Are you wondering how to invest your money? This article will show you how to get started with investing.
If you are getting started with investing, you may be wondering how to invest your money. During this article, we will discuss what types of investments are available, investment vehicles, key investing strategies, compound interest, and more.
If you have put off starting a retirement fund or been overwhelmed on where to start with investing, this article is for you! Maybe you feel like the market has fallen and you missed your chance. Or the market is falling and you are afraid to get in there. Either way, I’ll help you demystify investing as we talk about the available options.
By the way, it’s worth mentioning that getting professional help with your investments is huge! Some people try to pick individual stocks on their own, and this usually ends in disaster. As you read through this article, please keep in mind that a money coach or financial professional can often help you do better.
Alright, let’s go ahead and dive in now!
Types of Investments
Here are the most common types of investments:
Stocks – A company sells shares of its equity on the open market and the stockholders share in the gains and losses.
Bonds – You loan money to the bank and they agree to pay you interest on that loan.
Mutual Funds – A portfolio manager pools your money with others to buy stock and bonds from several companies
Exchange Traded Funds or ETFs – A portfolio of bundled stocks traded directly on the stock market. These funds are not actively managed like mutual funds, but often follow an index.
Certificate of Deposit or CD – Similar to bonds, but short-term in nature meaning less risky and pays lower interest.
Real Estate Investment Trust or REITs – Companies that own income-producing properties and trade on the stock market. Allows someone to invest in real estate by pooling money with other investors instead of buying a building.
As you can see, there are many common investments available to you. Deciding exactly how much to invest in each is highly personal, but as a general rule you’ll do better with ETFs than picking stocks. Likewise, CDs have low interest rates but are also very low risk. Others still prefer to invest in real estate, which may or may not be a good idea depending on your financial situation.
Investment Vehicles
Investors often purchase a combination of the above investments through one or more “investment vehicles.” This is also the most direct answer to the question of “how to invest” by the way. Individual investment vehicles are “how” your money gets from your pocket into the market. Furthermore, these can overlap—for example, your 401K may be managed by a brokerage account.
Brokerage account
Buy, trade and manage funds on behalf of an investor.
Discount brokers
An alternative to a brokerage account that actively manages your investments. Most of these offer online, do-it-yourself trades with fees and commissions much lower than a full service broker would charge. Fidelity, Charles Schwab, TD Ameritrade, and ETrade are all examples.
Individual Retirement Accounts or IRAs
An IRA is a retirement account that is tax protected and has restrictions on withdrawals before age 59 1/2. There are several types, but here are some of the most common:
- Traditional IRA – The usual IRA account where you deposit pre-tax money, with taxes deferred until withdrawal.
- ROTH IRA – A special IRA where you deposit after-tax money that grows tax free, and which you can withdraw tax-free.
- SEP IRA – Setup and funded by an employer, with much larger annual contribution limits. Employer gets tax benefits, but employee does not contribute out of his paycheck. This is usually offered in place of a 401K by a small business to their employees.
- Spousal IRA – Account can be opened in name of non-working spouse and funded by either spouse paycheck as long as they file jointly on taxes.
401K – Employee retirement benefit
You contribute a portion of your pre-tax wages to the account, and your employer may match a percentage. Investment companies manage the funds.
Employee stock
Your company may offer you stock purchase options or ongoing employee stock purchase plan (ESPP) where you purchase shares of the company at a discount.
As you can see, there are lots of options, both what to invest in and how to invest! This is where people become overwhelmed. But there are many reasons why you should invest for your long-term financial security, and sooner rather than later.
How to Earn Compound Interest from Your Investments
Compound interest (or interest on interest) is what beats you up when you owe money on a credit card. You don’t pay enough, so they charge interest on your balance. Now your balance is higher, so you will pay more in fees and interest next month.
But compound interest can work in your favor with the stock market. Now you are receiving interest on your investment, and then the next period, you gain more interest on your original investment plus the interest you earn. Just $1000 invested for 20 years at 10% will grow to $7328 with monthly compounding! Without compounding, it would be right around $3000. 10% may sound like a lot, but that is the average annual stock market return over the past century.
Of course, the year to year return fluctuates greatly. Consider the past 15 years, where we weathered the Great Recession, and then the longest period of bull market before the pandemic turned the market again.
Historically, the average duration of a recession has been less than 2 years when the National Bureau of Economic Research looked at data starting in 1919. From 1945 to 2001, the average duration was only 10 months. Over time, the market consistently provides a better return than savings.
Investing Strategies
Trying to actively manage your investments is one of the big downfalls I see with investors. They feel like they need to be doing something for better results. But patience and hands off is the best policy.
Working with a respected advisor can help you formulate a plan based on your tolerance for risk. They can also be an unbiased voice of wisdom when the market dips.
You and your advisor should also talk about diversification. Mutual funds and ETFs are popular because they automatically give your portfolio some built-in variance. Aside from a mixture of fund types, your portfolio may need a mixture of investments from different sectors and countries. Consider large cap vs. small cap investments. You may look into whether the companies you are supporting are in line with your values, whether that means who runs their board, their stance on sustainability, or the conditions where they source their product.
You should also discuss how you will purchase your funds. Many investors use dollar cost averaging, meaning they invest over a period of time to smooth out volatility in the purchase price.
Long Term Investing
To realize gains, investment strategy should be for the long term. If you are want to raid your 401K or Roth IRA because it’s losing so much value, please don’t. It is almost impossible to guess when the market is going to turn, and missing the ride back up after a downturn is a much bigger risk than waiting it out, not to mention you will pay huge tax penalties.
The caveat here is if you are out of work and in dire straits. The CARES act stipulates that you can now borrow up to $100,000 from your 401K with an option to pay it back. But this should be an absolute last resort. Missing the recovering market without that money in there could be devastating to your retirement.
Along with paying down high-interest debt and setting money aside for a rainy day, investing should be a top priority to help reach your retirement goals. The earlier you can set aside money to invest, the less you have to contribute over your lifetime. Compound interest over time will give you a shot at big gains, just as it works against you with debt.
Now You Know How to Invest
If you feel like investing is still out of your reach or you just aren’t sure where that money would come from, consider joining my Money Circle. It’s free to join right now, and you’ll find a community of people working towards financial security on their own terms. I look forward to seeing you there!
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