What to Invest In?
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What you invest in plays a big role in your financial success. It is not just about picking winning stocks, or stocks vs. bonds.
You need to make appropriate investment decisions based on your goals.
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Stocks
Why are stocks a good investment?
You should consider owning stocks because stocks have consistently proven to be the best way to build wealth over the long term.
U.S. stocks have outperformed most investment classes and delivered better returns than bonds, savings yields, and gold over the past decades.
This is because as a stockholder, you own a business. As the business gets bigger and more profitable, and the economy grows, you own a business that becomes more valuable.
In most cases, shareholders also earn a dividend.
This is the reason as to why stocks should make up the foundation for your investment portfolio.
For instance, if you're in your 30s, saving for retirement can ride out many decades of market volatility.
You should own almost entirely stocks.
If you're in your 60s, you should own some stocks for growth.
But you should also protect the assets you'll need in the next five years by investing in bonds and holding cash.
Main risks with stocks:
Volatility: Stock prices often swing variedly over very short periods. This is risky if you need to sell your stocks in a short period of time.
Permanent losses: Stockholders are business owners, and often times businesses fail.
If a company goes bankrupt, bond owners, contractors, vendors, and suppliers get repaid first. Stockholders get whatever is left.
You can limit your risks by understanding what your financial goals are.
How to manage volatility
If your financial goals are still years in the future, you can hedge against volatility by doing nothing.
Stocks delivered incredible returns for investors who bought and held through two of the worst market crashes in history.
If you need some urgent cash in the short-term, your goal should be protecting your capital by shifting the money you'll need out of stocks, and into bonds and cash.
How to avoid permanent losses
The best way to avoid permanent losses is to invest in a diversified portfolio.
Do not concentrate your wealth in any one company, industry, or end market.
Diversification will help limit your losses to a few bad stock picks, while your best winners will more than make up for the losses.
If you invest the same amount in 10 stocks and one goes bankrupt, the most you can lose is 1% of your capital.
Now if say one of the stocks goes up 2,000% in value, it makes up for not just the one loser, but would double the value of your entire portfolio.
Diversification can protect you from permanent losses and expose you to more wealth-building stocks.
Research companies and invest in individual stocks.
Index funds
Invest in index funds for a more passive approach, compared to buying individual stocks.
Bonds
Why should you invest in bonds?
Building wealth over the long term is the most important step.
Once you have built that wealth and got closer to your financial goal, bonds, which are loans to a company or government, can help you keep the wealth.
As you get closer to your financial goals, owning bonds that match up with your timeline will protect your assets in the short term.
Types of bonds
Corporate bonds, issued by companies.
Municipal bonds, issued by state and local governments.
Treasury notes, bonds, and bills, issued by the U.S. government.
Invest in bonds for predictable, more stable returns.
It takes more capital to invest in crowdfunded real estate, and unlike public REITs where you can easily buy or sell shares.
When you make your investment, you may not be able to access your money until the project is completed.
There's also a risk that the developer may not execute, and you can lose money.
The potential returns and income from real estate is compelling, and has been inaccessible to most people until crowdfunding changed the game.
Real Estate
Why and how to invest in real estate?
There are ways to invest in and make money from real estate.
Just like owning great companies, owning high-quality, productive real estate can be a great way to build wealth.
Throughout history, commercial real estate is counter-cyclical to recessions, and is often viewed as a safer, more stable investment than stocks.
Publicly traded REITs, or real estate investment trusts, are the most accessible way to invest in real estate.
REITs trade on stock market exchanges just like other public companies.
REITs are excellent investments for passive income, since they don't pay corporate taxes, as long as they pay out at least 90% of net income in dividends.
It's much easier to invest in commercial real estate development projects now more than ever.
In recent years, legislation has made it legal for real estate developers to crowdfund capital for real estate projects.
As a result, billions of dollars have been raised from individual investors looking to participate in real estate development.
What is your risk tolerance?
Invest in brokerage accounts that reduce taxes. Investing rightly will help you reach your financial goals, and where you invest is equally important.
A little bit of tax planning can go a long way. You should choose the appropriate kind of brokerage account based on what you're investing for.
Here are some examples of different accounts you may want to use on your investing journey.
401(K)
For employed retirement savers
Pre-tax contributions reduce your taxes.
Potential employer-match contributions.
Distributions in retirement are taxed as regular income.
Penalties for early withdrawals.
SEP IRA/SOLO 401(K)
For self-employed retirement savers
Pre-tax contributions reduce your taxes.
Higher contribution limits than IRAs.
Distributions in retirement are taxed as regular income.
Penalties for early withdrawals.
TRADITIONAL IRA
For retirement savers
Use to rollover 401(k) from former employers.
Contribute retirement savings above 401(k) contributions. Distributions in retirement are taxed as regular income.
Penalties for early withdrawals.
ROTH IRA
For retirement savers
Distributions are tax free in retirement.
Withdraw contributions without penalty.
Contributions are not pre-tax.
Penalties for early withdrawal of gains.
Contribution limits determined by your income.
TAXABLE BROKERAGE
For savers with additional cash to invest.
Contribute any amount without tax consequences or benefits.
Withdraw money at any time.
Taxes are based on realized events such as capital gains, dividends, and taxable distributions.
COVERDELL ESA
For college savers
More control over investment choices.
Withdrawals for qualified education expenses are tax free.
Contribution limits based on income.
Taxes and penalties for nonqualified withdrawals
529 COLLEGE SAVINGS
For college savers
Withdrawals for qualified education expenses.
Very high contribution limits.
More complicated, and varies by state.
Fewer investment choices.
Taxes and penalties for nonqualified withdrawals.
Maximize employer-based 401(k) plans up to the maximum amount your employer will match. If your earnings allow you to contribute to a Roth IRA, building up a tax-free income in retirement is an excellent way to secure your financial future.
Use the Roth-like benefits of the Coverdell and 529 college savings plans to minimize the tax burden, and get more cash to pay for education.
A taxable brokerage account is an excellent tool for other investing goals, or for getting extra cash above retirement account limits. Everyone’s situation is different.
You must consider your investment time limitations, desired returns, and risk tolerance to make the best investment decision to reach your financial goals.