonds are considered less risky than stocks because they tend to be less volatile and have a higher capital structure, meaning they get paid before shareholders.
- Real estate: Investing in real estate can bring diversification benefits to your portfolio by adding assets other than stocks and bonds. While you can buy a home or rent out a property, you can also invest in a real estate mutual fund or real estate investment trust (REIT).
When building your portfolio, keep diversification in mind to avoid taking too much risk on a single investment. If you’re young and your goals are far off, your portfolio may be skewed toward growth-oriented investments, such as stocks and mutual funds that invest in stocks. As you get closer to your goal, the allocation of the portfolio should shift towards less risky assets such as fixed income securities. Consider using a target date fund, which automatically shifts allocations as you approach the fund’s target date.
Are you ready to invest in your future?
Investing can be confusing if you don’t know where to start. Everyone’s situation is different, which means what works for you may not work for someone else. Take the time to evaluate your options and choose the one that works best for you. Investing is the best way to build long-term wealth and achieve your financial goals.
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