The ABC of Investing
L earning how to invest can set you up for long-term wealth management and growth. But, before you jump in, there are several factors to consider, such as your personal risk tolerance and investment goals. There are also a number of steps you’ll need to take to ensure that your investments work for you. Here we explore the steps you can follow to start investing as well as the basics you should understand when it comes to making effective and successful investment choices.
How to Start Investing
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Whether you have $1,000 to invest or $100,000, how you invest it is equally if not more important than how much you actually spend in investments. The ultimate goal of investing is to make your money work for you and to grow your wealth over time. These steps offer a great starting point to get your investments up and running and to put your money to work in the most efficient and successful ways possible.
1. Choose Your Investment Approach
Before you put a dime towards an investment, it’s first essential to get to know yourself in terms of what kind of investor you are. The following are factors to consider when determining the best investment approach for you:
- Your risk tolerance: Risk tolerance is a term used in investing that refers to how much variability you’re willing to endure in your investment returns. A person with a higher risk tolerance is able to endure a much higher loss (with the end goal being to profit in the long run), while a person with a lower risk tolerance will prefer to risk a smaller amount of money when investing. Higher risk tolerance is often best for investments such as ETFs, equities, and equity funds, while lower risk tolerance pairs well with bond funds, bonds, and other low-risk investment options.
- Your timeline: If you have a shorter timeline or you want to invest for the short term, you’ll likely want to take less risk and invest in certain financial vehicles that will yield a quick profit, such as penny stocks. If you have a longer timeline, which is very common among individuals in their 20s and 30s, you’ll likely be able to afford more risk as it will even out over time and yield higher returns in the long run. Knowing your timeline will help you decide the best investment options for your goals.
- Your goals: There are all kinds of goals someone can have when it comes to investing. Many people invest for their retirement, but others may invest for more short-term goals such as buying a house or paying for a child’s college education. Get as clear as possible about your goals (write down an exact number) and use this when determining what to invest in.
- Your tax bracket: The tax bracket you’re in now as well as the tax bracket you believe you’ll be in down the road (such as when you retire) is important when it comes to investing. For example, if you want to defer taxes right now, you’ll want to choose investments that allow you to do so.
2. Decide How Much Money You Want to Invest and Budget For It
Once you’ve determined the type of investor you are and established your goals, you should now decide how much you’re willing to invest and/or how much you need to invest to meet your goals.
Most financial professionals will recommend that you invest at least 10% to 15% of your income towards retirement each year, with how much your employer contributes to your 401(k) included in that percentage.
For other investments, use your time horizon and investing goals to determine how much you need to put forth. You can figure out the total amount you’ll need to invest to reach a goal, then work backward to figure out the smaller amounts you’ll need to invest on a weekly or monthly basis. Once you’ve established how much you need to invest, be sure to make room in your budget for it, so you aren’t pinching pennies in other areas of your life.
3. Open a Roth IRA
If your employer doesn’t offer a 401(k) option or you aren’t able to contribute a full 10% to 15% of your income to your 401(k) plan, consider opening a Roth IRA to grow your retirement funds further. Roth individual retirement accounts (IRAs) allow you to pay taxes on the money you contribute so you don’t have to pay taxes on that money when you take it out.
As of 2020, the total contribution you can make to a Roth IRA is $6,000 a year and $7,000 a year if you’re 50 years old or older. This is money you won’t touch until you retire, and that will continue to grow over the years.
4. Open an Investment Account
If you’re investing for goals outside of retirement, opening an investment account is a great way to get started investing. While retirement accounts have restrictions on when and how you can get your money out, investment accounts not used for retirement have fewer restrictions and are a good option for shorter-term goals. There are several online brokers that offer brokerage investment accounts, and many of which have little or no minimum investment to open the account.
An investment or brokerage account is where you can keep all of your investments and quickly see how they are performing. You can also regularly contribute to this account to continue growing your investments.
5. Know Your Investment Options
There are several options when it comes to investing, and knowing these options will make it easier to narrow down the ones that are best for your goals.
Good investment portfolios often consist of a variety of securities rather than just one or two. For example, rather than investing all of your money into one company’s stock, you’ll likely want to consider investing your money in several different securities such as stocks, bonds, and mutual funds.
The most common types of investments you should be familiar with include:
- Stocks: Stocks, which are referred to interchangeably with shares, is an investment in a company. When you purchase stock in a company, you are essentially purchasing part of that company. Companies use stock to raise capital for investing back into their organization and to grow their business. The two primary types of stocks are common stock, which is what publicly traded companies offer, and preferred stocks, which come with fixed dividend payouts.
- Mutual funds: Mutual funds consist of pooled money from several investors that are used in several different financial vehicles in one transaction. A professional money manager oversees mutual funds and will decide the best way to invest the pooled money in order to yield a return for the investors.
- Bonds: A bond is essentially a loan made by the investor to a company or other entity like the federal government. Bonds do not provide ownership in a company like stocks do. Rather, your money is simply lent to the company or entity and then given back to you at a later date with interest. This is a fixed-income investment, which means that you’ll receive regular interest payments.
- Index funds: Index funds are a type of mutual fund that tracks a particular stock index such as the Standard & Poor’s 500 index (S&P 500). Rather than being managed by a professional, index funds are passively tracked based on the index.
- Certificates of deposit: Certificates of deposit, often referred to as simply CDs, are low-risk investments in which you give a bank a set amount of money and promise to leave it in the bank for a set period of time. At the end of that time period, you can take the money out and will also receive a predetermined interest on the amount. This is a very low-risk and easy investment option.
6. Set Up Automatic Transfers to Your Investment Accounts
Once you’ve determined the type of investing you want to do and open an investment account, it’s time to set up automatic transfers to your account to ensure your investments continue to grow. Setting up automatic transfers makes it easy to regularly invest without having to think about it, and is what some of the most successful investors do.
Taking the time to educate yourself on your investment options and getting to know your investment goals and personality in terms of risk is essential to successful investing.