I know, I know. Your 401K is half the size you think it should be. Investing your money can be a scary thing, especially when considering retirement and your future. But, have no fear. I am here to teach you the basics of investing so when it comes time to invest, you can do so wisely with a better understanding and the guidance of an investment advisor.
The investing marketplace is noisy. That is for sure as a sense of urgency to invest now, now, now constantly rings out! People are continually asking why you're not checking investment boxes and saving for that 401K. Don't let others expectations crowd your mind and overwhelm you. Here is a quick, step-by-step of the basics of investing terms. Just a quick reminder, I don't sell any products, nor am I licensed in them, so please know I have your best interest in mind when offering this education.
That's right. Turn off the news. It's full of hype and speculation. Instead, look to the tortoise for your example. You know, the story of the tortoise and the hare? Be the tortoise. He may seem boring; however, the tortoise is steady and consistent. Embodying the traits of the tortoise is how you financially win over time! You see, this mentality is echoed by many popular and wealthy people, like Warren Buffett. Don't walk blindly into a financial advisor's office and look to him/her to teach you everything. You need to know the basics and then be open to receive their advise. Let's discuss some of those basics.
You probably think they're risky and go up and down a lot, right? Well, what is a stock and what does it mean to buy stock? Publicly traded companies sell stocks. They become publicly traded by offering stocks for sale to raise money they can invest in their company. If the company is new to the market, that is called an IPO (Initial Public Offering), which means they are now in the marketplace and have stocks that can be purchased. After that it's bought and sold just like any other stock in the market. Purchasing stocks in any publicly traded company, thus, makes you a shareholder. You are buying a stake in the company. If their shares do great, your shares go up in value and if they do poorly, your shares go down in value. As a shareholder, you are sharing some risk and investing in the company in hopes they grow and become better.
A bond is a debt instrument. An investor loans money to an entity which borrows the funds for a defined period of time at a variable or fixed interest rate. Basically, the company is saying, "Please buy a bond. Give us money and we'll repay you by X date." As bonds mature, you are returned your investment as well as a rate earned; however, those rates are typically very low, making for small profits but a more stable investment. It's important that your overall investment plan beats inflation. Inflation tends to average somewhere between 2% and 4% percent over history depending on the time periods you compare. So, if your money is making less then inflation you are losing money over time. Bonds have an inverse relationship with interest rates, so if interest rates are up then bonds are down in value. Additionally, bonds rarely beat inflation.
A mutual fund is a simple concept. A bunch of people put money into it and then it is managed and invested by a manager who has market experience. This fund doubles down on diversification, more about that later, by spreading the risk amongst all the investors as well as the actual investments being purchased through the fund being varied as well. Mutual funds are made up of stocks, bonds, etc. If the mutual fund manager invests the money in stocks, it's a stock mutual fund. If the manager invests in bonds, that's a bond mutual fund and so on and so forth.
An annuity is a plan that can vary from paying a fixed amount on a yearly basis with no or low fees all the way to those that pay variable amounts with high fees, which are typically used by those who are in their later years and didn't plan for retirement early on. Talk to your investment advisor as the fees can be very high and the return not so great.
Retirement accounts are the vehicle through which investments are purchased. Think of the investment as you, and the account as the car. The car isn't the investment, it is merely the means by which you reach your destination. There are two major types of vehicles that are the most common: retirement accounts and college savings accounts. Let's talk retirement first...
The most common form of retirement and typically available through an employer, it is an account you can invest in and is tax deferred. The money goes in pre-tax and grows tax deferred to be taxed later when you draw it out in retirement years.
Most commonly, these plans are for medical professionals and teachers and their version of the 401k.
Typically, these plans are used for municipality or government employees and are their version of the 401k. Other retirement plan options include:
This is like the HSA of retirement savings. You can own it and take it with you when you leave an employer. You can even roll over your 401k to it. But, you cannot touch it between the transfer. It must be direct. If you do, it triggers taxes and you will be taxed on it. An IRA gives you complete control and is not dependent on where you work. Additionally, there is Roth IRA plan, which comes from a piece of legislation headed by Senator William Victor Roth II of Delaware. Instead of paying taxes when you hit retirement, a Roth IRA flips the script where you pay taxes now instead of later. What's really nice is those post tax dollars grow tax free and when take it out in retirement years there are no taxes, which will save you money since taxes tend to rise over time. In terms of college education, there are two types of educational savings accounts.
Basically, this is an educational savings account that you save for college and your dollars are tax deferred.
These plans are state specific and many of them can really limit your ability to control how the funds are invested so be sure to meet with your investment advisor to determine which plan is best for you. The Coverdell ESA is a national program available in most states. Whichever you choose, the goal is to have an investment where you have the most control possible. Now, I've called these two categories investments and vehicles for a reason. Investments are just that, specified investment categories, while vehicles are the types of things you invest in. Here are some additional go-to terms that will help you even further.
A beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. When looking at an investment with a beta of 1, this is equal to how risky the overall stock market is as a whole. If the beta is 1.2, then it is 20% more risky than the typical stock market level, a beta of 2 is twice as risky, etc.
Well, mom always warned you not to put all your eggs in one basket. Diversification is that concept. It is putting your eggs in multiple baskets. Rather than buying single stocks for example, diversifying spreads the risk around both by kind of investment (stock, bond, etc.) and across multiple companies so there is less risk of losing all your money in one place. Think of your money like manure. Left to sit in one place it stinks, but spread it around and it can grow stuff.
All this means is you are buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. Over time, it will make more money than putting all your money in at once. Spreading out your money, and investing slow and steady, gives you more shares over time. The goal is that over time your share's value is more than you paid per share because you average out the costs over time. Here's a visual example.
One final note... You may be concerned about the risk of your investments, but if you employ the strategies of diversification, cost averaging, sticking with it for the long haul, and not reacting, you will come out ahead over time. You will live out the principle of the tortoise and reap the rewards. As your risk tolerance grows and your needs change, you will be more apt to invest wisely and get yourself in a better position as you approach retirement, which will keep your wallet heavy and your heart light.
Question: What did you learn this week about investing? Be sure to comment and let me know!
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