Investing is not just for stock market gurus and the rich. It is an important part of your financial journey and essential for building long term wealth.
Luckily, you don’t need a lot of money to start investing. But you’ll need to understand the basics in order to develop a plan and stick to it over time.
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Everyone’s economic condition is different. How you invest will depend on your unique circumstances and the financial goals you are trying to achieve. Before you dive in, make sure you have a good picture of your financial life and understand your income level, what you have and what you owe, as well as what your expenses look like.
Once you understand those basics, you are ready to begin the investing process. Here are some tips for how to invest your money now.
1. Identify your goals
Before you start investing, you need to spend some time thinking about your investment goals, both short and long term. Time frames for goals will help determine which investments are best suited for you.
- Short term goals: buying a car, buying a house, planning for kids, taking a vacation, building an emergency fund
- Long-Term Goals: Retirement, Funding Your Kids’ Education, Buying a Vacation Home
Goals may differ from person to person. What may be a short term goal for some may be a long term goal for others. Generally speaking, short-term goals are for things you expect to reach within the next three years or less, while long-term goals will probably be for things that are at least three years away, and possibly longer. .
You’ll want to be more conservative when investing for short-term goals than for long-term goals because you don’t have as much time before you need the money. On the other hand, long-term goals allow for greater risk-taking as you have more time to recoup any losses.
2. Choose your investment strategy
There are a few different layers to choosing your investment approach, and both revolve around how involved you want to be in managing your investments. First, you have to decide whether to go with a financial advisor (traditional or robo) or take care of things yourself. If you decide to manage your own portfolio, you must also decide whether to choose individual investments (active) or select a broad fund that tracks an index (passive).
Let’s take a closer look at those options:
- Traditional Financial Advisor: A traditional advisor will help guide you through the investment process, help you set goals, determine your risk tolerance, and identify an investment plan. You’ll probably check-in a few times each year to make sure you’re on track, but otherwise you shouldn’t need to worry much. The downside is that traditional advisory fees can be around 1 percent of your net worth, which eats into your returns over time.
- Robo-advisor: A robo-advisor provides another solution and, by automating much of the process, typically keeps fees well below traditional advisors. You’ll answer a series of questions to identify goals and risk tolerance, but your portfolio will then be built using the robo-advisor’s algorithms. You can also get features like automatic rebalancing and tax-loss harvesting.
- Active: If you choose your path, you’ll need to decide whether you want to try to identify individual investments that will outperform the rest of the market, or take a passive approach and match overall market returns. . While an active approach is tempting, it is difficult to outperform the market over time. You need to spend a lot of time to become highly educated in the markets, along with stocks and other types of investments.
- Passive: A passive approach makes sense for most people and involves investing in funds that track a broad market index such as the S&P 500. This approach helps in minimizing the fees, ensuring that you get higher returns of the market rather than the fund managers. You will never have to worry about tracking the daily movements of your portfolio. Index funds are as close to the “set-it-and-forget-it” approach as there is to investing.
3. Decide where you will invest
In order to invest, you will need some sort of investment account in order to transact. There are many different types of investment accounts, but most people will be covered by a few. Some have tax advantages that come with certain rules, while taxable accounts are more straightforward. Most of these accounts can be opened with online brokers such as Schwab, Fidelity or E-Trade.
Here are some of the most common investment accounts.
- 401(k): Many people have 401(k) retirement accounts through their jobs. These accounts allow you to contribute directly from your paycheck and the money is regularly invested in various funds. Your employer may also offer an equal contribution, which you should max out before investing in other accounts.
- Traditional IRA: An IRA is another type of retirement account, but it comes with more investment options than a 401(k) plan. In a traditional IRA, contributions are tax-deductible but you’ll pay taxes on distributions during retirement. If you withdraw before the age of retirement, you will have to pay a penalty.
- Roth IRA: Roth IRAs are similar to traditional IRAs, but contributions are made with after-tax dollars, which means you’ll no longer get a tax deduction, but you won’t pay taxes on distributions during retirement. Financial experts say the Roth IRA is one of the best investment accounts because it creates a tax-free pool for you to use during retirement.
- Brokerage Account (Taxable): There are no rules regarding contributions or tax deductions in these accounts. You can contribute as much as you want and use the money whenever you want. But remember that you will pay tax on whatever capital gains you make. Brokerage accounts are good for long-term goals that may not be as far away as retirement.
- Education Savings Account: These accounts are designed to help you save for education expenses. A 529 plan is a popular account used to save for college and allows your money to grow tax-deferred and grow tax-free, as long as it is used for qualified expenses. Coverdell ESAs also offer tax benefits and can be used for college, primary or secondary education expenses.
4. Select investments that match your goals and risk tolerance
After opening an account with an online broker or robo-advisor, it’s time to start investing. You will want to choose investments that align with your chosen investment goals, ensuring that you understand the risk profile of each investment.
Here are some of the most popular investments to choose from:
- Stocks: Stocks represent an ownership stake in a publicly traded company and you earn money over time based on the success of that company. Stock prices can be quite volatile, so they’re best for long-term goals like retirement. They have great potential for growth, but are quite 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 the risk across a greater number of investments reduces portfolio risk and allows you to diversify with the purchase of a single fund. gives. , 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 securities that allow governments and companies to borrow money for their operations or to finance certain projects. Investors receive interest payments on their bonds and their principal at the bond’s maturity date. Bonds are considered less risky than stocks because they are less volatile and higher in the capital structure, meaning they get paid first from stockholders.
- Real estate: Investing in real estate can provide diversification benefits to your portfolio by adding assets outside of stocks and bonds. While you can buy a home or rental property, you can also invest in a real estate fund or real estate investment trust (REIT).
When you’re building your portfolio, you’ll want to keep diversification in mind so that you don’t get too much exposure to a single investment. When you are young and your goals are far away, your portfolio will lean towards growth-oriented investments such as stocks and funds that invest in stocks.
As you get closer to your goals, the portfolio allocation should shift towards less risky assets such as fixed income securities. Consider using a target-date fund, which automatically shifts the fund’s allocation as you get closer to the fund’s target date.
Are you ready to start investing in your future?
Investing can be confusing if you don’t know where to start. Everyone’s circumstances are different, which means that what’s right for you may not be right for someone else. Take the time to evaluate your options and choose what is best for you. Investing is the best way to create long term wealth and achieve your financial goals.