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Investing is one of the best ways to grow your money over time. Whether you’re investing for retirement or another financial goal, putting your money into the stock market, mutual funds, exchange-traded funds (ETFs), or other investment vehicles can pay off significantly in the long run through the power of compounding returns. However, as a new investor, it’s essential to understand the various investment options, define your goals, and develop a strategy aligned with your risk tolerance.
This Investiit article will guide you through the fundamentals of investing, including choosing the right investment account, understanding risk and asset allocation, selecting suitable investment vehicles like stocks, bonds, mutual funds, and ETFs, and utilizing tools like robo-advisors and investment apps. By the end, you’ll have a solid grasp of how to start investing wisely, diversify your portfolio, and work towards achieving your financial objectives.
Define Your Investment Goals
Setting clear financial goals is the cornerstone of successful investing. Whether you’re aiming for retirement, wealth accumulation, or achieving a specific financial milestone, defining your objectives provides a roadmap for crafting an effective investment strategy.
Long-term vs. Short-term Goals
Long-term investment goals tend to be major life events further in the future, like retirement or college savings, while short-term goals are nearer future events like vacations, weddings, and home renovations. Long-term investments are bought and held for multiple years, such as 10 years or more, suitable for long-term financial goals like retirement and college savings. Short-term investments are typically bought and held for three years or less, suitable for more immediate needs or goals.
Retirement Planning
The biggest long-term financial goal for most people is saving enough money to retire. The common rule of thumb is to save 10% to 15% of every paycheck in a tax-advantaged retirement account like a 401(k), IRA, or Roth IRA. Estimate your desired annual living expenses during retirement, subtract income from Social Security, retirement plans, and pensions, and ensure your investment portfolio can cover the remaining expenses. Contribute to your employer’s retirement plan and take advantage of any employer match for maximum returns.
Specific Financial Milestones
Clarifying your financial goals involves identifying the specificity, measurability, time horizon, and risk tolerance. Set concrete, measurable goals with target savings amounts, investment returns, or net worth milestones. Break down larger goals into smaller, actionable steps to maintain momentum and track progress using the SMART criteria (Specific, Measurable, Achievable, Relevant, Time-bound).
Choose the Right Investment Account
A brokerage account is an investment account used to trade assets such as stocks, bonds, mutual funds and ETFs. There is no limit on the number of brokerage accounts you can have or the amount of money you can put into a taxable brokerage account each year, and there should be no fee to open one. The act of opening a brokerage account doesn’t mean you’ll be on the hook for additional taxes, but investment income within it is subject to capital gains taxes, which is why they are also called “taxable accounts”.
Retirement Accounts (401k, IRA)
401(k) plans are tax-deferred retirement savings accounts offered by employers, who may match an employee’s contributions. Individuals can also set up a traditional IRA or Roth IRA through a financial institution. The main difference is that 401(k)s allow higher annual contributions, while IRAs typically offer more investment options. Contributions to traditional IRAs and 401(k)s are generally tax-deductible, with earnings growing tax-deferred until withdrawal in retirement when they are taxed as ordinary income. Roth IRAs are funded with after-tax dollars, but qualified withdrawals in retirement are tax-free.
Taxable Brokerage Accounts
A taxable brokerage account allows investors to use after-tax dollars to buy securities like stocks, bonds, funds etc., without the tax advantages of retirement accounts. Any capital gains when selling securities, as well as dividends earned, are subject to taxes based on factors like holding period and income tax bracket. However, taxable accounts offer flexibility – money can be accessed anytime without penalty, and there are no contribution limits like in IRAs/401(k)s. They may be suitable for short-term goals, diversifying retirement portfolios, liquidity needs or estate planning purposes.
College Savings Plans
529 plans like the NC 529 Plan are tax-advantaged, allowing tax-free growth and withdrawals for qualified educational expenses. Each state sets a high total contribution limit, and 529 funds can be used for costs like tuition, room/board, books across most colleges/programs. Excess funds can even be used for retirement savings. 529 plans are reported as parental assets on the FAFSA, assessed at a lower rate than student assets for financial aid purposes. Other options like Coverdell ESAs, trust accounts (UTMAs/UGMAs) also exist but with limitations.
Understand Risk Tolerance and Asset Allocation
Assessing Risk Tolerance
Your risk tolerance refers to the amount of financial risk you’re comfortable taking when investing. Understanding your risk tolerance can help you create a portfolio that feels right for you. If you’re decades away from retirement, you may feel more comfortable with risk because you have time to recover from short-term market swings. Those with an aggressive risk tolerance don’t shy away from volatile assets and may direct a large portion of their wealth to higher-risk investments. Even if you aren’t keen on risk, it’s important to maintain some exposure to the stock market, as inflation could erode your wealth over time if you play it too safely.
Asset Allocation Strategies
Asset allocation involves investing across different asset classes like stocks, bonds, real estate, and cash to diversify your portfolio. The asset mix should reflect your goals and risk tolerance at any point in time. A strategic asset allocation strategy implies a buy-and-hold approach, where you continually rebalance to maintain your desired asset mix. Integrated asset allocation considers both your economic expectations and risk tolerance to establish an appropriate asset mix.
Diversification
Diversification aims to include assets that are not highly correlated to reduce the overall risk of your portfolio. Diversify across sectors, companies, asset classes, geographic regions, and time frames. Holding a variety of investments that perform differently can smooth your returns over time. Diversification attempts to protect against losses and improve risk-adjusted returns.
Select Investment Vehicles
Stocks
Investing in stocks means buying shares of ownership in a public company. When you invest in a stock, you’re hoping the company grows and performs well over time, which can help you earn a profit if you decide to sell the stock to another investor. One of the best ways for beginners to learn how to invest in stocks is to put money in an online investment account and purchase stocks from there. The best thing to do after you start investing in stocks may be the hardest: Don’t look at them compulsively checking how your stocks are doing several times a day.
Bonds
Bonds are debt investments where you lend money to corporations and governments. In exchange for lending money, you’re paid interest on bonds. There are risks associated with bonds, such as rising inflation and interest rates, which can lead to bonds losing value. However, bonds can also act as an inverse to stock performance, offsetting any losses you may experience when investing in stocks.
Mutual Funds and ETFs
The biggest similarity between ETFs (exchange-traded funds) and mutual funds is that they both represent professionally managed collections (or “baskets”) of individual stocks or bonds. ETFs and mutual funds both come with built-in diversification, including tens, hundreds, or even thousands of individual stocks or bonds in a single fund.
They also give you access to a wide variety of U.S. and international stocks and bonds, allowing you to invest broadly or narrowly based on your goals and investing style. ETFs and mutual funds are managed by experts who choose and monitor the stocks or bonds the funds invest in, saving you time and effort. An ETF can help you obtain the same level of diversification as mutual funds but at a much lower cost.
Conclusion
Investing is a powerful tool for building long-term wealth and achieving financial goals. By defining your objectives, choosing the right investment accounts, understanding risk and diversification, and selecting suitable investment vehicles, you can craft a well-rounded portfolio that aligns with your needs. Remember, investing is a journey, and maintaining discipline, regularly reviewing your progress, and making adjustments as needed are crucial for staying on track.
While getting started may seem daunting, the key is to begin with a solid foundation and gradually expand your knowledge and portfolio. Seek guidance from professionals, leverage educational resources, and stay informed about market trends and developments. With patience, perseverance, and a strategic approach, you can navigate the world of investing and unlock its potential for securing your financial future.