Investing isn’t just for the wealthy or the old, and it doesn’t take a Warren Buffet to get started. Actually, young adults who start investing early can see solid returns on their money and it’s okay to start small. Keep reading to get the skinny on investing.
Investing is putting money in the right places to (hopefully) make even more money, and it doesn’t take a large lump sum of cash to get started. Individuals can yield much higher returns with investments than with a traditional savings account. Investments can also reduce taxable income because if there is a loss from an investment, individuals may be able to apply the loss against any gains from other investments.
Common Investing Tools
Investors should have a basic knowledge of where their money is going. Here are some of the most popular options:
- Stocks: A stock is a share of ownership in a company and prices go up or down depending on the company’s performance. People also call these equities.
- When the price of a stock goes up, investors can sell their shares for a profit. The goal for investors is to buy stocks cheap and sell them when they are higher. Since the company doesn’t have to pay back shareholders, there is some risk to owning stock.
- Companies have the option to pay dividends to investors. This happens when the company gives a portion of its Retained Earnings to shareholders for investing in the company. Preferred Shareholders are paid before Common Stockholders, so shares of preferred stock are more expensive.
- Bonds: A bond is basically a loan to a company. Investors receive interest for a certain number of years until the maturity date of the bond, when the company has to pay them back their investment.
- Bonds have less risk than stocks because investors know exactly when they will be paid back and how much they will earn.
- Mutual Funds: A mutual fund is a combination of investments such as bonds and stocks. A mutual fund can have low or high risk, be short or long term, and can follow a certain market such as the stock market or money market. It can also be a combination of those factors.
- Rather than choosing specific stocks and bonds, investors choose a mutual fund that fits their needs. Generally, the higher the risk, the higher the potential return.
Diverse Portfolios Reduce Risk
A portfolio is the entire collection of stocks, bonds, and mutual funds that a person owns. When there is a mixture of low and high risk, short and long term investments, a portfolio is considered diverse. Diverse portfolios are the best solution to reducing risk. For example, if an investor owns only a large amount of one stock and the stock crashes, the investor is left with nothing. However, if the investor had a diverse portfolio of many stocks and bonds, that crashing stock wouldn’t be as harmful.
Young Investors can Afford More Risk
Older investors tend to be conservative because they need a predictable income with their retirement approaching. Their investments have low risk, but their return is also low. Alternatively, young investors can afford more risk. If a young person loses their money, they have more years in life to make it back.
Invest Disposable Income
Once investors know where their money is going, they also need to figure out how much to invest. First, monthly bills should be paid and individuals should have at least three months’ worth of living expenses saved in an emergency fund. After that, any proportion of disposable income can be used to invest, even as little as a few hundred dollars. A target to move towards is investing ten percent of a person’s total income.
It is Easy to Start
With any of these options, investors choose which investments to put their money in.
- A person can invest with a brokerage account. A broker works with an investor determining the level of risk they prefer and the investment options that best suit them. There are Regular Brokers who work directly with clients, or Broker-Resellers who act as a middle-man between the broker and the client. Regular brokers tend to be the more reputable option. There are full-service brokers who work more one-on-one with the investor and do more of the work for them, but this comes at a higher cost. Discount brokers provide guidance but leave investors to do some of the work, which appeals to young investors with limited resources.
- Employers may offer a 401(k) retirement savings plan in which employees invest part of their paycheck before taxes. Taxes are instead paid by investors when they withdraw the money from the 401(k) account, allowing investments to build more quickly. Some employers will match a 401(k) contribution up to a specified percentage. It is wise to contribute what’s needed to meet the maximum match percentage.
- An alternative to a 401(k), is an Individual Retirement Account, or IRA, and it also has tax advantages. An investor must be at least age 59 1/2 to take out withdrawals without penalty. There are two types of IRA’s:
- Traditional IRA: Investors get a tax break when they put the money in. Individuals must take out minimum distributions at a certain age.
- Roth IRA: Investors get a tax break when they take the money out for retirement. Individuals can wait longer to take out withdrawals, so they can grow tax-free as long as the person would like. However, Roth IRA’s require that the first contribution be at least five years before distribution.
What’s important to remember is that you’re never too young too start. In fact, the younger you are the better. Whether you can afford $100 or $1000 a month, it’s good to start investing early. If your employer offers a matching 401(k) program, start there. Contributions are made automatically so you’re not tempted to skip it for a few months. Plus you can start investing just a couple percent of your paycheck. If you’re feeling more ambitions, check out some of the other options discussed above. May the financial odds be ever in your favor!