As with any new endeavor, the first steps are often the hardest. But once you get started investing, you’ll find it’s not as complex as it may seem. Plus, the truth is that investing is the best way to grow your money and achieve your financial goals. Saving alone often isn't enough—inflation can eat away at your hard-earned cash and leave you with less purchasing power than you started with. You want to invest to make sure your money keeps up.
But what about the risks?
Yes, investing does come with risk. But some investments are safer than others, and you can adjust your portfolio to take on as much or as little risk as you can stomach.
How do I know how much risk I can stomach?
It depends on a number of factors, including what your goals are, how much time you have before you need the money you’ve invested, whether you have other savings you can count on and how you feel about the roller coaster ride that is the stock market.
Okay, so which investments are safe, and which are risky?
On the safer side of the spectrum are Certificates of Deposit (CDs) and Money Market Accounts (MMAs). Both tend to offer slightly higher yields than standard savings accounts—but still only as much as about 2.25 percent on average for five-year CDs (meaning you can’t touch your money for five years) in mid-2019. Bonds are also considered safer investments. They’re essentially loans you give to a company, government or other entity that have to be paid back by a certain date and with interest.
On the riskier side, you have individual stocks, which let you own a small piece of a public company—meaning your investment rises and falls based solely on the performance of that one company. If it has a killer year, so do you. But if it goes bankrupt, you lose, too.
With stock mutual funds and exchange-traded funds (ETFs), you can capture some of those potentially big gains while mitigating your risk. Funds can own hundreds of individual stocks at once, so big losses for one company in the portfolio can be offset by other companies’ gains.
Tell me more about diversification.
Glad you asked. Being well-diversified is key to investing wisely. Basically, by spreading out your investments you’re trying to increase your chances of making money on good investments and decrease your chances of losing money if one investment doesn’t perform well. That means investing in a mix of stocks, bonds and cash investments (like a money market account or short-term CD).
And don’t stop there: In the stock portion of your portfolio, it’s smart to own foreign and domestic stocks, as well as companies of different sizes and in different industries. You can also invest in a mix of government and investment-grade corporate bonds. When investing in individual stocks and bonds, you may have to purchase hundreds or thousands of different securities to achieve the kind of diversification you can more easily get through mutual funds, bond funds and ETFs, which allow you to buy shares of collections of individual stocks and bonds.
How you break it down between investments depends on your risk tolerance, timeframe and other factors. But, generally, the more time and risk tolerance you have, the higher the percentage of stocks vs. bonds and cash.
When I’m ready to begin investing, how much should I invest?
Despite what you might think, you don't need a ton of money to invest. But it’s a good idea to set aside as much as you can. Remember, investing is how you really start building wealth and means you won’t always have to rely on your paycheck alone for income.
That said, before you funnel all your money toward investments, you need to be able to comfortably cover all your expenses and have enough socked away for unexpected expenses. (Saving $1,000 should be enough to cover an unexpected medical bill, say, but aim eventually for three to six months’ worth of expenses in savings.)
What kind of account do I need to invest?
To answer that question, first ask yourself, “What are my goals?”
If you’re saving for retirement, set up automatic contributions to a 401(k), 403(b) or other employer-sponsored retirement savings plan available to you first. They offer tax advantages (like pre-tax contributions and tax-deferred growth), a hefty limit ($19,000 for 2019 if you’re under 50; another $6,000 if you’re 50 or older)—and many employers will even match some portion of your contributions.
Another option is an individual retirement account (IRA). With a Traditional IRA, you typically don’t pay taxes until you withdraw the money in retirement. (Note that contributions to a Traditional IRA are not always tax-deductible, depending on your access to a retirement plan at work and income.) For a Roth IRA, those who meet the income requirements pay taxes before investing, but the money grows and can be withdrawn tax-free. You can invest up to $6,000 in 2017 ($7,000 if you’re over age 50).
For money you’re saving for college, your best option may be a 529 plan. When you’re ready to tap this account for qualified expenses like tuition, room and board and books, your withdrawals will be tax-free.
For everything else—and once you go over your retirement account contribution limits—you can use a regular brokerage account. This gives you the opportunity to invest in a wide range of investments all in one place and there are no penalties for withdrawals, though you will likely pay tax on any gains.
What is the cost of investing?
Even when your investments are on a tear, you do lose some to fees and taxes. But you can minimize those costs with smart planning. If you’re investing in funds, look for those that come with low “expense ratios,” or fund management charges—you can easily find exchange-traded funds, or ETFs, with expense ratios under 0.1 percent (or $1 for every $1,000 you invest). Read the fine print to see if there are extra sales charges (or “loads”) or other fees for any fund you invest in.
To help keep your taxes down, invest within tax-advantaged accounts when appropriate (see above). Also, keep track of your wins and losses. When you’re ready to sell a winning stock or stock fund, you may have to pay capital gains taxes. Holding onto your winners can lower that rate, though: The short-term capital gains rate, for investments you’ve held less than a year, is the same as your ordinary income rate, while the long-term rate is lower.
* Investing involves risk including loss of principal. Past performance does not guarantee or indicate future results. This information is presented for educational purposes only and is not a recommendation to buy or sell a specific security or engage in a particular strategy.