If you are anything like I was before I started taking financial planning classes, you probably have no idea how to start investing. You might think investing is only for rich people or old people. You might have just opened a Robinhood account, collected a free stock, and now consider yourself a savvy investor. Wherever you may be at in your financial life, grab a cup of coffee (or a morning beer), take a seat, and get ready to learn the basics of investing.
So what is “investing?” Well, investing can be anything you want it to be. The most common investments are stocks, bonds, and real estate. Old people who don’t trust banks or conspiracy theorists who think the government is about to collapse might be invested all in gold, silver, or ammunition. 40 year old men who still live in their mom’s basement might be invested entirely in rare Magic: The Gathering cards.
An investment is anything you buy with the plan to one day sell it for a profit. In this article though, I’m mainly going to discuss what are widely considered good investments. And by good investments I don’t mean hot Canadian marijuana stocks, or small companies that will hopefully be the next Amazon. Anything you invest in with the hope of getting rich quick is usually not a good investment.
Before we discuss investments, we need to talk about where to actually put your money. You’re probably at least somewhat familiar with apps such as Robinhood, Stash, and Acorn; these apps offer taxable investment accounts. This means the money that you invest has already been taxed, and you’ll be taxed on the capital gains (how much your investment goes up) whenever you sell the stock, bond, or other investment. Taxable accounts are usually not the best way to save for the future.
The best way to save for the future is normally with tax-advantaged accounts. The two most popular options are IRAs (Individual Retirement Accounts) and employer-sponsored retirement plans (like 401(k) plans). Adults can open IRAs at any time, but you must have earned income to contribute (or if your spouse is working and you aren’t, they can contribute on your behalf). You can only get a 401(k) plan or other employer-sponsored retirement plans if your employer offers them (there are options for those who are self-employed, too).
There are two types of IRAs, Roth IRAs and Traditional IRAs. The money you put into a Roth IRA has already been taxed, but money you take out (in the form of qualified distributions) is not taxed. This means all the money you put into a Roth IRA will grow tax-free. Traditional IRAs are a little different; the money you put into a Traditional IRA goes in before it’s taxed. This means you’ll get a tax break when you contribute to a Traditional IRA, but distributions are taxed.
Roth IRAs are generally better for people who don’t make a ton of money right now (meaning it would be better to save money on taxes in the future), and Traditional IRAs might be better for someone who has a really high income and wants to pay less in taxes now.
Employer-sponsored retirement accounts, such as 401(k) plans, don’t give you as much control as IRAs. Your employer decides what type of account you can open and what type of investments you can pick. That’s why it’s usually better to put your money in an IRA, with a few exceptions: 1.) If you get an employer match, contribute to your employer-sponsored account first. Don’t turn down free money. 2.) If you’ve already maxed out your IRA (the limit for 2019 is $6,000 if you’re under 50, $7,000 if you’re over), contribute to your employer-sponsored retirement plan.
If you don’t currently have an IRA, you may be wondering how to open one. The most popular custodians (people you give your money to) are Charles Schwab, Fidelity, and Vanguard. The easiest way to open an account is by going online. There are also many robo-advisors now that offer IRAs; popular robo-advisors include Betterment, Wealthfront, and SoFi. Robo-advisors manage your money for you, and charge an additional fee of around 0.25% to 0.40% for managing your money. That might not sound significant, but it adds up over time. If you want to choose your own investments (it’s not as hard as you think, I promise), and save money while doing it, robo-advisors aren’t the best option for you.
Congratulations, the boring section about IRAs and 401(k) plans is now over. Hopefully it wasn’t as painful for you to read as it was for me to write. Now that you know more about what types of accounts are out there, we can move on to the exciting stuff, investments.
Did I say exciting? Sorry, I actually meant boring. Exciting investments are usually very risky, like those hot Canadian marijuana stocks I mentioned earlier, or Bitcoin (I actually had to change the value of Bitcoin in my article last week right before I published the newsletter because it had dropped over $2,000 in the span of a week).
Boring investments are usually the best. Not savings account that pays 0.01% interest boring, but index fund that tracks the S&P 500 boring. Morningstar is a great resource for researching specific funds. Index funds and target-date retirement funds are a great place to start; the custodians I mentioned, Vanguard, Charles Schwab, and Fidelity all offer their own versions of an S&P 500 index fund and target-date funds.
What are target-date funds? The year in the fund name represents the year you want to retire; a target-date 2060 fund would be designed for someone planning to retire in 2060. Target-date funds are designed to be riskier while you’re younger, and safer as you get older.
Investing may seem complicated, but once you know the basics it becomes simpler and simpler. I haven’t done all the work for you; the goal of this article was to give you the basic knowledge and confidence to make your own decisions about investing, not make your decisions for you.
Thanks for taking the time out of your day to read today’s newsletter. If you have any questions or comments, or suggestions for future newsletters, you can email me at email@example.com.