Contrary to popular belief, you don’t have to be an expert to start investing.
You don’t even need to be rich to invest, yet so many of us fail to get started managing our money because we’re intimidated or don’t know where to start.
However, investing is crucial. Inflation lops an average 3.87% off your money’s value every year, and investments are one of the only ways to grow your money fast enough to outpace it.
Investing takes on many different forms — from contributing to a tax-advantaged retirement account to buying stocks and investing in mutual funds — and it’s up to you to decide where to put your money.
To help you navigate the field of investing, here are 12 basics to understand before diving in:
This article was written by Business Insider without the involvement of Merrill Lynch.
Little, if anything, is guaranteed when it comes to investing.
You could earn money or lose it, so if you'll need quick access to liquid cash in the short term, you won't probably won't want to invest. Some professionals say you shouldn't invest money you'll need in the next five years, because if the market goes down, you won't have enough time to recoup those funds.
If your employer offers one, the simplest starting point is to invest in your office's 401(k) plan. Next, consider contributing money to a Roth IRA or traditional IRA, and then you can research other investment platforms.
In your 20s especially, your biggest asset is time. For nearly every type of investing -- including retirement savings -- nothing can make up for the effect of compound interest. Plus, if you lose money in the market, you'll have more time to make it back before you need it.
That said, 'it's too late to start investing' is not a good excuse to keep your money under the mattress. It's still better to start late than never -- as long as you aren't tempted into taking unnecessarily high risks to make up for lost time.
Just like in virtually every other aspect of personal finance, you don't want to rely on investing to 'get rich quick.'
What are you investing for? What is the purpose? What is the goal or objective?
'Start at the end. Know exactly what the goal of your investing is,' Tom White, CEO of iQuantifi, a provider of automated, personalised financial plans, explains to Business Insider.
Once you have your objective established -- saving for a home, your kids' education, a vacation, or retirement -- the time frame will become clear and you'll be able to figure out how to invest your money.
Your time horizon is the number of years between now and when you'll need to use the money you're investing. It should become evident after you establish your goal.
Once you have a time horizon established, you'll have a better idea of where to put your money and will be able to form a strategy. Generally, the more time you have until you need the money, the more risk you can take. That way, if something goes wrong, you have time to recoup those losses.
'In general, there are three types of asset classes in investing: cash, bonds, and equities (stocks),' White explains. 'And each of these three types have their own ranges of rates of return that you can more or less expect over a period of time.' Understanding these rates of return will help you determine how to invest.
Note that no matter what your timeframe, you'll want to maintain a properly diversified portfolio of investments (more on that in a moment). However, the following time frames may help give you an idea of where you might want to put more of your money:
If you need your money in 0-2 years ...
The first asset class White mentions, cash, has several different sub-categories: savings accounts, CDs, and money market accounts. Cash typically has a low return rate, but is stable. Therefore, this is your best option if you need your money in the short term, White says.
If you need your money in 2-5 years ...
'Bonds in general, over a period of time, will generate anywhere from three to as high as eight per cent,' White explains. 'If you have an objective to reach in two to five years, bonds are most appropriate, because they're more stable than stocks, yet they will generate a higher income than cash. They will fluctuate, but not to the degree of stocks in general.'
If you need your money in 5 or more years ...
For any goal that's over five years out, you can weight your portfolio more toward stocks, as they're the most likely to eventually outpace inflation and get you the most return. 'You should expect fluctuations,' White notes. 'Stocks have a huge range of returns, going from negative 38% as we saw in 2008, to even 30-plus per cent coming out in 2009 and 2010. But over a longer period of time, stocks have been reliably generating about 8% return over the course of 70 or 80 years.'
As mentioned before, it's important to diversify your investments.
Diversification means spreading your money out among different kinds of investments. While there are a lot of opinions out there about how diversified an investment portfolio needs to be, most everyone agrees that putting all of your financial eggs in one basket is a recipe for disaster.
'Consider building a complete, globally diversified stock and bond portfolio that meets your individual risk tolerance,' investment adviser Jonathan DeYoe writes on Business Insider. 'It's easy to find investment managers, mutual funds, and ETFs that mirror an all-country world index of stocks for the equity portion of your portfolio, and track a broadly diversified global index of bonds for the fixed income allocation.'
Investing isn't free. If you're working with an investment professional, you'll pay them either a percentage of your portfolio or a flat fee (you'll want to know if your adviser is 'fee-based' or 'fee-only' before you sign on).
The online investment platforms known a robo-advisers, such as Personal Capital, Betterment, and Wealthfront, each have their own fee structures -- depending on the size of your account, they will take a certain percentage each year.
Mutual funds and ETFs also charge fees, which they disclose upfront as 'expense ratios,' expressed as a percentage and usually ranging from 0.2% to 2%, and 'loads,' which are transaction fees. There are many no-load mutual funds available. Investopedia has a nice explainer on the difference between load and no-load funds, as well as mutual fund fees overall and how ETFs are different.
Warren Buffett and John C. Bogle, founder and former CEO of the Vanguard Mutual Fund Group, both recommend investing in low-cost index funds, which are a type of mutual fund tied to a specific market index -- in Buffett's case, he recommends funds tied to the S&P 500.
Do your research to minimise fees. You can find a fund's expense ratio, the minimum investment required, and other helpful information about index funds by searching them in the 'quote' field on Morningstar.
Taxes can greatly impact your investments.
The US government doesn't let you have the money you may make investing for free -- when you cash in, you'll owe what's called capital gains taxes. Various factors affect how much you'll have to pay, such as how long you've owned the asset. You'll pay a higher capital gains tax rate on investments you've owned for a shorter amount of time: If you sell an asset after owning it for just a year or less, expect to pay 10% to 20% more in capital gains taxes. (There's another reason to invest for the long term.)
On the flip side, you also may receive a tax break if you're investing in retirement accounts or a
529 savings plan to save for college.
With your employer-sponsored 401(k) plan, you'll pay taxes when you take your money out, not when you put it in.
Contributions to Roth IRAs, on the other hand, are taxed when they're made, so you can withdraw the contributions and earnings tax-free once you reach age 59 1/2.
We mentioned it briefly before, but there's a relatively new online investment platform -- 'robo-advisers' -- which aims to make investing effortless. They're online investment management sites that manage your investments for you through unique algorithms. All you have to do is open an account, deposit your money, and the robo-advisers will provide a diverse portfolio, and even re-balance it for you.
The fee structures vary depending on the adviser and how much you decide to invest. Of the two biggest names in the space, Wealthfront will manage your first $US10,000 for free, and then charge 0.25% in advisory fees after that.
Betterment charges a 0.15% to 0.35% management fee, depending on the size of your account.
This option is best-suited to people with relatively uncomplicated financial situations, who want professional expertise on their investments but don't want to hire an investment adviser or financial planner.
When it comes to money, our choices are often clouded by fear, greed, and nervousness. These emotions tempt us to constantly move our investments around -- into what seem at the time like safer positions or more conservative investments -- and can ultimately wreck even the most sound investment portfolio.
That's because one of the best things you can do for your investments is leave them alone.
'Avoid impulsively selling an underperforming investment and stay the course with a diversified portfolio that is able to withstand inevitable short-term rises and dips in the market,' certified financial planner Shelly-Ann Eweka writes on Business Insider.
To help focus on your long-term investment plan, avoid the temptation to check a stock ticker or your account on a daily, or even weekly basis. Markets go up and down every day, and so do individual stocks -- if you're investing for the long term, you don't need the anxiety of constant updates.
Yes, you should keep your hands off your money ... to a point.
Life happens, and there are times -- particularly big life changes -- when it's smart to make financial adjustments.
For example, if you're expecting a baby, you may want to consider contributing towards a 529 savings plan, which allows you to funnel up to $US14,000 a year, per parent, into a tax-deferred account.
Or, if you decide to retire early, you'll need to readjust your time horizon and the amount of risk you choose to take in your portfolio.
As your money grows, and as you get closer to the end of your time horizon, the original portfolio you created may no longer suit your needs. Adjusting it to fit your current situation is called rebalancing, and Investopedia explains it nicely.
This article was written by Business Insider without the involvement of Merrill Lynch.
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