Once you’ve mastered balancing your expenses, paying off debts, and have established a savings strategy – including retirement savings and a sufficient emergency fund – it’s time to think about investing. Investing in the stock market is a common way to grow wealth, but the process can seem daunting. But have no fear! We’ve created this beginners guide to investing to help you get started.
In the first two Young Professionals blog series, we’ve covered the basics of personal finance and reviewed smart money moves young adults can make when beginning their financial journey. In our first installment, we reviewed how to assess your income and learned how to read a paycheck. In the second part of the series, we covered tips for managing your money, how to establish savings and credit, and plan for the future. Now, we’re breaking down what you need to know about investing: Why investing is important, how to leverage it to build wealth, and what you need to know in order to be an informed investor. Let’s dive in…
Becoming An Investor
Does your to-do list include contributing to a retirement account or opening an investment account? Maybe you’ve heard the words dividends, interest, tax-free, tax-deferred, Roth IRA, and maybe kind of don’t know what they mean?
That is totally normal. The financial world loves to pretend it takes a PhD to understand these things, but it 100% doesn’t! You have the capacity to understand these concepts and be an informed and empowered investor.
Let’s explore the reason to invest and the mechanics of investing.
To grow your money, of course! Well, yeah, but why? We find the biggest reasons to invest are retirement and general wealth-building.
When you invest, your money experiences compound growth, which is different than if you simply saved your money into a checking or savings account.
If you saved $10,000/year into a savings account, after 30 years and a 2% annual interest rate, you’d have: $405,680.
If you saved $10,000/year into an investment account, after 30 years and an 8% annual rate of return, you’d have $1,132,832.11
Do you see the magic of compounding? Simply put, compounding means your money is earning money, which then earns money, which then earns money! When you decide to retire, you’ll be very happy you invested! There are Social Security benefits you’ll be able to access at retirement, but we find Social Security only covers ⅓ of people’s retirement needs on average. It’s up to you to cover the difference.
There are a variety of accounts you can start investing in. The most common retirement accounts are: 401(k)s, 403(b)s, Roth IRAs, Traditional IRAs, SIMPLE IRAs, SEP IRAs, 457 plans. It’s important to remember that retirement accounts aren’t accessible without a penalty until age 59.5.
You can invest outside of retirement accounts as well. These types of accounts are called brokerage or taxable accounts.
Hence, the cliched advice of “Save for retirement!” and “Contribute to your 401(k)!”
When to Invest?
If you’re contributing to a retirement account, you’re already an investor! When thinking about when to invest beyond retirement (or increasing your retirement contribution), it’s best to review your goals.
Do you have any short-term goals in the next 2 years that you’re saving for, such as a new car, downpayment, or grad school? If so, you should save to these goals and keep the savings in cash or bonds. Of course, if you have enough surplus savings, you can save for short- and long-term goals concurrently. Just remember it’s best to fill your Emergency Fund first before investing for the long haul (think decades!).
The Mechanics of Investing
Investing, in theory, sounds great! Grow your money for future spending – yay! But what exactly do these mean?
Investing in a stock is essentially buying ownership in a company. You are buying a tiny sliver of ownership, and you get to participate in the growth of that company. As the company increases in value (by selling more units or adding storefronts or expanding internationally), your tiny sliver (called a “share”) grows, too.
It’s important to note that Investing in companies can feel a bit like being on a rollercoaster. Companies grow and increase in value, but they also decrease in value, go through big changes and some will go out of business. As an investor, you’ll find out very quickly that accounts do not always follow an upward trajectory.
The antidote to this is diversity and patience. Investing for your future does not involve buying ownership in just one company (i.e. Netflix or Google or GE). The overwhelming advice (and the way Abacus invests all clients and employees) is to invest in thousands of companies across the world, of all sizes and across all sectors. That way you’re not only participating in, for example, the tech industries’ growth or Europe’s growth. Rather, you “own” the whole global economy.
But how are you supposed to keep track of 1000s of stocks? By way of mutual funds, which are bundles of stocks. For example, instead of buying each large US company, you can buy one share of a mutual fund, and they’ve already done the work of aggregating all large US companies.
At Abacus, we invest in the following mutual funds:
- Large Companies, US
- Small Companies, US
- Value Companies, US
- Large Companies, International
- Companies, Emerging
- Real Estate, Global
Some Quick Definitions
Stocks: A sliver of ownership in a company.
Bonds: A loan made by an investor (you) to a borrower (usually a company or the government).
Interest: Interest is the income earned for lending money. If you’re invested in bonds (or bond mutual funds), you are loaning money to corporations and governments. They pay you back the original loan plus interest (in the same way you pay interest to take out a loan). The interest is counted as income (taxable to you) unless they are non-taxable bonds.
Dividends: As an investor in stocks (or stock mutual funds), you may be eligible to receive dividends. Dividends are a distribution of profit that companies give back to shareholders (investors). The amount of dividend and when they’re distributed (i.e. end of year, quarterly) is specific to the company. You have the option to reinvest the dividends by purchasing more stock with the dividend proceeds, or you can opt to take the dividends as a cash distribution.
Capital Gain: This is the increase in your investment’s value. For example, if you invested $1,000 and it grew to $1,500, you have a capital gain of $500. If you sold your investment, you would have a realized capital gain of $500. If this is in a retirement account, you would not pay taxes on that gain (this is why retirement accounts are called tax-free growth accounts). If that investment was in a non-retirement account and you held it for longer than a year, you would pay taxes on this gain at the capital gains rate (0%, 15%, or 20%) and state income rate. If you did not hold it for more than a year, it would be taxed at the federal income and state tax income rate.
How to Begin Investing
Now that you know what investing means, what are the logistical steps to becoming an investor? Remember, your checking or savings accounts are not investment accounts.
First, you will have to open an account on an investing platform or with an investment company. Common online investment platforms are Vanguard, Betterment, Schwab, or Wealthfront.
Then you’ll need to decide which type of account to open, a retirement or non-retirement account. Next, you’ll want to establish a way to fund that account. Connecting your checking account can help make contributions easy. What’s important is once you transfer cash in, don’t forget to invest it! You don’t want an investment account that’s not invested.
Determining which mutual funds you invest in can be tricky. Many investment platforms will walk you through a risk assessment to help you determine the risk or growth in the portfolio. This will be a ratio of stocks to bonds. The longer you have to invest (10, 20, 30 years), you’ll want to invest in a mostly stock portfolio. Aim to have diverse and low cost stock funds.
Create a Plan
Once you’ve opened your investment account(s), it’s time to create a plan. Is this a retirement account? Are you able to put the recommended 15% of your income into this account? Maybe you aren’t there yet, but the next time you get a raise you can commit to increasing your savings percentage.
Perhaps you’re already maxing out your retirement account and you need a place to save surplus funds. We recommend auto-saving into a brokerage investment account! Set up annual savings goals and check in quarterly to see how you’re doing.
Whatever you decide, create a system for investing and, if possible, set up auto-contributions.
Outsourcing Your Investing
There comes a time when it makes sense to let a professional help guide you. Whether you don’t enjoy the process or pressure, or your account balance is large enough that one mistake could be dire – any of these steps along the way are a great opportunity to talk to an Abacus advisor. We help align your values with your money to create peace and comfort, so reach out today.