Investing is not just about saving for the future. It’s about wealth creation strategies that allow your reserves to actually grow. That’s because investing typically gets you a higher interest rate than if you kept all your money in a traditional savings account.
While historically low interest rates are great when you need to borrow money, they’re pretty frustrating when you’re ready to start saving. Investing does come with higher risk, but you can usually reduce that risk by diversifying your holdings and taking long-term positions. Plus, it’s easier than ever.
You’re not limited to working with an expensive brokerage firm or saving a large sum of money to meet a minimum investment threshold. Now, you can even use an app on your smartphone to invest with leftover change in your checking account.
Ready to learn how to invest? We’ve told you all you need to know.
What is Investing, and Why is It Important?
Investing is the act of putting money into a financial instrument, such as a stock, bond, or mutual fund, with the expectation of earning a profit. It allows individuals to save and increase their wealth over time and can provide a financial cushion for the future, such as during retirement.
The Benefits of Investing
The reason money grows so rapidly in investing is that it is driven by compounding returns. Investing usually implies a long-term strategy rather than taking money out every few months.
When you leave your money untouched in an investment vehicle that offers higher returns than a savings account, your earnings continue to grow.
No matter what age you are, now is a great time to start investing. If you’re young, you can build a solid foundation for really building wealth in the years to come.
Even if you’re older, you can catch up faster because you have higher returns. Don’t worry about getting started-even if you can only contribute a small amount each month, you’ll build the infrastructure and challenge yourself to contribute more as you start earning more.
How to Reduce Your Risks in Investing?
When investing for the long term, you can’t think about daily gains and losses; instead, think about how your allocation will perform over the long term. As you reach different stages of your life, you do need to revisit your investment choices; especially, as you get older, you become less militant.
In fact, most investors do not engage in volatile intraday trading. They spread their money across different types of investments to help reduce risk and maximize returns over time.
Economic cycles will always have highs and lows. But even downturns can be mitigated in a portfolio by spreading your money across different product categories and different areas of the economy. This can go a long way in protecting your money over time.
If you do want to try some riskier investments, make sure you view the money as discretionary risk capital, which means that even if you lose everything, your life and well-being won’t be affected.
How to Invest Your Money?
Diversification is necessary, as is setting up reminders to review the performance of your chosen stocks, such as quarterly reviews. It can also help you adjust your asset allocation based on your financial goals. Do you plan to retire earlier than initially planned? Are you contributing more each month?
With those strategies in mind, here’s a comprehensive review of different investment vehicles you can utilize to build wealth over time.
Retirement Accounts
Retirement accounts are probably the most common and accessible type of investment account. You can open a retirement account through your employer or on your own. Each type has different tax treatment, so review the details carefully.
Traditional IRA
A traditional IRA is a tax-advantaged account that allows you to deduct your contributions each year. Once you start withdrawing your retirement funds, you pay taxes to the IRS based on your tax bracket at the time.
They do have annual contribution limits. By 2022, you can contribute $6,000 unless you turn 50, in which case you can contribute up to $7,000.
If you want to take a distribution before age 59 1/2, you have to pay a 10% penalty on top of your taxes. There are some exceptions, such as when you use the money for a down payment on a house or qualified college expenses.
Another benefit is that, unlike other IRA options, there are no income limits for qualifying.
Roth IRA
A Roth IRA is another tax-advantaged retirement account. However, it has some key differences compared to a traditional IRA. You don’t get a tax deduction when you contribute, but you can deduct your withdrawals when you reach retirement age.
If you think you’ll be in a higher tax bracket once you retire, this could be a useful tool to save you taxes later in life. Contributions to a Roth IRA are capped at between $6,000 and $7,000, depending on your age.
However, there is another condition you must meet:the income limit.
The more you make, the less you can contribute. If a married person declares a joint income of more than $189,000 and a single person or head of household declares an income of more than $120,000, your contribution limit will be reduced.
Rollover IRA
A rollover IRA is a way to transfer an existing 401(k) from your employer once you decide to leave the company. Sometimes your employer will let you leave your money there, or roll over your money to a retirement plan at your new place of employment. Whether either scenario applies to you or you prefer the flexibility of an IRA, a rollover may be the right option for you.
Both traditional and Roth IRAs typically allow you to introduce a rollover IRA. Just be sure to check to see if you qualify for either type, as well as any associated costs you may incur during the rollover process.
SEP IRA
This type of IRA is designed specifically for the self-employed. While Traditional and Roth IRAs are typically used to supplement retirement savings accumulated through an employer’s plan, SEP IRAs allow for higher contribution limits when working for yourself. Contributions are the lesser of 25% of income or $55,000.
It has the same tax treatment as a traditional IRA. However, if you have employees, you must provide each with their own SEP IRA and contribute the same percentage of pay as you would your own. Still, it’s a strong option for accelerated retirement investing, especially if you have no employees or only a few.
Stocks
Investing in stocks is usually best suited for active investors, preferably those who already have experience with the stock market. If you’re just starting out, think of your stock investing as play money rather than something you need to rely on to achieve your future financial goals. Because individual stocks are much riskier, make sure you diversify your investment choices.
Buying and selling stocks can generate high commissions. Consider a buy-and-hold approach to avoid racking up too many fees, especially when you’re just starting out.
When you no longer need an established broker to execute trades, you can create a brokerage account with a larger brokerage firm. Your best bet is to compare fees as well as available research to help you make informed trading decisions.
Mutual Funds
Mutual funds combine your money with other investors to purchase securities for an entire group. The portfolio is professionally overseen by a manager who then selects different types of stocks, bonds and other securities on your behalf.
You can measure the performance of a mutual fund by comparing it to a selected benchmark index, such as the S&P 500. If it regularly performs better over a three- to five-year period, it may be a good investment choice.
Mutual funds are a popular choice because you usually don’t need a lot of money to start investing. You can usually choose one of your retirement accounts to get around the minimum requirements or even set up a recurring investment amount.
Additionally, mutual funds are very diversified, often holding as many as 100 securities per fund. This helps minimize your risk and the amount of time you spend managing your portfolio.
Index Fund
An index fund is a popular type of mutual fund that follows a predetermined investment methodology rather than having a portfolio manager pick the securities included.
For example, you might choose the Dow Jones Industrial Average fund, which includes 30 large U.S. companies. While this is a large-scale example, different investment firms create their own index funds for investors to choose from at their convenience.
Another benefit of investing in index funds is that trading costs are usually lower, as are their mutual fund expense ratios. Many index funds are also geared toward investors with low deposit balances. While some companies require a minimum opening balance of $100,000 or more, you can start with less when you choose an index fund.
Exchange-Traded Funds (ETFs)
Exchange-traded funds (ETFs) trade in the same way as stocks while tracking a basket of assets. There are a myriad of etf options to choose from depending on your investment goals.
Common options include market, bond, commodity, foreign market, and alternative investment etf’s. They are bought and sold throughout the day like stocks, but a major difference is that etf’s can issue and redeem their shares at any time.
ETFs have a number of benefits. First, you have more control over when you pay capital gains taxes. There are also lower fees, although you still have to pay brokerage commissions. Finally, while mutual funds can only settle after the stock market closes for the day, ETFs allow you to trade whenever you want.
Bonds
Bonds are a great portfolio tool because they are a low-risk option. Different types of bonds include corporate bonds, municipal bonds and treasury bills. Bonds are fixed-income investments, so you know exactly what to expect when the payment dates come around throughout the year. However, there are some drawbacks to this predictability.
First, bonds have a fixed investment period. If you’re investing in a long-term bond, then you’ll have to hold it until it matures – unless you decide to sell. But this involves risk in terms of interest.
Bond rates are not locked in, so if the same issuer raises rates at a later date, your bond could lose value. So if a new investor gets a better rate than you, you’re still locked into a lower rate. In general, bonds usually grow at a lower rate than other investments, but this is considered the price of a low-risk investment vehicle.
Real Estate
People will always need a place to live, so real estate investments can be an attractive option for investors. There are several ways to do this, indicating your desired risk tolerance and your desired level of involvement.
Investment Properties
If you want to own property, investing in real estate is one way to make a real estate investment. Depending on how you choose to manage your property, this can be a steady passive income.
Over time, you can also benefit from market appreciation, although this is not guaranteed. Investing in real estate carries risks. Unlike investing in stocks or funds, physical property involves costs such as maintenance, marketing and management companies if you want a hands-off experience.
You’ll also need some cash to get started, as most investment real estate loans require at least a 25% down payment. Most importantly, mortgages are considered part of your debt-to-income ratio, which could affect your future financing opportunities.
If you want to cash in on your investment, you will be affected by the prevailing market value. In addition, it’s a cumbersome and illiquid way to invest. Nonetheless, the returns from investing in real estate can be much higher than traditional investments, which makes investing in real estate an attractive option for some people.
REITs
If you want to invest in real estate without the hassle of being a landlord, consider a real estate investment trust (REIT). They can be traded on stock exchanges or offered as mutual funds or ETFs.
Returns may increase as real estate values rise and are usually concentrated in commercial real estate portfolios. Shareholders also benefit because REITs don’t pay corporate taxes, which also contributes to higher returns.
You can choose which sectors you want to invest in, such as healthcare, residential, hospitality or industrial REITs. Each has different risks that should be weighed carefully. Shares in REITs can be purchased through a broker and each has its own fee structure to review.
Crowdfunding
Real estate crowdfunding is a type of person-to-person (p2p) lending that is becoming increasingly popular with investors at all levels. New fintech companies are springing up to compete with REITs and claim higher returns. So what’s the difference between a real estate investment trust and a real estate crowdfunding site?
The biggest difference is that you can choose specific commercial properties to invest in, rather than a range of real estate within a certain asset class. While individual investors traditionally can’t invest directly in these types of projects, crowdfunding allows you to enter these markets with less cash.
One of the benefits is that you can do more specialized research to decide what properties to invest in. The process is far less passive than with REITs. The downside, however, is that the potential risk can be higher because your money is betting on a single building rather than a diversified portfolio.
Platforms for Investing Your Money
There are many ways to start investing. A financial advisor, while charging an extra fee, may be able to provide you with much-needed guidance and education, especially if you’re a beginner. But if you prefer less hand-holding, you may also want to consider two other options.
Online Brokers
An online brokerage firm gives you the convenience of investing online, with the added benefit of controlling your investments. So, it’s definitely a more practical process than a robo-advisor. However, like robo-advisors, most online brokers don’t have minimum balance requirements, so all types of investors can use them.
Online brokers usually charge a transaction fee, as well as a one-time fee, rather than paying a percentage of your money. The plus side is that you can choose only specific funds unlike robo-advisors. You can even choose individual stocks if you want. Online brokers and robo-advisors cater to two different types of investors, so the best choice depends on your specific goals.
Robo-Advisors
Seeking the help of a robo-advisor can be helpful for novice investors or anyone looking to capitalize on the “set it and forget it” mentality.
Robo-Advisors do not use human financial advisors; instead, they rely on computer algorithms to determine your portfolio allocation. Many of them also use tax strategies to minimize your tax burden at the end of the year.
Service fees are low, typically charged as a percentage of the money you invest. Transparency is excellent for new investors, and you can also benefit from lower minimum balances. Different robo-advisors offer different investment vehicles for you to choose from. You can also choose based on their investment strategy; for example, most people choose etf and index funds.
Bottom Line
There are many complexities to building your investment strategy and making your money work for you. Start with a plan that makes sense for your risk tolerance while still leaving room for growth.
There are countless resources you can access, from free online tutorials to paid financial advisors, to make sure you have a strong investment plan that will produce a passive income strategy to achieve your goals.
FAQs
What are the different types of investments?
There are many different types of investments. Some of the most popular investments include stocks, bonds, mutual funds, exchange-traded funds (etf), and real estate. Each type of investment has its own level of risk and potential return.
What are the risks of investing?
Investing involves risk, including the potential loss of principal. The value of investments can fluctuate and may be affected by market conditions, economic events and other factors.
It is critical to understand the risks associated with any investment and to consider your risk tolerance before making any investment decision.
How do I choose the best investments for me?
The best investment for you depends on your financial goals, how much risk you can tolerate, and other personal factors. It’s helpful to consult an investment advisor or do your own research to determine which investments are right for you.
It’s also wise to diversify your portfolio, or invest in a variety of different assets to spread risk and potentially maximize returns.
How much money do I need to start investing?
There is no minimum amount required to start investing. In fact, you can start investing with $500 or less. However, you should first have an adequate emergency fund before investing. Some investments may have minimum investment requirements, such as mutual funds or certain types of brokerage accounts.
What is a brokerage account?
A brokerage account is an investment account that allows you to buy and sell assets such as stocks, mutual funds, exchange-traded funds, and bonds. When you open a brokerage account, you usually open it with a financial institution, such as a bank, credit union, or online brokerage firm.
To open a brokerage account, you usually need to provide some personal information, such as your name, address, and social security number. You’ll also usually need to deposit a sum of money in this account, which you can use to purchase investment products.
Once you have a brokerage account, you can place orders to buy and sell investment products online, over the phone, or through a broker. The brokerage firm will execute the transaction on your behalf, usually for a commission or service fee.
Brokerage accounts offer a convenient way to manage your investments and buy and sell assets easily and quickly. They also offer a range of tools and resources to help you make informed investment decisions, such as market research, news and analysis, and educational materials.
Can I invest in stocks with just $100?
Yes, it is possible to invest in stocks with a relatively small amount of money, such as $100. Many brokerage firms have no minimum initial deposit requirement, allowing you to start investing no matter how much money you have.
How do I diversify my investment portfolio?
Diversification is the process of investing in a variety of different assets to spread risk and potentially maximize returns. This can be achieved by investing in different types of assets, such as stocks, bonds and real estate, or by investing in different sectors or industries within a specific asset class. It is important to maintain a diversified portfolio that is regularly reviewed and adjusted.
What is a financial advisor and do I need one?
A financial advisor is a professional who advises on financial matters, such as investing and saving for retirement. Whether you need a financial advisor depends on your financial goals, risk tolerance and investment experience. Some people may prefer to handle their own investments, while others may benefit from the guidance of an investment advisor.
How do I determine my risk tolerance?
Risk tolerance is an individual’s willingness to accept financial risk in the pursuit of potential rewards. Factors that may affect how much risk you are willing to take include age, financial goals and personal comfort with risk.
Can I lose money by investing?
Investing always involves a degree of risk because the value of your investment may fluctuate and be affected by various market conditions and economic events. It is critical to understand the risks associated with any investment and consider your risk tolerance and investment objectives before making any investment decisions.
Diversifying your portfolio and not committing more money than you can afford will help minimize potential losses. Always do your research and consider seeking investment advice from a financial advisor before making any decisions.
