Why Investing is Important
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Investing is an effective way to put your money to work and potentially build wealth. Smart investing may allow your money to outpace inflation and increase in value.The greater growth potential of investing is mainly as a result of the power of compounding and the risk-return tradeoff.
Compounding occurs when an investment generates earnings or dividends which are then reinvested. These earnings or dividends then generate their own earnings. Compounding is when your investments generate earnings from previous earnings.
Different investments also offer varying levels of potential return and market risk. Risk is an investment’s chance of producing a lower-than-expected return or even losing value.Return is the amount of money you earn on the assets you’ve invested, or the investment’s overall increase in value.
Investing in a money market or a savings account likely won’t offer the same return potential but is considered less risky than investing in stocks. The amount of risk you carry depends on your appetite or tolerance for risk.
Only you can decide how much risk you’re willing to take for the potential of higher returns. But if you’re seeking to outpace inflation, taking on some risk may be necessary. An increase in risk may provide more potential for your money to grow.
To help increase the potential benefits of compounding, start investing as soon as possible and automatically reinvest your dividends and other distributions. Investing is a time-tested way of putting your money to work for you, as you work to earn more of it.
By investing your money regularly, you may be able to increase it many times over time. That's why it's important to begin investing as early as possible and as soon as you have some money saved for that purpose. The stock market is a good place to start.
Whether you have $1,000 set aside or can manage only an extra $25 a week, you can get started. All investing comes with some degree of risk. It is always possible that the value of your investment will not increase over time.
A key consideration for investors is how to manage their risk in order to achieve their financial goals, whether these goals are short- or long-term. If you're just starting out as an investor, it's possible to invest in stocks with a relatively small amount of money.
You'll have to do your homework to determine your investment goals, your risk tolerance, and the costs associated with investing in stocks and mutual funds. You should also research various brokers to clarify the particular requirements of each and which may best fit your needs.
Remember, when investing:
Make sure you know and understand all the costs associated with buying, selling and managing your investments.
Have savings automatically deducted from your paycheck or checking account.
Beware of investments that seem too good to be true; they probably are.
Investigate financial professionals before you invest. Your state securities board provides free services to check credentials.
Earn additional income
It is possible to earn extra income by investing in quality investments. The return on your investments might be used as a source of regular extra income.
Depending on your appetite for risk, the benefits of investing can mean having more than some ‘rainy day’ cash.
Good financial advice
When it comes to financial advice, everyone is different. Some people want to do it all themselves, others want confirmation on the decisions they’ve already made.
Or they may want a financial mentor who can help them with every financial decision.
There are many financial advice options available, from advice on particular aspects of your financial situation to more holistic advice that looks at your complete financial situation.
You can choose how you would like to receive this advice, over the phone, through video or in person.
A good financial advice on life insurance, investing and wealth products can provide you with insights and support on a range of topics including investments, life insurance and more.
Nowadays, you can access advice in a way that suits you. Whether you choose to speak to someone over the phone or meet face to face, there’s a range of options available to you.
There is an art to choosing ways to invest your savings. Good investments will make money; bad investments will cost money.
Do your homework. Gather as much information as you can. Seek advice from licensed or registered advisers. Check with your state securities regulator before trusting any investment adviser.
Compound interest helps you build wealth faster. Interest is paid on previously earned interest as well as on the original deposit or investment.
How to Benefit from Investing
Building a portfolio of quality investments is one way to help you get ahead financially and achieve your long term goals.
Saving involves putting aside money today for use in the future while investing is more than building rainy day savings.
Savings is a sensible starting point in investing because it provides the funds you need to buy a range of different assets. However investing goes one step further, helping you achieve personal goals with some significant benefits.
Potential for healthy long term returns
Different classes of investment assets such as cash, fixed interest, property and shares often generate different levels of return.
Growth assets, such as shares and property, have historically had the best overall returns of all asset classes but have also had bigger peaks and dips.
As an investor, there is the potential to earn capital growth over the longer term as well as an ongoing income return like dividends from shares or rent from a property.
Assets such as fixed income and cash, may not generate the same level of returns over time as growth assets but these returns are less variable, with smaller peaks and troughs.
Inflation is the ongoing rise in the cost of living over time. One way to help outpace inflation and generate positive returns over the longer term is by investing in assets that are not just capable of delivering higher income returns but also offer the potential for capital growth.
Set some goals
Before you start investing, set some specific savings and investment goals. These give you something to work towards, and lets you tailor investments to your objectives.
Some people have a very clear idea of what they want to achieve and how to get there.
For others who are less certain, the first step to setting goals is to write down a few ideas about what you would like to achieve over different time frames in the short, medium and longer term.
Short term goals are usually around 1-3 years. Medium term goals are often between 3-5 years. The long term goals are those that may take some time between 5 or more years. Your goals may change over time.
Your personal goals will vary according to your lifestyle, priorities and stage of life. And they will change not just because you’re getting older but because of your ongoing life experiences and changing personal preferences.
The main point is that with a set of objectives in place you have a good starting point to develop a plan of action to achieve your goals even if these goals are changed over time.
How to Determine Your Investment Risks
Here are some things to think about when determining the amount of risk that best suits your investing options.
How much money do you want to accumulate over a certain period of time? Your investment decisions should reflect your wealth-creation goals.
How long can you leave your money invested? If you will need your money in a year, you may want to take less risk than you would if you won’t need your money for the next 20 years.
Are you in a financial position to invest in riskier alternatives? You should take less risk if you cannot afford to lose your investment or have its value fall.
While some investments such as a savings account have no risk of default, there is the risk that inflation will rise above the interest rate on the account.
If the account earns 5 percent interest, inflation must remain lower than 5 percent a year for you to make a profit.
Here are some options for investing your money.
Once you have good savings, you may want to diversify your assets among different types of investments. Diversification can help smooth out potential ups and downs of your investment returns.
Investing is not a get-rich-quick scheme. Smart investors take a long-term option, putting money into investments regularly and keeping it invested for five, 10, 15, 20 or more years.
Rule of 72
The Rule of 72 can help you estimate how your investment will grow over time. Simply divide the number 72 by your investment’s expected rate of return to find out approximately how many years it will take for your investment to double in value.
For example: Invest $1,000 today at 8 percent interest. Divide 72 by 8 and you get 9. Your investment will double every nine years. In nine years, your $1,000 investment will be worth about $2,000, in 18 years about $4,000 and in 27 years, $8,000.
The Rule of 72 also works if you want to find out the rate of return you need to make your money double.
For example, if you have some money to invest and you want it to double in 10 years, what rate of return would you need? Divide 72 by 10 and you get 7.2. Your money will double in 10 years if your average rate of return is 7.2 percent.
Make a plan and stick to it.
When you receive money, “pay yourself first," as a way to plan ahead to save money over time.
When you pay yourself first, you put an amount of money away first into savings, before spending on other items.
Once you have saved enough money for emergency needs, consider investing other savings to grow your money. Think about your short and long-term goals.
It is important to take time to think about your long-term goals as money saved can grow over time.
Long-term savings can be invested to further grow your funds. Look at investment choices that are appropriate for your goals and risk levels.
By investing, you are deciding where to put your money, where it will grow and provide additional money to help you achieve your goals.
It is never too late to save and invest.
Saving and investing are both important to consider in your future planning. Through saving money, your money is kept safe, and easy to access should you need it.
By investing early over time, your money grows in value, benefiting from compound interest.
Remember that investing early, along with compound interest, can result in higher investment amounts.
Take time to think through your savings needs and goals, both now and for your future.
How to Invest for Retirement
How much money will you need when you retire? Will you save enough today to meet your future needs at prices higher than today’s due to inflation? Many people don’t save enough for retirement.
Here are some options for how you can invest for retirement.
Individual retirement accounts
If you pay taxes, which most of us do, a tax-deferred investment will be worth the amount you invest multiplied by the tax rate you pay. A good wealth-creation plan maximizes tax-deferred investments.
Start a business
You can also start and invest in your own business as part of a wealth-creation plan. This requires planning, know-how, savings and an entrepreneurial spirit.
Starting a small business can be risky, but it is one of the most significant ways to create personal wealth.
Plan your investment strategy.
Consider the investment options you’d like to learn more about and weigh them against your wealth-creation goals, time frame and risk tolerance. Typically, we save first before we invest.
Think about why savings could be important in your life. Saving money for future use can help you meet life goals. Saving money for emergencies, short-term goals and long-term goals are all important.
Prepare for emergency
What happens in an emergency? Think about what an emergency might be in your life. If that occurred, would you be able to pay for it? If not, now is the time to make a plan to begin saving for that emergency.
Sometimes, it’s hard to imagine where you might find money to save. Start by taking a look at your spending and saving plan.
You may decide to prioritize your spending by cutting current expenses, find additional income, save gift money, bonuses, income tax refunds, or something else, depending upon your goals.
Why You Need to Start Investing Early
The earlier you begin planning for retirement, the greater your potential return on investment. By taking advantage of your youth, you can get a head start on saving for your future.
However, if you’re not sure about the benefits of early investing, here are some reasons why it’s best to start now.
Time allows you to take risks
Typically, when it comes to investing, investors, who have the time to recover if something were to go wrong, have the opportunity to make more riskier moves.
Those who begin to invest late in life are often more cautious with how they invest their money.
By continuously reinvesting your earnings, you are increasing your return on investment. Savvy investors understand the benefits of investing early and taking advantage of the potential gains from compound interest.
Spending habits will improve
Investing early allows you to develop disciplined spending habits by focusing on your budget and cutting expenses when needed.
The goal is to earn money by saving money. Through early investment, the lessons learned will pay off in the long run, especially, when you have even more capital to work with and much restraint is needed.
Be a step ahead of everyone else
The earlier you begin investing, the better your personal financial situation will be down the line.
Compared to those who may have chosen to invest later in life, over time you will be able to afford things that others can’t.
At some point your finances may become unstable, but by investing early you’ll be prepared to face such hardships.
Quality of life will improve
Those who invest in retirement plans such as a Thrift Savings Plan, 401(k) or Roth IRA are taking steps toward an improved quality of life.
Early investment will reduce the risk that you’ll be forced to make reckless choices to secure a stable retirement.
You can invest in various stock and bond mutual funds and target-date funds through a retirement plan such as a 401(k), if your employer offers one.
Once you enroll in a plan, contributions are made automatically at a level you set. Employers may make matching contributions on your behalf.
Your contributions are tax deductible and your account balance grows tax deferred.
This is a great way to maximize your investing funds with less effort. You can also start investing in stocks by opening an individual retirement account. Or, you can go with a regular, taxable brokerage account.
Normally, you'll have lots of options for investing in stocks. These could include individual stocks, stock mutual funds and exchange traded funds (ETFs), stock options.
Diversify and Minimize Risk
By investing in a range of assets, or diversifying, you reduce the risk that one investment’s performance can severely hurt the return of your overall investment portfolio.
This is where mutual funds and ETFs can help. Both types of funds tend to own a large number of stocks and other investments. This makes them a more diversified option than buying a single stock.
Minimums to Open an Account
Many financial institutions have minimum deposit requirements. Others may reduce costs, such as trading fees and account management fees if you have a balance above a certain threshold.
Still others may offer a certain number of commission-free trades for opening an account. It pays to shop around, and not just to find out minimum deposits.
How to Invest in Stocks: A Beginner’s Guide
Tolerance for Risk
Stocks are categorized in various ways, such as large cap stocks, small cap stocks, aggressive growth stocks, and value stocks.
They all have different levels of risk. Once you determine your risk tolerance, you can invest in the stocks that complement it.
You should also determine your investment goals. If you're just beginning, an investment goal could be to increase the amount of money in your account.
If you're much older, you may want to generate income as well as grow and protect your wealth.
Your investment goals might include buying a house, funding your retirement, or saving for tuition. Goals can change over time.
Just make sure that you define and review them often so that you can keep your focus on achieving the goals.
Some investors want to take an active hand in managing their investments, while others prefer to set and forget it. Your preference may change, but decide on an approach to get started.
If you're confident about your investing knowledge and capability, you could manage your investing and portfolio on your own.
Online brokers allow you to invest in stocks, bonds, exchange-traded funds (ETFs), index funds, and mutual funds.
An experienced broker or financial advisor can help you make your investment decisions, monitor your portfolio, and make changes to it.
This is a good option for beginners who understand the importance of investing but may want an expert to help them do it.
A robo-advisor is an automated, hands-off option that usually costs less than working with a broker or financial advisor.
Once a robo-advisor program has your goals, risk tolerance level, and other details, it automatically invests for you.
The Costs to Invest in Stocks
Commissions and Fees
All brokers have to make money from their customers in one way or another. In most cases, your broker will charge a commission every time that you trade stocks, whether you buy or sell. Trading fees range from $2 per trade to as high as $10.
Some brokers charge no trade commissions at all, but they make up for it with other fees. Depending on how often you trade, these fees can add up, affect your portfolio's return, and deplete the amount of money you have to invest.
Due to commission costs, investors often find it prudent to limit the total number of trades that they make to avoid spending extra money on fees.
Certain other types of investments, such as exchange-traded funds (ETF), carry fees in order to cover the costs of fund management.
These costs alone can eat into your account balance before your investments even have a chance to earn a positive return.
Mutual funds are professionally managed pools of investor funds that focus their investments in different markets.
They have various fees that you should be aware of. One of these is the management expense ratio (MER). The MER is the fee paid by shareholders of a mutual fund (or ETF) and goes toward the expenses of running a fund.
It’s based on the total of a fund's assets under management. The MER can range from 0.05 percent to 2 percent annually.
For beginning investors, mutual fund fees may be more palatable compared to the commissions charged when you buy individual stocks.
You can invest less to get started with a mutual fund than you’d probably pay to invest in individual stocks. Investing small amounts consistently over time in a mutual fund can give you the benefits of dollar cost averaging (DCA) by reducing the impact of volatility.
Brokers are either full-service or discount. Full-service brokers offer a full range of traditional brokerage services, including financial advice for college planning, retirement planning, estate planning, and for other life events and opportunities.
This custom-tailored advice justifies the higher fees that they usually charge, compared to other brokers.
It can include a percentage of your transactions, a percentage of your assets under management, and sometimes, a yearly membership fee. Minimum account sizes can start at $25,000.
Discount brokers offer you tools to select your investments and place your orders. Some also offer a set-it-and-forget-it robo-advisory service. Many provide educational materials on their sites and mobile apps, which can be helpful for beginning investors.
Some brokers have no or very low minimum deposit restrictions. However, they may have other requirements and fees.
Be sure to check on both of these as you look for a brokerage account that meets your stock investing needs.
Since Betterment launched, other robo-first companies have been founded. Established online brokers such as Charles Schwab have added robo-like advisory services.
If you want an algorithm to make investment decisions for you, including for tax-loss harvesting and rebalancing, a robo-advisor may be for you.
The success of index investing has shown that if your goal is long-term wealth building, a robo-advisor may fit your investment style.
Stock Market Simulators
Beginner investors who wish to gain experience investing without risking their money in the process may find that a stock market simulator is a valuable tool.
There are a wide variety of trading simulators available, including those with and without fees.
Stock market simulators offer users imaginary, virtual money to invest in a portfolio of stocks, options, ETFs, or other securities.
These simulators often track price movements of investments and, depending on the simulator, other notable considerations such as trading fees or dividend payouts.
Investors make virtual trades as if they were investing with real money.
Through this process, simulator users have the opportunity to learn about investing and to experience the consequences of their virtual investment decisions without putting their own money at risk.
Some simulators even allow users to compete against other participants, providing an additional incentive to invest by making well thought out decisions.