Weigh Portfolio Options
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Put simply, stocks, otherwise known as equity securities, are the ideal entry point into investing for most people. U.S. equity markets, which include large and familiar companies like Apple, Amazon, Pfizer and Tesla, are also very liquid, and the returns of stocks as a whole tend to reflect overall economic growth. Stocks can be risky, so if you’re going to invest in individual stocks, buying a diversified portfolio of at least eight stocks will help you reduce the risk that one or two underperformers will severely impair your overall returns.
By far the easiest way to start investing is via a workplace retirement account. If your job doesn't offer a plan or you don't qualify for it, open an investment account with a large brokerage that you can trust. There are also a growing number of robo-advisors, which are online firms using predetermined algorithms that create portfolios of index funds for you. Many large financial firms offer their own “robo-advice” options.
Given the breathtaking rise in cryptocurrencies like bitcoin, some have wondered whether these digital assets should replace stocks in your portfolio.
Cryptocurrency investing ranges from bizarre options like dogecoin—modeled after a shiba inu and created as a joke—to gamechangers like Ethereum.
That means crypto assets are extremely volatile, risky and probably not suitable if your goal is funding retirement or college educations. When it comes to crypto, invest only what you can afford to lose entirely.
Real estate is another popular asset class.
The idea of buying an investment property and having tenants essentially pay off your mortgage is alluring. When it goes well, it's an attractive and effective way to build assets, since the availability of mortgages means you can acquire more assets with less cash on hand.
While real estate can be a great investment, the barriers to entry (lending, capital, time, etc.) are much higher than for stocks. It's also a lot harder to diversify with real estate, so stocks are still the most common avenue for retirement savings.
Your 401(k) Retirement Account
Employer-sponsored retirement plans are ideal places to start investing for several reasons. The first is that there are already systems in place to help you invest directly from your paycheck. In most cases, you’re given choices among mutual funds and exchange traded funds, which contain baskets of stocks so your investments will be diversified. Importantly, a 401(k) allows you to contribute money before income taxes, and your investments then grow tax-deferred. Moreover, in most cases, some of your contributions will be matched by your employer.
Automatic payroll withdrawals are also a powerful behavioral force because your money is deposited into your investment account before you have a chance to spend it. Research has shown that this simple automatization significantly increases the amount you'll save and invest over your lifetime.
If your workplace doesn't offer a retirement account, or if you already take advantage of it, IRAs are another type of investment account that offers similar tax breaks. If you'd prefer to avoid the contribution and withdrawal restrictions of tax-advantaged accounts (you generally can't withdraw your funds without penalty until 59.5 years of age), you can open a standard investment account. These accounts are sometimes referred to as brokerage or taxable accounts.
Active Versus Passive
When you think of investing in the stock market, you might be imagining picking companies like Amazon or Ford or FedEx and buying their individual stocks. This “active” investment style typically requires researching and continually monitoring the companies you own. A portfolio with fewer stocks in it is riskier, so you'll want to keep a close eye on it. By contrast, mutual funds often have hundreds or thousands of stocks in them, making them less risky.
Additionally, active investors who regularly buy and sell individual stocks in an attempt to beat the market’s average performance have historically underperformed the very benchmarks they’re trying to surpass. Fortunately, if you prefer “passive” investing and want a portfolio that you can set and forget, many options are available.
Even the world’s greatest stock picker, billionaire Warren Buffett, recommends that most people engage in passive investing via low-cost funds. The following choices all optimize for diversification and low fees: index funds, target retirement funds and robo-advisors.
A stock index fund is a packaged product backed by an extensive basket of stocks that seeks to mimic the performance of an underlying index, like the S&P 500, which is a broad diversified representation of large companies in the U.S. A target-date or target-retirement fund is a diversified portfolio that shifts its allocation between stocks and bonds, which are less risky, and gradually raises its bond holdings as it approaches its maturity (and your retirement) date. You'll need to open an investment account and fund it before investing in either of these choices.
Lastly, you can invest using a robo-advisor, which is essentially an investment platform that selects your investments for you based on your risk tolerance, investment goals and time horizon. The leading robo-advisors invest in low-cost index funds, so they ascribe to the same tried and tested “set it and forget it” philosophy—but they do the setting (or asset allocation) for you.
Put Your Goals And Objectives First
Before you buy a single stock or fund, it is critical that you establish goals for your portfolio. For example, if your goal is to buy a house in the next 18-24 months, you'll want your money invested in an easily accessible and safe place, like a no-penalty CD or high-rate money market account.
However, if your goal is to retire in 30 years, you'll want to take more risk by investing in stock funds since growth of capital is paramount and you have more time on your side to help smooth out the bumps along the way.
In truth, however, most people have multiple goals and priorities. For example, you might want to buy a house, invest for retirement, and put money aside for a child's college education at the same time. Understanding your goals will help you determine what your financial needs are so you can decide how much money to invest from each paycheck. The most important thing is that you continue to invest throughout your life and career.
Remember, investing doesn't need to be complicated to be effective. Thanks to compounding, your success will mostly depend on your ability to invest regularly and consistently.