One of the riskiest aspects of managing your finances may sound like investing in the financial markets, but it also has the potential to be the most lucrative. Although significant market declines can be unsettling, investing is one of the few ways to beat inflation and increase your purchasing power over time. Simply put, you can’t amass wealth through savings.
That makes investing one of the best things Americans of all ages can do to start down the path to financial security.
Investing can help you build a better financial future, and here’s how to get started and start reaping the rewards.
There are six things you can do to begin investing
1. Consider retirement plans
The employer-sponsored retirement plan, which is probably a 401(k) and is available as part of your employer’s benefits package, is the best place to start for many people.
Every time you make a contribution to a 401(k), your money grows tax-free until you start taking withdrawals at retirement age. For employees who take part in their sponsored plans, many employers even match employee contributions up to a certain percentage.
Depending on the 401(k) plan type you select, these plans also offer the following advantages.
With a traditional 401(k), you can deduct your contributions from your pay so that you only have to pay taxes on the money when you eventually withdraw it.
After years of gains, a Roth 401(k) enables tax-free withdrawals, but contributions are subject to taxation.
Here are all the information on 401(k) plans, regardless of the option you pick.
You can see how much your money will increase over the course of your career using Bankrate’s 401(k) calculator.
In particular, recent graduates or those who have never made a contribution may find the mechanics of a 401(k) to be perplexing. Consult your employer for advice. Your plan’s administrator, which could be a sizable broker like Fidelity, Charles Schwab, or Vanguard, may provide tools and planning resources to assist you in becoming knowledgeable about sound investing principles and the 401(k) plan options.
Consider opening a traditional IRA or Roth IRA if your employer doesn’t offer a 401(k) plan, you don’t fit the typical mold of an employee, or you just want to increase your contributions.
With a traditional IRA, you invest money before taxes, let it grow over time, and then pay taxes when you withdraw it in retirement.
Contrarily, when you invest in a Roth IRA, your money grows tax-free and isn’t subject to taxes when you withdraw it.
For people who work for themselves, there are also specialized retirement accounts.
Keep in mind that the IRS has set a yearly maximum for the contributions you can make to each of these accounts.
The cap on 401(k) contributions (before employer matches) is $22,500 for 2023 and $6,500 for IRAs.
An IRA allows an additional $1,000 contribution, while older employees (those over 50) can add an additional $7,500 to their 401(k)s as catch-up contributions.
2. Utilize investment capital to lower risk
One of the first things you should take into account when beginning your investing journey is your risk tolerance. Many investors leave the market when it declines, as it did in 2022. Long-term investors, however, frequently view such downturns as opportunities to purchase stocks at a discount. The market historically has an average annual return of about 10% for investors who can withstand such downturns. But when times are tough, you must be able to remain in the market.
Some investors desire a quick profit in the stock market without suffering any losses, but the market doesn’t operate that way. Gains can only be reaped after enduring down times.
Diversification is the key to lowering risk as a long-term investor. When you’re young and your withdrawal date is far off, you can be more aggressive with your stock allocation. Reduce your risk as you get nearer to retirement or the time you plan to take money out of your accounts. In order to avoid suffering significant losses during a market downturn, your diversification should gradually become more conservative.
An index fund allows investors to build a diversified portfolio quickly and easily. An index fund passively owns every stock in an index rather than attempting to actively select stocks. Although they won’t completely eliminate the risk associated with stock investing, investors can reduce it by owning a diverse range of businesses as opposed to just one or two individual stocks. You should have no trouble locating an index fund in your 401(k) plan as they are a common option.
A target-date fund is another popular passive fund type that can lessen your risk aversion and simplify your investing process. As you get closer to retirement, these “set it and forget it” funds automatically rebalance your assets to a more conservative mix. As you get closer to your date, they usually switch their portfolio from one with a higher stock concentration to one with a stronger bond emphasis.
3. Know your investment options
You have access to a variety of new investment opportunities with a brokerage account, including the following:.
Stocks
Stocks are among the best ways to create long-term wealth for you and your family because they give you a small portion of a company’s ownership stake. The longer you plan to hold them, the better, as they can be extremely volatile in the short term. You should plan to hold them for at least three to five years. Here’s how stocks function and how becoming a stock investor can help you generate significant income.
Bonds
Bonds are a reliable source of income for investors, and while bond ownership carries a lower level of risk than investing in stocks, it also yields lower returns. Bonds are the perfect way to counteract the high volatility of stocks in a portfolio by fluctuating much less than stocks do. Here’s how bonds function and how to power your portfolio with the numerous varieties of bonds.
Investment funds
A mutual fund is a collection of investments that are owned by a number of different investors. These investments are typically stocks or bonds, though occasionally both. You purchase shares in the fund, which is frequently diversified among a variety of investments, lowering your risk and perhaps even raising your returns. For novice investors looking to make significant returns in the market, mutual funds are fantastic.
Known as exchange-traded funds (ETFs).
In that they allow you to invest in stocks, bonds, and other assets, ETFs are very similar to mutual funds, but they also have a few advantages over them. Compared to mutual funds, ETFs are typically less expensive to own because of their generally low management fees. Additionally, ETFs can be traded during the day like stocks. Of course, even inexperienced investors can earn sizable returns using ETFs.
4. Balance your investments between the long and short term
Which types of accounts work best for you will depend on how long you plan to use them.
Money market accounts, high-yield savings accounts, and certificates of deposit will be the most practical if you’re concentrating on short-term investments, those you can access within the next five years. Your money will be there when you need it because the FDIC insures these accounts. It’s safer in the short term, but your return won’t typically be as high as with long-term investments.
Short-term stock market investments are typically not a good idea because, in the event of a downturn, the market may not recover for five years or less.
However, the stock market is a great option for long-term investments and can offer you excellent returns over time. You have a number of options, as index funds, mutual funds, and exchange-traded funds all offer stocks, bonds, or both, whether you’re saving for retirement, planning to buy a home in ten years, or getting ready to pay for your child’s college tuition.
With the rise of online brokerage accounts tailored to your specific requirements, getting started is simpler than ever. With brokers cutting commissions to zero and fund companies continuing to reduce their management fees, investing in stocks or funds has never been more affordable. Even better, you can pay a very affordable fee to have a robo-advisor choose your investments.
5. Don’t make simple mistakes
Being overly involved is the first error that new investors frequently make. According to research, actively traded funds typically perform worse than passive funds. If you don’t check (or change) your accounts more than a few times per year, your money will grow more and you’ll have peace of mind.
Failure to use your accounts as intended poses another risk. The tax and investing benefits of retirement accounts, such as 401(k) and IRA accounts, are reserved only for retirement. If you use them for almost anything else, you’ll probably owe taxes and face additional penalties.
While it’s possible to borrow money from your 401(k), you must repay the loan within five years (unless it’s being used to buy a home) or you’ll have to pay a 10 percent penalty on the remaining balance, which means you lose out on the gains that money could be earning.
If you’re using your retirement account for anything other than retirement, you should pause and consider whether the expense is actually necessary.
6. Continue to gain knowledge and accumulate funds
The good news is that you’re already taking steps to educate yourself, one of the best ways to get started. Be sure to read reputable books, articles online, follow experts on social media, and even watch YouTube videos if you want to learn more about investing. Finding the investing strategy and philosophy that work best for you can be aided by a number of excellent resources.
You can also look for a financial planner who will assist you in creating individualized financial goals for your journey. You should look for an advisor who is looking out for your best interests as you conduct your search. Verify that they are a fiduciary acting in your best interest by asking them about their recommendations, and make sure you comprehend their payment strategy to avoid being hit with any unexpected costs.
A fee-only fiduciary—one that you pay, rather than one that is compensated by the major financial institutions—will typically have the fewest conflicts of interest.
why it’s so crucial to invest
The most efficient way for Americans to increase their wealth and save for long-term objectives like retirement is through investing. or making college payments. or investing in real estate. The list keeps going.
The sooner you start investing, the sooner you can benefit from compounding gains, allowing the money you put into your account to grow faster over time. Without your involvement, your money makes money. To ensure your future financial security, you want your investments to grow sufficiently to not only keep up with inflation but to outpace it. Your purchasing power will increase over time if your gains outpace inflation.
Final conclusion
Many people are hesitant to invest, but if you learn the fundamentals, a prudent strategy can help you accumulate significant wealth over time. A lifetime of financial security and a happy retirement may be yours for the taking if you decide to start investing, which can be your best financial move ever.