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What You Should Know Before Investing Your Money


For many young people, investing can actually be something of an emotional endeavor. When it comes to investing our money, it’s common to either feel ridiculous for not taking advantage of a great stock buy-in that you see your friends and family members making a killing off of, or feeling thankful for avoiding the allure of an investment that started great, but began to tank (bitcoin, anyone?). For many of us though, the most overwhelming emotion we encounter is intimidation. Not only is the entire industry muddled in confusing terms, perplexing abbreviations, and bewildering strategies, but the idea of possibly losing your hard-earned money in a complex system inherently fraught with uncertainty can feel terrifying. With that daunting concept in mind, some may wonder what the point of investing is when they can just put their money aside in a savings account. Well, the truth is that investing is an absolutely critical aspect of effective life planning, and one day, whether it’s your retirement or putting the down payment on your first home, investments can greatly help you secure what you desire in life.

At its heart, investing really comes down to allocating money into goods, products, or shares in hopes of generating greater wealth for the future (AKA putting in some money now so you can have more money later). The best way for investing to appear less scary or confusing is by asking yourself these three very basic questions about what you want out of your life.

  1. How comfortable are you with investing your money?

  2. What is your personal goal in investing your money?

  3. What type of investments do you want to own?

The most important first step of investing is honestly evaluating and discovering your personal tolerance for risk. Giving away your money and trusting that someone will handle it with enough care to provide a return on investment (ROI) isn’t easy, but understanding how much difficulty you have with that idea will determine what your individual risk level is like, and that will ultimately determine what types of investments you should consider, and which types you should absolutely avoid.

If you are comfortable with being highly aggressive, that means that you believe in “high-risk, high-reward” investing that can possibly expose you to hugely volatile market swings, and even possibly losing your principal investment. People whom are moderately comfortable with risk are people who want to protect themselves from market volatility, but also don’t want to miss out on any potential market gains. Also, by identifying yourself as someone who is risk-averse, you are effectively stating that you would like to see your money invested conservatively because you treasure protecting your investments from any big potential drops, far more than you desire exposing your funds to any potential big market gains.

Just as understanding your risk tolerance is a deeply personal discovery, so too is understanding what you’re looking to get out of investing your money in the first place. Different people obviously have very different intentions when it comes to when they want their money and what they want to do with their money, and those answers both determine how they should invest their money. it really comes down to this: are you interested in a short-term ROI, or a long-term ROI? Some people invest because they want to make money for next year, while others invest because they want to be set for their retirement, decades from now.

Once you’re aware of your tolerance level and personal investment goals, in comes the truly challenging part: deciding which investment vehicles are best for you.

STOCKS

Investing in common stock (a security that represents shares of ownership in a corporation) is probably the most familiar form of investment to most people. Stocks become available to new investors after a private business, usually in an effort to raise funds, decides to sell off parts of their company (“going public”) on the stock market (i.e. New York Stock Exchange [NYSE], or the National Association of Securities Dealers Automated Quotations  [NASDAQ]) in a process known as an Initial Public Offering (IPO). Once this occurs, investors can swoop in and purchase as many shares of the company as they can afford. Common stock is typically high-risk, high-reward, as your investment will perform as well as that particular company does. Besides common stock, you can also invest in preferred stock, which gives shareholders some degree of ownership which means they are less exposed to any potential volatility. An advantage of owning preferred stock over common stock is that if the company goes bankrupt, preferred-stock holders are paid out before common-stock holders.

It’s very important to know that there are different classifications of stocks, such as income stocks, value stocks, and growth stocks. Income stocks typically derive from companies that are well-established, have a long-track record of sustained growth, and may even be household names. Their main goal is to provide shareholders with steady dividend payments (a sum of a company’s profits paid out to investors over a certain period of time, usually quarterly). Value stocks are stocks that are underpriced as compared to their competitors, and growth stocks are stocks of companies with quickly rising profits.

If you hear someone refer to a stock by its “market capitalization,” that just refers to the size of a company. It’s important to note that smaller companies typically tend to present more of a risk than larger companies. Also, owning preferred or common stock outright isn’t typically an investment you just dump money into and wait for it to mature at retirement. It is important to monitor your stocks and ensure that you regularly receive and inspect your statements.

BONDS

While a stock gives a shareholder ownership of a part of the company, a bond provides the shareholder with ownership of a loan in which the company, city, or government promises to pay you back in full with interest, through regular payments. While bonds aren’t risk-free, they are typically far less volatile than investing in stock. Bonds issued by the U.S. government tend to be the safest form of bonds (called “Treasurys”). Typically investors see higher yields (the amount the investor is paid) the longer they hold on to a bond.

MONEY MARKET ACCOUNTS

Investing in a money market account is typically far-less aggressive than investing in stocks and bonds. In fact, it’s almost like investing in your bank’s savings account, except that it provides a higher return. If investing was a highway, stocks would be the fast lane, bonds would be the middle lane, and money markets would be the slow lane. While money markets are great ways of avoiding risk, they can provide better growth than a savings account at your local bank.

MUTUAL FUNDS

A mutual fund is a managed portfolio of stocks and bonds that takes money from multiple different investors and pools it together to achieve specific results for the shareholders. Some mutual funds can be more aggressive, investing in riskier stocks and bonds, while others can be far more conservative, investing less in stocks, and more in less risky bonds.

CURRENCY

While bitcoin and cryptocurrency has become so notable, investing in currency itself is not a new thing. The FOREX (“foreign exchange”) is the world’s single largest financial market, where individual investors, financial institutions, and corporations trade different nation’s currencies. This is incredibly volatile, high-risk, and short-term. In fact, some FOREX brokers make trades within hours based on global geopolitical shifts that can make one nation’s money be worth more, and another nation’s money worth less. Cryptocurrency is essentially just digital cash. As much is changing with how businesses accept cryptocurrency, and how governments legislate it, massive changes will be coming to that industry shortly. Investing in bitcoin, right now, is very volatile and not necessarily a retirement investment strategy, but much of that is still to be determined.

Outside of the different types of investments, there are also different types of investment plans that one can place their money into.

RETIREMENT PLANS

These are plans for people looking for long-term investments that will provide them with an income later in life when they decide to stop working. Understanding the difference between pre-tax (contributions you make to your retirement plan before the government has removed taxes) and after-tax (contributions you make to your retirement plan after the government has removed taxes) is critical because it determines how you will file your taxes every year.

401(K): This is a employer-sponsored plan that you can opt into at work (if your job offers one and you qualify) where money is deducted from your paycheck.

403(B): This is a employer-sponsored plan for people like teachers, non-profit employees, and self-employed ministers.

IRA: This is an individual retirement account that you can operate and manage at a financial institution separate from your employer, where your money is contributed and grows on a pre-tax basis.

Roth IRA: This is an individual retirement account that you can operate and manage at a financial institution separate from your employer, where your money is contributed on an after-tax basis.

Simple IRA: This is an employer sponsored plan typically offered by smaller businesses where employees are provided with individual retirement accounts that the employer also makes contributions to (company match).

Pension: This is an employer-sponsored plan that is much different from a 401(k) or a 403(b) because the majority of the work is done by the employer. They are tasked with making the right investments to ensure that your regular contribution grows.

OTHER PLANS

529 Plan: This is an individual investment plan typically for parents, grandparents, or guardians, interested in growing a sum of money, tax-free, to use to pay for their kids’ post-secondary education.

Certificates of Deposit (CD’S): A CD is an insured individual investment, typically offered by a bank or a credit union, that offers investors a predictable return on a rate higher than what a bank offers. But, these plans penalize investors who attempt to withdraw their money from the plan before a set period of time.

Annuity: This is an individual investment contract you establish with an insurance company where they ensure to provide you with periodic payments starting immediately or at some point in the future.

Real Estate Investment Trust (REIT): A REIT is a company that buys and owns income-generating properties and allows investors to buy shares of the real estate so they can generate funds to purchase more real estate.

While this just scratches the surface, there are many more different types of plans available to fit any investor’s needs, but as complex as the plans may get, it’s important to never forget your investment goals and your risk-tolerance level. While it’s generally stated that investors should be more aggressive when they’re younger (to grow their funds), and less aggressive when they’re older (to maintain their growth), there is no one correct way to invest your money. As long as you are committed to continuing learning about how different investment plans work, the most important thing is to do what makes you comfortable.

Related: 2018 Is the Year I Become Financially Literate



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