As with any new endeavor, the first steps are the hardest. You might be avoiding investing because of all the numbers and jargon, as well as the fear that you’ll slip up and, you know, lose all your money.
But once you get started, you’ll find it’s not as scary (or risky) as it seems. Plus, the truth is that investing is the best way to grow your money and achieve your financial goals. Saving alone isn’t enough now—inflation will eat away at your hard-earned cash and leave you with less purchasing power than you started with. You need to invest to make sure your money keeps up.
But what about the risks?
Yes, investing does come with some risk. (Although, remember, so does not investing.) 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.
OK, so which investments are safe, and which are risky?
On the safest side of the spectrum are Certificates of Deposit (CDs) and Money Market Accounts (MMAs). Both offer slightly higher yields than standard savings accounts—but still only as much as about 2.25% on average for five-year CDs (meaning you can’t touch your money for five years). Bonds are also considered relatively safe investments. They’re essentially loans you give to a company, government or other entity, so they 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, you want to spread your bets across a range of investments to increase your chances of finding a winner—or, at least, to minimize your losses if one company you invest in tanks. That means 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, you should 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. How you break it down between investments depends on your risk tolerance, time frame 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 start, 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 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 pretax contributions and tax-deferred growth), a hefty limit ($18,500 for 2018)—and possibly free money. Seriously. Many employers will match some portion of your contributions.
The next stop should be 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 $5,500 in 2018 ($6,500, if you’re over age 50).
If 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 superstar)—you can use a brokerage account. This gives you the opportunity to invest in a range of investments all in one place.
How much is this going to cost me?
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. Pick funds that come with low “expense ratios” (or fund management charges)—you can easily find ETFs with expense ratios under 0.1%—and no extra sales charges (or “loads”) or other fees.
Read: The ‘ramen noodles’ savings plan, explained
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 on to 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.
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