Investing is an umbrella term that refers to different ways you could potentially grow your wealth over the long term. The stock market is typically the first thing to come to mind, but investing encompasses much more than publicly traded stocks.
No matter what you invest in, the goal is getting your money to work a little harder for you. Sitting on the sidelines could be something you regret. One MagnifyMoney survey found that over three-quarters of Americans wish they’d started investing earlier in life. If you’re new to investing, read on for a brief rundown of how it works.
Should I start investing?
Before we get into the nuts and bolts of investing, it’s important to check in with your finances to see if investing is a good idea. If you’re struggling to make ends meet or are having a hard time staying within your budget, pouring money into investments might not be the smartest move. In other words, consider strengthening your financial foundation first. This might include:
- Building your emergency fund
- Paying down high-interest debt
- Following a budget that allows you to live within your means
If you’ve ticked off those boxes, you might be ready to give investing more serious thought. It’s worth noting, however, that those who have access to a 401(k) with an employer match could be missing out by waiting around. A 401(k) is an employer-sponsored retirement account that allows you to contribute on a pre-tax basis. The money you put in is tax-deductible, which effectively reduces your taxable income during your working years. Contributing enough to snag an employer match could be a great way to start building your nest egg—even while shoring up your financial foundation.
Different types of investments
Investing takes many forms. Here are some common investment vehicles you might consider:
- Stocks: Buying stocks gives an investor an ownership stake in companies. You could turn a profit if you sell your shares for more than you paid. Just keep in mind that you’ll likely have to pay something called capital gains tax. All investing is risky. However, since its inception, the S&P 500 has historically generated an average annualized return of 10.5%, according to Investopedia.
- Bonds: These are debt securities that allow investors to loan money to government agencies, corporations and municipalities. These organizations then repay the bond with interest over a predetermined amount of time. They’re considered lower-risk investments, though returns aren’t usually as robust when compared to stocks. According to Charles Schwab, the average annual return for bonds was 6.1% over the 30 years that ended in 2018.
- Exchange-traded funds (ETFs) and mutual funds: These are funds that allow investors to buy all kinds of securities, including stocks and bonds. This can provide some degree of diversification. With ETFs and mutual funds, it’s important to note that both charge fees that could diminish returns, according to the SEC.
This is by no means an exhaustive list of investment options—and there’s always the possibility of losing money. Like anything else, it’s important to do your research and make sure you understand the potential risks of different investments.
How to start investing
If a 401(k) is available to you through work, you might consider starting there. Beyond that, you can also explore individual retirement accounts (IRAs). A traditional IRA works like a 401(k) in that contributions may be tax-deductible. And like a 401(k), the withdrawals you make in retirement are taxed as ordinary income. A Roth IRA is different. Since it’s funded with after-tax dollars, investors can enjoy tax-free withdrawals.
Beyond retirement accounts, you can also open a regular brokerage account to invest in stocks, bonds, ETFs, mutual funds and more. You may be able to tap these investments, though you may still be taxed on investment gains.
Investing can be a powerful way to grow your wealth over time, but it isn’t without risk. In the end, every investor is different. What’s right for you will depend on your unique financial situation. Your age, financial goals and risk tolerance may come into play as well.
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