Welcome to Investing 101! You’ve come to the right place for the right information on investing basics.
Before we start, I want you to hear me say this: The world makes investing way more complicated than it should be. But don’t let that intimidate you. Investing is less complicated than you think. You can do this!
When you’re saving your money for retirement, you’re putting aside money now so you will have money later. That’s a simple definition of investing.
Financial investments fall into four massive buckets called asset classes.
Pretty much every investment you could make can be lumped into one of these four buckets:
1. Cash assets—Money you put into checking, savings, a money market account or a Certificate of Deposit (CD). Think low risk, low return. Really low return. These accounts won’t keep up with inflation.
2. Bond assets—A bond is a loan agreement between the borrower (like the government or a corporation) and you as the investor. The borrower agrees to pay you a set interest rate after a fixed amount of time. If you buy a $10,000 corporate bond with an interest rate of 8%, you’d get your $10,000 back plus $800 (interest on the loan).
3. Stock assets—Stocks represent tiny pieces (or shares) of a company. As the performance of the company (its earnings) goes up, the cost of its stock will go up, too. That increase in the price is your profit (or return) from investing in that company. So, if you bought 100 shares of a stock at $25 a share and you sell that stock when it rises to $50 a share, you’ve doubled your money.
Many people put their investments in mutual funds, which consist of a group of people pooling their money together to buy stocks in different companies.
The four main types of mutual funds that I recommend are:
- Growth and income funds—These are the most predictable funds in terms of their market performance.
- Growth funds—These are fairly stable funds in growing companies. Risk and reward are moderate.
- Aggressive growth funds—These are the wild-child funds. You’re never sure what they’re going to do. High risk, high return.
- International funds—These are funds from companies around the world and outside your home country.
With me so far? Good. Now, hang with me a little longer. You’ve probably heard the word cap attached to these funds. That word is short for capitalization, which describes how much a company is worth. Here’s how companies are classified:
- Small-cap: Companies valued below $2 billion
- Mid-cap: Companies valued between $2 billion and $10 billion
- Large-cap: Companies valued over $10 billion
Now, let’s put this together. A large-cap, growth stock mutual fund is made up of big companies (worth more than $10 billion) that are growing (like Amazon, Facebook, Microsoft). A small-cap, aggressive growth fund is made up of small companies (like tech start-ups) that have a high chance of success but also a high chance of failure. Big risk, big reward.
4. Real estate—This is land and anything on it (house, apartment, retail space, etc.). Lots of people purchase a home to then use as rental property to generate income. Go this route only if you have a passion for it (it’s time-intensive) and only if you can pay cash for the rental property.
If you’re new to investing or feel like you’re at the 101 level, I would encourage you to start with mutual funds. This allows you to diversify (or spread your investments) across different kinds of stocks with different levels of risk. This is one of the most basic principles of investing. Don’t ever put your money in one single stock. That’s like putting all your proverbial eggs in one basket. There’s an ugly mess to deal with if the eggs break.
Where Should I Start Investing?
With that basic information covered, let’s drop down and take a closer look at where you should start investing.
The best place to start is by looking at any retirement plans your employer offers. As soon as your company allows you to start participating in their retirement savings program, jump in with both feet! This is especially important if your employer will match what you put into your 401(k), 403(b) or similar plan. That’s free money, people!
Let’s say your company will match up to 4% of your total gross income. If you make $40,000 a year and invest 4%, you’d get a $1,600 match. In 20 years, that 4% match by itself earns you over $100,000 at a 10% rate of return. Look at it this way—if you’re not taking advantage of that company match, you’re throwing away $100,000! Have I convinced you to go talk to HR? Good!
When you go to HR to sign up, you’ll have to fill out paperwork that asks how much you want to take out of each paycheck. Some companies ask for a dollar amount. Others ask for a percentage of your salary. You will also decide which mutual funds you want to invest in.
Here’s where diversifying comes in. I recommend spreading your investment across all four types of funds (growth, international, etc.). That allows you to spread out risk and take advantage of stable funds. If you want an equal balance between risk and return, then you’d designate 25% of your paycheck to go to each of the four funds (25% x 4 = 100%). However, you can choose to take on more or less risk. In those cases, you’d just change the percentages to match your risk tolerance. For instance, you may be young and want to put 50% of your investment into aggressive growth funds and spread the remaining 50% across the other funds. You get to control your portfolio.
If your company doesn’t offer a retirement program, you can still put away money for the future in an IRA. You can go to a bank or a brokerage firm to open one. There are other options as well, but the particulars can be a little confusing. Talk with an investment advisor for information about these investing vehicles.
What Are Tax-Advantaged Savings Accounts?
Back in the day, private companies set money aside for their employees to live on in retirement. These accounts were called pensions. For lots of reasons, including the changing economy, most companies have replaced pension plans with the 401(k), the 403(b), and the 457. Those plans were named after sections of the tax code that authorized the plans. You can only contribute money in one of these accounts through your workplace.
However, you can also put money into an individual retirement arrangement, referred to as an IRA. These retirement accounts aren’t connected to any company. In fact, you can contribute to a 401(k) and put money in an IRA.
Some investments get special treatment under federal law, so they’re called tax-favored investments.
Under that umbrella, there are two categories: tax-deferred and tax-free.
- Tax-deferred plans: Investments that are in a 401(k) or a 403(b) fall under this label, as do traditional IRAs. With these plans, the money comes out of your paycheck and goes directly into your investing account before you pay taxes on it. That lowers how much income tax you pay every year. However, you will pay income tax on money that you take out at retirement. You deferred paying taxes on the money.
- Tax-free plans: This refers to investments in a Roth 401(k), a Roth 403(b), a Roth 457 or a Roth IRA (basically, anything with Roth in the name!). This term is a little misleading, though. You pay income taxes on the money before you invest it. You’re investing “after-tax” dollars. When you withdraw money from that fund at retirement, you pay no taxes on it. And you pay no taxes on the growth.
Now, there are limits to how much money you can put into tax-favored plans. For 2017, you can invest $5,500 using IRAs and Roth IRAs. If you’re 50 or older, that number jumps to $6,500. The limit on 401(k), 403(b) and 457 plans is $18,000. If you’re 50 or older, it’s $24,000.
How Much Should I Invest in Retirement?
Remember, when you fill out the paperwork to participate in the program, you’ll need to designate an amount. I recommend you put away 15% of your income. At this percentage, you can provide for your future and still have money to put toward a college fund and to pay off the mortgage early. If you’re just starting out and can’t put away that much, then work toward it. At the very least, invest up to the company match. Free money, right?
If your company offers a Roth 401(k) option, take it! Remember, you won’t owe any taxes when you withdraw money in retirement. You can park your 15% there and be done. However, if your company doesn’t offer a Roth option, invest up to the company match. Then, put the rest in a Roth IRA. Now, since the Roth IRA has contribution limits, you could max it out. If that happens, go back to the company 401(k) to finish off investing 15%. The same principle applies to other company plans, like 403(b)s and 457s.
Should I Automate My Contributions?
Ever heard the phrase, “out of sight, out of mind”? I’m guilty of forgetting something because it wasn’t right in front of me, like doing the dishes or returning an email. You can actually use this principle in your favor by automating your investing.
When you go to HR to talk about participating in the workplace retirement plan, you can ask to have the money taken directly out of your paycheck. Because you never see that money, you won’t even know you’re missing it. And that means you’ll be less tempted to use the money to pay for a new tire or a new pair of jeans.
If you invest directly through a financial advisor or investing firm, you can still automate your monthly savings. This will require an extra step in paperwork, but it’s worth the time you take to ensure that you’re putting money away consistently. Slow and steady wins the race.
Now, I have one more important piece of advice: Leave your investments alone, especially when the market slumps. Don’t panic! In the investing world, what goes down eventually comes back up. For example, during the financial crisis of 2007–2009, the S&P 500 Index (which tracks the performance of the top 500 companies in the U.S.) dropped 57% between October 2007 and March 2009.(1) However, the S&P recovered—and by 2013, stock prices had recovered and have been steadily improving since.(2) When you invest, you have to think long-term and wait patiently for your portfolio to grow.
Why Should I Work With a Financial Advisor?
I hope this information has helped you feel more confident about investing. But I’m guessing you probably have more questions for your situation. While I can’t speak into the specifics about your future (I wish I could!), you can sit down with a professional in your area who has the same approach to investing as I do. And that’s great news!
If you’re looking for someone to help you with investing and wealth building, check out a SmartVestor Pro. These financial advisors will sit down with you, look at your numbers, and provide recommendations and specific investing strategies for you. Plus your initial consultation is free, so you can make sure the person is a right fit for you and your family. What have you got to lose?
No matter when you start investing and no matter who you work with, keep in mind that you are in control. An advisor can give you suggestions and options, but you need to stay educated and make informed decisions. The buck stops with you—literally. Your financial future is too important to put on autopilot.
Contact a SmartVestor Pro!
If you are looking to go from an investing rookie to the CEO of your retirement, contact a SmartVestor Pro and develop a plan for your future!